With productivity growth falling to a 60-year low over the past decade, there’s no time to waste in stimulating Australian output. 

    Speak to any economist about Australia's productivity challenge and it won’t be long before you hear famed Nobel laureate Paul Krugman’s aphorism, “Productivity isn’t everything, but in the long run, it’s almost everything.”

    The observation holds sway because, as Krugman explained, a country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker. Yet, in the three decades since his proclamation, productivity growth in most advanced economies around the world — Australia included — has been sluggish compared to historical levels.

    Sparking particular concern in Australian economic circles is that, unlike most other advanced economies, after a brief post-pandemic pop, Australian productivity has not only slowed, it’s gone backwards. Reflecting the slump, the government has lowered the productivity assumptions underlying its economic forecasts, with the flow-on implication that in 40 years, Australians’ income will, on average, be almost 20 per cent less.

    “Productivity is at a 60-year low,” says Melissa Wilson, senior economist at the Committee for Economic Development of Australia (CEDA). “Knowing how important it is for living standards and long-term prosperity for Australians, it’s absolutely critical that we do turn it around.”

    The big question, then, is how?

    It’s a problem being taken increasingly seriously by policymakers, as signalled in the latest 40-year Intergenerational Report released by the federal government last year. Soon after, it demanded “more rigorous, relevant, timely and practical advice” from the Productivity Commission as set out in a “statement of expectations” — the first since the body was set up in 1998.

    Productivity challenge

    Speaking at the ASIC annual forum in November, Productivity Commission chair Danielle Wood acknowledged the scale of the productivity challenge along with the government’s appetite to tackle it. But while policy “can and does make a big difference”, Wood said many of the levers of productivity growth are in the hands of business.

    It’s a view shared by Westpac chief economist Luci Ellis, who predicts Australia’s precipitous productivity slump is unlikely to last. She views it as a ripple effect from the post-pandemic population surge that has already peaked.

    “One of the disappointing aspects of the discourse in Australia is this thought that the reason we have slow productivity growth is something to do with a lack of reform,” says Ellis, a former assistant governor at the Reserve Bank of Australia. “Productivity is not something the government does to us. Rather, it reflects decisions private businesses and other organisations make to improve how they work. While you don’t want governments to be continually adding excessive governance to the system, it’s more important that firms are making sure everybody is doing an extra one per cent better, every year. The level of investment and adoption of technology matters, but so does the way business processes are designed and how work is organised.”

    A key challenge has been the massive structural shift in Australia’s economy from its historical domination by traditional goods sectors — such as mining, agriculture and manufacturing, in which productivity is intuitive to grasp and improve — to one dominated by services.

    “Today, the services sector is responsible for 80 per cent of output and employs almost nine out of 10 people, and that has a big drag effect on productivity,” says Wilson. “In professions like hairdressing, childcare and healthcare, it’s very labour-intensive, less commoditised and much harder to get productivity gains. So, it’s important that we think creatively in those areas, such as introducing things like smart use of technologies, automation and the like.”

    Wilson says a key to better understand how to shift the needle may lie in recent research, led by CEDA, into the “dynamic capabilities” of Australian businesses. While businesses can move closer to the productivity frontier by improving “ordinary capabilities” (the basic skills needed to run a business efficiently), she explains, “dynamic capabilities” are more forward-looking and strategic, helping businesses maximise their chances of long-run survival and success in highly volatile, complex and ambiguous environments.

    “We did find links that those businesses with strong dynamic capabilities are more innovative and productive, but we also found there’s plenty of room to improve,” says Wilson.

    Productivity and AI

    It’s likely the historic productivity leaps sparked by technology advances over past decades can be replicated in future as new tech applications are embraced. The next standout on this front is artificial intelligence (AI), lauded for its potential to transform workplaces on a scale that will potentially surpass the launch of personal computers, the internet and social media.

    In fact, according to economic modelling by the NSW Productivity Commission, taking full advantage of emerging technologies could increase the state’s productivity growth to two per cent a year. “With the take-up of AI, quantum computing, 3D printing and autonomous vehicles, the world is on the threshold of an enormous technology opportunity which, if adopted widely and quickly, could boost productivity growth tremendously,” says NSW Productivity Commissioner Peter Achterstraat AM FAICDLife (pictured above). “But while Australian consumers tend to adopt new technologies very quickly, our businesses are not as keen on implementing other companies’ technology as quickly. In 2021, we were 78th in the world for knowledge diffusion and 52nd for knowledge absorption at the business level.”

    Indeed, the diffusion of ideas, their adoption and adaptation by the broad mass of Australian businesses is the “main game” in productivity policy, according to the Productivity Commission’s latest five-year productivity inquiry. It was listed among five key reform pillars, with 71 recommendations, alongside ways to build an adaptable workforce, create a more dynamic economy, and secure net zero at least cost, to limit the productivity impact caused by climate change.

    “It’s not as if we don’t know what to do,” says influential economist and non-executive director Professor Ian Harper AO FAICD. “Mustering the will to do it is the issue politically now.”

    Harper encourages businesses to continue to let governments know when their rules “gum up the works” and lobby for improvements, noting that governments “don’t always think commercially, and commercial people don’t think like governments”.

    He also views as critical a lift in business investment from the weak levels of recent years, a task he says turns on “a whole raft of other issues” such as policies related to abating foreign investment restrictions and increasing availability of investment opportunities.

    “The quick way to increase productivity per hour worked is to increase the amount of capital,” says Harper. “The more capital there is relative to labour, the more productive labour is — and capital is not just machines, but human capital, skills, knowledge and technology. All of those things come about as a result of investment.”

    Ellis is confident current conditions will help the lift in investment along. “As the economy slows and labour becomes a bit more expensive, the incentive is there for firms to invest in labour- saving technology,” she says.

    “Investment will mechanically catch up to population growth as population growth slows. With more capital to work with, I’m reasonably confident that workers will become more productive.”

    The confidence that Ellis and her colleagues have in businesses and policymakers being up to the task bodes well for Australia’s likelihood of regaining its productivity mojo — which is good news for those who deem productivity to be “almost everything”.

    WFH: productivity drag or driver?

    While Australia’s top companies have largely accepted that flexible working- from-home options are here to stay, the jury is still out on the productivity effects.

    Last year, the Fair Work Commission heard a dispute about an employee’s right to request flexible working arrangements, the first test case since this was enshrined under the Fair Work Act 2009 last June. The tribunal found the worker’s employer had “reasonable business grounds” to reject his request to work from home full-time, including that it would likely result in a significant loss in productivity. The ruling supported the employer’s view that working in the office for at least 40 per cent of the time would be “advantageous” to the employee’s productivity and ability to contribute to team culture and training.

    The ruling comes at a time when many organisations are fine-tuning flexible working policies in the face of increasingly polarised views about the benefits of working remotely versus in-office, as the COVID spectre fades.

    “We know hybrid work can be productivity-enhancing if done well,” says CEDA senior economist Melissa Wilson. “Gains can be made in various ways, whether by employees working a little bit longer each day because they’re saving on commute time or because they can have quiet, uninterrupted concentration time. But we also know there are good reasons to be [working] with your colleagues.”

    KPMG’s 2023 CEO Outlook report, a global survey of more than 1300 CEOs, suggests hybrid work over the past three years “has had a largely positive impact on productivity”, but also found that about two thirds of CEOs anticipated a full return to the office within the next three years, with 87 per cent likely to reward returning employees with favourable projects, raises or promotions.

    There’s little doubt that offering flexible work conditions has become a critical factor in attracting and retaining talent. “It’s all about finding the right balance,” says Wilson.

    This article first appeared under the headline 'Arrested Development’ in the March 2024 issue of Company Director magazine.

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