To boost Australia’s productivity, pay the states to drive reform

Treasurer Jim Chalmers was right to bring forward the release of Australia’s second five-yearly productivity review, Advancing Prosperity, as the economy struggles through the post-pandemic hangover and years of lacklustre productivity performance before that. 

As the 1000-page Productivity Commission (PC) review demonstrates, however, policymakers have no trouble identifying productivity-enhancing reforms. The difficulty has been in designing and implementing them – and bringing all parties to the table.

But productivity is a Swiss Army knife for the economy. It can enable real wage growth, help to quell long-term inflation, lift living standards and insulate the budget position. It can help to cure many of the economy’s ills today and insulate it from many of the challenges of tomorrow.

As hard as these changes might be in the short-term, in the long-term they can deliver big benefits to the community through higher incomes, lower prices, better education, more affordable housing, less traffic congestion, better jobs and more.

Just like its predecessor, Shifting the Dial, released in 2017, Advancing Prosperity identifies many opportunities for reform that will require co-operation from state and territory governments, in particular on the critical areas of health, education and infrastructure.

The Treasurer and others have rightly observed that the reforms that will make a difference today will be different to those of past reform eras. The twin challenges for productivity today are harnessing data and digitisation to enable workers and lift business productivity, and improving the way we deliver critical services such as aged and health care to the community. This must all be done amidst broader efforts to decarbonise and manage a more volatile global economy.

But if the Commonwealth is serious about beginning a new era of reform, it should take at least one tip from successful past playbooks. It should offer productivity payments to states that act on the to-do list.

While paying the states to undertake reform sounds simplistic and expensive, it has been a consistent feature of successful federal-state productivity agendas. The National Competition Policy and the more modest Seamless National Economy agenda, which introduced changes including the Australian Consumer Law and a national consumer credit framework, both provided facilitation and reward payments to the states.

Australia’s Federation has been at its best when at least one state is pushing for greater ambition, urging its counterparts to get on board and the Commonwealth to bring dollars to the table. Victoria’s National Reform Agenda set the stage during the late 2000s, resulting in a reinvigorated federal agenda across health, skills, early childhood development and regulatory hotspots.

Leveraging the Federal Budget in this way can be justified on multiple counts, even in a highly constrained environment.

First, given our scrambled tax sharing across the Federation, states that reform first risk losing precious tax revenue, further eroding a revenue base struggling to keep up with the demands of vital service delivery in health and education. Past analysis has shown states that go it alone in slashing inefficient taxes on insurance and stamp duty risk losing up to $1 billion in GST payments. Further, the Commonwealth always stands to gain the greatest fiscal dividend from productivity reforms given the breadth and strength of its tax base.

Second, funding productivity-enhancing reforms should be a high priority for the economy and the budget. Lifting labour productivity back to historical averages would improve GDP by 1.75 per cent by the end of the next decade, while reducing debt by 2 per cent of GDP.

Finally, these payments are hardly extravagant if past examples are any guide. National Competition Policy payments averaged around $600 million a year while making the economy up to 5.5 per cent bigger over the long term, while $550 million was provided for Seamless National Economy reforms.

Provided the states have flexibility in how they pursue the PC’s recommendations, rather than the prescriptive model underpinning many fiscal transfers, the funding should provide the maximum benefit.

Progressing meaningful policy changes that support productivity is no picnic. It requires thoughtful design and execution, and for many different parties to come together with an appetite for change. That includes industry groups, who often call for productivity-enhancing changes but object when their sector is in the firing line.

But if the Albanese Government is serious about curing Australia’s economic hangover and making the most of the PC’s five-yearly review, it should open its wallet to recognise that the fiscal odds are often stacked against the states and territories despite their vital role.