Turbocharging Australian productivity

Adrian Blundell-Wignall, former director of the OECD and professor at Sydney University, says:

  • “It’s not enough to tweak R&D incentives – we, Australia, need a detailed plan that will change the whole climate for smart investment and productivity growth
  • During the (recent) election, the focus was on tax cuts and “having a go”
  • The Treasurer has since talked about tax incentives for R&D
  • But improving productivity growth will need a broader framework of reforms to avoid our cloudy future”

Past government plans have resulted in the shrinkage of manufacturing in high-labour-cost economies:

  • In Australia, from around 16% of GDP in 1975 to 6% today
  • In the USA, the decline was less – 16% down to 11% of GDP

Australia made up this gap via finance and mining – and we became ‘contented and complacent’

Since China joined the WTO at the end of 2001, the commodity super-cycle pushed up the terms of trade – the real purchasing power of the income generated by domestic production was boosted by 9% of GDP, the equivalent of three full years of economic growth – the resulting feel-good factor got credit booming and house prices rising – finance and insurance now make up over 9% of GDP versus only 7% in the USA

However, mining and finance now both face headwinds:

  • In mining, China’s massive investment-focused strategy has resulted in diminishing returns – investments need to earn good returns if rising debt is to be paid for – China is on the classic path for financial crises – it suffered something of a recession in 2015, and more will follow – China is slowing structurally and diversifying its resource supply – both will hurt Australia
  • In finance, house prices and debt levels are too high and must unwind in the years to come, not least because of low interest rates.

And, outside these two industries, Australia’s labour productivity growth looks terrible – so much so that there’s a good case for excluding them from the measure:

  • Mining, because it’s so large and heavily capital intensive – relatively few people are employed there and the huge costs in equipment are someone else’s output
  • Finance, because it’s imputed from interest rate spreads

Excluding them both reveals even lower productivity growth – a meagre 0.3% p.a. over the past six years – compare that with the UK, an economy without resources, which is doing much better

So Adrian says having a plan is essential – a plan which creates an environment for more diversified and higher value-added growth covering three broad groups of firms:

  • Those with strong productivity growth accompanied by significant sales at home and in foreign markets
  • Large incumbent companies in the domestic market with negative productivity growth and weak penetration of foreign markets
  • A large number of medium-sized companies characterised by moderate growth and a domestic sales focus.

We know digitisation and technological innovations allow some firms to quickly saturate their domestic markets – however, only those that take advantage of economies of scale by expanding into foreign markets are able to remain in the strong productivity growth group

In addition:

  • Fast growers are always those firms with the highest levels of R&D expenditure
  • Mergers and acquisitions (M&A) activity are a recurrent theme in their business models

R&D innovations that drive productivity do not (outside Silicon Valley) come from small start-up companies “having a go” – R&D is a huge cost activity – in the main, it comes from larger companies with barriers to the appropriation of their IP by others, and which have access to external finance, particularly equity finance, essential for risk-taking and for entering foreign markets – their ability to restructure quickly, opening and shutting down plants via M&A, is critical – small firms lack capital and resources to carry out meaningful R&D and to launch products based on it

Overall, the “plan” should be to develop a research-and-innovation culture and policy certainty – one which recognises that better education output is central to future productivity growth – one which supports an equity culture for risk taking – so it must remove barriers to domestic and cross-border M&A

The plan must also resolve the problem that while economies of scale depend on foreign sales, tax avoidance by firms also relies on cross-border activity – IP, trademark and other earning rights should not be owned by foreign subsidiaries in tax havens

Adrian thus concludes that Australian productivity requires many hard reforms rather than just tinkering with R&D tax incentives.

Adrian Blundell-Wignall is also author of ‘Globalisation and Finance at the Crossroads’

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