Australia's productivity challenge


Australia's productivity challenge

Dr Jonathan Kearns

01 Sep, 2023


“…there's been no growth in labour productivity in three years. That's a problem. If that were to continue it would mean lower growth in the economy, it would mean smaller gains in asset values, it would mean real wage increases would be very difficult, and it would mean a smaller pie for government to provide the services that the community wants. I think it's the No. 1 medium-term economic issue.”

“…wages growth is still consistent with the inflation target, provided that productivity growth picks up” RBA Governor Low1 

Several things have contributed to Australia getting richer over recent decades, but it’s likely to be harder going in coming years. As a country we can:

  • Get paid more for our exports – we got lucky with the rise of China, but if anything export prices are likely to decline in relative terms as China’s demand for commodities eases.
  • Work more – we did that in the 1980s and in recent years as workforce participation increased, but the population is aging, so this won’t give us much.
  • Be more productive, i.e., produce more for the same amount of work. Brilliant. All we need to do is be more productive. 

Increased productivity would also help our inflation problem as higher productivity delivers lower inflation for a given growth of wages. The Treasurer and the RBA Governor are among the many voices wanting to lift productivity. It was a major talking point for the Treasurer last week with the release of the Inter-Generational Report (the assessment on how the economy and government finances might evolve over the next 40 years).2 

But notice nobody ever says that we don’t need higher productivity growth? Productivity growth is always good. Productivity growth gives us a bigger economic pie, making it easier to share the benefits, making everyone happy. 

Productivity growth GDP per hour worked

What is the productivity problem?

The easiest way to measure productivity is the economy’s total output (GDP) divided by the total number of hours worked.3 In the past few years, average growth in GDP per hour worked has slowed to barely above zero. We shouldn’t read anything into the extreme volatility in productivity in the past few years as it was greatly affected by the pandemic. With various workarounds initially output didn’t fall as much as hours worked, and so measured productivity surged. But with the economic recovery, hours worked have caught back up, and so the growth of measured productivity collapsed. It’s best to average over this period, but that average just above zero is anaemic. We could hope that recent weak productivity growth is just a side-effect of the pandemic, but the evidence from Australia and other countries suggests that the decline preceded the pandemic. Not only is productivity growth a long way below the highs around 2.5% in the 1990s (that followed the micro-economic reforms) but even the rates around 1% in earlier decades. 

Productivity growth Australia and OECD

Why has productivity growth declined?

Slowing productivity growth is widespread across countries over the past few decades suggesting there are some common drivers.4  

Common drivers include: that over time high productivity sectors need less employment and so numerically they contribute less to aggregate productivity; the outsourcing to Asia of goods production (productivity growth tends to be higher for goods than services); and the relative growth of services sectors as we get richer and older (e.g., demand for health). An additional headwind to productivity will increasingly come from climate change (particularly for agriculture and tourism).

How can we boost productivity?

Increases in productivity come through improvements in technology, increases in workers’ skills or removing inefficient constraints on business.

Australia’s Productivity Commission’s 2023 report makes 71 recommendations to improve productivity.  If length of the document is anything to go by, the Commission’s staff have been highly productive, it is over 1,000 pages! The major areas of recommendations include:

  • Boosting competition particularly in highly regulated industries (more efficient rules) so that firms have stronger incentives to innovate, and more productive firms prosper.
  • Increase workers’ skills and flexibility with a focus on the quality of training (as opposed to the focus up to now on more education – higher school completion rates, university attendance), that is suitable for new ways of working and evolving careers (e.g., lifelong learning). They also propose that more migrants should have skills with the greatest return to the economy (not having a specified list of professions for skilled migration).
  • Tax reform. Reducing disincentives to working (particularly for higher skilled workers) that come from income tax rates and the interaction with welfare and subsidy payments. Removing distortions from different tax treatments of alternative saving options, gaps between corporate and personal marginal tax rates, and between the tax rates for small and large companies, and minimising transaction taxes that hamper the efficient allocation of capital assets, and efficient pricing (e.g., tolls) to fund transport infrastructure and ease congestion. 

What happens if productivity doesn’t increase? 

In the near-term, if productivity doesn’t recover, the current rate of wage growth will continue to exert upward pressure on inflation. The RBA’s outlook for inflation is predicated on a recovery in productivity and so if productivity remains weak interest rates may have to increase further and won’t come down as fast as some people expect. Wages growth is currently around 3½% (and probably heading a bit higher) which needs productivity growth of at least 1% (well above the recent ¼% average) to sustainably deliver 2½% inflation.

Further out, low productivity growth has significant implications for asset values. Low productivity growth means that the economy and so profits won’t grow as fast, depressing the current value of equities and other assets priced on the stream of their future payments or profits.

Lower growth also means that in the long run interest rates will be lower. The neutral interest (the interest rate that is neither stimulating nor restricting the economy) is related to the growth rate of the economy, and so productivity. The logic is that if productivity is lower, then people’s future income will be lower and so they will want to increase their saving to compensate and hence need to be offered a lower interest rate to induce that saving.

Of course, many other factors also affect asset prices and interest rates, but we shouldn’t forget the effects of productivity growth. For now, it’s not a good story. We hope productivity rebounds.

1 Emphasis added. Quotes from here and here
2 The Intergenerational Report (IGR) is available here
3 Sometimes we exclude the farm sector (droughts and rain cause random big movements in output) and other sectors where it is hard to measure productivity. But the trends are very similar.
4 Australia’s profile differs from other countries as we were late to embark on micro-economic reforms and so our productivity growth was much slower in the 1970s and 1980s but once reforms here took hold, Australia briefly had world-leading productivity growth in the late 1990s.
5 The PC report is available here


Jonathan Kearns Biography

Jonathan Kearns is Chief Economist and Head of Regulatory Affairs at Challenger, where he also sits on the investment committee.

He worked for 28 years at the Reserve Bank of Australia, occupying a wide range of senior roles, including Department Head for Domestic Markets Department, Financial Stability Department, Economic Analysis Department and Economic Research Department.  He also led the Bank’s work on climate change across four departments.

Jonathan also worked at the Bank of International Settlements in Basel. He has published research in the fields of international finance and macroeconomics. He has a Ph.D. from Massachusetts Institute of Technology and Bachelor of Economics (Honours) from the Australian National University.