Why productivity matters
By Nico Louw
First published in the MRC’s Watercooler newsletter. Sign up to our mailing list to receive Watercooler directly in your inbox.
It’s been 35 years since economist Paul Krugman observed that “productivity isn’t everything, but in the long run it is almost everything.” It’s as true today as it was then.
Productivity growth means getting more with less. It’s the reason that the average Australian worker now earns seven times more in real terms than they did at Federation, while working 14 fewer hours per week.
Despite its importance, productivity is one of the least understood concepts in public policy. Don’t expect to hear the word much in the election — explaining productivity is hard enough without being limited to a sound bite or TikTok reel.
Australia is facing a productivity crisis. Average annual productivity growth in the decade to 2020 was already the slowest in 60 years. More recently, productivity has collapsed. It is now 5.7% lower since the last election.
Sustained increases in productivity matter a lot for living standards and for the Commonwealth Budget.
In 2022, Treasury downgraded its projections for productivity growth by 0.3% per year. Reversing this over the longer term would mean per capita incomes over the next 40 years would be $11,000 higher.
Analysis in a new Menzies Research Centre report released this week, The Productivity Imperative, found that a modest 0.3% increase in productivity would erase the cumulative $221 billion in deficits projected over the next decade and replace them with a cumulative $12 billion surplus.
Unfortunately, improving productivity growth is hard. There is no consensus on the solutions to lower productivity growth and no single lever that governments can pull to guarantee higher growth.
Many reforms that economists generally agree on, such as removing stamp duty on property and insurance, have been put in the political too-hard basket. There hasn’t been a serious conversation about more contentious reforms, such as changes to the GST, in almost a decade.
The debate surrounding productivity policy in Australia has devolved into deciding which sector gets to withdraw from the Government ATM. In favour at the moment are businesses involved in renewable energy and battery manufacturing, plus (for some reason) a US quantum computing company.
Almost all our productivity eggs are in one basket — the Government is betting on Australia becoming a ‘renewable energy superpower’. What do we do if it doesn’t work or another country beats us to it?
We need the Government to pursue productivity policy that works across a broad range of fronts to improve productivity in both the private and public sector.
The latest MRC report outlines the many ways the Commonwealth can take steps today to improve productivity in the long term that don’t require contentious legislation or entering challenging negotiations with the states.
None of these ideas sound very exciting, but that doesn’t mean they shouldn’t happen.
In the private sector, Government must recognise that the overwhelming majority of businesses are not innovators — they follow the most innovative firms and wait to adopt new ideas and technologies. Rather than attempt to decide what these innovations will be, the role of Government should be to position and enable business to seize new opportunities by getting the basics right.
This means appointing a Minister to lead a vigorous and ongoing assault on the red and green tape holding back businesses, including implementing a quota of annual regulatory reductions and requiring new regulations to be offset on at least a one-to-one basis.
It also means not doing bad things such as smothering innovation in new areas such as AI, which the Government seems keen to do by emulating the EU’s disastrous AI Act. As a general rule, looking to the EU for policy ideas is a terrible idea.
To back productive private investment, the Government should instead follow the UK’s lead in allowing businesses to defer Capital Gains Tax when they reinvest proceeds from asset sales into new assets.
A technology-agnostic energy policy that supports lower cost energy generation will also be vital to give businesses the confidence to invest in Australia.
In the public sector, addressing productivity in ‘non-market’ services such as healthcare, aged care, disability care, childcare and education is one area where the Government can and must have a direct influence. Measured productivity in these sectors has been close to zero for 25 years, which means productivity will be dragged down nationally as they grow as a share of the economy.
Politicians and commentators often complain that implementing reforms to address productivity is impossible without a ‘burning platform’ (read: recession) to create the impetus for change. Such a platform already exists.
The Chinese Navy flotilla currently circumnavigating Australia is just the latest example of the new geopolitical environment we face. Global geopolitical disorder and the rise of strategic competition between democracies and the autocracies of China, Russia, Iran and North Korea means it has never been more important for Australia to find ways to improve productivity and become a stronger economy.
The uncertainty surrounding the Trump administration’s trade policies and the potential for tariff and trade wars and significant economic decoupling makes this task even more urgent.
Addressing this challenge is an opportunity for governments and businesses alike to step up.
