Tax cuts and competition the way to arrest productivity decline

Incentives will drive growth in the economy. AAP

In recent years productivity growth in Australia has been in alarming decline.

A series of government reports have identified some of the causes: infrastructure and skills inadequacies, bottlenecks and capacity limitations.

The Government’s response has been to invest in infrastructure, improve education and skills, cut red tape and encourage more research and development.

But I would argue that the Government is focusing almost exclusively on enablers to to drive productivity growth at the expense of incentives. Research suggests that incentives are far more important than enablers.

Enablers make it possible for firms and individuals to lift productivity. However, just because firms and individuals can improve productivity does not mean that they will, particularly if there is no incentive for this to occur.

A focus on incentives such as competition, tax policy and governance should be the central tenet of government policy if the Federal Government is serious about arresting the fall in Australia’s productivity growth.

In 1995, a National Competition Policy was adopted by all Australian state governments. The aims of the policy were clear - to channel the forces of competition to lift productivity and efficiency and improve community welfare.

The Federal Government has reaffirmed the importance of productivity in a number of reports. The ‘Australia to 2050: Future Challenges’ Intergenerational Report, released last year, underlined the critical role of productivity growth as one of the main drivers of economic growth and living standards in the future.

Also last year, the House of Representatives Inquiry into Productivity found that “achieving multi-factor productivity growth rates above Australia’s long-term average of 1.1 per cent is a critical, long-term national goal.”

But despite this professed commitment to improving productivity, recent performance is not encouraging.

Competition policy and other microeconomic reforms rolled out in the late 1980s and early 1990s helped drive Australia’s multi-factor productivity growth from an average of about 0.2 per cent in the 1980s, to close to 2 per cent by early 2000.

But in the last several years, multifactor productivity growth has slumped, averaging only 0.4 per cent each year.

If we compare performance against OECD countries the same picture emerges— a decade or so of under-performance through the early 1990s, then over-performance up to about the last five years when Australia’s productivity growth stalled both in absolute and relative terms.

The decline has been most marked in agriculture, mining and the energy sector. (Although in some cases the decline is occurring for valid reasons - such as drought in the case of agriculture - and in mining and utilities, the need to invest in assets that will have returns well into the future.)

Bottlenecks

Why is this the case? Recent reports by the Productivity Commission, House of Representatives, Treasury and Reserve Bank of Australia suggest infrastructure and skills inadequacies, bottlenecks and other capacity limitations are putting a brake on the nation’s ability to continue to increase productivity.

Others point to a decline in research and development, with technological innovation less rapid than it had been in the 1990s when new information and communication technologies had a significant impact.

The argument made in this paper is that the prime cause of low productivity is a slowdown in microeconomic reform that emphasises incentives to improve.

In the 1990s, Australia experienced the coincidence of the implementation of the comprehensive national competition policy, tariff reductions, and financial and labour market deregulation, all within the context of a relatively stable and conservative fiscal and monetary policy.

However, this government policy approach focusing on incentives has begun to weaken.

In 2000, the competition payments made to state governments under the National Competition Policy were halved, decreasing the incentive for these governments to persist with pro-competitive policies. Payments stopped altogether in 2006.

Between 2003 and 2008, Australia tightened market regulation, in contrast to the period from 1998 to 2003 where Australia deregulated, as measured by the product market regulation indicator developed by the OECD.

Tax policy has previously encouraged productivity growth through the major cuts to the corporate rate in the 1990s—falling from 46 per cent to 30 per cent between 1985 and 2004.

However, in the last several years no further corporate tax reductions have been implemented.

In addition, the corporate governance agenda has switched its emphases to compliance and conformance rather than performance.

The current response to Australia’s low productivity has been to focus on enablers: to invest in infrastructure, improve education and skills, cut red tape and encourage more research and development.

However, this approach is unlikely to significantly lift productivity even in the medium term because incentives are getting weaker and receiving little policy attention and enablers on their own are largely ineffective.

The importance of incentives has been long recognised in economic thought.

Change of focus

So why has emphasis on competition policy diminished since Australia made good progress during the latter 1990s through to the early part of this century? Competition lost its place in the productivity agenda for largely political reasons, not because it is not effective.

In 1995, then-Prime Minister Paul Keating put in place a solid process with both review and reward mechanisms to drive the implementation of policy for the next decade. This process was well under way by late 1996 when John Howard became Prime Minister.

For most of Howard’s term as prime minister, competition policy did not need extra attention or focus as the incentives were in place to drive it via the National Competition Council and the competition payments to states.

However, when these payments ceased in 2006, leadership and election issues drowned out the need for the continued support and revitalisation of competition policy.

In 2007, Labor was elected to government. That year, however, saw the onset of the GFC, and the government’s attention turned to the crisis.

Financial system stability, employment and macroeconomic performance were all-consuming issues.

Meanwhile, market systems and neoclassical economics, areas central to competition policy, were seen as causes of the GFC, with former Prime Minister Kevin Rudd among those attributing blame.

The possibilities for regulatory and implementation failures as a result of government action and regulation were largely ignored. Consequently, competition policy reform fell off the agenda.

The National Competition Council, which was established by the National Competition Policy Committee to provide high-level, analytical and policy advice in which all governments would have confidence, no longer exists with either teeth or a broad mandate.

Because some governments were concerned that a broad mandate might surface politically difficult issues, the NCC was established with a more limited mandate, focusing on monitoring implementation and recommending competition payments accordingly.

Even this limited mandate disappeared in 2006 when the role of the NCC was redefined to recommending regulation of third party access to services provided by a monopoly infrastructure.

As a result, there is now a gap in the provision of advice on policy that could apply judgment to integrate the findings of the Australian Competition Consumer Commission (ACCC), the Productivity Commission, Reserve Bank and other expert bodies.

A stronger voice

Since implementation of the competition policy in 1995, responsibility for it has moved steadily further and further from the centre of government.

More recently, responsibility moved to Chris Bowen when he was Minister Assisting the Treasurer and not a member of Cabinet, and now to David Bradbury, Parliamentary Secretary to the Treasurer.

Given the centrality of competition policy to productivity and economic performance, responsibility should rest directly with the Treasurer, Wayne Swan.

There is a strong case for a review of competition policy, given the 15 years and changed circumstances since the national policy was implemented. A thorough review is required of why progress with respect to competition policy appears to have stalled in some key areas, particularly energy and infrastructure.

The focus of the review should be on incentives. It should also cover international competition policy and regulation, which has become more important since 1995.

Competition policy is an area where Australia has been widely recognised as a leader. Our policy framework formed the basis of reforms in economies as diverse as Canada, India and Mexico.

Learning from our success by revitalising competition policy and the institutional framework that supports it – with a balanced emphasis on both enablers and incentives - provides the best opportunity to achieve high productivity growth again.

This is an edited version of a paper, ‘National Competition Policy – 15 years on’, by President and Vice Chancellor of the University of NSW, Frederick G Hilmer, at UNSW’s Economic Measurement Group Annual Conference, December 2010.

Read the full version here.