The Nobel Laureate and economics guru Paul Krugman has famously said "productivity isn’t everything, but in the long run it is almost everything". When it comes to living standards, this is not merely true, it is a truism. There are only two ways that a society can achieve higher per capita incomes: by producing more per person or getting higher world prices for what is produced. Although the former has been overshadowed by the latter during the 2000s, productivity remains the more dependable route in the long run. Bounteous terms of trade cannot last forever, even for a ‘Lucky Country’.
The escalating terms of trade, which have yielded historically high growth in real household incomes, have been seen as masking the productivity slump. While in a sense that is true, the structural pressures emanating from the terms of trade boom have actually contributed to the decline in measured productivity growth.
This is well illustrated within the mining sector itself, which has recorded unprecedented input growth, especially capital investment, and resorted to higher cost ore extraction, in pursuit of the profits to be had from (much) higher export prices.
Part of the observed decline in the productivity statistics, therefore, is adjustment related and should in time be reversed. But to the extent that some of the decline has been exacerbated by policy actions (like unduly costly investments in water desalination and alternative energy), the ability for productivity to recover will have been weakened. Moreover, it is important that policy responses to the current ‘two-speed’ structural pressures do not further weaken our productivity potential just when we need it most.
So what should governments do? It seems that everyone has their own answer to this question. Typically these focus on a single policy area, like infrastructure or industrial relations or red tape. The more challenging reality is that there is no ‘silver bullet’. A policy framework to enhance the productivity of our economy needs to address multiple determinants of productivity performance at the level of individual enterprises, which is where it all begins. While a firm’s performance has more to do with its managers than governments, policy can enhance a firm’s productivity potential though three mechanisms:
– Firstly, by ensuring that the incentives to be cost-conscious and innovative are not dulled by regulations that inhibit foreign or local competition, or by subsidies that prop up uncompetitive activities;
– Secondly, by allowing managers to make the organisational and production changes needed to meet competitive challenges and exploit market opportunities – for example, by ensuring workplace regulations address fairness and safety without unduly constraining managerial prerogatives, or unduly raising the cost of process innovations;
– Thirdly, by underpinning the capabilities of firms, through sound education and training systems, efficient infrastructure and cost-effective public administration.
These three areas – incentives, flexibility and capability – are mutually reinforcing in their effects on a firm’s (and ultimately our economy’s) productivity performance. For example, targeting infrastructure or education, important as these may be, cannot take us far if regulatory changes deprive enterprises of the flexibility they need to utilise better inputs and adopt better processes.
Governments need an integrated policy approach to enhancing productivity growth – one that recognises that an economy’s performance is merely the sum of what is happening within individual enterprises, and that continuing policy attention must be paid to both the drivers and the enablers of firm-level productivity.
Finally, it bears repeating that productivity matters not for its own sake, but because it generates the income and taxes needed to raise living standards and rectify disadvantage. As has been said, a government cannot redistribute what its economy does not produce. Almost regardless of the policy question, ‘productivity’ is nearly always the answer.
Gary Banks is chairman of the Productivity Commission.