State of the Nation 2022 forum
The Australian economy went into the COVID-19 pandemic with weak growth in both productivity and average incomes. In 2018-19, Australia’s labour and multi-factor productivity went backwards, while growth in per capita income slowed to just 0.3 per cent. Suppressing the pandemic will come at a large cost to economic activity. The closing of Australia’s borders serves to dramatise to the extent to which our standard of living depends on integration with the global economy.
Before the onset of the pandemic, there was widespread concern about the decline in Australia’s productivity performance. Australia is not alone in this regard. Most economies have experienced slower productivity growth on average since around the mid-2000s relative to previous decades, without a clear consensus on underlying causes.
In my report for the United States Studies Centre, Failure to Converge? The Australia-US Productivity Gap in Long-Run Perspective, I look at some of the factors that might account for slower productivity growth in Australia.
The report takes as its starting point the observation that much of Australia’s productivity performance is effectively imported from the rest of the world. In particular, Australia’s integration with the global economy allows us to import trends from the global productivity frontier represented by the United States.
Australia’s productivity grows in line with the global frontier in the long-run, but the level of productivity has remained stubbornly below that of the US, pointing to structural impediments to closing the productivity gap.
The reforms that internationalised the Australian economy starting in 1983 have been widely credited for the productivity surge in the 1990s.
Many of these reforms focused on opening-up the Australian economy, in particular, reductions in tariff protection and greater openness to foreign capital, which in turn increased export competitiveness.
The liberalisation of merchandise trade alone between 1986 and 2016 is estimated to have raised Australia’s real GDP per capita by $3506, representing a lower bound on the gains from broader economic liberalisation.
The income gains from the terms of trade boom between 2003 and 2011 would have bypassed Australia were it not for increased openness to trade. The estimated 7.4 per cent increase in real wages due to merchandise trade liberalisation points to economy-wide productivity gains given the long-run relationship between productivity and workers’ compensation.
Recent firm-level data shows that Australian exporters enjoy labour productivity 13.4 per cent higher than non-exporters and average wages 11.5 per cent higher.
The technology shock from the information and communications technology (ICT) revolution is also credited for the 1990s productivity surge. Australia is one of the few advanced economies to generate significant productivity benefits from the use of ICT, accounting for around one-third of Australian labour productivity growth in the 1990s.
Because Australia is a net consumer and importer of ICT equipment rather than a producer and exporter, the ICT revolution was experienced by Australia as a form of capital deepening. This contributed to labour productivity, as well as multifactor productivity from user-based innovations based on ICT. Australia was only able to capitalise on these labour productivity gains because of its openness to imports of ICT capital equipment, which facilitated a high take-up rate for new technology, as did product and labour market reforms.
The declining relative price of imported ICT capital goods reduces the relative price of investment in Australia and induces capital accumulation, boosting productivity through capital deepening. Lower imported ICT prices also assist income growth through Australia’s terms of trade. Because the technology revolution is largely exogenous to the Australian economy, its benefits largely accrue via Australia’s openness to the rest of the world.
Inadequate investment in education and innovation is sometimes suggested as one cause of the productivity slowdown. Human capital formation and its contribution to the quality of labour inputs could explain recent productivity trends. However, the quality of labour inputs has generally been improving through both the 1990s and 2000s and labour quality has made a positive contribution to MFP growth. The education gap with the US has closed in recent years.
Australia’s stock of human capital is augmented through migration, especially skilled migration. For example, over half of the increase in Australian graduate numbers since 2013 hold degrees from overseas universities or are non-citizen holders of Australian university degrees, implying nearly half of Australia’s human capital formation at the university degree level receives little or no assistance from Australian higher education policy.
Migration also contributes to productivity growth through innovation (thought to be proportional to population), spurring new business formation through increased demand and generating efficiency gains through increased scale economies.
Migrants to Australia earn between three and five dollars per hour more than non-migrants, implying higher rates of productivity. Migrants accounted for around 0.2 percentage points of annual productivity growth and 0.1 percentage points of multifactor productivity growth between 2006 and 2011.
The proportion of Australian’s born overseas is at its highest since the late 19th century at 29 per cent, suggesting migration was making a stronger contribution to both the quantity and quality of labour inputs, at least before the pandemic closed the borders.
Research and development (R&D) spending is also sometimes highlighted as a potential factor in slower productivity growth, but there is little or no support for this view in the case of advanced economies. In Australia’s case, changes in R&D spending do not have a clear relationship with productivity growth.
Given these international influences on Australian productivity, it is not surprising to find that a measure of the globalisation of the economy helps explain Australia’s long-run productivity growth. The pace of globalisation in the Australian economy slowed after 2000, coincident with the slowing in productivity growth.
For a small open economy, Australia is not as globally integrated as many of its peers. It has one of the lowest traded goods shares of any economy in the OECD apart from large relatively closed economies like the US and Japan. The KOF Globalisation Index ranks Australia 58th in terms of international economic integration, only slightly more globalised than the US, which ranks 59th.
However, the US is already at the global productivity frontier and so does not depend as heavily as Australia on international connectedness for its productivity.
In the wake of the pandemic, the most urgent task facing Australian policymakers is to re-establish Australia’s international connectedness. Policy should then aim to improve on Australia’s pre-pandemic levels of global economic integration with a view to raising productivity growth and narrowing the productivity gap with the global frontier represented by the United States.