The missing piece of the Australian economic puzzle

What is productivity? And how does one produce it?

I can hear the groans already. That ever elusive term that politicians bandy about like it's going out of fashion. Often it's used to justify the intangible - we are not sure what it is, but we are told we need more of it.

Australia's productivity growth levels have fallen to historic lows. Credit: James Alcock

Technically, productivity is the rate of output per unit of input. In Australia, the rate at which we have been growing that output per person has slowed to historic lows.

The more efficiently we can produce things, the faster our living standards and wages grow, so it's in everyone’s interest to fix the problem.

In a recent speech, Treasury deputy secretary Meghan Quinn spelled out what could be done to improve the situation beyond the usual political glib about “productivity enhancing reforms”.

Fundamentally, Australia does not have enough firms producing innovative, groundbreaking technologies

She can do this because Treasury has been working on business-level data, right down to the individual employee. The data follows workers over time and will this year produce Australia’s first longitudinal employee-employer data-set.

This evidence will be presented to government to improve the economy beyond its income tax plans. It has at least the next three years to govern, and not much else on the agenda, so it's worth their while taking notice.

Treasury found Australia runs into trouble in both its top and bottom tier of companies.

Fundamentally, we do not have enough firms producing innovative, groundbreaking technologies like Apple or Google. Atlassian is an exception, but there are few others.

Worse still, our “laggard firms,“ those at the bottom of the pile, have barely improved their productivity in 15 years.

Many of Australia’s productivity leaders are mining companies. Quinn says non-mining firms should take note as they become an increasingly important part of the economy.

“Typically [miners] are operating closer to the international frontier - have been faster to adopt new technologies than firms in other sectors,” she says.

Rio Tinto’s remote controlled rock-crushing trucks started life as a video game. Now they clear mines 1500 kilometres away in the Pilbara from a control centre in Perth.

“[But] this is true even for technology that doesn't seem to be that high a priority for mining on the surface such as data analytics,” says Quinn.

Her analysis suggests that labour productivity in the non-mining sector could increase by 6 per cent if some of the more innovative practices rose to those in the mining sector.

But there is a bigger problem. The number of companies entering the market has fallen. The firm entry rate was 14 per cent in the early 2000s, that has now dropped to 11 per cent.

That means there is less competition in the market and fewer companies for workers to switch to.

The result is workers switching jobs less frequently, down from 11 per cent in the early 2000s to 8 per cent now. Most of the downgrade is coming from fewer people starting at new companies.

“These results warrant close attention,” Quinn told the Organisation for Economic Co-operation and Development’s global productivity forum in June.

“We know that a fall in firm entry is generally bad news for job creation and technology adoption. For any given level of employment and unemployment, this would result in less upward pressure on wages.”

An ongoing review of R&D tax credits has caused investment paralysis - exactly the opposite effect the government would have hoped for

There’s the rub. Treasury research found that 1 percentage point decrease in the job switching rate is roughly associated with a 0.5 percentage point decline in wages growth - a key reason why workers are battling historically low pay rises.

And even the most productive firms aren’t seeing the number of workers switching to them that they used to. Their labour re-allocation rate has fallen 2 percentage points.

It means those laggard firms are surviving longer, squeezing out opportunities in the market for more productive ones.

The key take outs are companies should embrace new technology, invest in training their workers and more people should be prepared to take risks by entering the market for the greater good.

But the government has a role to play here too.

One of the largest inducements to taking risks are research and development tax incentives. Last year the government cracked down on them, ordering companies like Airtasker to pay back millions of dollars they had claimed in research.

Since then, the start-up industry has said an ongoing review of R&D tax credits has caused investment paralysis - exactly the opposite effect the government would have hoped for when trying to stimulate mythical productivity.

The Coalition has also declined to match Labor’s 20 per cent instant asset write-off for capital expenditure above $20,000. The policy, backed by business groups, would encourage firms to buy new machinery and get rid of inefficient processes - engineering a productivity bump in the process.

The Reserve Bank took the unusual step last week of issuing a public plea for the government to do more. It is running out of room to cut interest rates below 1 per cent as the economy stalls.

As Quinn notes, monetary policy “needs to be complemented by policies that lift potential economic growth - the supply side of the economy”.

Time to start coming up with some ideas.

Ross Gittins is on leave.