Australia’s productivity slowdown is a problem federal and state governments need to acknowledge and urgently address, writes AICD chief economist Mark Thirlwell MAICD.

    On 7 February this year, the Treasurer tasked the Productivity Commission with undertaking its second five-yearly review of Australia’s productivity performance, asking it to “analyse Australia’s productivity performance and identify priority areas for reform, including data and digital innovation and workforce skills... [and] consider how the COVID-19 pandemic and our response have shaped Australia’s productivity challenges and opportunities”.

    The context for what will be the first sequel to the commission’s 2017 Shifting the Dial report is a growth and productivity challenge that pre-dates the economic disruption wrought by the pandemic. Last February’s column cited a June 2021 Productivity Commission report highlighting that the previous decade had seen Australia experience its slowest rates of per capita growth in output and income in at least 60 years, even excluding the impact of COVID-19. The opportunity cost of that deterioration in performance has been substantial — the commission reckons that if pre-2011–12 growth rates had persisted until 2019-20, average Australian incomes would have been about 10 per cent ($11,500) higher. According to the commission, a slowdown in the rate of growth of labour productivity is the main explanation for this lacklustre result.

    We’ve been this way before

    Five years ago, the Shifting the Dial report warned that to avoid a mediocre economic performance, Australia needed to adopt a new policy model focused on individuals, innovation and learning. Headline recommendations focused on health (eliminate low- value health interventions; more patient-centric care; better use of data and technology; amending alcohol taxation), future skills and work (improve educational outcomes; more proficiency-based assessments; more independent assessments; cover universities under consumer law), better-functioning towns and cities (strengthen governance for public infrastructure; improve road provision and establish road funds; pilot road user charging; apply competition policy principles to land use; remove stamp duties and implement a transition to land tax), market efficiency (reform the national electricity market as a priority including by stopping “the piecemeal and stop-start approach to emission reduction” and “adopt a proper vehicle for reducing carbon emissions that puts a single effective price on carbon”; create an environment more conducive to innovation), and more effective government (a formal Commonwealth/state joint reform agenda; tax changes that improve revenue- sharing agreements between governments to support that agenda; improve accountability for fiscal strategy; and renew intergovernmental relations).

    Five years on, what items should top the productivity reform agenda?

    What directors think

    One set of answers comes from the AICD’s Director Sentiment Index (DSI), which has regularly asked directors about measures to lift national productivity. In the 2017 (first half) DSI — which roughly corresponds to the timing of the Shifting the Dial report — directors’ top five suggestions were: less focus on short-termism (chosen by 49 per cent of respondents — who could choose more than one option), more infrastructure spending (33 per cent), broad-based tax reform (33 per cent), a greater focus on fostering innovation (31 per cent) and better standards of education (27 per cent).

    The same question was asked most recently in the first half of 2021 DSI. This time, the top five responses were: less focus on short-termism (37 per cent), a greater focus on fostering innovation (35 per cent), better standards of education (30 per cent), faster adoption of technology (28 per cent) and improved outcomes between the Commonwealth and states (26 per cent). Infrastructure spending (24 per cent) and broad-based tax reform (22 per cent) were still cited by a significant share of directors, but no longer made the top five.

    So, while a reduction in short-termism remains at the top of many directors’ to-do lists in terms of boosting productivity, there has also been a shift towards a relatively greater emphasis on the importance of innovation, education and technology.

    Innovation investment slump

    An alternative — but in several ways complementary — source of suggestions is the latest (2021) International Monetary Fund (IMF) assessment of the Australian economy, which included the Reigniting Productivity Growth in Australia paper. The IMF emphasises “the role of productivity-enhancing investments and competition in explaining the productivity slowdown” with a particular focus on declining investment in research and development (R&D) and information and communication technology (ICT). The paper notes that R&D investments fell from about three per cent of GDP in 2010 to less than 2.5 per cent in 2019 — below the OECD median. At the same time, investment in ICT has fallen from an annual peak of 3.5 per cent of GDP in the early 2000s to less than two per cent more recently.

    The IMF also cites research findings that various measures of product market competition in Australia — including mark-ups (the extent to which firms can charge prices above costs), concentration metrics (the extent to which a sector is dominated by a few large firms), and firm entry and exit rates —have deteriorated, suggesting that this could be adding to productivity headwinds, as lower competition impacts innovation and resource allocation. It also cautions that shortages of skilled workers due to international border closures and skill erosion — reflecting the disruption of education and training by public health lockdowns — could further challenge future productivity performance.

    The policy prescriptions that follow include: improving the effectiveness of tax incentives to promote R&D investment, particularly among smaller firms; scaling up direct government spending on R&D; boosting incentives for more university-business collaboration; promoting ICT investment; enhancing competition via more deregulation; and reducing entry barriers and financing constraints for SMEs.

    Echoing the DSI findings, the IMF also emphasises the productivity benefits of a strong education system and a skilled workforce, warning that Australia’s average scores in the OECD Programme for International Student Assessment have declined steadily over time.

    There is no shortage of ideas on how to boost productivity, but how useful will a new inquiry be, beyond offering a stocktake of the latest thinking and a recap of some of the productivity debate’s “greatest hits” such as tax reform? A degree of caution seems warranted given that a look at the Productivity Commission website and the previous Shifting the Dial report — sent to government on 3 August 2017 and tabled in Parliament on 24 October 2017 — reveals the following note: “There has not been a government response to this inquiry yet”.

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