Why we should approach claims of a productivity crisis with caution

The headline result shows that the labor productivity of the economy has continued to grow at a healthy rate of 2.2% over the last year. The rate of growth is broadly in line with the long-term average. On this measure, one might be forgiven for thinking that the “lucky country” had continued to enjoy an outrageous stretch of good fortune.

However, while labor productivity has been increasing, “multifactor productivity growth” has been declining. In fact, multifactor productivity has decreased over much of the period since 2003-04.

These findings have been widely cited as indicating a “productivity crisis” in Australia. And it will no doubt add to the federal government’s argument that the economy is in for tougher times and we will need to get used to budget cuts.

Comparing apples and oranges

Before I prosecute the case that we indeed do face a productivity crisis, let me first explain why the Productivity Commission’s analysis needs to be treated with some skepticism.

Most significantly, the data presented do not compare like with like. While the Productivity Commission reports labor productivity estimates for the whole economy, they are compared with Multifactor Productivity estimates for a selected group of industries – those more reliant on capital investments and more likely to suffer a slowdown in MFP.

To understand this, we need, first of all, to define our terms. Labor productivity – the usual base for measuring productivity – is measures the ratio of output produced per unit of labor inputs. Multifactor productivity, in contrast, takes account of both labour inputs and investments in new capital and equipment as sources of productivity growth.

The importance of this difference has been particularly stark in the mining sector.

Consider a new mining operation – say, an A$10 billion operation that takes five years to construct before it becomes operational. Over the last decade, in a period in which rising prices have meant the productivity of labor – the value of output per unit of labor inputs has grown – has also been a period in which investments in new operations are yet to produce a single unit of production. These new investments in the capital swamp this apparent growth in the value of the production such that periods of labor productivity growth is also a periods of negative multifactor productivity growth.

Crisis? What crisis?

The report does provide some insightful breakdown of productivity growth in individual industries. The fall in multifactor productivity in the mining sector has occurred for the very reasons I highlight above.

The available data on investment in mining indicates that this negative growth in multifactor productivity is set to continue.

Frankly, this should not be of concern to anyone. We canof this as investing in productivity growth for the future.

A similar story appears evident in utilities – such as gas, water, and waste – where investments in new plants and infrastructure are likely to create the source of productivity growth in the future.

Here, however, there is a slight twist. Reductions in energy and water consumption – probably due to public education around the environmental costs of wasting natural resources, as well as rising prices, have resulted in lower demand and hence growth rate in these sectors. Again, this is hardly something we can repent.

Star performers

The Productivity Update also shows that some industries have been star performers. Financial and Insurance Services – now the largest industry in the so-called market sector – has enjoyed stellar growth, well above the national average.

Agriculture has been one of the surprise stars over the last decade. While 2012-13 has not been a good year, over the last decade, it has outperformed other sectors by an even greater margin than Financial and Insurance Services.

The real crisis

More problematic is the manufacturing sector, where no similar investment in new plant and equipment has occurred, but multifactor productivity has also declined.

Here, we have a crisis – with productivity declining at a much faster rate. And, as the more recent events and announcements would suggest, this sector is heading into what can only be described as a very challenging phase.

International comparisons

Even more alarming is the comparison with other economies. While many developed countries have experienced a productivity slowdown over the last decade, the tide is turning.

Yet, the high-growth economies on which the Australian economy has been increasingly dependent have experienced a productivity slowdown. For the first time in a very long time, for example, China experienced a multifactor productivity growth rate of zero. India experienced a negative growth rate of 2.7%.

Solutions

The Productivity Commission suggests that much of this productivity crisis may be sorted through better pricing – pricing that reflects market value and productivity growth. In its view, many of these sectors, utilities being the prime example, are best dealt with through reforms that reduce pricing distortions that send wrong signals to investors and consumers.

This is no doubt part of the problem, but only one part of the problem. Focusing on price signals needs to be balanced with a focus on the real source of productivity growth – the workplace.

As I have noted previously, Australian workplaces suffer from an innovation deficit.

If we are to address what is now becoming the curse of low productivity, then we need to find ways of driving innovation and creativity. It will require government – and business – to embrace a new phase of micro-economic reform.

And an approach to regulation that embraces new business models, innovative ways of working, and a culture that supports entrepreneurship and capable managers and employees.