Saturday, December 3, 2016

Many guesses why productivity may have stopped improving

Conventional economics is falling apart, no longer making the sense we thought it made. Economists are entering a period of puzzlement and uncertainty, while their high priests struggle to hold the show together.

You can tell all that if you read between the lines of the Productivity Commission's discussion paper launching its inquiry into Increasing Australia's future prosperity, published last month.

It’s meant to be the first five-yearly review of our productivity performance, the micro-economic equivalent of Treasury’s (misnamed and now politically hijacked) five-yearly macro-economic intergenerational reports.

So it has potential to be a big deal. If you missed hearing about the discussion paper it may be because it was overshadowed that week by something that happened to a Mr Trump.

The commission opens its discussion with the alarming observation that "there is a justified global anxiety that growth in productivity – and the growth in national income that is inextricably linked to it over the longer term – has slowed or stopped".

Productivity is a measure of an economy's (or a business's) ability to convert inputs of resources into outputs of goods and services.

We commonly (and least inaccurately) measure it as output per unit of labour input – per worker or per hour worked.

But the commission prefers to measure it as output per unit of both labour and capital inputs, which it calls "multi-factor productivity". This is intended to be a measure of the essence of productivity improvement: technological advance and increased human capital.

Trouble is, the commission says, "since 2004, multi-factor productivity has stalled, here and around the developed world. This is a long enough period to suggest something is seriously awry in the economic fundamentals and the consequent generation of national wealth and individual opportunity."

Actually, by the commission's own figuring, Australia's labour productivity in the "12-industry market economy" improved by 1.9 per cent in 2014-15, the most recent year available, and our multi-factor productivity improved by 0.8 per cent, which was also our average rate of multi-factor improvement over the previous 40 years.

It's true, however, that our multi-factor performance has looked pretty sick since the turn of the century.

But the first point to note is that the problem is global, not just some weakness of ours – a fact a lot of those who've used our weak numbers to push their own favoured "reforms" have often failed to mention.

Next point, which is also often not mentioned: economists can't measure multi-factor productivity with even remote accuracy. That's mainly because they can only guess at the contribution one unit of physical capital (whatever that is) makes to production.

So it's hard to be sure the weak multi-factor productivity figures most developed countries are producing are real.

Next, assuming they are real, economists can only guess at the factors causing them. There's a lot of guessing going on by some of the world's top economists, but as yet there are no policy changes we could make with any confidence that they'd fix the problem.

Our eponymous commission produces an annual update on our productivity figures but, though it's been wringing its hands for years, its analysis has never once been able to put its finger on a causal factor we could do something about.

The few explanations it's found are either temporary or nothing to worry about.

The discussion paper acknowledges, but then dismisses, the argument of those wondering if the whole "problem" is merely a product of monumental mismeasurement.

I don't dismiss it. Had the economists not assured us of the opposite, most of us would look at the wonders of the digital revolution and the many industries being hit by digital disruption and assume the productivity indicators must be going gangbusters.

How can we be sure they aren't? One of our most thoughtful economists – one who's always gloried in digital advances – is professor John Quiggin, of the University of Queensland.

Quiggin argues that the economists' conventional model for thinking about the economy and how it grows is based on an industrial economy, which made sense in the 19th and 20th centuries, but is becoming increasingly outmoded and misleading.

We focus hard on the production of goods – agriculture, mining and manufacturing – but are vaguer about the production of services, which is the main part of the economy that's growing.

Today, he says, the primary engine of economic development is information, but information has radically different characteristics to a physical good or a service such as a haircut.

Information is often free ("non-excludable", as economists say) and it can't be used up ("non-rivalrous").

This outdated, industrial-age way of thinking about growth and productivity is reflected in the way we define and measure the economy and productivity via gross domestic product.

For instance, we measure only economic activity in markets, meaning we exclude all the activity taking place in households, and can't measure the productivity of the 20 per cent of GDP created in the public sector, including such minor industries as health and education.

And we ignore one of the most valuable outcomes of the greater prosperity that is the Productivity Commission's god: hours of leisure.

None of this, however, will stop the commission using its ultimate report to advocate a bunch of "reforms" intended to improve our small corner of the world's alleged productivity problem.

As we speak, Canberra's second biggest industry – the lobbyists – are busy churning out their self-interested submissions to the inquiry, advocating such radical new ideas as cutting company tax and weekend penalty rates.

To be fair, the commission says it's "particularly interested in new and novel ideas because there is already a strong awareness of many reform options that parties would like to see implemented. More of the same is not likely to be helpful."

We'll see how far it gets with that fond hope.