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Opinion article

Better managers can narrow the productivity gap

In the first article in a series on business dynamism, CEDA Senior Economist Melissa Wilson shows how substandard business management practices are holding back Australia’s productivity.
 

Productivity is the key driver of long run economic growth and prosperity. In Australia, productivity growth has contributed over 80 per cent of growth in real gross national income per person over the past 30 years.[i] With migration and exports limited by border closures, the windfall gains of the 2000s mining boom well and truly behind us, and further ageing of the population ahead of us, Australia’s need for productivity is more pressing than ever.

Productivity recently returned to the spotlight in the 2021 Intergenerational Report, which assumes that labour productivity will transition to a long-run average growth rate of 1.5 per cent. This is a brave assumption, one that would require a sizable and sustained improvement on the lacklustre productivity performance of the past three decades.

Debate about how to boost productivity often focuses on policy, but businesses also play a critical role. International research shows that management practices are a key driver of differences in performance at the firm level, and ultimately in productivity and prosperity at the national level.

According to this research, the US has the best managers, followed by Sweden, Japan, Germany and Canada.[ii] At the other end of the spectrum, China, India and Greece have the lowest management scores, with much larger shares of poorly managed firms.

Australia ranked in the second tier of countries, along with France, Great Britain and Italy. More recently, Australian executives delivered a dim assessment of management capabilities in the latest IMD World Competitiveness Yearbook: Australia ranked 58th out of 64 countries on management practices in the 2021 Yearbook, down from 35th only a year ago.[iii]

There is considerable variation in management practices between firms. One study found that only six per cent of Australian firms have highly engaged managers, while at the other end of the spectrum around 58 per cent have low management engagement.[iv] Australian firms have particularly weak capabilities when it comes to managing digital and technology integration into businesses, and penetration and adoption of environmental practices.[v]

There are also notable differences across industries. The health care and social assistance industry was found to be the standout performer,[vi] but recent CEDA research on aged care services has found a large divergence in management practices across the sector. Some service providers are still spending large amounts of time on manual rostering and record-keeping, for example, while others have embraced more efficient digital solutions.[vii]

Firms with better capabilities tend to be larger and older, with more educated managers and workers. External influences are also a positive: multinationals, exporters and firms exposed to strong product market competition are generally better managed than their more insulated peers. Firms held to account by public shareholders or private-equity owners are typically much better managed than those that are family- or government-owned.

Econometric modelling suggests that differences in management capabilities may explain up to half of the productivity gap between Australia and the US.[viii] This shows how individual firms adopting best practices, which has obvious benefits for them, can also have significant benefits at the macroeconomic level.

The good news is that adopting best practices doesn’t require any innovation or new ideas, firms simply need to acquire and absorb information that already exists. We need more firms to implement formal and regular processes to measure and critically assess their management practices, identify performance gaps, and initiate improvements.

One important finding is that most firms are unaware of their own management standards and ways they can improve.[ix] For policymakers, ‘encouraging the take-up of good management behaviour may be the single most cost-effective way of improving their economies’.[x] Australian policymakers could learn from the UK Business Basics Programme, which is testing innovative ways to encourage businesses to adopt existing technologies and management practices to improve their productivity.[xi]

Adopting managerial best practices (or strong ordinary capabilities) is low hanging fruit in terms of moving Australia closer to the productivity frontier. Beyond this, further gains will be made through innovation and new ideas. In other words, expanding the productivity frontier will require dynamic capabilities – the ability to identify areas of competitive advantage, seize these opportunities and innovate. CEDA will be undertaking a survey to assess the dynamic capabilities of Australian businesses as part of its Business Dynamism and Competitiveness research program.


References

[i] Commonwealth of Australia 2021 Intergenerational Report

[iv] Moran, I., Balaguer, A., Majeed, O., Agarawl, R., Bajada, C., and Brown, P. (2018), ‘Strategic Management in Australian Firms’, Research Paper, Department of Industry, Innovation and Science. 

[v] Agarwal, R., Bajada, C., Brown, P., Morgan, I. and Balaguer, A. (2019), ‘Development of Management Capability Scores’, Research Paper, Department of Industry, Innovation and Science.

[vi] Ibid.

[viii] Bloom, N., Sadun, R. and Van Reenen, J. 2017, ‘Management as Technology?’, Working Paper, 22327, National Bureau of Economic Research. The analysis was based on the manufacturing sector, which the authors argue is a good proxy for the whole economy given that manufacturing TFP is very highly correlated with whole economy TFP and management scores in manufacturing are highly correlated with management scores in other sectors.

[ix] Bloom, N., Dorgan S., Dowdy J., and Van Reenen, J. (2007), ‘Management Practice & Productivity: Why they Matter?’, Management Matters, November, p. 10 and Australia Department of Innovation, Industry, Science and Research (2009), ‘Management matters in Australia: just how productive are we?: findings from the Australian Management Practices and Productivity global benchmarking project’, DIISR, Canberra.

[x] Bloom, N., Dorgan S., Dowdy J., and Van Reenen, J. (2007), ‘Management Practice & Productivity: Why they Matter?’, Management Matters, November, p. 10.

About the authors
MW

Melissa Wilson

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Melissa Wilson is Senior Economist (NSW) at the Committee for Economic Development of Australia (CEDA). She also has over a decade of experience as an economist at the Reserve Bank of Australia (RBA), where she worked in a broad variety of areas, including the RBA’s business liaison program, overseas economies and international relations, labour markets, domestic markets, financial stability and public education. Melissa holds Bachelors degrees in Economics and Commerce from the University of Adelaide, an Honours degree (majoring in Economics) from the University of Melbourne, and a Masters of Economics from the University of New South Wales.
 

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