Tuesday, July 10, 2012

Productivity: we're winning half the battle

"Productivity isn't everything, but in the long run, it's almost everything. A country's ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker."

US economist and columnist Paul Krugman (1994).

WE HEAR a lot about productivity now, and with good reason. Productivity is what makes Australia a rich nation and India a poor one. But since 2003-04, the statistics say that Australia's productivity has been falling.

Why do office workers and carpenters, teachers and taxi drivers, earn so much more in Australia than they do in India? Because the productivity of the Australian economy is so much higher than that of India.

What is productivity? In a word, efficiency. A recent Reserve Bank paper defines it as "the efficiency with which an economy employs resources to produce economic output". Or, as economist Saul Eslake puts it: "Productivity is what a workplace, a business . . . or a nation gets by way of goods and services for what it puts in, in terms of labour, capital and other factors of production."

When 75 per cent of us are employed in services, how are we more productive than services workers in India? Well, start with the computers at our desks. They have relatively fast broadband and good software that allows us to do jobs quickly (so long as we don't start surfing the net). We are skilled in using them and thinking laterally when we run into problems.

Second, our workplaces are run so that we work at full stretch, whereas Indian shops usually have more workers than customers.

Technology levels, skill levels and work intensity: these are the factors that University of Queensland economist John Quiggin singles out as the keys to productivity growth. They're not the only ones: Eslake highlights the role of economic reforms in lifting productivity growth. The switch to workplace bargaining in the 1990s is widely seen as having opened the way for productivity-enhancing trade-offs.

The quality of infrastructure matters, too. One argument for the NBN is that high-speed internet connections will raise productivity by allowing us to do more tasks more quickly. Ridding Melbourne of the congestion caused by level crossings would raise productivity by cutting delivery and transport times.

Policymakers are focused on productivity because, after a decade of rapid growth in the 1990s, the statistics say productivity in Australia peaked in 2003-04 and since then it has gone gently into reverse.

Labour productivity the amount we produce per hour worked has kept rising, but at a far slower pace. And capital productivity the amount we produce per dollar invested has gone from shrinking slowly to shrinking fast.

Should we be worried? And if not, why not?

Many analysts have shed light on Australia's productivity puzzle. There are differences of emphasis between the conclusions of policy insiders (the Productivity Commission, Treasury and the Reserve Bank) and those of independent economists such as Eslake and Quiggin. But there is a broad consensus that, to coin a phrase, the glass is half-full (or half-empty). Part of the productivity slowdown is a mirage, but part of it is real.

The mirage stems from what Productivity Commission consultant Dean Parham calls "the usual suspects": events (or errors) that lower official measures of productivity, but don't change underlying productivity. They include the timing of investments, temporary issues such as drought, shifts between industries, and measurement errors, such as ignoring the improved quality of the goods and services we produce.

The first is the big one. In a decade, the mining construction boom has trebled the industry's workforce and doubled its capital stock. Yet so far it has created only a 30 per cent growth in output so productivity in mining has slumped by 40 per cent.

But most of that is just a timing issue. The projects employing those workers and capital are creating long-term assets that will deliver huge increases in future mining output and productivity.

Productivity in the electricity industry has slumped for similar reasons. There's a huge wave of investment under way in transmission and distribution lines, with no increase in output. Electricity, water and mining account for roughly half of the productivity slump.

But what of the other half? There are many opinions, but few unarguable facts.

Eslake blames the lack of big economic reforms since the GST came in. Reserve Bank board member John Edwards takes a more benign view, pointing out that the '00s, like the '80s, saw a lot of growth in employment, largely in low-productivity industries. "Higher participation," he argues, "is not something we should complain about."

I lean towards Edwards' view, but there is truth in both explanations. And for business pressured by the higher dollar, raising productivity is not an option, it's a necessity.