If bulldusting about productivity was productive, we'd all be rich

It seems the longer we wait for a sign that productivity has stopped flatlining, the more and the sillier the nonsense we have to listen to, brought to us by a media that likes to stand around in the playground shouting “Fight! Fight! Fight!″⁣.

The combatants are led by Canberra’s second-biggest industry, the business lobbyists, unceasing in their rent-seeking on behalf of their employer customers back in the real world. Their job is to portray all the problems businesses encounter as caused by the government, which must therefore lift its game and start shelling out.

In your naivety, you may have imagined that if a business isn’t managing to improve its productivity, that would be a sign its managers weren’t doing their job. But, as the lobbyists have succeeded in persuading all of us, such thinking is quite perverse.

Apparently, productivity is something produced on the cabinet-room table, and those lazy pollies haven’t been churning out enough of it. How? By deciding to cut businesses’ taxes. Isn’t that obvious? Bit weak on economics, are you?

Unfortunately, those economists who could contribute some simple sense to the debate stay silent. The Chris Richardsons and Saul Eslakes have bigger fish to fry, apparently.

The latest in the lobbyists’ efforts to blame anyone but business for poor productivity was their professed alarm at the Fair Work Commission’s decision last week to increase award wages, covering the bottom 20 per cent of workers, by 3.5 per cent, a shocking 1.1 percentage points above the annual rise in the consumer price index of 2.4 per cent.

According to one employer group, this was “well beyond what current economic conditions can safely sustain”. According to another, the increase would hit shops, restaurants, cafes, hospitality and accommodation the worst.

Innes Willox, chief executive mouth for the Australian Industry Group and a leading purveyor of productivity incomprehension, claimed that “by giving insufficient attention to the well-established link between real wages and productivity, this decision will further suppress private sector investment and employment generation at a time our economy can least afford it”.

The least understanding of neoclassical economics shows this thinking is the wrong way round. It’s when the cost of labour gets too high that businesses have greater incentive to invest in labour-saving equipment.

At present, we’re told, business investment spending as a proportion of national income is the lowest it’s been in at least 40 years. If so, it’s a sign that labour costs are too low, not too high.

The other reason firms are motivated to invest in expanding their production capacity is if business is booming. But this is where business risks shooting itself in the foot. Whereas keeping the lid on wages may seem profit-increasing for the individual firm, when all of them do it at the same time, it’s profit-reducing.

Why? Because the economy is circular. Because wages are by far the greatest source of household income. So the more successful employers are in holding down their wage costs, the less their customers have to spend on whatever businesses are selling. If economic growth is weak – as it is – the first place to look for a reason is the strength of wages growth.

Fortunately, however, while sensible economists leave the running to the false prophets of the business lobby, my second favourite website, The Conversation, has given a voice to Professor John Buchanan, of the University of Sydney, an expert on the topic who isn’t afraid to speak truth to business bulldust.

“In Australia, it has long been accepted that – all things being equal – wages should move with both prices and productivity,” he says. “Adjusting them for inflation ensures their real value is maintained. Adjusting them for productivity [improvement] means employees share in rising prosperity associated with society becoming more productive over time.”

In recent times, however, all things ain’t been equal. Depending on how it’s measured, the rate of inflation peaked at 7.8 per cent (using the CPI, which excludes mortgage interest rates) or 9.6 per cent (using the living cost index for employed households, which does include them).

So the Fair Work Commission has cut the real wages of people on award wages by about 4.5 per cent – something the lobby groups somehow forgot to mention. That’s what honest dealers these guys are. If there’s a way to fiddle the figures, they’ll find it.

The supposed real increase of 1.1 per cent in award wages is actually just a reduction in their real fall to about 3.4 per cent. So much for the impossible impost that will send many small businesses to the wall.

The commission has always been into swings and roundabouts. Cut real wages now to get inflation down, then, when things are back to normal, start getting real wages back to where they should be. So we can expect more so-called real increases – each of them no doubt dealing death and destruction to the economy.

Speaking of fiddling the figures, the commission points out a little-recognised inaccuracy in the conventional way of measuring real wages. It says that, if you take into account that prices rise continuously but wages rise only once a year, award wage workers’ overall loss of earnings since July 2021 has been 14.4 per cent.

What the lobbyist witch doctors have been doing is concealing the truth that the best explanation for our weak productivity performance is that employers have been seeking to increase their profits by holding down wage costs, rather than by investing in labour-saving technology.

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Why we need our economists to try a lot harder

I noticed in The Psychologist magazine one of that profession’s old hands advising newbies to “think outside the box and question everything”. What? With economists, such heretical advice would be unthinkable.

In their profession, all the advice is to learn the orthodoxy and never question it. Why? Because it’s the revealed truth.

The weird thing is, the great project for academic economists since the 1960s has been to make their discipline more scientific. Within their universities, economists get looked down on by the physical scientists, and they hate it.

They hate being regarded as one of the soft “social” sciences, such as psychology, or worse, those lefty lightweight sociologists. So for decades they’ve been working to make their discipline more “rigorous”. How? By expressing ideas about how the economy works in equations, not mere words.

Trouble is, there’s more to science than maths. The hallmark of a scientist is that they’re searching for the truth. They have a theory about how something works, but they’re beavering away to improve it, get it a bit closer to the truth. So their best guess at the truth is slowly evolving and is significantly different today than what it was 50 years ago.

That’s a million miles from academic economics. With most economists – practising as well as academic – their view of how the world works is virtually unchanged from one decade to the next. They’ve already found the truth, so nothing needs changing.

What do you call it when you know the unchanging truth? A religion. Economics is a secular religion, but a religion nonetheless. And when you know the truth, all that’s left to do is convince the rest of the world of its truth.

It’s true that a minority of leading academic economists have been working on new ideas about how the economy works. The annual Nobel Prize in “economic sciences” – which is sponsored by the Swedish central bank – is awarded to academics (not all of them economists) who have important new thoughts on economic questions.

Most of the new discoveries acknowledged by the award of a Nobel Prize – such as about the role of information – are attempts to learn more about aspects of the economy’s workings that are oversimplified or simply assumed away in the “neoclassical” model of markets and the economy that was set in concrete by the late 19th century, but which still dominates economists’ thinking about the economy.

Trouble is, apart from some modifications arising from the work of John Maynard Keynes and his followers after the failure of conventional economics at the time of the Great Depression, few of these advances in thinking get incorporated into the model all economists carry in their heads, nor the mathematical models that academic economists spend so much of their time playing with.

Why not? Because if you want to express economic ideas in equations rather than words, you have to keep it simple. There’s little room for complications or nuance in econometric models.

This is particularly true of the findings of behavioural economics, which uses social psychology to test the assumptions of neoclassical economics – such as that all of us always act rationally, and that we’re rugged individualists, whose decisions are never influenced by what other people are doing. Almost always, behavioural economics finds those assumptions grossly oversimplified at best.

The great test of any model is the accuracy of the predictions it makes about what will happen next. Even the most sophisticated models’ forecasts are often wrong and, not infrequently, seriously wrong. Every economist knows this, but desperately tries not to think about it.

The forecasts in the federal budget, for example, which are given great attention on budget night are quite unreliable, but nobody does anything about it. The Reserve Bank went year after year predicting that wages would grow far more than they actually did.

Clearly, the Reserve may know a lot about money, but its understanding of how the labour market works is woeful – something I’m not sure its boffins admit even to themselves. To them, the labour market works the same simple way every market works.

Their basic mistake comes from the neoclassical model’s implicit assumption that both parties to every economic transaction have roughly equal bargaining power. A boss bargaining with an individual worker? No probs.

The point is, rather than the mathematising of economics making the discipline more rigorous, it’s diverted the profession’s attention from what it really should be doing: being like a scientist and working to fix their model’s oversimplifications and dubious assumptions, in the hope this will make its predictions more reliable.

With the cost-of-living crisis coming to an end as the inflation rate returns to the 2 to 3 per cent target range, and interest rates falling back to more normal levels, the government can turn its attention to a problem we – and all the rich economies – have had for a decade or so: only slow improvement in the productivity of businesses and government providers of services.

Right, so what can economists tell us about productivity? Short answer: not all that much. What they do know is that improving productivity – increasing output faster than you increase inputs of raw materials, labour and physical capital – is the main way capitalist economies have been able to improve their material standard of living over the decades.

They’ve also figured out that most productivity improvement comes from the application of advances in technology, particularly labour-saving equipment. So spending on research and development should help. A better educated and trained workforce probably helps ,too.

So, what else can our learned economists tell us about productivity – how it works and how we can get more of it?

Not much. If productivity’s so important to our standard of living, you’d think economists would have put an enormous research effort into learning more and more about where productivity comes from and how we get more of it.

Sorry, we’ve been too busy with our maths and our modelling. Economists are great believers in innovation. They’d like to see a lot more of it. But they don’t practise what they preach. In academia, all the pressure is to stick to the orthodoxy. New ideas are usually wrong.

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Working less could be the answer to one of our biggest problems

By MILLIE MUROI, Economics Writer

Inflation has been the talk of the town for the past few years, but now that it’s paled enough for interest rates to start coming down, it’s the dreaded ‘P’ word – and our seeming lack of progress on it – that’s resurfacing as a threat to our living standards.

Still, there’s only a handful of people who are noticing it and like talking about it: among them, the Productivity Commission, which couldn’t ignore the issue even if it wanted to.

But if it’s such a huge deal, why don’t most people care? Probably because it’s not easily seen or measured.

Plenty of headlines have lamented our failed attempts at boosting productivity (a supposed need to work harder?). Apparently we’ve been suffering from a decade of it – and it matters because more than 80 per cent of our real income growth (income adjusted for inflation) over the past three decades has been thanks to how much more productive we’ve become.

But measuring how much better we’ve become at making things and providing services with the same amount of workers and time is hard – especially if you can’t put a dollar figure on the outcome.

It’s fairly straightforward, for example, to measure how many more bananas or cows we’re pumping out. But what about the quality of those bananas and cows? How do we put a figure on how much better quality those products are? Even worse: how do we measure how much better we’ve become at providing services like healthcare? Is a surgeon rushing through more surgeries always a better outcome?

Because of this, it’s hard to pinpoint exactly where – and how much – we’re going wrong.

And at an individual level, there’s not a lot we can do.

The biggest leaps in productivity – pumping out more or better-quality things with the same amount of resources (like workers and time) – have come from technological developments like the invention and spread of the internet, electricity or the steam engine.

Sure, a handful of individual geniuses helped bring these things to life, but a majority of workers are limited in their ability to do things more efficiently, often by the tools, rules and conditions they’re forced to work with.

One suggestion made by the productivity boffins in their latest push (triggered by Treasurer Jim Chalmers’ request for reform recommendations) in the economy-wide brainstorm on how to overcome the productivity road block, is shaking up the way companies are taxed.

Specifically, the commission is looking at ways to prod businesses to invest more (something that has been lacking in Australia for quite a few years). Specifically, it will consider tax incentives for businesses to spend on things like better equipment, tools and technology – things which help workers to save time and produce more or better things without having to work harder.

A barista, for example, who doesn’t have to share a machine with their colleague, may be able to serve more coffees, and an accountant with access to better software provided by their company may be able to slash the time it takes to crunch numbers for their clients.

Cutting the 30 per cent corporate tax rate (an option currently on the table according to Productivity Commission boss Danielle Wood), though, is probably not a good move unless there’s a way to guarantee those big businesses won’t just pocket the extra profit or pay it out to shareholders.

It’s probably also bad news if it gives big companies – which already dominate many sectors of the economy – more power, making it difficult for small and medium-sized businesses to challenge them and drive innovation.

However, tax breaks for new investment which, in theory, should encourage firms to invest, seem less effective in Australia compared with many other countries, according to the Reserve Bank.

While big businesses might be keen for such changes, they probably don’t provide bang for our buck, and they come at a cost to the government’s budget.

This makes it more difficult to achieve some of the commission’s other reform priorities such as improving school student outcomes and upskilling the workforce. The better-educated we are, and the more we’re able to build on our skills, the better we become at doing things.

Under-resourcing of schools has been a well-documented issue – and probably a key factor behind Australia’s lagging performance academically. It’s also something the government will struggle to improve if its budget is tight.

Cutting red tape is another area of reform being examined by the commission. This is a good thing – especially when it comes to the net-zero transformation. It’s clear that climate change and the increased prevalence of natural disasters will hamper our ability to work. And without making it easier for Australian businesses to transition to cleaner energy, we’ll be left behind in the global shift, and fail to act on a hugely promising area of growth.

Speeding up approvals for new energy infrastructure is a good example from the commission of how we can improve productivity. Instead of being bogged down by lengthy approval times, businesses can get on with investing in transformative projects aimed at harnessing some of our natural gifts: sunlight, wind, and other cleaner forms of energy.

And while they are just lofty aims for now, other focus areas including supporting government investment in preventing health problems (rather than waiting to treat them after they arise) and improving our uptake of digital technologies, should make us more productive by ensuring a healthy workforce and helping us harness the power of developments such as artificial intelligence.

But these are all things we’ve known for some time.

It’s also about bosses and government departments listening to the lesser – but consequential – suggestions made by their employees.

If you ask any worker what the most time-consuming and unnecessary parts of their job are, they’ll almost always have an answer. Most teachers, for example, point to the growing and excessive administrative work they’re required to do which reduces their ability to do what matters for students – and what will actually affect students’ outcomes.

Yet, at company and department level, there’s usually little to no engagement with employees about what they think could be done better – and even when there is, a dismal amount is actually done about it.

A key determinant of the Productivity Commission’s success in improving productivity will be to compel top decision makers and bosses to act on all of these reform ideas. Paradoxically, legislating a shorter working week seems radical, but – as with the laws which brought in the eight-hour working day – could boost productivity.

There have been multiple studies showing shorter work hours improve workers’ wellbeing, focus and efficiency. Having less time to get things done often pushes us to lock in and get more done in a shorter amount of time.

And if this isn’t the case, shorter work hours will push bosses to implement the productivity-boosting changes required to support their workers to work more efficiently and improve productivity in the longer term.

Productivity growth isn’t always about our need for incessant growth in material things. It’s just as much about making our lives easier by giving ourselves the tools and conditions to help us work less for the same outcomes.

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Want greater productivity? Set wages to rise by 3.5 pc every year

Stand by for yet more talk about productivity. With the election over and Labor more comfortably ensconced on the Treasury benches, Treasurer Jim Chalmers has pronounced that top priority can turn from fixing the cost of living to fixing our poor productivity performance.

We’ll get the first of the Productivity Commission’s reports today on things we can do to improve our ... productivity. Well, let’s hope something comes of it. I’ll believe it when I see it.

Forgive my scepticism, but the great and good have been sermonising on the need for productivity improvement for well over a decade and, so far, the rate of improvement has gone down, not up.

A few years back, the Australia Institute reminded us that just about every economic change the Abbott-Turnbull-Morrison government made came with an assurance it would lead to greater productivity. It didn’t.

(But usefully, the think tank defined productivity as the amount of output of goods and services that can be extracted from each unit of input of labour or physical capital.)

So, at the opening of open season on claims about productivity, let’s start by spelling out a few clarifying facts. First, over the past decade or so, productivity improvement has slowed throughout the developed world. Thus, if we manage to turn ours around, we’ll have achieved something none of the other rich countries have managed.

Second, almost everything we hear implies that if productivity isn’t improving, it must be the government’s fault. So productivity must be something supplied by the government and, if the supply is inadequate, the government must produce more.

Nonsense. Productivity is determined by how efficiently every workplace is organised. Since the great majority of workplaces are privately owned, if the economy’s productivity isn’t improving from year to year, it’s primarily because the nation’s bosses aren’t bothering to improve it.

Remember this next time you see the (Big) Business Council issuing yet another report urging the government to do something to improve productivity. What businesspeople say about productivity is usually thinly disguised rent-seeking.

“You want higher productivity? Simple – give me a tax cut. You want to increase business investment in capital equipment? Simple – introduce a new investment incentive. And remember, if only you’d give us greater freedom in the way we may treat our workers, the economy would be much better.”

Why do even economists go along with the idea that poor productivity must be the government’s fault? Because of a bias built into the way economists are taught to think about the economy. Their “neoclassical model” assumes that all consumers and all businesspeople react rationally to the incentives (prices) they face.

So if the private sector isn’t working well, the only possible explanation is that the government has given them the wrong incentives and should fix them.

Third, businesspeople, politicians and even economists often imply that any improvement in the productivity of labour (output per hour worked) is automatically passed on to workers as higher real wages by the economy’s “invisible hand”.

Don’t believe it. The Productivity Commission seems to support this by finding that, over the long term, improvement in labour productivity and the rise in real wages are pretty much equal.

Trouble is, as they keep telling you at uni, “correlation doesn’t imply causation”. As Nobel Prize-winning economist Daron Acemoglu argues in his book Power and Progress, workers get their share of the benefits of technological advance only if governments make sure they do.

Fourth, economics 101 teaches that the main way firms increase the productivity of their workers is by giving them more and better machines to work with. This is called “capital deepening”, in contrast to the “capital widening” that must be done just to ensure the amount of machinery per worker doesn’t fall as high immigration increases the workforce.

It’s remarkable how few sermonising economists think to make the obvious point that the weak rate of business investment in plant and equipment over the past decade or more makes the absence of improvement in the productivity of labour utterly unsurprising.

Fifth, remember Sims’ Law. As Rod Sims, former boss of the competition commission, often reminded us, improving productivity is just one of the ways businesses may seek to increase their profits.

It seems clear that improving productivity has not been a popular way for the Business Council’s members to improve profits in recent times. My guess is that they’ve been more inclined to do it by using loopholes in our industrial relations law to keep the cost of labour low: casualisation, use of labour hire companies and non-compete clauses in employment contracts, for instance.

Sixth, few economists make the obvious neoclassical point that the less the rise in the real cost of labour, the less the incentive for businesses to invest in labour-saving equipment.

So here’s my proposal for encouraging greater labour productivity. Rather than continuing to tell workers their real wages can’t rise until we get some more productivity, we should try reversing the process.

We should make the cost of labour grow in real terms – which would do wonders for consumer spending and economic growth – and see if this encourages firms to step up their investment in labour-saving technology, thereby improving productivity of workers.

Federal and state governments should seek to establish a wage “norm” whereby everyone’s wages rose by 3.5 per cent a year – come rain or shine. That would be 2.5 percentage points for inflation, plus 1 percentage point for productivity improvement yet to be induced. Think of how much less time that workers and bosses would spend arguing about pay rises.

Governments have no legal power to dictate the size of wage rises. But they could start to inculcate such a norm by increasing their own employees’ wages by that percentage.

The feds could urge the Fair Work Commission to raise all award wage minimums by that proportion at its annual review. If wages of the bottom quarter of workers kept rising by that percentage, it would become very hard for employers to increase higher wage rates by less.

A frightening idea to some, maybe, but one that might really get our productivity improving.

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Ross Garnaut: Prophet with a sunny view of our better future

Economist Paul Krugman’s endlessly repeated maxim that “productivity isn’t everything but, in the long run, it’s almost everything” has deluded far too many of the economics profession’s conventional thinkers.

It’s a throwaway line that should be thrown away.

It implies that any economic objective other than improved productivity is hardly worth worrying about. Such as? Distributional fairness aka “intergenerational inequity”. Tell that to the 40 per cent of voters under 40, and see how far you get.

It implies that the structure of our economy never changes, nor does the planet we live on. So the single-minded pursuit of improved productivity will somehow either stop climate change or magically deliver us a zero-carbon economy without any need for government intervention.

Or maybe the proviso “in the long run” is saying that our great, great-grandchildren will be able to look back on the clean-energy transition as little more than a blip. What a pity we live in a succession of short runs, not the long run.

A more realistic view is that, should the world fail to stop climate change, life will become almost unlivable, much of the economy will be stranded assets, and every spare cent we have will be spent shifting from one part of the country to another, and on buying hugely expensive water and permanent air conditioning.

A less cataclysmic future would see climate change get a lot worse before the major economies finally got their act together and ended the use of fossil fuels. This, of course, would lead to much unemployment in our coal and gas industries and much loss of export income.

Our future, no matter which way you envisage it, doesn’t sound very inviting. Much of our “natural endowment” of coal and gas deposits will be worthless and our “comparative advantage” in flogging them off to other countries will have disappeared. Do you still believe our government should be only worried about improving productivity?

What we need is some sort of economist prophet who can help us overcome this existential threat, not an army of blinkered economists telling us all that matters is raising our material standard of living.

Fortunately, among the profession’s abundance of unproductive thinkers is a lone prophetic, and so productive, thinker, Professor Ross Garnaut, who sees not only how we can minimise the economic cost of the transition to clean energy, but also what we can do for an encore. What we can do to fill the vacuum left by the looming collapse of our fossil fuel export business (which, by chance, happens to be our highest-productivity industry).

Because economists are such incurious people, Garnaut seems to have been the first among them to notice that, purely by chance, Australia’s natural endowment also includes a relative abundance of sun and wind.

Until now, we thought these were non-resources and of little or no commercial value. It took Garnaut to point out that, in a post-carbon world, they had the potential be our new-found comparative advantage. To provide us with a whole new way of making a bundle from exports, while generating many new jobs for the miners to move to.

When you add the possibility of structural change to the rules of conventional economics, you get what’s a scary thought for many economists: maybe our natural endowment isn’t ordained by the economic gods to be unchangeable through all eternity.

Maybe there are interventions fallible governments should be making to move our economic activity from one dimension of our natural endowment to another. Maybe such a switch is too high-risk and involves too many “positive externalities” (monetary benefits than can’t be captured by the business doing the investing) for us to wait for market forces to take us to this brave new world.

Maybe changing circumstances can change the nature of our comparative advantage in international trade, meaning the government has to nudge the private sector in a new direction.

It was Garnaut who first had the vision of transforming Australia into a “Superpower” in a world of ubiquitous renewable energy. And it was he who uncovered the facts that made this goal plausible.

Exporting our fossil fuels is cheap, whereas exporting renewable energy would be much more expensive. So whereas it was more economic to send our coal and iron ore overseas to be turned into steel, in the post-carbon world it soon will be more economic to produce green iron and other green metals in Australia and then export them.

In a speech last week, Garnaut acknowledged that, in its first term, the Albanese government began to lay the policy foundations for the Superpower project. The economic principles are set out clearly and well by Treasury’s “national interest framework” for A Future made in Australia, released after last year’s budget, he says.

The re-elected Albanese government has already restated its commitment to the project. Garnaut says there’s much more for the government to do in creating the right incentives for our manufacturers to re-organise and expand.

Research sponsored by his Superpower Institute finds that Australian exports of goods embodying renewable energy could reduce global emissions by up to 10 per cent. So we can contribute disproportionately to global decarbonisation by supplying goods embodying renewable energy that the high-income economies of Northeast Asia and Europe cannot supply at reasonable cost from their own resources.

This would “generate export income for Australians vastly in excess of that provided by the gas and coal industries that will decline as the world moves to net zero emissions over the next few decades”.

Garnaut concludes: “The new industries are large enough to drive restoration of growth in Australian productivity and living standards after the dozen years of stagnation that began in 2013.”

The present fashion of obsessing with productivity improvement for its own sake is counterproductive and probably won’t achieve much. We should get our priorities right and focus on fixing our most fundamental problems – unfairness between the generations, action on climate change and fully exploiting the opportunities presented by our newfound strength in renewable energy – and let productivity look after itself.

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The real truth on productivity: the bosses aren't trying hard enough

At last, some sense on the causes of our poor productivity performance. For ages, we’ve been told it’s the government’s fault – maybe even the voters’ fault – for failing to make economic reforms. But last week the econocrats finally set the record straight: the problem is, our businesses have stopped doing the things that make us more productive.

For about a decade, we’ve had little improvement in the economy’s productivity – its ability to produce more goods and services from an unchanged quantity of inputs of labour and capital. That is, to be a bit more efficient this year than we were last year. Most of the other rich economies have the same problem, but ours seems worse than most.

It’s by increasing our productivity that we’ve become so much more prosperous than our great-grandparents. For instance, in 1901 it took 18 minutes of the average worker’s time to afford a loaf of bread, while today it’s just four minutes.

It’s remarkable the way the nation’s economists have stayed silent while vested interests such as the (Big) Business Council have sought to use this problem to press the government for favours that would make them more profitable without having to try any harder.

Until now, and except for former top econocrat Dr Michael Keating, no economist has pointed out how far the politicking over productivity has strayed from Economics 101. To hear the rent-seekers talk, you’d think that one of the main things governments are responsible for is producing and distributing productivity.

Nonsense. Because the private sector produces the great majority of the economy’s goods and services, it’s overwhelmingly the job of businesses – big and small – to gradually increase the productivity of their activities. So, when productivity’s lagging, the first place you look is in businesses’ backyard.

Next, every high school economics student knows that the main way businesses increase the productivity of their workers’ labour is by giving them more and better machines to work with. When they remember to mention it, economists call this “[physical] capital deepening”.

So, how have we been going with increasing business investment in buildings and plant and other equipment over the past decade or so? Short answer: not well.

Really? Really? Business investment has been weak for a decade but, when you preached your last sermon on the need for greater productivity, you didn’t see a need to mention this small fact?

There’s most of the problem right there. The productivity of labour hasn’t increased much because business hasn’t been spending much on labour-saving equipment. Mystery solved.

Almost to a person, economists are great believers in high rates of immigration. Immigration, they keep telling us, is great for economic growth. It’s true. There’s no easier way to grow an economy than to increase the number of people in it.

Businesses love high immigration because it gives them a bigger market to sell to. But whether that kind of economic growth leaves the rest of us better off is a different matter. As all the economists were taught at uni but keep forgetting to mention to the punters, the claim that immigration raises our material standard of living – which is the oft-stated benefit of economic growth – comes with a big proviso.

Which is? Productivity. If you get more people, but fail to provide them with the same capital equipment as the rest of us have – extra machines for the extra workers, extra houses for the extra families, and extra roads, public transport, schools and hospitals for the extra families – everyone’s standard of living goes down, not up.

In economists’ jargon, you have to ensure immigration doesn’t cause a decline in the “capital-to-labour ratio”. As well as the spending on “capital deepening” needed to raise our productivity, you also need spending on “capital widening” merely to stop our productivity worsening.

Guess what? We’ve had years of high immigration without the increased capital spending to go with it. Part of the problem is that the level of government with control over immigration, the feds, is not the level of government with responsibility for ensuring adequate additional investment in public infrastructure, the states.

As for the additional investment in machines to cover the needs of the bigger workforce, that’s down to the nation’s businesses. Guess what? They haven’t bothered. Our ratio of capital to labour is actually a little lower than it was a decade ago.

And surprise, surprise, we’ve had little improvement in productivity over the same period. Who knew? Why didn’t somebody tell me? Well, the business lobby was busy covering its backside by blaming it all on the government. And the economists have been so busy with their maths and models that they’ve got a bit rusty on the economic basics.

But here’s the news: last week, the econocrats got their act together and showered us with much-needed sensible analysis. The Reserve Bank’s Dr Michael Plumb gave the best-written and most informative speech to come out of the Reserve in yonks. He delivered it to a meeting of the Australian Business Economists, and boy did they need the tutorial. It’s required reading.

Plumb blamed the problem on the slow improvement in the amount of (physical) capital available to each worker and, to a lesser extent, little improvement in our firms’ ability to combine labour and capital more efficiently (known to economists as “multi-factor productivity”).

As well, the Productivity Commission issued a more technical paper by Lawson Ashburner and Vincent Wong examining multi-factor productivity, Learning but not always doing. Focusing on businesses, it found that “a creeping inefficiency and failure to push the boundaries of innovation has contributed to Australia’s poor productivity performance”.

So why have our businesses done so little to improve their productivity? Rod Sims, former boss of the Australian Competition and Consumer Commission, answers the last part of the puzzle.

He says that increasing productivity is just one way for a business to increase its profits. I think our guys have found it much easier to increase their profits by using legal loopholes such as casualisation and labour hire to screw down their wage costs.

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Why bribery is key to boosting our economic prosperity

By MILLIE MUROI, Economics Writer

Of all the incentives in the world, money must be among the most powerful. Since its birth thousands of years ago, dosh – chasing it, saving it, and paying it back – has driven us to ruin but also some remarkable feats. So, it shouldn’t be any different when it comes to the “p” word.

Before your eyes glaze over at the mention of productivity, you should know that had it improved more in recent years, we’d all probably have a lot less to complain about when it comes to issues such as cost of living – and the Reserve Bank wouldn’t be so worried about wage rises feeding into inflation.

What if I told you that boosting our productivity starts with bribing our state governments?

In a speech to the Queensland Economic Society of Australia in Brisbane last week, economist and former corporate watchdog boss Karen Chester identified one of the biggest hurdles to lifting our living standards: a problem called “vertical fiscal imbalance”.

Here’s the issue. Some of our most fundamental needs are taken care of by the state government: education, health, transport, and law and order to name a few. This all requires mountains of cash which the state governments have little ability to raise.

It’s the federal government that has the power to raise a lot of money – mostly through taxation, meaning there’s a mismatch: state governments might be tasked with the big asks, but it’s the federal government that has the cash to splash. As Chester puts it: “The states wear the political pain and the budget loss in doing the right thing.”

Money can’t buy happiness or solve all our problems, but without it, it’s hard to pay for – or incentivise – fixes in some of our biggest sectors, including boosting productivity.

Our productivity improves when we increase the quantity or quality of the goods and services we produce with a given set of resources, such as workers. Making people work longer hours doesn’t count towards improving productivity, but using better technology or other innovations does.

The reason we care so much about productivity is that it’s the main way capitalist economies have kept making us better off – at least materially – over the past few centuries. Innovations from the lightbulb to the assembly line to the internet have made us faster and better at doing our jobs.

Right now, we’re in a productivity slump. Despite a record-breaking increase in hours worked in 2022-23, the amount we’re producing hasn’t been climbing all that much.

Over the long-term, Australia’s productivity has grown by about 1.3 per cent every year. In 2022-23, our labour productivity – the amount of GDP we pump out for each hour we work – actually fell 3.7 per cent.

While pay rises are awesome, there’s a problem when we get them without productivity growth as we’ve had recently: it can feed into inflation. Why? Because it means we push up the cost that goes into providing goods and services without much change in how much we’re actually producing.

So, how do we push up productivity? And how do we fix the vertical fiscal imbalance problem strangling state governments’ ability to take some bold action? Chester says one way is for the federal government to take over chunks of the states’ existing debt which they’ve used for things such as building roads and other public infrastructure.

Why should the federal government scoop up this debt which they aren’t responsible for spending? Because it significantly cuts states’ annual interest bill and boosts their ability to borrow more for new projects. Why is this? Because the federal government can borrow at a lower interest rate than the states – mostly because those who lend to them see a smaller risk of the federal government defaulting, meaning it has a better credit rating.

The total amount being borrowed by the public sector can stay the same but the interest paid on it can be squashed down.

Now, this transfer of debt has to come with some strings attached. Namely, it should be conditional on the states making progress in implementing agreed reforms.

Chester says these reforms should be aimed at resuscitating flat-lined productivity through changes such as tax reform, jack-hammering entrenched disadvantage through measures such as more social housing for people with chronic and debilitating mental health, and relieving structural inflation pressures such as those arising from natural disasters and soaring insurance costs.

Instead of the federal government spending 96 per cent of its natural disaster budget on mopping up the mess, it should give states more money (the amount could also be matched by the states) to spend on mitigation efforts: reducing the risk of future harm from natural disasters such as floods, cyclones and bushfires. This would also put a brake on surging insurance costs.

It’s not the first time we’ve had the idea to give states more headroom to make meaningful reform. In the late 1990s, there were three tranches of payments from the Australian government to states and territories based on their populations – and only if they made satisfactory progress on their reform commitments.

These payments, known as national competition policy payments, cost roughly $1 billion annually (in today’s terms) over six years. But they helped push through reforms such as removing restrictions on retail trading hours, setting up the national electricity market and abolishing price controls on dairy. The Productivity Commission estimates the payments helped lift GDP by at least 2.5 per cent.

By comparison, Treasurer Jim Chalmers last month set up a $900 million fund to prod states and territories into enacting productivity-boosting reforms: a baby step forward – especially, as Chester says, because we confront a much bigger to-do list than we did a few decades ago.

The idea to transfer debt from the states to the Commonwealth government would be a lot cheaper than the old competition policy payments – and it’s a huge opportunity to make big steps forward in improving productivity and wellbeing.

Why do we need this? Because of the sad truth that the vertical fiscal imbalance we’ve talked about has sunken the states into a mentality where they don’t want to make any reforms that the Commonwealth government wants them to make unless they’re bribed into doing so.

Chalmers this week said his government was bold and reforming. But reform needs to take foot in some of our most consequential sectors including health and education. To achieve this, we need states to buy into the vision and, most importantly, act on it.

The good news? Chester says implementing the buyback program is relatively quick. We just need the guts to do it.

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Why the planet needs the economy to go round in circles

By MILLIE MUROI, Economics Writer

For as long as humans have walked the earth, we’ve grappled with this dilemma: how to satisfy our unlimited wants and needs with limited resources. Eventually, people started putting pen to paper, and called the study of this problem “economics.”

Over time, we’ve become better at making – and doing – more: by piecing together machines that can dig more out of the ground, stripping the soil, and producing all sorts of foods, gadgets and shelter. Our ancestors would be shocked walking through the supermarket, and trawling online, at the seemingly infinite choices at our fingertips today.

But all this has come at a cost – which we haven’t been particularly good at factoring in.

For the past few centuries, we’ve measured our success, economically speaking, mostly by how much we’re able to produce. The bigger the amount (often measured by gross domestic product (GDP). the better.

In simply prioritising greater output, though, we’ve been pumping out emissions, producing massive amounts of waste and damaging land and waterways. We’ve been scoring own goals, even as we press forward in this seemingly never-ending game of producing more.

Now, the solution isn’t necessarily to rewind the work we’ve done. But it does pay to look back in time. For many indigenous communities, it has been the case for millennia that people take only what they need, leaving enough for remaining resources to regenerate, and reusing and repairing things rather than tossing them away.

These principles are also at the heart of the concept of a “circular economy”.

Our economy now is mostly “linear”, meaning we tend to take raw materials from the earth, make things out of them, then pretty quickly dispose of them when those things start falling apart. A lot of the valuable materials we take from the land end up buried in landfill or drifting around in the atmosphere or our oceans – which, apart from harming the environment, is a problem when we’re on a planet with limited resources.

Now, most of us have a decent understanding of recycling. You probably divvy-up your hard plastics from your soft plastics, and you might even have a compost bin or worm farm.

Australia’s overall material recycling rate in the 2021–22 period was about 63 per cent – or 1568 kilograms of recycled material for each person, up from 57 per cent in 2011-12. It’s an industry which added roughly $5 billion in value to the Australian economy, more than 30,000 jobs, and paid over $2.5 billion in wages and salaries in 2021-22. And there’s room to grow.

But the circular economy starts long before we decide to toss things out. It’s about designing things in ways that create less waste: from the process of making them (how can we limit by-products like carbon dioxide when building a house, or make a car using less material?) to designing goods that last the distance, or run more efficiently (how can we make T-shirts that hold their shape for years, or planes that run on less fuel and cough out fewer emissions?)

It’s also about a mindset shift – which could actually make us happier. In our consumption-led economy (household spending drives more than half of our economic growth), it’s easy to fall into the trap of buying things. Ads spruiking that thing you really need are everywhere. Whether it’s the newest iPhone, that cute outfit you’ve been eyeing up, or that power tool which will definitely complete your collection, the dopamine hit when you walk away with a new item is a fuzzy feeling many of us are familiar with.

But that excitement tends to wane over time, buyer’s remorse can creep in, and we often end up with a lot of clutter which we compare to other people’s clutter and fall into an endless cycle of sorting through.

Being more conscious about our purchases, buying things that are made sustainably, and thinking about how to extend the life of our possessions, are good places to start. “Buy Nothing” groups where people give away things they no longer need, and repairing things rather than throwing them away, are ways we can save money and feed into this circular economy.

The way we consume things is undeniably a game-changer. But the government and the country’s businesses also have a role. In October 2022, Australia’s environment ministers committed to speeding up the transition to a circular economy by 2030.

This week, the Productivity Commission opened up its desk to submissions for its inquiry into Australia’s opportunities in the circular economy. Requested by Treasurer Jim Chalmers, the inquiry will look into ways Australia can “improve materials productivity and efficiency in ways that benefit the economy and the environment.”

While we’ve tended to fixate on how we can improve the productivity of workers, international studies suggest a more circular economy can lead to higher economic growth and productivity, largely by boosting how productive we are with our inputs: essentially making more with a given amount of raw materials.

Australia has the fourth-lowest rate of materials productivity among OECD countries, generating $US1.20 of economic output for each kilogram of materials we consume. That’s less than half of the OECD benchmark of $US2.50.

Of course, it’s important to remember Australia is a bit of an outlier. We’re a highly resources-driven economy, with vast amounts of land separating us from our cows, sheep, mines and one another. While we can make transport less wasteful, achieving 100 per cent circularity is practically off the table.

Moving towards a more circular economy, though, is a worthwhile exercise – and one we’ve been making progress towards. Our material productivity has increased from $1.45 generated from a kilo of materials in 2010, to nearly $1.60 a kilogram in 2023, and we’re generating a bit less waste per person than we were a couple of decades ago.

Since the industrial revolution, we’ve rapidly fattened up our economy by pumping out products and consuming more. While going around in circles is generally a bad thing, the best way forward might be just that.

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How GPT (not that one) could help fix our inflation problem

By Millie Muroi, Economics Writer

ChatGPT is not the answer to Australia’s productivity problem. At least, not yet.

But I asked ChatGPT what its chances were of productivity improving in Australia – if it was a betting man. The answer? 70 to 80 per cent.

Productivity growth excites economics nerds, like those at the Reserve Bank ... and just about no one else. But it matters for everything from your mortgage to the prices you pay at shops and the quality of your life.

Why? Because productivity growth means being able to make more with what we have, which is the best solution to the biggest economic issue of our time: inflation.

After all, there are two sides to this inflation problem: too much demand and too little supply. Instead of the Reserve Bank beating down our appetite for goods and services through ramping up interest rates, wouldn’t it be nice if businesses could simply produce more with the workers and equipment they already had, therefore keeping prices in check?

We could work longer hours and maybe even put our machines under more strain, but we can only do that for so long: it would be like trying to run a marathon at sprinting speed.

That doesn’t mean we should abandon all hope.

Instead, to curb price rises, and to lift our living standards over time, we need to improve productivity. Like a marathon runner improving their running technique, we need a way to get faster or better at what we do. A crucial way of doing this is through discovering and using new technology that helps us pump out more, or better quality, goods and services, in a way that can be maintained.

The most influential of these tools (those that have transformed the way we live) are called General-Purpose Technologies – or GPTs for short. The steam engine, cars, electricity and the internet all count as GPTs, because they were widely adopted and became crucial pieces of technology which dramatically yanked up our productivity.

We may not consciously think about it. But imagine what our lives would look like today without electricity, internet and cars. We would be slower, have much less information at our fingertips and would find it harder to work once the sun sets.

As Andrew Leigh points out in his book The Shortest History of Economics, the journey to create the electric bulb itself shows how our productivity has improved. In prehistoric times, producing as much light as a regular household lightbulb using wood fire would have taken our ancestors about 58 hours of foraging for wood. Today, it takes less than a second of work to earn enough to flick a household light bulb on for an hour.

ChatGPT is an example of a tool that could become a general-purpose technology. But the “GPT” in its name actually stands for “generative pre-trained transformer”: a fancy way of saying a piece of software trained using huge amounts of data to offer up human-like answers to questions like mine.

During the pandemic, there was a short-lived surge in the take-up of cloud computing (IT services that businesses can use without owning or running the physical servers, hard drives and networks required themselves). But generally, Australian businesses are behind the curve when it comes to adopting new technologies – and we don’t develop much of it ourselves.

That doesn’t mean we should abandon all hope. Instead, we need to think about the drivers of, and barriers to, adopting technologies such as cloud computing and artificial intelligence: two GPTs in the making.

Kim Nguyen and Jonathan Hambur at the Reserve Bank say these technologies could alter the way we do business. But knowing how to use and make the most of them also requires highly skilled and educated workers.

A website called ChatGPT is raising questions about the role of artificial intelligence in our education, work and relationships.

Nguyen and Hambur’s research involved trawling through the annual reports, job ads and earnings calls of Australian businesses to figure out how much workers’ and managers’ skills matter when it comes to successful adoption of GPTs.

Here’s what they found. Firms which had snagged a board member with experience in the IT industry were 30 percentage points more likely to adopt a GPT. While there were certainly businesses which took up GPT without a technologically skilled board member on their team, these firms generally failed to see much improvement in their profitability after putting a GPT in place.

Basically, having board members with relevant technological experience has been linked to more profitable use of GPT. Of course, the authors point out this could be because firms that appoint technology-savvy board members tend to be more focused on IT in the first place, and therefore more likely to be able to adopt GPT in a way that increases profitability.

But firms with technologically skilled board members were also more likely to look for workers with GPT skills, indicating those workers might also play an important role in profitable GPT adoption. Whatever the exact link, uptake of GPT is linked to higher demand for skilled workers, meaning education and training will be key to nailing the use of these technologies.

While the Reserve Bank’s toolkit is limited to setting interest rates (and, informally, jawboning) the less painful solution to getting inflation under control is to improve our productivity, and therefore the amount of goods and services to go around.

Productivity growth is difficult to measure, and quarter-to-quarter movements can be rocked by things that have little to do with anything. But it has flattened out in recent months, and without productivity growth to match, wages, which have begun to pick up in recent times, will worry the Reserve Bank and may build the case for the Reserve Bank to keep interest rates higher for longer.

ChatGPT has hit the headlines over the past year: from students using it in a bid to boost their marks and to some media companies relying on it to churn out AI-generated content. While it’s yet to join the ranks of coveted general-purpose technologies, ChatGPT is an example of innovation which could turn out to be a game-changer.

Right now, it’s an imperfect tool being put to use by an inexperienced user (me). But I asked ChatGPT if it could write a better opinion piece, and faster than I could. The answer? “I’d love to give it a try!” 

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Why the Reserve Bank thinks it's too soon to cut interest rates

By Millie Muroi, Economics Writer 

When the Reserve Bank’s second-in-command – recently appointed deputy governor Andrew Hauser – took shots at his closest observers this week, he ruffled plenty of feathers.

“It’s a world of winners and losers, gurus and charlatans, geniuses and buffoons,” he proclaimed. Then he wagged a finger at those confidently commentating from the sidelines on the direction of the economy. “It’s a dangerous game,” he warned.

We know economists – including those at the Reserve Bank – are notoriously bad at knowing exactly what we (and therefore the economy) will do. So, why was Hauser so mad at those confidently making their own calls?

Brash statements made by the media, government and economists have real-world consequences. People often rely on that information to make decisions, from taking out mortgages to negotiating wages.

“What about Phil Lowe?” you may ask. Didn’t the former RBA governor promise in 2021 that interest rates would not go up until 2024? Well, sort of. It was actually couched in caveats which many people glossed over.

The Reserve Bank generally treads carefully because the words of its bosses can shift behaviour: a hidden weapon beyond its interest rate-setting superpower.

RBA governor Michele Bullock often declares she is “not providing forward guidance” when fielding questions from journalists trying to get a steer on interest rates. But last week, she gave the closest thing to guidance in a while: people’s expectation for rate cuts in the next six months doesn’t align with the RBA board’s feeling, she said. At least, “not at the moment.”

In doing so, Bullock flexed the bank’s hidden bicep. She signalled for all of us to rein in our expectations of a rate cut and, she would have hoped, our inflation expectations.

This is important because what people believe can become reality. If we expect inflation to stay high, this belief can feed into the wages we ask for, and the prices businesses charge.

That’s not to say the Reserve Bank doesn’t believe its own thinking. The only medicine it can explicitly prescribe is the level of interest rates, but the central bank busies itself with a lot of data gathering, discussions and number crunching to diagnose the state of the economy.

Core to the Reserve’s thinking is its observation that, collectively, we are consuming more than we can produce for an extended period of time. Sure, young people and mortgage holders have been tightening their belts as housing costs surge. But that’s been more than offset by older, affluent Australians splurging on things such as travel, by population growth and by government spending.

Now, the government has bones to pick with any suggestion that its spending is contributing to inflation. And Government Services Minister Bill Shorten this week trashed RBA chief economist Sarah Hunter’s assessment that the economy is “running a little bit too hot”.

However, it is important to note Hunter’s view isn’t necessarily that Australians are doing too well, or that the economy is bubbling along. It’s more a reflection of the limited spare capacity we have to cater for the spending – however little or much of it we may be doing.

We’re spending “too much” mostly by comparison to the limited resources we have to keep up with it: the people making our coffee in the morning and machines they use to brew it for us, for example.

Unless we become more productive, making more with the things we already have, the more we strain people and machines to meet our demands, and the pricier things will be to produce.

Productivity is especially difficult to improve for sectors such as hospitality, which rely heavily on people rather than machines (there’s only so many ways your barista can brew a coffee faster and better). And it’s why services inflation is proving so much more stubborn than goods inflation.

How does the Reserve Bank know how much spare capacity we have (and therefore how much pressure we might expect on prices)? It looks at something called the output gap: the difference between how much we’re producing and how much we could produce without putting too much pressure on prices.

Heaven for the Reserve Bank would be an output gap of zero. Any lower means we’re not using our resources as intensively as we could – including people who want to work, but can’t find jobs, or machines sitting idle.

Any higher, and we’re using our resources too intensively. This can be OK for a short period, but as workers demand higher wages, machines are run into the ground and businesses compete for a shrinking pool of resources, prices rise. For the past few years, this is the state the Reserve Bank thinks our economy has been in.

Measuring the output gap is tricky. We can’t really see it, and our capacity can change over time as our population changes, or we find better ways to do things. So, how does the RBA measure it?

How much the economy is producing is measured through statistics such as Gross Domestic Product. The trickier task is pinning down how much the economy could produce without adding to inflation. To do this, the Reserve Bank uses economic models which spit out results based on things such as what’s happened in the past and the data plugged into them: relatively straightforward numbers such as population, as well as educated assumptions about other factors influencing the economy.

The bank also asks businesses about their capacity usage through surveys and by chatting with them through its liaison program. Then, there’s also the inflation figure itself.

While the output gap is just one gauge, it is given considerable weight in the Reserve Bank’s decisions. So far, the gap is narrowing, the bank says, but it’s likely we’re still pushing our resources past the ideal level to pull inflation back into line.

There’s not much the central bank can do to increase potential output, or capacity, in the economy, which is why it is instead focusing on weakening our demand, or spending.

While a rate cut now would be like an iron infusion for an anaemic economy, help preserve jobs, and bring mortgage holders relief, the bank is clearly on the warpath against its public enemy number one: inflation.

Keep in mind, though, no one is perfect. The Reserve Bank is careful to stress that the output gap, like most of its other measures, is “subject to considerable uncertainty.”

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Productivity isn't working, so why not try being more ethical?

Economists and business councils have been telling us for years that we must improve our productivity if we want to be more prosperous but, so far, they’ve had little success. Surely, there’s something else we could try?

As we’ll see, it’s something for Treasurer Jim Chalmers to ponder as he puts the finishing touches to next Tuesday’s budget.

Economists have many strengths, but they don’t win many prizes for thinking outside the box. Productivity is the obvious way to increase our prosperity but, despite all the admonition, for years it’s been hard to achieve, both here and in the other rich economies. It’s clear there’s a lot economists don’t know about how productivity is improved.

So, is there nothing else we could do to improve the way the economy works and the satisfaction it brings us? Of course there is – particularly when you remember this isn’t just about dollars and cents. Don’t you think life would be better if we could do all our earning and spending in an economy that generated less angst?

I’m indebted to Dr Simon Longstaff of the Ethics Centre for reminding me that behaving more ethically would be a good way to get better results from the economy.

Huh? How does that work? Let me tell you.

Ethics is a set of beliefs about the right way for people and organisations to behave, particularly in their relations with other people. Often, the right thing for us to do in particular circumstances is obvious.

It’s obvious, for example, that we should (almost) always obey the law. It’s just that obeying the law isn’t always convenient or inexpensive. And sometimes when our own interests are top of mind, it’s hard to see what’s obvious to everyone else.

In any case, because differing groups of people have differing beliefs and motives and objectives, ethical dilemmas – deciding what’s the right thing to do in all the circumstances – are common, particularly in business. That’s why we have a new profession of ethicists offering advice to organisations, of which Longstaff is the most prominent.

But what’s that got to do with the economy?

Well, let’s be clear. The only reason we should need to do the right thing is that it’s the right thing to do. And the only reward we should expect is being able to sleep well at night in the knowledge that we’re treating people justly, often at some cost to ourselves.

However, as Deloitte Access Economics has demonstrated in a report for the Ethics Centre, there is a strong “business case” for behaving ethically. A case that makes sense not just for individuals and businesses, but also for the treasurers and Treasuries responsible for improving the way the economy’s working.

The case rests on an obvious, but often forgotten truth: market economies rely on a high degree of trust. Trust between buyers and sellers. Trust that you’re not selling me a dud. Trust that your cheque won’t bounce.

Trust that you’ll let me return it if there’s a problem. Trust that you’ll honour your promise to service the thing for the next X years. Trust that you won’t pinch someone else’s bag from the airport carousel. Trust that you’ll repay the money I lent you.

Trust that if I let you check yourself out at my supermarket, you won’t slip in a few things you didn’t ring up. Trust that if I work for you, you’ll treat me fairly. Trust that the law will back me up if you do the wrong thing.

Point is, the more confident we are that we can trust each other – trust the businesses we deal with – the more smoothly and cheaply the economy runs and the more business gets done. When we have to spend a lot of money on security and making sure we’re not ripped off, the costs mount up, and we end up not doing all the transactions we could.

So, how do we get more trust into the economy? How do workers, employers and businesses get themselves a good reputation? By always behaving ethically. (I could say this also applies to politicians, but that would be pushing it.)

Research by Access Economics finds evidence that fewer unethical decisions lead to better mental and physical health for individuals. And evidence that unethical behaviour leads to poorer financial outcomes for business. And evidence that ethical behaviour results in higher wages.

But Access also reminds us of the evidence that our ethical standards could be a lot higher than they are. The World Values Survey finds that only a bit over half of Australians think most people can be trusted. The Governance Institute finds that, on a scale running from minus 100 to plus 100, Australia ranks at plus 45, or “somewhat ethical”.

Then there’s the string of royal commissions finding unethical or even illegal behaviour in institutional responses to child abuse, misconduct in the banking industry, and aged care. And that’s before we get to the epidemic of “wage theft” that so many otherwise respectable big businesses have had to admit to – all of it purely accidental, apparently.

OK, OK, we could do a lot better, with that producing tangible economic benefits. But how? Well, one approach would be for economists and econocrats to switch their sermonising from productivity to ethical behaviour.

Perhaps not. What would help is for ethical questions to get a lot more of our attention. As sociologists understand, but most economists don’t, businesses – like the rest of us – tend to want to do what others are doing. If we’re all being ethical, I don’t want to be seen as uninterested in ethical behaviour.

If we could give ethics a higher profile, we’d probably get more of it. If expert advice on ethical problems was more readily available, more would be asked for. If there were more training and meetings and conferences on the topic, more decisions would be examined for their ethical implications.

Longstaff’s Ethics Centre has a proposal to improve our “ethical infrastructure” by teaming up with the universities of Sydney and NSW to establish an Australian Institute of Applied Ethics, which would be open to receiving requests from governments and the private sector to report on major ethical questions facing the nation. It would be a bit like the Productivity Commission or the Australian Law Reform Commission, but it would not be a government body.

It would also contribute to education, training and leadership development, building the practical skills of good decision-making on ethical issues in the private and public sectors.

Copying the pattern used to establish the hugely successful Melbourne-based Grattan Institute, the proposal is for the federal government to contribute $30 million towards a $40 million one-off endowment. The new institute would be funded from the earnings on this endowment, plus earnings from providing education, training and other services.

We’ll learn on budget night whether Chalmers and his boss are acting on this sensible idea for achieving a better economy, or whether they will be content with more platitudes on the need for greater productivity.

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It's not perfect, but our health system is one of the best

When it comes to self-belief, Australians are funny. We have no doubt that Australia punches well above its weight in almost every sport. And our Diggers are braver and more dependable than the rest. In other departments, however, we don’t rate ourselves highly.

Australians pay among the lowest taxes of all developed nations, but the belief that we’re among the highest taxed is so widely believed it’s impervious to facts.

Take the latest headline that we’ve been “flattened by the biggest tax increase in the world”. “There, I knew it,” I hear you mutter. Well, not quite.

It’s true, as the story said, that in 2023 working Australians suffered the biggest increase in their average tax rates in the developed world, according to figures issued by the Organisation for Economic Co-operation and Development.

The increase was caused by bracket creep and the Morrison government’s sneaky decision to end the “low- and middle-income tax offset” (a move that never made it to a press release, meaning most of the media didn’t notice and didn’t tell their audience about).

But that doesn’t in any way confirm our belief that we’re highly taxed. It may have been true last year, but it will be far from true this year as the huge stage 3 tax cuts take effect in July.

Nor is it confirmed by the repeated assertion that we are more dependent on income tax than any of the other OECD countries. This is literally true, but only because, unlike almost all the others, we don’t impose separate social security contribution taxes on the incomes of workers and employers.

The more important point, however, is that so far we’ve been talking only about the biggest and most noticeable of our taxes, personal income tax. Surely you don’t think that’s the only tax we pay?

What about a little thing called the goods and services tax? (Or, to other rich countries bar the United States, value-added tax.) Our tax rate of 10 per cent is way lower than even the Kiwis’, let alone all the Europeans’. They’re up in the 20s.

No, all told, we pay less tax than almost all the others. But how would you rate us on, say, healthcare? My guess is most people’s answer would be, at best, nothing to write home about.

Wrong. We keep hearing about problems with Medicare, but every country’s healthcare system has its shortcomings. New research by the Productivity Commission – hardly known for its boosterism – has found that our health system “delivers some of the best value for money of any in the world”.

The commission has been measuring the productivity of our healthcare system – roughly, what we get for what we pay – and, for the first time, taking account of changes in the quality of that care.

In principle, the system covers all our spending on healthcare: public and private; hospitals, GPs and specialists, whether paid for by taxpayers, health insurance or directly out of our pockets.

Over this century, our total spending on healthcare has risen from 8 per cent of national income to about 10 per cent – meaning it’s grown much faster than the economy has, including the growth in our population.

The continued rise in the average age of our population, the growing burden of chronic diseases and our expectations that governments will keep spending more to improve our health means our spending on healthcare will continue to grow faster than on most other things.

This being so, it’s important to check that the increased spending is leading to better health. The researchers were able to check the performance of only part of the system: the treatment of cancers, cardiovascular diseases, blood and metabolic disorders, endocrine (organs and glands) disorders, and kidney and urinary diseases.

These account for about a third of healthcare spending. The study found that, after allowing for changes in quality, the “multifactor” (that is, combining labour and physical capital) productivity of this care improved by about 3 per cent a year over the six years to 2017-18.

If that doesn’t impress you, it should. It compares with productivity improvement of just 0.8 per cent a year in the whole market sector of the economy.

Importantly, all the healthcare improvement came from improved quality in the treatment of ailments. This arose from technological advances in how they are treated, rather than from simply doing more with less. And the gain was in lives saved rather than the reduced illness of people living with those diseases.

But here’s the kicker. When the commission compared the level of our productivity with that of 27 other rich countries (after allowing for differences in risk factors, such as obesity – the big one – smoking, diet, alcohol and age) it found we came third, beaten only by Iceland and Spain.

Coming a distant last was the United States. The Yanks win two prizes: one for the most expensive system, the other for coming last on value for money. Why? Because their system is designed to maximise medicos’ incomes. At which they take away another prize.

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Good news: our falling productivity is too bad to be true

There are few aspects of the economy on which more bulldust is spoken than our productivity. The world abounds with people trying to tell us that our productivity performance is a real worry and the way to fix it is to cut their taxes or give them a government handout. Yeah, sure.

These snake oil salesmen (and they’re almost always men) have been having a field day lately. Did you know that last financial year, 2022-23, the productivity of our labour actually fell by 3.7 per cent?

Fortunately, some sense arrived this week. The Productivity Commission issued its annual productivity bulletin, providing “the most complete picture to date of the drivers of Australia’s productivity decline over 2022-23,” it said. We now have a clearer understanding of what’s behind the slump, we’re told.

But first, let’s be sure you know what productivity is. It’s a comparison of the economy’s output of goods and services – measured by real gross domestic product – relative to our inputs of raw materials, labour and physical capital (machines, buildings, roads, bridges and so forth).

Our productivity improves when we use the same quantity of inputs to produce a greater quantity of outputs. In other words, it’s a measure of our efficiency.

We can improve our technical efficiency by inventing better machines for workers to work with, thinking of better ways to organise our mines, farms, factories and offices, increasing the skills of our workers, and having the government provide us with better roads and public transport to go about our business.

Usually, we focus on the productivity of our labour, measured by dividing real GDP during a period by the total number of hours employees and bosses worked during the period.

Over the past 28 years, the productivity of our workers increased at the average rate of 1.3 per cent a year. This improvement, when passed on to workers as higher “real” wages – wages growing faster than prices – is the main reason our material standard of living is much higher than our grandparents enjoyed.

The productivity of our labour generally improves a bit almost every year. It can fall a little during recessions, but it’s never fallen by anything like as much as 3.7 per cent. Which may mean the world’s coming to an end, but it’s more likely to mean there’s something funny going on with the figures.

The commission’s first revelation is that the number of hours worked during the financial year grew by an unprecedented 6.9 per cent, whereas the economy’s output of goods and services grew by 3 per cent. So, as a matter of simple arithmetic, our productivity worsened.

Now, before you jump to terrible conclusions, there are a few points to make. The first – which the commission didn’t make, but should have – is that one of the most basic things we expect the economy to do for us is to provide paid employment for all those of us who want to work.

And what happened last financial year is that a lot more people got jobs, and a lot of people working part-time got the extra hours of work they’d been seeking. It’s a safe bet that all those people being paid to work more hours were pleased to oblige.

So, before we beat ourselves up, we need to be clear that the unprecedented rise in hours worked was a good thing, not a bad thing. It was, in fact, part of the economy’s return to full employment for the first time in 50 years. That’s bad?

No, rather than cursing our bad luck or bad management, we should be asking questions: how on earth did that happen? It doesn’t make sense. Employers employ people to produce goods and services, not because they feel sorry for people who need a job.

So, if they increased their labour inputs by 6.9 per cent, how come their output of products increased by only 3 per cent?

When you hire more workers, you usually need to buy more tools and equipment for them to work with. If you don’t bother, then the extra workers won’t be as productive as your existing workers, and your average productiveness will fall.

The commission points out that businesses’ decisions to hire more workers didn’t lead them to acquire an equivalent amount of extra machines and other physical capital. The nation’s ratio of physical capital to labour fell by 4.9 per cent in the year – the biggest recorded decline in our history. “This meant on average, each worker had access to a shrinking amount of capital, which weighed down labour productivity,” it told us.

The point is, if you want productivity to improve, you need an increasing ratio of capital to labour. So, if businesses aren’t increasing their investment in capital equipment and structures sufficiently, don’t be surprised if productivity is getting worse rather than better.

But while I think it’s true that weak business investment is an important part of the explanation for our weak performance on labour productivity over the past decade, I don’t think it’s the reason productivity fell by 3.7 per cent last financial year.

No. One possibility is that while business has hired a lot more workers, it’s taking a bit longer for the increased investment and greatly increased output to come through. This is a common problem with the interpretation of changes in the economy over short periods. Wait a bit longer and the puzzle disappears.

But I think the true explanation is bigger than that – and so does the commission. It points out that, during the pandemic, measured productivity rose rapidly – mostly because high-productivity industries kept working, while low-productivity industries were locked down – but last financial year that measured gain disappeared.

Get it? COVID and our response to it, with lockdowns and economic stimulus, did strange things to the economy and to our measurements of it.

But by about June last year, the level of labour productivity was about the same as it was before the pandemic. We didn’t get much productivity improvement, but nor did we go backwards.

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Two-class school system a great way to entrench low productivity

In 2011, the Gonski report recommended that government funding of schools be needs-based and sector-blind. More than 12 years later, it still hasn’t happened. And it’s by no means certain it will happen any time soon.

The idea of sector-blind schooling – funding all students according to their needs, rather than their religion – fell at the first hurdle. Sectarianism has bedevilled attempts to ensure all our kids get a decent education since the introduction of compulsory schooling in 1880.

And so fearful of the religious vote are both major parties that this time’s been no different. Providing adequate funding for the more disadvantaged kids congregated in public schools could have been a simple matter of redistributing money from privileged private schools, but no.

Former prime minister Julia Gillard was straight out of the blocks, promising that private schools would be left no worse off. That is, disadvantaged kids would be helped only to the extent that extra money could be found for education, at the expense of all the government’s other responsibilities.

So the private schools – almost all of them professing some religious affiliation – have retained their funding priority. It used to be a matter of Catholics and Protestants but, thanks to the Howard government’s introduction of a new education priority – giving parents greater choice of which school to send their kids to – it’s now also a matter of Jewish schools, Muslim schools, “Christian” schools (code for the smaller non-conformist Protestant denominations) and soon, no doubt, Hindu schools and Buddhist schools.

If you wonder why the eternal enmities of the Middle East are echoed in faraway Australia, that’s part of the reason. “Choice” is a nice idea but, from the taxpayers’ perspective, it comes at a cost. Public schooling used to be part of the way we could be multicultural and still socially cohesive.

Now we’re paying more for it to be less so. Now, if you choose to have your kid grow up never having rubbed shoulders with people of other religions, that’s another service the taxpayer provides.

Except that it involves a monetary cost we’re reluctant to pay, and our politicians are reluctant to make us pay. How to square the circle? I know, let’s short-change the (majority of) kids still going to public schools.

But not to worry. The more things keep going the way they are, the fewer kids will be left going to public schools and the less the pollies will have to worry about the raw deal they’re getting.

We’ll have more kids leaving education with inadequate numeracy and literacy, of course, but who’ll notice that – or the extra cost to the budget – when we’ll all be so busy listening to the Business Council giving yet another sermon on the pressing need to reverse our declining productivity by cutting the company tax rate.

The beauty of a new plan to have most kids going to private schools – whether their parents can afford it or not – while only the kids of the rock-bottom poor are still going to public schools is that it’s self-reinforcing.

The more the better-paid and better-educated shift their children to private schools, the more those who are left will scrimp and save to join them.

And don’t forget this: public schooling is the default setting. One of the ways private schools maintain their reputation for greater discipline is to decline students with special needs, and expel students who cause too much trouble.

The public schools have no choice but to pick up the rejects. This wouldn’t be such a problem if they were given the extra funds needed to cope with the extra problems. But depend on it: they won’t be. This will give parents even greater incentive to get their kids out of there.

The plan does have a big drawback, however. No parent ever wants to admit it but, for many of them, a great attraction of private schooling is the greater social status it confers on the parents, as well as the old-school-tie benefits it confers on the kids.

Economists see education as a prime example of a “positional good” – a product that advertises to the world your high position in the pecking order. Trouble is, social status requires exclusivity. The more kids pile into private schooling, the less exclusive it becomes.

Economists say the demand for a good or service is “inelastic” if a rise in its price does little to deter people from buying it. As a positional good, the demand for private schooling is highly inelastic.

This explains why, not content with the big government subsidies they receive, the oldest and most famous private schools can charge parents huge fees on the top. Their fees rise faster than the inflation rate year after year, even in years of a cost-of-living crisis.

It may be that, the more parents pile into the cheaper Catholic systemic and other private schools, the more the elite private schools have to raise their fees to retain their exclusivity – their status as a positional good.

And, of course, the higher their fees, the more desirous status-seeking parents are to be seen paying them. Only the Reserve Bank’s ability to print its own money beats that. Remind me, why exactly is the taxpayer subsidising elite private schools?

Economists also say education is a “superior” good, meaning that the higher people’s real incomes rise, to more of that income they’re willing to spend on the product. In theory, people are buying more education or higher quality education.

But I have a theory that two-income families are more likely to choose private school education to prove to themselves their kids aren’t missing out. If so, they’re victims of a rarely remarked economic fallacy: anything that costs more must be of higher quality.

Fallacious though such thinking may be, the rise of the two-income family helps explain the shift to private schools and suggests it has further to run. Yet another reason to question why the federal government is propping up private schools at the expense of public schools.

Since Gonski, the feds have calculated the “schooling resource standard”, an estimate of how much total government funding a school needs to meet its students’ educational needs. The previous federal government’s agreement with the states required it to contribute 80 per cent of the private schools’ standard, with the states contributing the remaining 20 per cent.

For public schools, it was the reverse: the states pay 80 per cent, while the feds pay 20 per cent. Since the feds’ taxing powers are far greater than the states’, this deal had an inbuilt bias in favour of private schools.

As it’s worked out in practice, almost all private schools are fully funded, with many being overfunded, whereas almost all public schools are still underfunded, more than 12 years since Gonski.

The Albanese government’s Education Minister Jason Clare is renegotiating the funding agreement with the state education ministers, who met with him on Friday. They’re demanding that he hasten the public schools’ achievement of full funding by raising the feds’ contribution to 25 per cent.

You’d expect a Labor government to care about public school students getting a decent education. We’ll soon find out if it does.

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Want better productivity? Start by ensuring our kids can read

The trouble with our economy is that there are so many things needing to be fixed, it’s hard to know where to start. And so many of them are urgent we don’t have time to fix things one at a time. But since the economy consists simply of all the workers and all the consumers – that is, all the people – one of my guiding principles is that governments should manage the economy for the many, not the few.

This may seem obvious but, during the decades of “neoliberalism” from which we’re still emerging, it became far from obvious. Neoliberalism is the doctrine that what’s good for BHP is good for Australia. We got used to listening with rapt attention when the top 100 or so chief executives told us what needed to be done to improve productivity.

It took us too long to realise that their idea of a well-functioning economy was one where their incomes grew considerably faster than ours. They’re still at it, not having realised that we’ve stopped listening.

They’re arguing again that the most important thing we need is major tax reform – which, when you inquire, turns out to mean they’d pay less tax while we paid more.

No. I’m far more persuaded by this week’s report from Dr Jordana Hunter and Anika Stobart of the Grattan Institute, arguing we should start at the bottom, not the top, and make sure all our kids become confident readers as early as possible in their time at school.

If you’re building a house, you start by laying a firm foundation, and education should work the same way. Hunter says that in no area of education is improvement more urgent than reading. “Reading proficiency is a foundational skill that unlocks the broader curriculum and empowers young people to grasp opportunities for themselves,” she says.

Stobart says, “When children do not read fluently and efficiently in early primary school, it can undermine their future learning across all subject areas, harm their self-esteem, and limit their life chances.”

Students who struggle with reading are more likely to fall behind their classmates, become disruptive, and drop out of school. They are more likely to end up unemployed, or in poorly paid jobs, we’re told.

Why are they telling us this? Because last year’s NAPLAN testing results show that one in three Australian primary and secondary students cannot read proficiently. For Victorians, the news is better, sort of: a mere one in four.

But for Indigenous students, students from disadvantaged families, and students in regional and rural areas, it’s more than half. (Which makes you wonder why Barnaby Joyce and his National Party mates don’t have a lot more to say on public school funding.)

This appalling deficiency hasn’t just happened, it’s been going on for years without anyone making a fuss about it. Why is it happening? Hunter says the reason most of those students can’t read well enough is that we aren’t teaching them well enough.

“A key cause,” the report says, “is decades of disagreement about how to teach reading. But the evidence is now clear. The ‘whole-language’ approach, which became popular in the 1970s, doesn’t work for all students [including someone in my family years ago]. Its remnants should be banished from Australia’s schools.

“Instead, all schools should use the ‘structured literacy’ approach right through school, which includes a focus on phonics in the early years. Students should learn to sound out the letters of each word.”

Now, let’s be clear. I like teachers – especially those who tell students they must read my columns. So this is no attack on our hard-pressed teachers.

“The real issue here,” Hunter says, “is, are governments doing enough to set teachers up for success? The challenge is making sure best practice is common practice in every single classroom.”

But a key improvement is regular classroom testing, to ensure kids who are struggling get identified early and given extra help to catch up.

That, of course, takes extra money. But federal Education Minister Jason Clare is renegotiating the school funding agreement with the premiers. “The reading wars are over. We know what works,” he’s said. “The new agreement we strike this year needs to properly fund schools and tie that funding to the sort of things that work. The sort of things that will help children keep up, catch up and finish school.”

Economists often worry that the things you could do to make the economy fairer come at the expense of the economic efficiency that improves productivity. But ensuring our kids get off to a good start in life – including through early education, two years of pre-school and good literacy and numeracy – ticks both boxes.

It gives our kids better lives, it makes our workforce better skilled and more valuable, and it saves the budget a bundle in having fewer people who need special help.

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The next thing on Albanese's to-do list: fix competition

In a capitalist economy, every capitalist professes to believe in stiff competition. In truth, it’s their biggest hate. Why? Because it limits their ability to put up prices and makes them work harder for their money.

Just this week, big business has been saying that, if only we could get proper tax reform – by which they mean lower taxes on companies and the highly paid – we’d get more productivity and more innovation.

In truth, what’s far more likely to improve innovation and productivity is stiffer competition, particularly in those many industries dominated by just a few giant corporations.

The federal government doesn’t have a minister for competition, but it does have an assistant minister: Dr Andrew Leigh, a former economics professor.

Last year, the Albanese government announced a rolling two-year review of competition and set up a taskforce within Treasury. It’s supported by an expert advisory panel with some big names: Dr Kerry Schott as chair, David Gonski, the former boss of the Australian Competition and Consumer Commission, Rod Sims, and the new boss of the Productivity Commission, Danielle Wood.

This week Leigh gave us an update on what the taskforce had been doing and discovering. But he started with a locker room pep talk on why competition is the key to making capitalism – or “the market system” as economists prefer to call it – benefit the customers more than the capitalists.

“Competition provides a check on unbridled profit-seeking by business. In a competitive market, innovators can bring new products and services to market, without fear of being shut down by entrenched monopolists,” he says.

Competition limits unearned privilege and seeks to treat everyone fairly. Competition guides labour and capital to their most valuable uses and combinations, driving the productivity improvement that underpins sustainable wages growth.

“For workers, genuine competition between businesses provides greater opportunities to switch jobs, allowing workers to make the most of their skills and secure better pay and conditions.”

“For consumers, competition provides more choices, allowing people to shop around and find better value products and services. Indeed, the most obvious benefit of competition is in delivering cheaper prices. There is no better tool than competition policy for keeping real prices down.”

And, Leigh adds, competition is also crucial if Australia is to make the most of the big shifts involved in digitisation, growth in the care economy and the transition to net zero carbon emissions.

But Leigh warns of “worrying signs the intensity of competition has weakened over recent decades, with evidence of increased market concentration and [profit margins] in several industries.”

“Other countries find themselves at similar crossroads and many are – like us – reviewing their competition policy settings,” he says.

Our taskforce is taking a fresh approach to competition policy: digging out and analysing large sets of data to understand what the problems are and help craft solutions to them.

The digital revolution is producing masses of “microdata” on what businesses are doing, while making it easier for statisticians to measure the growth in the economy earlier and more accurately.

It gives academic economists great ability to analyse what’s happening in particular industries, and gives the econocrats a better understanding of what and how to regulate the things business gets up to.

For the first time, the taskforce has developed a database that tracks company mergers throughout the whole economy. Believe it or not, it does this by looking at the flows of workers moving to different employers.

This will allow it to track the effects of mergers on the performance of businesses, on employment and on industry concentration – that is, fewer firms controlling more of a particular market.

The new database has already revealed three worrying things. First, because notifying the competition regulator the ACCC of an intended merger is voluntary, it hears of about 330 mergers a year, whereas there are between 1000 and 1500 mergers occurring annually.

Second, for the most part, it’s huge firms swallowing smaller firms, rather than medium and small firms joining. Get this: the largest 1 per cent of firms account for about half the acquisitions.

Larger companies made more acquisitions over the course of the 2010s. And mergers were most common in manufacturing, retail, professional services, and health and social services.

Third, the firms that are the targets of takeovers are more than twice as likely to own a patent and almost twice as likely to own a trademark.

Remember that patents give inventors a long-term legal monopoly over the use of some invention. So this finding raises the fear that at least some takeovers are motivated by a desire to gobble up an effective competitor, or may even be “killer acquisitions” aimed at killing inventions that threaten the profits of some big player.

Leigh says we can expect to hear more from the government this year on mergers and how they should be regulated. The taskforce issued a consultation paper in November asking for opinions on whether the present arrangements remain fit for purpose.

The ACCC has already proposed a significant increase in its power to block mergers considered likely to substantially lessen competition.

And, last December, the federal government secured agreement from the state treasurers to revitalise national competition policy and commit to developing an agenda for pro-competitive reforms.

Meanwhile, Leigh points to findings by British academics Geoff and Gay Meeks that reveal only one in five research papers find that the typical merger boosts the profits or the sharemarket value of the merged business.

They point out that mergers often boost the remuneration of the company’s managers, while leading to layoffs among workers.

Leigh acknowledges that mergers aren’t necessarily a bad thing, but the small number of proposed mergers that do raise competition concerns warrant close scrutiny.

He says that “for the sake of shareholders, workers and citizens, it is important to ensure that Australia’s regulatory system is not facilitating value-destroying mergers”.

Many of the nation’s chief executives may not agree with that, but most of the rest of us would.

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