Perspectives on Australia’s recent poor productivity performance
Measured productivity in Australia is below pre-pandemic levels. This is unusual: productivity growth was slow, but still positive, in the years leading up to the pandemic. The RBA is clearly worried that it won’t recover. Without an explanation for why productivity has fallen, it is hard to quantify how important that risk might be. It could just be noise, or lags.
This week’s ASIC Annual Forum included a panel with both new RBA Governor Michele Bullock and new Productivity Commission (PC) Chair, Danielle Wood. Given the current public debate about Australia’s exceptionally weak productivity performance, it is useful to have the perspectives of both institutions in the same forum.
To date, RBA communication has stated that at current rates, wages growth is consistent with inflation returning to target, provided productivity growth recovers. In the panel, the Governor stated the issue differently, saying that current rates of wages growth would be ‘on the high side’ (that is, not consistent with returning to target) if productivity growth remains where it is. This was probably not intended as a change in rhetoric, but rather making the same point in a different way. It does suggest, though, that the RBA is getting more worried that productivity will not pick up. This was flagged as a risk in the Statement on Monetary Policy this month. Both there and in the November minutes, the RBA noted that the forecasts assume productivity growth will pick up. Without any kind of narrative about why productivity has fallen, though, it is hard to quantify how much weight to put on the possibility that it will not recover.
No such narrative is evident in the minutes or other key RBA policy publications, but an article by RBA economists Angelina Bruno, Jessica Dunphy and Fiona Georgiakakis in the RBA’s September Bulletin contains some useful hints. (‘Recent Trends in Australian Productivity’ https://www.rba.gov.au/publications/bulletin/2023/sep/recent-trends-in-australian-productivity.html). Part of the decline stems from lingering compositional effects following the pandemic. In other words, people have not individually become less productive; there are simply relatively more low-paying jobs than before, which account for less GDP per hour. If true, this is a level shift effect and should not have a lasting effect on growth in productivity.
Another possibility to consider is that productivity as measured in the national accounts is subject to measurement error. It is the ratio of GDP to total hours worked. Both are noisy, and so their ratio is necessarily noisier and the change in the ratio even more so. It is entirely possible that the last year of data is just noise that will soon reverse out. It is also possible that data revisions will make the period of falling productivity look less stark, or even disappear. GDP could be revised up or total hours worked revised down, or a combination of the two. Even for a high-quality statistical agency like Australia’s, revisions are a fact of life, especially when population trends are shifting rapidly and compositional change in the workforce is higher than usual. Either revision would lend support to the idea that domestic demand is still out of line with supply, so the underlying monetary policy imperative would not change. But it would change how one should interpret the role of wages growth in contributing to inflationary dynamics.
Some signs that data issues could be a factor can be seen in the annual national accounts. In the section of the Statement on Monetary Policy on productivity outcomes, the RBA showed a graph decomposing year-average labour productivity growth into capital deepening (how much capital workers had to work with) and multifactor productivity (MFP). Both components fell sharply in 2022/23 in a way that is counter to historical experience. Given how quickly hours worked increased, the capital stock necessarily could not keep up. Perhaps this is real, but if so, it will not continue if the labour market slows or if investment remains resilient. It is best thought of as a function of lags. The unusual fall in MFP is harder to rationalise.
An explanation based on noise is not very satisfying to a pattern-seeking, story-telling species. One thing policymakers and other observers seeking a pattern do need to be mindful of is that unit labour costs are volatile. It is not appropriate to assume that one or two years of outcomes map directly into inflation. Given how little room for manoeuvre the RBA has in the face of upside surprises on inflation, their concerns are understandable. But neither should they assume that Australian workers have mysteriously become less productive.
That said, productivity growth was slow before the pandemic, and there may be cause for concern here. It was heartening to hear PC Chair Wood’s acknowledge that, while it can contribute to good outcomes, the government does not have full control over productivity in the whole economy. Too often the public debate in Australia seems to embed the belief that productivity is something the government does to us. Hence the constant calls to address productivity concerns with “reform”. (Indeed, I cannot help wondering if the fact that Australia is one of the few countries with a public sector agency like the PC inadvertently contributes to that mindset by making productivity appear to be a government responsibility.) Too often it is forgotten that many important reforms, like floating the exchange rate and eliminating tariffs, can only be done once. They were worthy reforms, but they were one-offs.
Productivity is not something the government does to us. It reflects decisions private businesses and all other organisations make to improve how they work. The level of investment and adoption of technology both matter, but so does the way business processes are designed and work is organised.
Whatever the reasons for Australia’s poor performance, any explanation other than measurement noise has to account for the fact that – as documented in Bruno and co-authors’ article – productivity is also below pre-pandemic levels in Canada but not elsewhere. In the case of the US and Norway, the pandemic effects have completely washed out and productivity is back on the pre-pandemic growth trend. A lack of reform is not the main story. The recovery in the capital to labour ratio seen in the US and Norway, but not yet Australia, is more relevant. Australia’s productivity slump is therefore unlikely to be lasting.
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