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					Reserve Bank of Australia Bulletin                                                   October 1995

                  Productivity and Growth

On 10-11 July 1995, the Bank convened a             the economy under insular policies of industry
conference entitled ‘Productivity and Growth’.      protection, excessive regulation, and
The following excerpt is the introductory chapter   centralised industrial relations which failed to
of the conference volume.                           deliver adequate improvements in living
                                                    standards – an issue reinforced by rapidly-
  The economics profession was born of              rising living standards in other economies,
Adam Smith’s inquiry into the nature and            especially those in neighbouring East Asia. In
causes of the wealth of nations, and the issues     fact, concern about Australia’s economic
he addressed remain as important today as           performance relative to other countries has
they were when he raised them. Although             often been dramatised by our slide down the
economic progress does not follow a simple          ‘totem pole’ of comparative per capita income
pattern to be explained with any certainty, an      levels.
understanding of the environment conducive             In response, over the past two decades,
to growth is central to the achievement of          there has been a program of market
continuing advances in the standard of living.      liberalisation. Whilst a gradualist and mainly
  While Adam Smith had great instinct about         consensual approach has been adopted, the
the forces that enrich a nation, formal analysis    program has been extensive. Financial
of growth had to wait until the conceptual          markets have been deregulated, industry
tools of the Keynesian revolution, particularly     protection has been largely dismantled and a
national-income accounting, were assimilated        range of activities targeted for microeconomic
and yielded the neoclassical growth model.          reform. Liberalisation has also extended to
Further analysis awaited the new growth             labour markets, which are now moving from
theory of the past decade. These analyses,          a centralised system of industrial relations to
however, have not led to a clear operational        one that embraces enterprise agreements. The
guide for policy makers but, instead, suggest       extent of reform marks a clear regime change,
a range of possible causes of growth and policy     one that endorses competitive markets as the
prescriptions. Ultimately, though, the policy       means of securing the most productive use
prescriptions in different economies reflect        of the nation’s resources. Furthermore,
what is acceptable to each society.                 official inquiries into the competitiveness of
  In the Australian context, there has been a       Australian industr y, such as the
growing acceptance that productivity and            Hilmer Report, form the basis of an agenda
growth are enhanced by the liberalisation of        to continue the reform process.
markets. This acceptance has arisen partly             This change in approach to economic
from dissatisfaction with the performance of        management has been embraced in the belief

Productivity and Growth                                                                           October 1995
that it will deliver a growth dividend and                been inadequate. This view is supported, for
improve living standards. With this process of            example, by data published by official
refor m underway for some years, it is                    inter national agencies indicating that
appropriate to take stock of Australia’s growth           productivity growth has been slower in
performance and prospects. The papers in this             Australia than in other comparable countries
Volume were commissioned by the Bank to                   for an extended period.
improve our understanding of productivity                    Table 1, drawn from a new comparative
and growth. In particular, the papers seek to             database recently published by the OECD,
address four main questions:                              summarises the conventional evidence. It
• How bad, or good, is Australia’s growth                 shows that while total output growth in
   and productivity performance?                          Australia was in line with that of other OECD
• What developments in productivity and                   countries over the period 1970-89, both
   growth have occurred at the sectoral and               labour and total-factor productivity were well
   enterprise levels?                                     below. In fact, Australia had the lowest total-
• What lessons can be learned from the                    factor productivity growth of the 14 OECD
   extraordinar y East-Asian growth                       countries for which data were available.
   experience?                                               An additional OECD study for the period
• What is the role for policy in the                      1989-94 gives a more favourable impression
   achievement of Australia’s growth                      of Australia’s recent economic performance.
   potential?                                             It suggests that, over the past five years, both
                                                          labour productivity and total-factor
                                                          productivity have slightly surpassed the
Australia’s Comparative                                   OECD average. The difference is not,
Growth and Productivity                                   however, great and may be affected by cyclical
Performance                                               influences. Over a longer run of years,
                                                          productivity growth has been less than in other
                                                          industrialised economies.
  There is a widespread view that Australia’s                There is, as well, evidence of a progressive
growth and productivity performance has long              decline in Australia’s level of real per capita

         Table 1: Australia’s Comparative Growth and Productivity Performance
                                  (Per cent per annum)

                          Australia   Canada       Germany         Japan         UK          US       OECD
 1970 to 1989
 Real GDP                   3.2          3.7           2.5           4.6         2.1        3.0         3.1
  productivity              1.0          1.4           2.3           3.7         1.7        1.0         2.0
  productivity              0.6          0.8           1.5           2.1         1.1        0.7         1.4
 1989 to 1994
 Real GDP                   2.2          1.0           2.9           2.1         0.8        2.0         1.9
  productivity              1.8          0.7           2.7           1.0         1.9        1.0         1.5
  productivity              1.1         -0.4           1.8          -0.5         1.2        0.6         0.5
 Note:    Database confined to: Australia, Belgium, Canada, Denmark, Germany, Finland, France and Italy, Japan,
          Sweden, the United Kingdom and the United States. These countries account for over 90 per cent of
          GDP in all OECD countries.
 Sources: For the period 1970-89, data are from OECD Working Paper No. 145, and for the period 1989-94, they
          are from OECD, Economic Outlook, June, 1995.

Reserve Bank of Australia Bulletin                                                   October 1995
income relative to other countries. In 1938,       the economy matures. Less-developed
Australia was ranked 4th in conventional           economies can enjoy rapid growth through
league tables of per capita income. By 1960,       technological catch-up and by encouraging
its ranking was 11th; by 1993 it was 15th,         factors to accumulate faster than is sustainable
equal with Belgium. According to estimates         for an advanced economy. Once allowance is
by the World Bank, Australia’s real per capita     made for each country’s position on its
income is now less than the high-performing        development path, Australia’s per capita
East-Asian economies of Hong Kong and              growth has proceeded at a rate to be expected
Singapore. Thus we are presented with two          of a mature, industrialised economy. In this
stylised facts, suggesting that Australia’s        respect, our growth performance has been
productivity and growth performance has            remarkably average.
been relatively poor.                                Of course, achieving average performance
   However, as the papers in this Volume show,     amongst economies of our type implies there
while such summary measures of economic            is room for improvement. Analysis of
progress are valuable in certain contexts, they    productivity, in particular differences at the
can be naive and lead to inappropriate             sectoral and enterprise level, provides some
conclusions about comparative performance.         guidance here.
Three main problems give the flavour of the
issues involved.
   First, Australia began its economic             Sectoral and Enterprise
development as a ‘frontier’ economy with a         Developments
rich endowment of natural resources and a
small population; it is to be expected that its
initial levels of real per capita income were        Trend improvements in productivity are
very high. However, a comparative advantage        necessary to sustain a desirable pace of
in the production of primary commodities,          economic growth. Indeed, much of the
with low income elasticities of demand and         program of market liberalisation has been
secular price falls, does not lend itself to the   designed to secure continuing improvements
maintenance of such relative affluence.            in productivity. Consequently, it has been
   Second, meaningful comparisons of               both a puzzle and a source of concern, that
per capita income levels are difficult to          during much of the 1980s in Australia, labour-
perform. They require each country’s income        productivity growth was unusually slow.
to be denominated in the price of a set of           Many argue that poor labour-productivity
representative goods. For conventional league      growth in the second half of the 1980s was a
tables, the choice of this set of goods is most    consequence of wage moderation. The wage
appropriate for a ‘core’ group of countries in     pause and the Prices and Incomes Accord
Europe, but less so for other countries, like      restrained real wages, encouraging a shift in
Australia, that are outside this core. When        the capital/labour ratio. While this resulted in
attempts are made to address this problem,         increased employment, it lowered labour-
or when account is taken of differences in the     productivity growth. But we can also throw
living conditions and preferences of               light on this issue by decomposing the
communities, Australia’s ranking improves,         aggregate outcomes. Examination of sectors
often considerably.                                reveals substantial differences in productivity
   Third, even if accurate relativities can be     performance.
established, comparisons of growth                   Over the course of the last business cycle,
performance made at the same point in time,        the level of labour productivity declined in four
as opposed to the same stage of development,       main industries – construction, wholesale and
are misleading. Economies tend to follow a         retail trade, finance, and recreation. These
development path in which growth takes off,        declines were offset by improvements
accelerates and subsequently slows down, as        elsewhere in the economy to generate an
Productivity and Growth                                                              October 1995
overall slowdown in productivity, at least in       productivity is central to the ability of firms
measured productivity.                              to maintain competitiveness in both domestic
   While part of the slowdown is real, part can     and foreign markets.These developments have
be attributed to measurement problems.              been complemented by the new focus of
Indeed, it would be surprising if falls in actual   organised labour on the objectives of
productivity levels have occurred. There are        enterprises. Returns to labour are increasingly
inherent difficulties in identifying the            benchmarked against indicators of
productivity of non-market industries where         perfor mance at the enterprise level,
it is hard to obtain the market value of output,    encouraging wage outcomes in line with
and also of service industries where it is hard     productivity – a prerequisite for achieving the
to measure the quality of output. And yet these     objectives of competitiveness and
industries comprise a large and increasing          maintenance of low inflation.
share of the economy.                                 Given our pursuit of sustainable growth
   Measurement problems are epitomised by           through market-induced improvements in
the deregulation of shopping hours that             productivity, what lessons can be learned from
occurred progressively throughout the 1980s         the extraordinary growth achievements of
and early 1990s. Opening shops for longer           East Asia?
hours should hardly affect aggregate sales and
hence, measured output. It does, however,
require more staff, so measured labour and          The East-Asian Miracle
total-factor productivity growth are lower
while shopping hours are being lengthened.
In the meantime, though, shops have provided
a new and improved ser vice, called                    East-Asian economies have enjoyed
‘convenience’, that is difficult to value. In a     remarkably rapid economic growth for a
number of industries, these types of                generation – a performance that has attracted
measurement difficulties appear to have             the attention of policy makers hoping to
become especially pronounced in the second          emulate this success. For economists, the
half of the 1980s.                                  East-Asian experience presents the intellectual
   In some areas, at least, we expect               challenge of providing an explanation in terms
measurement problems to be reduced.                 of economic conditions and policies, rather
Consequently, measured productivity should          than simply characterising it as ‘miraculous’.
recover. This, combined with the positive              For OECD countries, growth-accounting
influences of market liberalisation and             exercises suggest that technology usually plays
outward orientation, already evidenced in           a larger role in the growth process than factor
some sectors, gives cause for optimism that         accumulation. This result is not so clear-cut
Australia’s trend rate of productivity growth       for East-Asian countries where some have
will be higher in future than it was in the         argued that growth may be ‘extensive’, in the
1980s. In fact, productivity performance at         sense that it reflects massive factor
the enterprise level provides strong evidence       accumulation as resources are mobilised in a
in support of this view.                            newly-industrialising society. This conclusion
   At the enterprise level there have been          appears, however, to be a fragile one. The
important changes in both attitude and the          more widely-endorsed view accepts that factor
organisation of work that have delivered, and       accumulation has been important for East-
will continue to deliver, productivity              Asian growth, but argues that technological
improvements. Case studies indicate that the        progress has also played a key role.
program of market liberalisation, in particular        Of course, forces other than factor
the increased exposure to international             accumulation and technology have
competition, has encouraged firms to focus          contributed to East-Asian growth.
on a range of aspects of performance. Of these,     Macroeconomic management has been

Reserve Bank of Australia Bulletin                                                       October 1995
generally good and has been complemented              markets designed to encourage greater
by policies that have enhanced the integrity          efficiency in resource use. This has already
of the financial system. There has also been          had demonstrable effects on productivity in
an extensive array of selective interventions         many sectors of the economy, with tentative
designed to promote growth by encouraging             signs that higher aggregate productivity
certain types of economic activity, in                growth is in prospect.
particular investment and exports – the so-              While economic theories of growth offer
called ‘engines of growth’. Identifying the role      guidance for microeconomic-policy design,
played by policy has, however, proven difficult.      they do not assign a specific role to
To what extent would strong growth have been          macroeconomic policy. Nevertheless, it is hard
achieved anyway, through the ‘natural’ forces         to believe that macroeconomic policies have
of factor accumulation, catch-up and                  no influence on growth. Indeed, there is by
convergence? Has economic success                     now considerable agreement about the
permitted particular policies to be pursued           features of a macroeconomic environment
(e.g. with respect to saving) or did the policies     conducive to growth: a stable and sustainable
generate economic success?                            fiscal policy; an appropriate real interest rate;
  One way to address this issue of reverse            a competitive and predictable real exchange
causality is to examine the conditions                rate; a balance of payments that is regarded
prevailing at the beginning of the growth             as viable; and a low and predictable inflation
period. For example, had high rates of                rate. Several of these conditions have figured
investment or exports preceded economic               prominently in public-policy debate in
growth, it might confidently be argued that           Australia.
they helped cause it. In fact, high rates of             A country’s fiscal position, the viability of
investment and expor ts evolved only                  its balance of payments and its level of national
gradually, making their role in the growth            saving are all inextricably linked. In Australia’s
process harder to interpret. Nevertheless,            case, national saving has fallen, both as a result
there are other attributes of these economies         of public dissaving associated with budget
that did precede their rapid growth. As well          deficits, but also as a consequence of a decline
as low initial-income levels, predisposing them       in private saving – one that is unusual by
to technological catch-up, East-Asian                 OECD standards. If international capital
countries had less inequality of income and           flows were highly mobile, national saving
land distribution, and more primar y                  would not be a constraint on investment and
education than comparable countries that              growth, as capital would flow from countries
were subsequently less successful. Perhaps            with excess saving to those where profitable
these were important ingredients in the               investment opportunities exceed domestic
transition to rapid growth and technological          saving. But this appears not to be the case.
catch-up.                                             Owners and managers of each nation’s saving
                                                      act to keep most of it at home. Consequently,
                                                      if domestic saving is deficient, investment and
The Role for Policy                                   growth are lower than they would be if capital
                                                      were perfectly mobile. This suggests a need
                                                      for both fiscal restraint and incentives to boost
                                                      private saving.
  It is of vital interest to economists to identify      The final ingredient of a macroeconomic
public policies that promote growth, or               environment conducive to growth is a low and
certainly do not inhibit it. In the Australian        predictable inflation rate. Indeed, satisfying
context, the principal focus has been on              this condition is of key concern to central
‘getting the basics right’. With regard to            banks. Higher inflation interacts with the tax
microeconomics, this has entailed a program           system to affect saving and investment. It
of liberalisation in both goods and factor            generates greater uncertainty about future

Productivity and Growth                                                                October 1995
inflation, discouraging long-term contracting        stability accrue only gradually, however, so
and raising risk premia on interest rates,           that empirical estimation of the growth
thereby inhibiting investment. Higher inflation      dividend from low inflation is confounded by
is also associated with more relative price          a myriad of other influences. Nevertheless, the
variability so that price signals become more        widespread concern that inflation is costly has
difficult to interpret and the sectoral allocation   led to endorsement of a low-inflation objective
of resources is adversely affected.                  in Australia. This reflects a belief that, in the
  In principle, each of these factors can have       long run, the growth benefits of low inflation
a causal effect on growth.The benefits of price      are worthwhile.