The majority of Australians would prefer higher living standards. This can take the form of better access to better healthcare services and education, better environmental outcomes, more time for friends and play, more support for the disadvantaged, as well as lower cost, higher quality and new versions of food, clothing, housing and so forth.
Ultimately, someone has to produce the additional and better goods and services. Productivity growth, or producing more with less, is the only sustainable way for Australians as a country and as individuals to provide the expected increases in living standards. A report released yesterday by the Economist Intelligence Unit highlighted Australia’s poor productivity growth (ranked second worst out of 51 countries) and its struggle to remain globally competitive over the past decade.
As noted by David Gruen in his address to the Economic Society of Australia last month, since about 2000, rising living standards of Australians has been supported primarily by a near doubling of the terms of trade, or the quantity of goods and services we can import per unit of goods and services we export. Productivity growth has been negligible, and well below the rates achieved in the preceding 50 years. With the almost certain fall in the terms of trade over the next decade, and continuation of the poor productivity of the 2000s, our expectations for rising living standards will not be met.
Productivity across most segments of the Australian economy is well below world-best practice. The Business Council of Australia, for example, estimates that construction costs of Australian hospitals, schools, and oil and gas plants are 40% or more below US levels. In terms of education, Australian students have fallen further behind the best performing countries according to OECD data on literacy, numeracy and science over the last decade. The good news from this sorry picture is that there is a large potential for catch-up productivity growth to support the aspirations of higher living standards.
So, what is meant by productivity growth, and how is it achieved? At its simplest, productivity growth means producing more valued goods and services per unit of labour, capital and natural resources, or producing the same with less inputs. Increasing productivity involves all of us: politicians, bureaucrats, business managers, employees and households. It involves changes in the way we do things. Higher productivity involves, for example: the production of new and better products which better meet evolving changes in household preferences; the adoption of production processes generating more output per unit of inputs, or working smarter; investing in the development of, and the adoption of, new technology, R&D, better work and management practices; and moving labour, capital and natural resources from less productive uses to more productive uses.
For the private sector, which is responsible for about three-quarters of the goods and services produced in Australia, the profit motive and competition are the drivers of productivity. Firms which deliver better products to buyers at lower costs (that is, improve their productivity ahead of the pack) gain the reward or carrot of higher profits and market share. Their competitor firms, who are slower to improve productivity, lose market share and profits from the competitive stick. For competition and the changes that bring higher productivity to work, firms need the freedom to make changes to the products they produce and the way they undertake production. Also, effective competition requires minimal barriers to enter and compete for innovative and new firms.
Government policy has many important influences on effective competition in the private sector and its adoption of productivity improvements. Unnecessary and over-lapping regulations not only add to costs, but also they act as a brake on the development of new products and technology. Furthermore, many regulations significantly raise the barriers to entry for new firms. A flexible industrial relations system should support the ability of different firms in an industry, and firms across industries, to change work arrangements necessary for the adoption of new technology, better work and management relations. There is a growing list of anecdotal evidence that the Fair Work system is restricting the ability of some managers to adopt better productivity systems. However, it also is the case that the current productivity slump occurred while WorkChoices was in place.
A more neutral and less distorting tax system, such as many of the reforms proposed by the Henry Review, would facilitate the reallocation of capital from less productive to more productive uses. A relatively stable macroeconomic environment of high employment and low savings, with ticks for performance over recent times, provides an important background for a productive private sector. Subsidies to struggling industries slow down the transfer of resources from lower productivity to higher productivity options.
Governments are primarily responsible for the supply of about a quarter of the goods and services of the Australian economy, including education, health, law and order, and much of our transport infrastructure. These areas offer considerable - and not before time - opportunities for productivity improvements. In the absence of competition, formal, transparent and public benefit cost assessment of such major government investments as the NBN and desalination plants are vital to avoid repeating the likely misallocation of large sums of limited capital. New technology and reconsideration of management and work practices, and especially sorting out the duplication and blame games of multi-level governments in the provision of health, education and the NDIS, are promising productivity reforms.
Productivity growth comes at the cost of changes to the way we do things. But it is a positive sum game, and it is the only sustainable way of meeting our expectations of higher and higher living standards.