IF PRODUCTIVITY IS THE ANSWER, WHY ARE WE NOT PURSUING IT HARDER

Australia’s economy sails under uncertain skies. To tame inflation, interest rates have been increased. This has hurt households and a recession lurks. Globally, the lingering economic impact of the pandemic and an on-going geopolitical recalibration create headwinds. Confidence, the life blood of any economy, ebbs.

In the foreground sit Australia’s economic managers, tending our macroeconomic cauldron. Like the witches of Macbeth, round they go with fillets of fenny snake (interest rates), eyes of newt (fiscal policy) in hand. Outside influences, both positive (concert of Tay Tay) and negative (global uncertainty and China), complicate the brew.

Comparing macroeconomic management to witchcraft is obviously, but not entirely, unfair. For one thing, Macbeth’s witches had a larder full of ingredients from which to choose. Bits of frogs, bats, dogs, owls and lizards went into the cauldron, all before the third Witch made some particularly horrible additions. Our economic managers have fewer ingredients to call on. One they would like – higher productivity growth – is proving hard to find.

Productivity is both an ingredient in, and emergent property of, the economic cauldron. It is a key source of growth and, in the long term, drives higher wages. Productivity also creates choice; allowing individuals and government to look beyond the ‘purely’ economic to other things, like more leisure.

Demand for productivity flows fundamentally from what sociologist Hugh McKay calls our desire for ‘more’. Economist Adam Smith sees it as a biological desire for ‘better’ which “comes with us from the womb and never leaves us till we go to the grave”. For both, wanting more/better is an innate and unchanging part of the human condition. History is on their side.

Our desire for more/better is in conflict with finite global resources and dwindling environmental capacity. Add a growing global population and the lure of creating more using less – productivity – becomes clear. It is little wonder economists are in its thrall.

Productivity is considered so important that Australia has a whole Commission to look after it. Every five years, the Productivity Commission examines ways of increasing Australian productivity. Its most recent report runs to nine volumes and 71 recommendations. This followed an earlier report with 28 (albeit more encompassing) recommendations and 16 supporting papers. Someone in the PC is presumably calculating which was most productive.

Australia’s recent record of low productivity is not for want of potential policy responses. Yet many of the PC’s 99 recommendations sit idle. Those that have been implemented do not, as yet anyway, seem to have made much difference. 

Australia is not alone in this. Low productivity is a feature of most so-called advanced economies. Despite its apparent desirability, productivity is more talked about than acted on across the globe. It’s all a bit odd.

Is politics the problem?

For some, the main problem is politics. Policy answers exist but political short-termism stands in the way. This argument has merit. The benefits of higher productivity are diffuse and primarily realised in the long term, while getting them often involves short term pain with clear winners and losers. It is a temporal mismatch that democracies struggle with world-wide.

Is there less productivity out there?

Another possibility is that achieving productivity growth has become more difficult. The problem is less that we are not trying and more that there is less productivity out there.

Imagine extracting liquid (production) from a wet sponge (economic potential). To increase the flow of liquid (productivity) you have two options: squeeze harder or increase the size of the sponge. Now imagine that the sponge has wetter spots and drier spots. Finally, imagine the sponge sitting in the sun drying out.

In its most recent report, the PC describes three barriers to faster productivity growth. The first involves the increasing importance of services to our economy. The second is the need to decarbonise our economy. The third involves shifts in the global economy, including a return to protectionism across the world.

Historically, services productivity has grown more slowly than that of agriculture or manufacturing (it is also harder to measure). Productivity growth for government-controlled services (health care, childcare or aged care etc) has been even slower. While gains are to be made, the PC accepts they may be structurally smaller than we have seen in the past. In relative terms, the drier spots in our sponge are getting larger and wetter spots smaller.

The PC’s focus on decarbonisation is understandable. It is, by far, the biggest environmental game in town.  How we manage the transition will be critical to our future. But it is only part of our growing understanding that global and local environmental capacity is less than previously assumed. This too could mean a drier sponge and, as a consequence, less scope for productivity.

Shifts in the global economy are working in a similar direction. After a period of liberalisation, constraints on trade are emerging. Pandemic induced shortages are also causing firms (and nations) to rethink supply chain strategies that were initially pursued in the name of productivity. These shifts further dry our sponge, reducing productivity potential.

Squeezing the sponge harder (what economists call static efficiency) or increasing its size (dynamic efficiency) may also have become more difficult.

Static efficiency was an especially influential driver of public policy across the 80s and 90s. Competition policy, deregulation and marketisation were all seen as ways of better squeezing the economic sponge. More recently, however, the approach has fallen out of favour and bears the pejorative: neo-liberalism.

Ideology aside, potential reasons exist for the declining emphasis on static efficiency. One is that the flow of additional benefits from these efforts was always limited, and fewer gains are now available as the easy things have been done. Another is that these policies came with larger costs than expected. Both ring at least somewhat true.

A third explanation is that our policy paradigm needs updating to suit modern times. James Plunkett certainly thinks so. Plunkett argues that today’s digital and platform-based economy requires a major shift in the way government see its role and operates. Others - such as Kate Raworth - agree, albeit for differing reasons and with different solutions.

Separating static and dynamic efficiency is easier in words than in policy design. In the real world the concepts interweave, with policies designed for one having an impact on the other. That said, improving dynamic efficiency leans more into what the PC calls the ‘determinants of market growth’: innovation, human capital and investment.

Innovation is seen, in particular, as the holy grail of long-term growth. Without innovation, the argument goes, economies will ultimately stagnate no matter how statically efficient or institutionally sound they are. While this remains the general view, the ongoing power of innovation to improve productivity is subject to a surprising amount of debate. 

US economist Robert Gordon is a self-styled prophet of pessimism. He argues the great bursts of productivity we have seen in the past are less likely in the future. One reason is that innovations which allowed the creation of large cities (such as sewerage) have been exhausted. Another is that an undesirable driver of innovation, war, occurs less often.

Gordon’s view is that technology advances such as the internet are important but are unlikely to result in big increases in productivity. His message to young people is don’t expect the same improvement in living standards enjoyed by your parents or grandparents. As if increasing interest rates, the high cost of living and getting Tay Tay tickets aren’t problems enough.

Other economists are much more positive. One, Joel Mokyr, hails from the same university as Gordon. Mokyr describes Gordon as ‘misguided’ (their corridor chats must be quite something) and highlights the importance of the culture of innovation created in western society. He is a techno-optimist and puts the lack of improvement in productivity partly down to measurement problems.

Beneath the debate lie some other potential dynamics. For example, rather than accruing to ‘mature’ economies, the benefits of innovation may be flowing primarily to emerging economies. Some of this is a natural result of globalisation. But countries – notably China – also stand accused of stealing technical advances made by other nations, disrupting the connection between inventive effort and productive benefit. Those familiar with global colonial history may see a slight irony here.

The extent of this and other issues affecting the domestic innovation process are hard to judge. For one thing, as the PC points out, most Australian productivity comes from the adoption of innovations created overseas rather those created at home.

Spice Girls to the Rescue?

In presenting its latest report, the PC did not explore why past recommendations to improve productivity have had such a lukewarm reception. This is understandable. The Commission’s role is to put forward a positive program of change, reflecting its charter and relevant terms of reference.

While understandable, it leaves a hole in our understanding. It also leaves the managers of our economic cauldron short a key ingredient. Political short-termism, while a factor, is not compelling as a full answer. Nor is the growing challenge of extracting productivity from a potentially drier economic sponge.

At the end of the day, productivity is not an end itself. It is a means for meeting the desire of our citizens for more/better in a resource constrained world. The assumption is that the way we measure productivity aligns, borrowing from the Spice Girls, with what we “really, really want”. It is an assumption worth testing.