Immigration the cheap and nasty way to grow the economy

The ABC's temerity in hosting a debate about the merits of high population growth has drawn predictable repostes from the economic establishment. Shades of the legendary note in the margin of a politician's speech: "shout here - argument weak".

There are at least four counts against the advocates of high immigration. First, their refusal to engage with the academic environmentalists arguing that we've exceeded the "carrying capacity" of our old and fragile land. Scientists? What would they know?

Second, they keep asserting high immigration's great economic benefits, blithely ignoring the lack of evidence. Whenever the Productivity Commission has examined the issue carefully it's found only small net effects, one way or the other. Its latest modelling found only a "negligible" overall impact.

Third, the advocates not only decline to admit the high social and economic costs that go with high rates of immigration, they decline to accept their share of the tab, doing all they can to shift it to the young, the poor and those on the geographic outer, including many of the migrants.

You rarely hear pro-immigration economists acknowledging the clearest message economic theory gives us on the topic: more population requires more spending on additional public and private infrastructure if material living conditions aren't to deteriorate.

The more we invest in such "capital widening" to stop the ratio of capital to labour declining, the less scope for investment in "capital deepening" to keep the ratio increasing, and so improving the productivity of our labour.

When we fail to invest sufficiently in capital widening – which we have – the decline in living conditions is manifest in overcrowding, traffic congestion and long commuting times.

Why have we failed to invest sufficiently? Partly because a high proportion of the promoters of high immigration are also promoters of Smaller Government, never acknowledging the two are incompatible.

A bigger population requires a bigger government, with more debt, not less. When you persist with high population growth, but put the clamps on government, you end up with overcrowding, congestion and the rest.

Another truth the high immigration advocates refuse to acknowledge is that a much bigger population must lead to much bigger cities and higher-density living in those cities.

The Reserve Bank's estimates of the huge addition to Melbourne and Sydney house prices caused by state governments' acquiescence to resistance to higher density in inner and middle-ring suburbs, are partly a consequence of successful attempts to shift the spatial cost of high immigration onto the less well-placed.

The fourth criticism of high immigration is that it's the cheapest and nastiest way to pursue economic growth. You get a bigger economy, but not the promised benefits. The studies repeatedly fail to show high immigration leads to a significant increase in real income per person.

Of course, the business lobby has no reason to care whether high immigration yields economy-wide benefits. All they're after is a bigger domestic market, allowing them to sell more widgets, make a higher profit and justify a bigger salary package.

Few economists can see this is a cop-out. An escape hatch. As a way of achieving corporate growth, it's even easier than taking over your competitors. And it sure beats the hard graft of trying to increase profits by being more efficient and contributing to national productivity improvement.

As we've seen, high immigration probably comes at the expense of productivity-enhancing (capital-deepening) business investment and public infrastructure. To the extent that inadequate capital-widening leads to overcrowding and congestion, it worsens productivity.

In principle, one productivity-enhancing effect of high immigration is that you get greater human capital on the cheap by pinching it from other (mainly poor) countries.

After foreign students have come here and paid full freight for Australian qualifications, you let them stay and work. You select permanent immigrants on the basis of their skills, or you let skilled workers on temporary visas stay on.

But as Dr Bob Birrell, of the Australian Population Research Institute, has shown, there's a big gap between the claims made for our skilled migration program and the reality. We let in people whose skills aren't in high demand, and plenty of them end up driving taxis because the local professions' gatekeepers refuse to recognise their qualifications.

So it's not clear the benefits of our skill-pinching program exceed the cost of discouraging businesses from incurring bother and cost training enough of our own young people, when you can always get the government to let you bring in someone ready-trained.

High immigration may suit our rent-seeking business people, but it's a hell of a way to pursue the professed benefits of economic growth.

Read more >>

The economy is readying for faster growth

The last three months of 2017 were yet another quarter of weak growth in the economy. Fortunately, however, they weren't as weak as we've been led to believe.

According to the national accounts, issued this week by the Australian Bureau of Statistics, real gross domestic product grew by 0.7 per cent in the previous quarter, but slowed to 0.4 per cent in the December quarter.

This caused the annual rate of growth to slump from 2.9 per cent to 2.4 per cent.

Trouble is, the sudden slowdown is largely the product of quarter-to-quarter volatility, caused by one-off factors and unexplained "noise" in the figures – noise that stops you hearing the signal those figures are trying to send.

This is why the bureau also publishes "trend" or smoothed figures, which reduce the noise and make it easier to hear the underlying signal.

The trend figures show the economy growing at a fairly steady rate of 0.6 per cent a quarter, and by 2.6 per cent over the year to December.

This is likely to be closer to the truth, though it's still weaker than we've been hoping for, especially since employment grew by a remarkably strong 3.3 per cent during 2017 – almost 400,000 more souls.

How can the economy's production of goods and services grow by only 2.6 per cent when the number of people employed to produce those goods and services has grown by 3.3 per cent?

Over a period of more than a few years, it can't. But over shorter periods it's surprisingly common for the standard relationships between economic variables not to show up in the figures. Why? In a word: noise. (And noise not even statistical smoothing can penetrate.)

Note, however, that for as long as employment is growing faster than production, the productivity of labour will be falling, just as a matter of arithmetic. If you think employment growth is a good thing, this temporary fall in productivity is nothing to worry about.

To emphasise how weak quarterly growth averaging 0.6 per cent is, consider this. Growth in GDP per person is averaging only about 0.2 per cent a quarter.

This gives annual growth in GDP per person of 1 per cent. (Huh? Four quarters of about 0.2 per cent adds up to 1 per cent? Yes. You can't just add 'em up, you have to allow for compounding - otherwise known as "interest on the interest", as in compound interest.)

To have GDP growth of 2.6 per cent, but growth per person of only 1 per cent, is a reminder of how fast our population is growing, and how much of our growth (almost invariably faster than the growth rates of those rich countries whose populations aren't growing much) comes merely from population growth – a point every economist knows, but few bother pointing out to the uninitiated.

And don't hold your breath waiting for any treasurer to point it out. To those guys, a big number is a big number – and what's more, it's solely the result of our government's wonderful policies.

But back to the reasons this week's news of further weak growth isn't as bad as it sounds.

The first is that annual growth of 2.6 per cent isn't a lot lower that our estimated "potential" (medium-term average) rate of growth of 2¾ per cent.

It's true, however, that we've been growing at below our non-inflationary potential rate for so many years we've acquired such a lot of spare production capacity (including unemployed and under-employed workers) – such a big "output gap", in econospeak - that we could and should be growing a fair bit faster than that medium-term speed limit of 2¾ per cent, until the spare capacity's used up.

Another indication things aren't a bad as they've been painted is Reserve Bank governor Dr Philip Lowe's statement that this week's figures give him no reason to revise down the Reserve's forecast that growth will strengthen to 3 per cent this year and next.

Why so confident? Because when you look into the detail of this week's results, you see more signs of strength than weakness. (From here on I'll switch to quoting the unsmoothed figures favoured by those who prefer the exciting confusion of noise to the boring wisdom of signal.)

First point is that "domestic demand" (gross national expenditure) grew over the year at the healthy rate of 3 per cent, meaning it was a fall in "net external demand" (exports minus imports) that caused growth in aggregate (domestic plus external) demand to be only 2.4 per cent.

The fall in the volume of "net exports" (exports minus imports) was caused mainly by a fall in exports, but there's little reason to believe this was due to anything other than temporary factors.

Turning to the biggest components of domestic demand, we've been worried that consumer spending wasn't growing strongly because of the lack of growth in real wages. But this week's figures show consumer spending growing by 1 per cent during the quarter and a healthy 2.9 per cent over the year.

Quarterly growth of 1 per cent won't be sustained, but an upward revision to the previous quarter's growth adds to confidence that household consumption is stronger than we'd believed.

All the increased employment is boosting household income, even if real wage growth isn't.

Business investment in new equipment and structures fell by 1 per cent in the quarter, but this was explained by another fall in mining investment (which falls are close to ending) concealing stronger than expected growth in non-mining investment (as estimated by Treasury) of 2.1 per cent in the quarter and 12.4 per cent over the year.

As Paul Bloxham, of the HSBC bank, summarises, "the key drivers of domestic demand – household consumption and non-mining business investment – were strong, and should drive a lift in overall growth in 2018".

Read more >>

Politicians should get wings clipped on infrastructure

The more our ever-more "professional" politicians put political tactics ahead of economic strategy – put staying in government ahead of governing well – the more pressure they come under to cede more of their power to independent authorities.

The obvious instance is our move in the mid-1990s to transfer control over interest rates ("monetary policy") from the elected government to the independent central bank.

Shifting interest rates away from those tempted to move rates down before elections and up after them has proved far better for the stability of the economy.

Another issue on which voters don't trust politicians to make good decisions – mainly because of the risk of collusion between them – is their own remuneration.

So, first, responsibility for setting politicians' salaries, and now, their expenses, has been handed over to independent bodies.

Then there was the Gonski report's proposal that responsibility for determining the size of grants to public, Catholic and independent schools be taken away from deal-doing pollies and given to a properly constituted authority, following consistent and transparent criteria.

The idea was rejected by Julia Gillard but, particularly now the amazing variance in the deals Labor did with different school systems has been revealed under the Coalition's version of Gonski, there's still hope we'll end up with an independent, rules-based grants authority.

Some years ago, the Business Council took up a proposal by Dr Nicholas Gruen for the example set by monetary policy to be spread to fiscal (budget) policy. An independent body would set the budget's key parameters – for spending, revenue and budget balance – leaving the government to decide the specific measures to take within those parameters.

The idea didn't gain traction, but it may have boosted the push for independent evaluation of infrastructure projects.

You can see an admission that "something needs to be done" in the establishment of Infrastructure Australia by the Rudd government, and its rejig by the Abbott government, as a supposedly "independent statutory body providing independent research and advice to all levels of government".

Trouble is, the authority has little authority. Its role is to create the illusion of independent evaluation and reformed behaviour, while the reality continues unchanged.

There's no obligation for even the federal government to have all major projects evaluated, for them to be evaluated before a government commits to them and begins work, nor for those evaluations to be made public as soon as they're completed, so voters can debate the merits of particular projects with hard evidence.

Promises to build particular projects in a state, or even an electorate, are a key device all parties use to buy votes in election campaigns.

As Marion Terrill, of the Grattan Institute, has demonstrated, few of the projects promised by the government, opposition and Greens at last year's election had been ticked by Infrastructure Australia, and many of those it had ticked weren't on anyone's list of promises.

Terrill's research has revealed the huge proportion of government spending on capital works that's unlikely to yield much economic or social return to taxpayers.

For some years the Reserve Bank, backed by the International Monetary Fund and the Organisation for Economic Co-operation and Development, has argued that fiscal policy should be doing more to help monetary policy get our economy back to trend growth by spending more on worthwhile infrastructure projects. These would add to demand in the short run, and to supply capacity in the medium run by improving private sector productivity.

This changed approach would involve shifting the focus of fiscal policy from the overall budget deficit (including capital works spending) to the more meaningful recurrent or operating deficit.

This year's budget seemingly accepted this proposal, promising to give greater prominence to the NOB – net operating balance – and announcing two huge new infrastructure projects: the second Sydney airport and the Melbourne to Brisbane inland freight railway.

See the problem? Government infrastructure spending does wonders for the economy only if the money's spent on much-needed projects. As a proper evaluation would show, the inland railway is a waste of money (the product of a deal with the Nationals).

So it's little wonder that cities and infrastructure are the third big item, after healthcare and education, on the Productivity Commission's new agenda for micro-economic reform.

It's first recommendation? "It is essential that governments ensure that proposed projects are subject to benefit-cost evaluations and that these, as well as evaluations of alternative proposals for meeting objectives, are available for public scrutiny before decisions are made."

This is something the professed believers in Smaller Government, and those professing to be terribly worried about lifting our productivity, should be making much more noise about.

Read more >>

Report heralds big change in economic reform priorities

Government reports come and go with great rapidity. Some are acted on, most are quickly pigeonholed. Last week Scott Morrison tabled a report from the Productivity Commission called Shifting the Dial, but it was soon lost amid all the excitement about raids on a union and politicians being thrown out of their jobs.

Despite this inauspicious beginning, let me make a fearless prediction: when the history of the economy in the early decades of the 21st century is written, this report will get prominence.

Why? Not because this government or the next will rush out to implement its recommendations, but because it will be seen as a turning point in the thinking of the nation's economic advisers.

The populist revolt against the doctrines of "neoliberalism" – or economic rationalism, as we've called it in Australia – has been apparent for most of this year. It's been apparent since the middle of the year that the long-running bipartisan consensus in support of neoliberalism in the advanced economies has collapsed.

But where to now? The economy and its apparatus are far from perfect and there's always something that needs working on. The econocrats need something to be working on to justify their existence, so what are they to do now that so many citizens are jack of deregulation and privatisation?

Well, now we know. Ostensibly, the commission's report is just the first of many five-yearly reports on ways to improve the economy's "productivity" – its ability to increase its outputs of goods and services faster than the increase in its inputs of land, labour and capital – the magic that's made us so much richer than our great-grandparents.

The Productivity Commission, would you believe, is preoccupied with productivity. Same old, same old.

Don't be deceived. The commission – formerly a leader of the economic rationalist charge – has taken the initiative in proposing an agenda for economic improvement that's quite different to what we've had so far.

Its new agenda attempts to restore public support for economic "reform" (a word it tries to avoid) by responding to popular criticism of the push that, while well-intentioned and necessary when it originated in the Hawke-Keating years, has since seemed to degenerate into "bizonomics" – what's good for big business is good for the rest of us.

Gone is the unending obsession with tax reform (cutting the rates of tax on companies and high-earning individuals) and industrial relations (cutting penalty rates and shifting bargaining power in favour of employers).

In their place, the commission focuses on three big issues: healthcare, education and cities.

On health, it argues there needs to be more emphasis on preventing and managing the growing incidence of chronic illnesses, such as diabetes. This may involve less reliance on paying doctors according to fee-for-service.

The health system – state-run public hospitals in one box, most doctors in another and pharmaceuticals in a third – needs to be better integrated so as to make it more centred on the needs of patients rather than the suppliers of health care.

This greater co-ordination should happen at the local level.

On education, too many students are being let down at every level.

The commission finds that school results are deteriorating, vocational education and training is "a mess" and universities are more concerned with publishing research papers than improving teaching standards.

As for cities, they produce a growing portion of our gross domestic product – about 80 per cent, with Sydney and Melbourne accounting for half of that.

By the time we reach 2050, almost 11 million extra people will be squeezed into our capital cities, according to Morrison.

The social costs of congestion in our capital cities will grow from almost $19 billion a year in 2015 to more than $31 billion a year by 2030, we're told.

See how different all this is to the economic reform talk we're used to?

It's shifted the focus from business to the "non-market economy" run mainly by government bodies. It's less concerned with mining, farming and manufacturing, and more with the services sector.

Its approach to reform is bottom-up – concentrate on the needs of patients and students, on getting to work – not trickle down.

Putting it another way, it's people-friendly, not business-friendly.

The three issues are two-sided: they directly affect the wellbeing of individuals, but also the nation's productivity, as a healthier, better-skilled workforce gets to work more easily.

This means the "reform agenda" ought to be a lot more relevant and appealing to ordinary voters. It also means it can be pursued by either side of politics.

One of the great objections to the old agenda was fear that it benefited the better-off at the expense of the rest of us.

Rest easy – the commission has got the message.

"A key issue will be to ensure that future economic, social and environmental policies sustain inclusive [note that word]growth – by no means guaranteed given current policy settings, and prospective technological and labour market pressures ...

"One of the advantages of better healthcare, education systems and cities is that they provide strong prospects for improving lifetime outcomes for people from all backgrounds.

"Indeed, improvements in these areas have the potential to decrease health inequalities, and reduce job insecurity and wage risks for those whose skills are at most risk from technological change," the commission concludes.

Read more >>

Turns out productivity's been fine all along

What a joke. A scholarly article in Treasury's latest Economic Roundup has admitted that all the years of handwringing over our poor productivity performance was just jumping at shadows.

Turns out all the angst was caused by not much more than the figures being distorted by the mining industry's construction boom.

This after our top econocrats gave speech after speech urging "more micro reform" to improve productivity and keep living standards rising. (They'd have advocated more reform even if productivity was improving at record rates; its supposed weakness was just a convenient selling proposition.)

Meanwhile, the business lobby groups, led by the Business Council of Australia, claimed – without any evidence – the supposed weakness had been caused by the "reregulation" of wage fixing under Labor's evil Fair Work changes, and demanded the balance of bargaining power be shifted yet further in favour of employers. (A claim even the Productivity Commission wasn't convinced by.)

Even at the time, it seemed the contortions of the mining industry during the decade-long resources boom were a big part of the story, but that didn't stop people who should have known better going into panic mode.

"Despite concerns", the paper by Simon Campbell and Harry Withers, says with masterful understatement, "Australia's labour productivity growth over recent years is in line with its longer-term performance.

"In the five years to 2015-16, labour productivity in the whole economy has grown at an average annual rate of 1.8 per cent.

"This compares to an average annual rate of 1.4 per cent over the past 15 years, and 1.6 per cent over the past 30 years," it says.

Let's take a step back. Productivity compares the quantity of the economy's output of goods and services with the quantity of inputs of resources used to produce the output.

When output grows faster than inputs – as it does most years – we're left better off. This improvement in our productivity is the overwhelming reason for the increase in our material standard of living over the years and centuries.

Productivity can be measured different ways. The simplest (and least likely to be inaccurate) way is to measure the productivity of labour: growth in output per worker or, better, per hour worked.

Labour productivity improvement is caused by two factors. The first is by increases in the ratio of (physical) capital to labour used in the economy.

This known as "capital deepening" – translation: giving workers more tools and machines to work with, which makes them more productive.

The second driver of labour productivity is improvements in the efficiency with which labour inputs and capital inputs are used, arising from such things as improved management practices. This is known as MFP – multi-factor productivity.

In recent years the figures have shown multi-factor productivity growth to be zero or even negative, causing great concern among some economists, including the Productivity Commission.

But Campbell and Withers argue this focus on MFP is misplaced. They remind us that MFP is calculated as a residual (the product of a sum), meaning its likelihood of mismeasurement is high.

And they criticise the conventional view that physical capital should grow no faster than output – known as "balanced growth" - because capital deepening is an inferior source of productivity improvement to MFP.

People take this view because (making the unrealistic assumption that the economy is closed to transactions with foreigners) increased investment in physical capital must come at the expense spending on consumption.

The authors point out that achieving improved MFP isn't costless, while the price of capital goods (most of which are imported) has fallen persistently relative to the price of consumption goods.

"This has allowed Australia to sustain its high rate of capital deepening without forgoing ever higher levels of consumption," they say.

Actually, they say, our economy has never fitted the "balanced growth" story. Of the 30-year average of 1.6 per cent annual growth in labour productivity, MFP contributed only 0.7 percentage points, while capital deepening contributed 0.9 points.

Next the authors examine the causes of the ups and downs in labour productivity improvement overall by breaking the economy into six sectors: agriculture, mining, manufacturing, utilities, construction and services (everything else).

They find that labour productivity in agriculture is now 2 1/2 times its level in 1989, but it's too small a part of the economy – 2.5 per cent – for this to make much difference to the economy-wide story.

The utilities sector showed strong productivity growth until the turn of the century, before steadily declining through to 2011-12, mainly because of one-off developments such as the building, then mothballing of many desal plants.

The story of mining is well-known: its productivity fell because of the delay between companies hiring more workers to build new mines and gas facilities and that extra production coming on line. Since 2012-13, however, mining productivity has shot up. What a surprise.

Productivity in manufacturing and construction has grown at similar rates to the economy overall, as has productivity in the services sector (hardly a surprise since services now account for 70 per cent of gross domestic product).

Over the past five years, more than half of our total labour productivity improvement was attributable to the services sector, compared with about a quarter attributable to mining.

Apart from productivity improvement in the various sectors, overall productivity can be affected when changes in the industry structure of the economy cause workers to shift from lower-productivity sectors to higher-productivity sectors, or vice versa.

Because mining, being highly capital-intensive, has by far the highest level of labour productivity, the authors say it's really only when workers move in or out of mining that structural change has much effect on economy-wide productivity.

"These movements of labour into and out of mining have been the key driver behind the fluctuations in ... aggregate labour productivity growth," the report concludes.

Now they tell us.

Read more >>

Why wage growth will strengthen before long

It's become deeply unfashionable to presume any of the present weakness in wage growth is merely cyclical (and thus temporary) rather than structural (and thus lasting). Sorry, my years of economy-watching tell me it's never that simple.

It's the mark of an amateur – a journalist who prefers sexy stories to boring stories that are more likely to be true; a youngster who believes all they're told on social media – to believe the established patterns of the past have no bearing on the present.

Note, I'm not denying the likelihood that a significant part of the problem may arise from deep, structural causes requiring correction by judicious government intervention.

What I'm saying is it's far too soon to conclude no part of the weakness is temporary. We'll know the truth of the matter only with hindsight.

We know the importance of "confidence" in driving the business cycle, but it doesn't just apply to businesses and consumers. It also applies to workers negotiating pay rises.

There's a chance that, with all the union movement's exaggerated talk of an ever-rising tide of "precarious employment", organised labour has spooked itself into accepting lower pay rises than it needs to.

As Reserve Bank governor Dr Philip Lowe keeps hinting, one day workers will decide to contest bosses' claims that they couldn't possibly afford more than a 2 per cent pay rise.

For another thing, it's surprising the wage-rise pessimists have failed to take heart from the Fair Work Commission's decision in June to raise not just the national minimum wage, but the whole structure of award minimums, by 3.3 per cent.

This compares with a rise last year of just 2.4 per cent.

It's true that only about a quarter of employees are directly affected by this decision, but many more are affected indirectly because the "individual arrangements" by which their wages are set consist merely of a set margin above their award rate.

And why would the supposedly more industrially powerful workers on enterprise agreements settle for another 2 per cent rise when, all around them, weaker workers were getting 3.3 per cent?

But there's a more technical argument that a period of weak wage growth was just what was needed as part of our transition from the decade-long resources boom. With that transition close to completed, it shouldn't be long before wage growth strengthens.

As Professor Ross Garnaut warned in 2013 in his book, Dog Days, the big fall in the nominal exchange rate that (eventually) followed the collapse in mining commodity prices wasn't all that was needed to restore the international price competitiveness of our export and import-competing industries.

We also needed the nominal depreciation to become a "real" depreciation, with the costs faced by Australian firms rising much more slowly than the average of costs faced by firms in our major trading partners' economies.

Garnaut doubted we could achieve the high degree of wage restraint need to make the depreciation stick but, as former top econocrat Dr Mike Keating pointed out in a recent blog post, that's just what's happened.

Keating says you'd expect that, over the medium to longer term, real wages, the productivity of labour and "real net national disposable income" per person (a version of gross domestic product that's adjusted for swings in our terms of trade) would each grow by about the same amount.

Between 2002 and 2012, the period of the resources boom, real wages grew faster than productivity, though by less than the strong growth in the real national income measure.

But Keating notes that, following the 2012 peak in the resources boom, these relationships were reversed, with real national income actually falling between 2012 and 2016. Real wages then needed to rise by less than productivity, which is just what's happened.

"My judgement is that equilibrium between productivity, [real] wages and real net national disposable income per person has now been restored," Keating concludes – implying there's now scope for real wages to grow in line with improvements in productivity.

This fits with the Reserve Bank's conclusion in its May statement on monetary policy that, as measured by comparing our "nominal unit labour costs" (nominal wage growth versus the change in labour productivity) with those of our trading partners, our real exchange rate has fallen to about its post-float average. This wouldn't have changed much since May.

So there's been a sound economic justification – the need to restore our industries' international price competitiveness – for our weak wage growth over the past three or four years.

But that need has now been satisfied, allowing us to hope for a return to real wage growth.

Read more >>

Many guesses why productivity may have stopped improving

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Read more >>

Reduced competition may be slowing US growth

US financial markets may be betting that the Trump administration's budget policies will stimulate economic growth and inflation, but they're cheered by this prospect only because of deeper fears that America and the advanced economies have entered an era of persistently weak growth.

America's rate of growth has been slowing for decades, starting long before the onset of the global financial crisis.

As part of this, America's rate of productivity improvement has been weakening, despite a short-lived uptick in the 1990s.

So the hunt's been on for factors that may be causing this slowdown. There are many suspects. But one you often see mentioned by economists such as Professor Paul Krugman is a decline in the strength of competition in many American markets.

If markets are significantly less competitive, you'd expect this to mean consumer prices that are higher than they might be, profits that are higher, less innovation, slower productivity improvement, worsening inequality and slower growth.

But what's the evidence of reduced competitive pressure? Earlier this year President Obama's Council of Economic Advisers issued a paper reviewing the evidence, which I'll summarise.

There are various ways to measure the degree of "concentration" in an industry – that is, how much of the business done by an industry is captured by a small number of large firms.

Figures collected by the US Census Bureau show that, over the 15 years to 2012, the share of total sales revenue earned by the 50 largest firms in 13 broad industry categories fell in three, was unchanged in one but increased in nine.

If 50 sounds like a lot of firms, remember this is America, whose economy is about 12 times bigger than ours.

Sales concentration was highest among utilities – electricity, gas and water – at 69 per cent, which isn't surprising considering many are natural monopolies. Even so, concentration increased by almost 5 percentage points.

After that came finance and insurance, where concentration was up by 10 percentage points to more than 48 per cent, followed by transportation and warehousing (up more than 11 points to 42 per cent) and retail trade (up 11 points to 37 per cent).

This picture is confirmed by studies of specific industries, the briefing paper says. One study of the national market for loans found that, over the 30 years to 2010, the top 10 banks' market share increased by 20 points to 50 per cent.

For deposits, the market share increased from 20 per cent to almost 50 per cent.

Another study found that, for hospital markets over the decade to 2006, a common measure of concentration increased by about 50 per cent, to a degree equivalent to having just three equal-sized competitors in a market.

A different measure of possibly reduced competition comes from looking at what's happened to the rates of profitability of big firms.

When researchers take the rates of return on invested capital for listed US companies, then rank them from highest to lowest, they find that for firms at the 90th percentile (that is, 10 per cent down from the top; 90 per cent up from the bottom) their rate of return is five times higher than for the median (dead middle) firms.

A quarter of a century ago, the 90th percentile firms' rate of return was closer to twice the median firms'.

This suggests some firms are better able to extract "economic rent" than they were. Economic rent is the profit you make that exceeds what you'd need to earn to be willing to remain in the industry.

Yet another indication comes from the "long-term downward trend in business dynamism", as indicated by a steady decline since the late 1970s in the proportion of new firms entering markets each year.

This is while the proportion of firms exiting markets each year has been little changed. Since the entry rate has now fallen to be equal to the exit rate, the total number of firms – which used to grow by about 6 per cent a year – is now unchanging.

Part of the explanation for the decline in the number of new firms could be rising "barriers to entry" into many industries.

This could be caused by increased federal, state or local licensing requirements, ever-rising economies of scale or data-mining information advantages to incumbent firms, or successful lobbying for government rules to protect against new entrants.

Labour market dynamism – how often workers change employers – has also declined since the 1970s.

This could have many causes, including no-poaching agreements between employers and greatly increased occupational licensing, which limits people's freedom to move between states.

The briefing paper notes it's not yet clear how these various indicators suggesting the US may be suffering a fall in competition within its markets fit together.

Turning to possible causes of reduced competition, it notes the problem of "common ownership". Researchers have argued that institutional investors who are large owners of the biggest firms in a particular industry, implicitly encourage those firms not to compete with each other, thus raising the investors' profits.

According to other research, the role of institutional investors has grown over the past 30 years so that, in 2014, they controlled 61 per cent of worldwide investment assets.

One anti-competitive development the briefing paper doesn't mention is the US Congress's willingness to keep extending the lives of existing and future patents and copyright.

Meanwhile, US government trade negotiators use bilateral preferential trade deals – going by the Orwellian name of "free trade agreements" – and plurilateral deals such as the Trans-Pacific Partnership agreement to press partners like us to extend the lives of our patents and copyright to fit with the Yanks' domestic arrangements.

Maybe one reason economic growth is slowing is that the world's multinational corporations are getting too good at finding ways to inhibit competition between them, including by enlisting the help of governments.

Read more >>

Maybe the end of economic growth draws near

If you think the possible ascension of Donald Trump is our one big worry you haven't been paying attention. Some climate scientists are worried sick over the possibility that climate change may be passing the point of no return while we procrastinate over controlling it.

Meanwhile, the nation's – nay, the world's – economists worry that the wellsprings of economic growth are drying up in the developed countries. Think of it – an economy without growth!

On Monday the Productivity Commission issued a discussion paper exclaiming that there is "justified global anxiety" that improvements in productivity and the growth in national income they cause have "slowed or stopped".

In my job I'm not supposed to say it but, sorry, I'm a lot more worried about inaction on climate change than the feared end of economic growth – if for no other reason than that going backward must surely be worse than not going forward.

Why can't most economists see that? Because climate change is not their department. They're meant to be experts on how to make economies grow, and that's all they want to talk about.

Most economists I know never doubt that a growing economy is what keeps us happy and, should the economy stop growing, it would make us all inconsolable.

They can't prove that, of course, but they're as convinced of it as anyone else selling something.

I'm not so sure. I'm sure a lot of greedy business people would be unhappy if their profits and bonuses stopped growing, but I often wonder if the rest of us could adjust to a stationary economy a lot more easily than it suits economists and business people to believe.

And get this: there is a fair chance we may get to find out if I'm right.

The economy – the amount of economic activity, measured as annual production of goods and services – grows as the population and, more particularly, the amount of work being done, grows.

The economy also grows when we save some of our income from producing goods and services and invest it in additional productive equipment – machines, buildings, infrastructure – thus making our workers capable of producing more goods and services with each hour they spend.

But here's the bit many scientists and others don't get: the secret sauce of economic growth is our ability to produce more goods and services this year than we did last year even with the same quantity of labour and capital equipment.

This is the pure essence of economic growth: improved "productivity" – productiveness. How is it possible? Mainly by giving workers not just more machines, but better machines; machines that do better tricks. By technological advance.

And also, these days, by using further education and training to make our workers capable of doing fancier tricks – including working with more sophisticated machines – and organising work in better ways.

This essence of productivity – which economists call "multifactor" productivity – is what seems to be drying up. In Australia, according to the eponymous commission, it hasn't improved since 2004.

But it's much the same story in all the developed economies. Many economists are starting to accept Harvard professor Lawrence Summers' revival of the theory of "secular stagnation" – that we've entered a lasting period of little or no growth in national income (gross domestic product), especially income per person.

What's helping to persuade them is the argument of another American economist, professor Robert Gordon, perhaps the world's leading expert on productivity.

His contention – which no young person would believe – is that the slowdown in measured productivity improvement has occurred because there is now much less innovation than we became used to over the past century.

Despite the unending wonders of the digital age, and the digital disruption of industry after industry, they just don't compare with the life-changing and economy-transforming technological advances of the past: electricity, the internal combustion engine, even underground water and sewerage.

We spent all of last century fully exploring and exploiting the potential just of electricity – from light bulb to production line to dishwasher to the computer and all it has spawned.

But there's more to Summers' secular stagnation. He argues that population ageing is leading people in the West to save more, while digital innovation and weak population growth are reducing the need for much new physical investment by businesses and governments.

Higher saving and lower investment equal permanently lower interest rates and lower economic growth.

Well, possibly. A rival theory is that the digital revolution and the shift from more goods to more services is changing the economy in ways that the economists' conventional measuring system is incapable of picking up.

We're still getting better off, but in ways that aren't showing on the economists' dials. It's certainly true that much of the time-saving and convenience flowing from the internet is not measured by GDP.

That's been my big problem with economists' obsession with economic growth. It defines prosperity almost wholly in material terms. Any preference for greater leisure over greater production is assumed to be retrograde.

Weekends are there to be commercialised. Family ties are great, so long as they don't stop you being shifted to Perth.

But I'd like to see if, in a stagnant economy, we could throw the switch from quantity to quality. Not more, better.

Read more >>

Faster growth demands better chief executives

Sometimes I'm tempted by the thought that a major economic reform would be for the Business Council of Australia to disband, so the nation's big business chiefs had to spend more time doing their knitting.

For them to spend less time attending committee meetings to decide what the government should be doing to make life easier for them and their business, and more time working on ways to improve their company's performance.

It always surprises me that economist upholders of free markets and business defenders of private enterprise so easily fall into the view that the fate of our largely private-sector economy rests on the actions of politicians.

Econocrats are susceptible to that misconception because their model's assumption that business decisions are always rational leads them to conclude any inadequacy in businesses' performance must arise from perverse incentives created by misguided government intervention.

For their part, it's almost unknown for business leaders to explain their company's poor performance as anything other than someone else's fault. The failures of our hopeless government – any government – have long been the favourite excuse of less-than-successful chief executives.

An entire career in the private sector has inoculated me against any delusion that businesses are always rational and never perform at less that their best.

One common human failing you won't find in any economics textbook is managers' tendency to be so busy fixing problems they find easy to fix that they have no time to grapple with more important problems they're not sure how to fix.

We worry about the era of low productivity and low growth our economy – and every other advanced economy – seems caught in, and it's true there are "reforms" governments could make that would improve our performance – though they're not the reforms highest on the business council's list.

But the deeper truth remains that the nation's productivity is fundamentally determined by the performances of its many businesses. And if our business leaders took it into their heads to lift their companies' performance, the nation's productivity improvement and growth would be faster.

If you don't believe that, you must be a socialist.

A study by Deloitte Access Economics for Westpac assembles evidence that there's plenty of room for improvement in the performance of Australia's managers.

A report prepared for the federal government in 2009 used the methodology of the World Management Survey to rank the quality of our management sixth of 16 countries studied, behind Canada, Germany, Sweden, Japan and the US.

A paper by Nicholas Bloom and others, from Stanford University, finds that well-managed firms perform better than their peers and make a greater contribution to a nation's total-factor productivity.

Differences in how well-run businesses are help explain differences in productivity between nations. For instance, thanks in part to its successfully run businesses, the US has one of the highest total-factor productivity levels in the world.

Bloom and colleagues estimate that, across all countries, 29 per cent of the difference in productivity between the US – which has the highest management effectiveness scores – and other nations can be explained by how well businesses are run.

Using this finding, Deloitte Access estimates that, if the gap in management quality between Australia and the US were halved today, our productivity would rise to 80 per cent of the US level, up from its present level of 77 per cent.

Achieving such an increase today would lead to a 4.3 per cent increase in gross domestic product over its present level.

This represents an increase in GDP of about $70 billion, equivalent to about $3000 a person per year.

Such a boost would raise our ranking on the league table of GDP per person (adjusted for differences in the purchasing power of particular currencies) from 19th to 14th in the world – just the "metric" that so appeals to the top dogs on the Business Council.

Deloitte Access concludes from other research that fast-growing businesses "take an attitude that success is in their hands and nobody else's.

"High-growth firms perceive issues they cannot control – such as economic conditions and competition – as less of a barrier to success than [do] low-growth firms, placing greater concern on issues they can control, such as recruitment and cash flow …"

So "businesses' own decisions and strategies drive their success. The state of the economy and industry trends are clearly important factors affecting business profitability …

"But business success can come during any market conditions, and opportunities can arise in any industry, provided there's the right leadership to seize potential."

So that's what our over-paid and under-performing chief execs are getting wrong.

Read more >>

Workforce participation a key for Turnbull's new plan

Now it's likely the Turnbull government will scrape back to office, what's next? What will it do to improve our economic prospects?

Malcolm Turnbull went to the election offering a "national plan for jobs and growth" that was supposed to secure our future.

Trouble is, it now looks unlikely he'll be able to implement the centrepiece of that plan, the phased reduction over 10 years of the rate of company tax, from 30 per cent to 25 per cent.

Unsurprisingly, the proposed cut in company tax did not impress the voters, who think companies are paying too little tax, not too much.

Labor opposed the cut, save for the immediate reduction to 27.5 per cent for genuinely small business.

With the government now facing an even more hostile Senate, it's unlikely Turnbull will get any more than that.

This would be no great loss in the quest for jobs and growth. The government's own modelling suggested the tax cut would do virtually nothing to create jobs, and the boost to growth in Australians' incomes would be tiny and come only after a decade or three.

But what about the other parts of Turnbull's "five-point plan"? It's a muddle of things that will be done, things already done and a point saying what the plan will achieve.

Point one is "an innovation and science program bringing Australian ideas to market". Already done; benefits likely to be modest.

Point two is "a new defence industry plan that will secure an advanced defence manufacturing industry in Australia". Or a highly protectionist and costly way of buying votes in South Australia, of debatable defence value.

Point three is "export trade deals that will generate more than 19,000 export opportunities". This refers to preferential trade deals already made with Japan, Korea and China.

As my colleague Peter Martin has demonstrated, this is one of the big lies of the campaign. Such trade deals usually add more to our imports than our exports (which, of itself, is no bad thing).

Point four is the company tax cut and point five is "a strong new economy with more than 200,000 jobs to be created in 2016-17". This is just Treasury's budget forecast for growth in employment. Few of those extra jobs would have been "created" by anything the government did.

Get it? The "plan for jobs and growth" is a (now-thwarted) plan to cut company tax, plus a lot of packaging. That is, Malcolm Turnbull has no plan.

And, as we've been reminded by noises coming from one of the credit rating agencies, nor does he have a plan to get the government's budget back to surplus anytime soon.

His projection of that happening in 2020-21 relies heavily on a host of forecasts and assumptions.

Many people conflate the need for action to get the budget back to surplus with the need for "reform" to hasten our rate of productivity improvement and economic growth.

The two are related, of course, but they're not the same thing and we should consider them separately.

Remember that whereas productivity improvement is what you could call a "positive" objective, leaving us clearly better off materially, fixing the budget is a "negative" objective – it would just reduce the risk of problems down the track.

Obviously the longer we take to get back to balance, the more our interest bill grows. If this arises from borrowing to cover recurrent spending at a time when the economy is back to growing at about its trend rate, this is a bad thing.

However, if the borrowing is needed to cover spending on infrastructure (as you discover is largely the case when you study the information buried on page 6.17 of the budget papers) this is no cause for concern – provided the money hasn't been spent wastefully.

The cost of any credit rating downgrade is overrated, but it is true that, if we've got the budget back to surplus by the time we're hit by the next recession, we'll feel freer to respond as we should: allowing the downturn to push us back into deficit and adding temporary stimulus spending on the top.

Getting the budget back to surplus will do nothing to create "jobs and growth". Indeed, if you go about it the wrong way, it could come at the expense of jobs and growth.

A lesser-known point is that improvements in our productivity performance do little to improve the budget balance.

That's because it does about as much to increase government spending (directly and indirectly) on public sector wages and wage-indexed welfare payments, as it does to increase economy-wide wages and profits and, hence, tax collections.

As he casts about for a real plan to implement in the coming term, Turnbull should remember the thing that does help both the budget and Jobson Grothe: increased participation in the workforce.

This truth was lost when Turnbull was led astray by the rent-seeking of the Liberals' generous big business supporters and their obsession with cutting their own taxes in the name of "reform".

So one obvious place for Turnbull to start is with women. The Abbott government made a good start with the reform of childcare subsidies, but this has been blocked in the Senate because of the insistence on linking it with a crazy attempt to save money on paid parental leave in a way that would discourage employers from offering paid leave at their own expense.

The government should ensure that lack of available childcare isn't limiting young mothers' participation and continuing progress in their careers.

It could do much more to reduce the amazingly high effective marginal tax rates that discourage "secondary earners" (aka married mothers) from moving from part-time to full-time.

And then it could take a more careful run at winning public support for raising the age pension age to 70. We can get on with a slow phase-in, or wait until it's unavoidable.

Read more >>

Productivity and fairness should go together

They say we get the politicians we deserve but recent weeks convince me we also get the election campaigns we deserve. When we're moved more by scare campaigns than by policy debate, guess what the pollies give us?

To the extent that we have been debating policy choices, we've had economic policy but much less social policy.

That's pretty standard for elections. The Coalition's offering has been mainly about its "plan for jobs and growth".

What could be more important than that? Ignoring climate change, not much – provided we remember that the income from jobs and growth needs to be shared widely and fairly, including with people unable to work.

They haven't mentioned it much in the campaign, but our politicians and their economic advisers are worried that our prospects for economic growth are weak because our productivity – production per worker – isn't improving as much as it used to.

In its latest annual economic outlook, the Organisation for Economic Co-operation and Development – a club of mainly rich nations – very much shares that concern.

But here's the trick: unlike our economic managers, the OECD brackets weak productivity improvement with worsening inequality of incomes, describing them as "a twin challenge".

The two issues are interrelated. Although the report doesn't canvas the respects in which inequality may be contributing to weaker productivity improvement, it does emphasise that the policy measures we choose to improve productivity could come at the expense of worsening inequality, or could improve both productivity and income equality at the same time.

That's one of the big discoveries of the international economic agencies in recent years: whereas economists have long assumed that "efficiency" and "equity" (fairness) are conflicting objectives, there are various policy choices that can bring us more of both.

Part of this is their realisation that the size of a country's government – its level of taxes and government spending – has little bearing on its government efficiency and rate of growth.

The report notes that most advanced economies have experienced slower rates of productivity improvement since the early 2000s.

Income inequality – the gap between the highest and lowest incomes – has been widening for the past two or three decades.

"The productivity slowdown and the rise in inequality have impacted the wellbeing of many workers and their families. Low- and middle-income households have had to cope with slow-growing, and in some cases stagnant or falling, real incomes," the report says.

"These trends are threatening progress in living standards, fiscal sustainability and social cohesion."

(If you wonder why so many Americans have flirted with a clown like Donald Trump, I think it's their uncomprehending way of reacting against the fact that so many of them have gained so little extra real income from the United States' economic growth over the past 30 years.)

In a well-functioning economy, wages – real, not just nominal – should rise in line with the improvement in the productivity of labour.

So the report says lower rates of productivity growth have been bad news for workers, since this has reduced the room for productivity-driven growth in real labour income (wages).

But it's worse than that, for two reasons. First, average real labour income across the OECD's rich member countries has grown less than productivity has grown.

That's particularly true for the US but, according to the OECD's calculations at least, also for us.

Second, the inequality of labour income has increased, with some employees getting much bigger wage increases than others.

Over the period from 1990 to 2013, the rich members' labour productivity grew by 3.1 per cent a year until 2000, then by just 0.9 per cent a year for the past 13 years.

But whereas productivity improvement averaged 1.8 per cent a year for the full period, average real labour income improved by only 1.5 per cent a year.

And remember that, because of the presence of a relatively small number of very highly paid employees, the average (mean) income is always higher than the more-representative "median" (dead middle) income, which improved by just 1.3 per cent a year.

But it's worse even than that. Since 1990 the real disposable income of the top 10 per cent of households has increased by 30 per cent, whereas that of the bottom 10 per cent has increased by only 4 per cent.

(Note that "labour" income becomes "market" income when you add households' capital income – from profits, dividends, rent or interest earnings – and then becomes "disposable" income after you allow for taxes paid and welfare benefits received.)

So what can be done to tackle the "twin challenge" of weak productivity improvement and worsening inequality? You look for those policy changes that create "synergies" between the two.

The report says productivity growth has slowed partly because of weak demand since the global financial crisis. Governments need to stimulate demand (spending) by making more use of fiscal (budgetary) policy, it says, implicitly criticising the resort to policies of "austerity" by governments in Europe and elsewhere.

This would not only reduce inequality immediately by reducing unemployment, it would help reduce inequality more permanently because "long-term unemployment erodes the skills of workers and their earnings prospects".

In resorting to fiscal stimulus, the emphasis should be on increased public investment in infrastructure because this adds more to demand than do tax cuts or increased recurrent spending – it has a larger "multiplier" effect.

The report says government effectiveness in delivering high quality services – such as education, health and transport – is empirically associated with higher economic growth and productivity, plus lower income inequality.

"The empirical links of better and more education [particularly early childhood education] with higher growth, productivity and equality suggest long-term benefits from a greater share of education in public spending," it says.

If we were having a more adult election campaign, these are issues we'd be debating.

Read more >>

Don’t be sure lower penalties mean more jobs

The argument that reducing or eliminating weekend penalty wage rates would have great economic benefits is obvious to all business people and economists – but not to me. I think it's fallacious.

The received wisdom was well expressed by Anna McPhee, of the Retail Council: "The rebalancing of penalty rates to reflect the needs of the modern economy will mean retailers can create jobs to meet increased consumer demand, which in turn will benefit the economy more broadly."

She was responding, of course, to the proposal in the Productivity Commission's draft report on Australia's Workplace Relations Framework that Sunday penalty rates in the hospitality, entertainment, retailing, restaurant and cafe industries be cut to the same level as Saturday penalty rates.

Even the commission goes along with the received wisdom: "Excessive penalty rates for Sundays reduce hours worked, mean unemployment is higher than it needs to be, and reduce options for businesses and consumers. Trading hours are likely to be lower and capital under-utilised."

But I believe such thinking rests on a fallacy of composition, that what's true for the individual must be true for the whole.

It's not hard to see why particular business people, thinking only of the circumstances of their own business, see lower penalty rates leading to more sales, higher profits and, as a pleasant side-effect, more not-so-well-paid casual employees.

There would be some, of course, who looked no further than benefit of the lower wage rates they'd be paying even if they didn't bother opening their business for more days or longer hours than they are at present.

And, indeed, since they'd now be earning more than they were, that might be enough for some.

But let's assume the owners of the affected businesses really did want to open longer, sell more and profit more. Their fixed costs would now be spread over more sales, while their main variable cost – wages – would be lower per hour.

Question is: where would all these extra sales come from? From rivals that didn't bother opening on Sundays? That advantage isn't likely to last.

From businesses in other industries that now sold less during the week because their customers were seizing the opportunity to spend more on the weekend?

Of course, even if that were true it need be of no concern to any business person confident of being able to sell more. Their motive is to make more money and that's all a market economy expects of them.

But here's my point: just because some businesses can make more and employ more, this doesn't do much for the economy overall if their success comes at the expense of other businesses that make less and employ fewer.

When the advocates of lower penalty rates tell us that many extra jobs will be created, they're surely expecting us to take that as meaning more jobs overall, not just more jobs in some industries but fewer in others.

So let's switch to a macro or, as the commission likes to say, "economy-wide" perspective. We're told it will be great because, with more businesses open on the weekend, consumers will spend more and it's this extra spending that will create more jobs.

But how much the nation's consumers spend is ultimately constrained by their income. Are we expecting that consumers will spend more by saving less? Why would this be a good thing?

Why are we compelling employees to save 9.5 per cent of their wages if we really don't care about people saving much? (And don't mind being more reliant on foreign investment as a consequence.)

Maybe so as to spend more on weekend entertainment the nation's consumers might borrow more – on their credit cards or however. Would this be good for the economy? In any case, borrowing to boost your consumption is not something the nation's consumers can go on doing for long.

I don't believe there is much scope for us to be consuming a lot more than we are already – certainly not over the medium term. If so, then a lot of the businesses that sell more will be taking sales from other businesses.

And there's another possibility, one I suspect is quite likely: those businesses that open for longer on the weekend will sell more at the weekend, but less during the week.

To the extent that businesses achieve nothing more than spreading essentially the same amount of sales over longer opening hours – which I think is quite likely – they're likely to be worse off rather than better. The economy-wide benefits will be small, as will the net gain in employment.

Read more >>

Why the economy's slow growth may last

The biggest economic story last week wasn't all the wishful thinking about raising the goods and services tax, it was Reserve Bank governor Glenn Stevens' warning that the economy's "potential" rate of growth may be lower than we've assumed.

Predictably, those commentators who did see the significance of this news were too busy putting their own spin on it to make sure what Stevens' said was widely taken in. So let me have a go.

The macro managers' long-standing belief that the economy's "trend" rate of growth is 3 per cent a year or a fraction more has been challenged by the Bureau of Statistics' labour force estimates showing that, over the past year, the rate of unemployment has stabilised at 6 per cent.

Trouble is, the latest national accounts show the economy growing by only 2.3 per cent over the year to March. This is well below the trend rate that, almost by definition, is the rate at which the economy must grow to hold the unemployment rate steady.

How is this discrepancy explained? Stevens ran through the range of possibilities. Maybe employment hasn't been growing as strongly as the figures say at present. Maybe the economy has been growing more strongly than the figures say at present.

Or maybe part of the surprisingly strong growth in employment is explained by the unusually slow growth in wage rates, which would be saving some jobs and creating others.

The final possibility – and the one to which Stevens gives most weight – is that the trend rate of growth is lower than we've assumed, thus allowing unemployment to stabilise at a lower rate of economic growth than we've assumed.

Economists use the term "trend" in both a backward-looking and a forward-looking sense. If you calculate our average actual rate of growth over the past 10 or 20 years, this must have been our "potential" growth during that period.

If nothing in the economy has changed over that time, it should also be our average, trend rate of growth in the coming five or 10 years.

However, things do change – the population ages, for instance – so economists have to make guesses about what our potential growth rate will be in the future.

Our potential growth rate is the maximum rate at which the economy can grow on average over the medium term without a causing a serious inflation problem. It's set by the economy's supply side.

It represents the average rate at which the economy's capacity to produce goods and services is growing. And this is usually thought of as being determined by the rate of growth in the working population plus the rate of improvement in the productivity of labour.

(Whether in any particular year the economy is growing at a rate below, at or above its potential growth rate is determined by the strength of demand at the time. However, the economy can grow faster than its potential "speed limit" only for as long as it has idle production capacity to use up.)

But this is where those commentators who cottoned on to the significance of Stevens' views jumped to their own conclusions about what was causing the suspected slowdown in potential growth. They assumed it must be caused by a slowdown in labour productivity improvement.

Why? Because this fits well with the economists' (including Stevens') long-running campaign to persuade us to undertake more micro-economic​ reform so as to raise productivity and, hence, material living standards.

What they missed in their missionary zeal was Stevens' clear indication that he thought the culprit was slower-than-expected population growth.

The econocrats' figuring suggest a potential growth rate of 3 per cent would be explained by population growth of 1.7 per cent to 1.8 per cent a year, plus growth in labour productivity of 1.2 per cent to 1.3 per cent a year.

So their expected rate of productivity improvement is already pretty low, while the end of the mining construction boom and slow growth generally have seen population growth slow to 1.5 per cent a year or less as the net intake of workers on temporary 457 visas falls and Kiwis go home to a faster-growing economy.

The other thing the missionaries missed was Stevens point that, to the extent the lower trend rate is caused by lower population growth, it shouldn't involve any slower rate of improvement in our material living standards, as measured by growth per person.

Missionary micro-economic reformers won't win lasting converts by misrepresenting our present position, nor the outlook for growth. Their pessimism about future productivity improvement isn't supported by our more recent performance. It's little more than a guess.

Read more >>

We're not doing too badly on productivity

Rummaging through the media's rubbish bins this week, I happened upon some good news. According to the Productivity Commission's annual update, the productivity of labour improved by 1.4 per cent in 2013-14.

And get this: in the 12-industry "market sector" of the economy, it improved by 2.5 per cent in that year and by 3.7 per cent the year before.

To give you an idea, the 40-year average rate of market-sector productivity improvement is 2.3 per cent. So, despite all the worrying we've been doing in recent years about our poor productivity performance, it seems we're now doing quite well.

In which case, how come no one wanted to tell us? I can think of three reasons. First is the media's assumption that good news is of little interest to their customers.

Second is that the Productivity Commission's preference is for brushing aside the labour productivity figures and getting us to focus on the figures for "multi-factor productivity", which show an improvement of just 0.4 per cent in 2013-14 and 0.4 per cent the year before. This compares with the 40-year average of 0.8 per cent a year.

Third is that the nation's economists are engaged in a campaign to persuade us we need a lot more micro-economic reform so as to raise our rate of productivity improvement and, hence, the rate at which our material standard of living is rising.

They'd make the same argument whether our productivity performance was good, bad or indifferent, but it helps the selling job if they leave us with the impression our recent performance is poor.

Anyway, let's take a closer look at the commission's new figures. Productivity, which compares the growth in the output of goods and services with the growth in inputs of labour and capital, is a measure of the efficiency of our production. When outputs grow faster than inputs, the economy – the economic machine, so to speak – has become more efficient.

The simplest (and probably least inaccurate) way of measuring productivity is to take the increase in the quantity of goods and services produced during the year and divide it by the increase in the total number of hours worked to produce the stuff.

The main way to increase the productivity of workers is to give them more machines to work with. But the commission believes a more revealing measure is multi-factor productivity. You calculate this by dividing the increase in output by the increase in labour inputs plus the increase in capital inputs (use of machines and other equipment).

The main thing causing an increase in multi-factor productivity is technological advance – the invention of better machines plus improved ways of running businesses. But also improvements in "human capital" – the rising education and skill of the workforce.

That's all fine in theory, but it gets pretty ropey in practice. For a start, we have no way of measuring the productivity of the public sector (healthcare, education and public administration) because, for the most part, it doesn't sell its output in the market.

The market sector covers the financial services, mining, construction, manufacturing, transport, retail trade, wholesale trade, information media and telecommunications, electricity gas and water, agriculture, accommodation and food services, arts and recreation services, rental hiring and real estate services, professional scientific services, administrative support services, and "other" services industries.

That's 16 industries – though, for reasons it doesn't explain, the commission's 12-industry measure of market sector productivity doesn't include the last four industries on that list. Even so, the 12 industries account for 65 per cent of gross domestic product.

A much more serious problem is that the measurement of multi-factor productivity is quite dodgy. It's measured as a residual, meaning that any error in measuring the three other items in the sum will (and does) make the measurement of multi-factor productivity wrong.

More particularly, economists have no way of accurately measuring capital inputs. Just one of their problems is that they can't distinguish between more machines and better machines, meaning their so-called measure of multi-factor productivity excludes much of the technological advance it purports to measure.

The besetting sin of economists is the way they confidently quote their figures to a trusting public, without breathing a word about the data deficiencies and dubious assumptions that lie behind their calculations. When they fail to issue a product warning, it's the duty of the conscientious economic journalist to call them out.

In such circumstances, the commission's results need to be treated with scepticism – particular when, as was true in the noughties, they were so unprecedentedly low as to be implausible.

But let's look at the commission's breakdown of the latest year's supposedly weak result of 0.4 per cent. Half of the 12 industries – all of them in the services sector – achieved remarkably strong improvements, ranging between 1.1 per cent and 5.4 per cent.

Three industries – mining, construction, agriculture – had growing production but marginally declining multi-factor productivity. We know the problems in mining and construction are temporary. Agriculture's poor performance came mainly from drought.

The last three industries – utilities, manufacturing and transport – suffered declining production but lesser declines in inputs, meaning their multi-factor productivity deteriorated quite significantly.

We know the utilities, particularly electricity and gas, are coping with major structural changes, not helped by the earlier misregulation of poles and wires. We know manufacturing is still recovering from the high exchange rate caused by the resources boom. Whatever transport's problem is – we're not told – it will get over it.

That's the trouble with the supposedly worrying figures for multi-factor productivity. Apart from the ropiness of their calculation, when you investigate the stories for the particular industries involved you can't find anything major to worry about.

I'd say that, despite all the barrow-pushers wanting to use poor productivity figures to bolster whatever cause they're promoting, we're not doing too badly on productivity.

Read more >>

How growth can make us worse off

Just about every economist, politician and business person is a great believer in a high rate of immigration and a Big Australia. But few of them think about the consequences of that attitude – which does a lot to explain our economic problems.

The latest figures from the Bureau of Statistics show our population grew by 1.4 per cent to 23.6 million in 2014. Less than half this growth came from natural increase (births exceeding deaths), with most of it coming from net migration.

When I saw the 1.4 per cent growth figure, I thought it much of a piece with the 1.5 per cent growth over the year to September. It confirmed us as having one of the fastest growing populations among the advanced economies.

But, the Business Bible assured us, growth of 1.42 per cent was a big worry. It was clearly less than the 1.49 per cent average rate of the past 15 years and was, indeed, our weakest growth in eight years.

Slower population growth meant slower growth in real gross domestic product and this would also make it harder to get the federal budget back into surplus, we were told.

Really? This is crazy talk. It shows even our economists have turned off their brains on the question of immigration and lost their way between means and ends. Now they believe in growth for its own sake, not for any benefits it may bring us.

Of course slower growth in the population means slower growth in the size of the economy. But what of it? What do we lose?

The economic rationale for economic growth is that it raises our material standard of living. But this happens only if GDP grows faster than the population grows. So it doesn't follow that slower GDP growth caused by slower population growth leaves us worse off materially.

That would be true only if slower population growth caused slower growth in GDP per person. I suspect many people unconsciously assume it does, but where's the evidence?

I doubt there is any. The most significant recent study, conducted by the Productivity Commission in 2006, concluded that even skilled migration would do little to increase income per person. And what little growth the commission could find was appropriated by the new arrivals.

I doubt it's by chance that economists rarely, if ever, adjust the GDP figures they obsess about for population growth. Meaning we're constantly being given an exaggerated impression of how well we're doing in the materialism stakes. I can't remember GDP per person rating a mention in the budget papers.

Politicians are always boasting about record government spending on this or that, but they never make allowance for population growth in making such claims. (Why would they when often they don't even allow for the effect of inflation?)

As for the claim that slower population growth will make it harder to reduce the budget deficit, it reveals just how unthinking we've become on immigration. It's true enough that slower growth in the workforce means slower growth in tax collections.

But is that all there is to it? What about the other side of the budget? Aren't we assuming a bigger population is costless? Skilled immigrants and their dependents never use the health system? They don't have kids needing to be educated?

They don't add to traffic congestion, wear and tear on roads and 100 other taxpayer-provided services? Since there's often a delay while they find jobs, who's to say budgets, federal and state, wouldn't be better off with fewer immigrants?

But what's strangest about the economic elite's unthinking commitment to high immigration is the way they wring their hands over our weak productivity growth and all the "reform" we should be making to fix it, without it crossing their minds that the prime suspect is rapid population growth.

It's simple: when you increase the population while leaving our stock of household, business and public capital unchanged, you "dilute" that capital. You have less capital per person, meaning you've automatically reduced the productivity of labour.

So you have to do a lot more investing in housing, business structures and equipment and all manner of public infrastructure – a lot more "capital widening" – just to stop labour productivity falling.

The drive for smaller government – and the refusal to distinguish between capital and recurrent government spending – simply doesn't fit with a commitment to rapid population growth and a rising material standard of living.

Lower immigration would help reduce a lot of our economic problems – not to mention our environmental problems (but who cares about them?).

Read more >>

We're not taking productivity seriously

Given our obsession with materialism, productivity "isn't everything, but in the long run it is almost everything," as Paul Krugman famously said. If so, the intergenerational report's consideration of the topic is quite inadequate.

It's partial in both senses. It mentions most of the key factors that influence productivity improvement - defined as increased goods and services produced per hour worked - but doesn't do justice to many, including climate change.

That's partly because, though the report purports to be about the future of the economy, its real target is Treasury's eternal top priority, the future of the budget balance.

But it's also because the econocrats are leading us towards their preferred policy response to our alleged productivity problem and away from those responses their "priors" - preconceived beliefs about how the world works - cause them to disapprove of.

There are two broad approaches to government efforts to improve productivity: one which involves more intervention and spending and one which involves less intervention and little change in spending. Guess which one Treasury's priors lead it to favour?

For the past 200 hundred years, most of the world's productivity improvement has come from technological advance - people inventing better machines and thinking of better ways to do things.

But the other fish Treasury wants to fry prompt it to embrace an extreme view held by a few American economists that we've entered a period of much less rapid technological change.

When you consider all the disruption the digital revolution is unleashing on so many industries this is hard to believe.

In the era of the knowledge economy, you'd expect much long and earnest discussion about what governments should and shouldn't be doing to encourage acquisition of the "human capital" that comes from education and training.

Should we be cutting budgetary support for science and research and development? Is now the right time to be pushing university funding off the budget and on to students and universities' money-making schemes?

Why would a government that professes to believe in "equality of opportunity" welch on its professed support for the Gonski reforms to school funding? Why would it view Gonski as about private versus public rather than about lifting the future participation and productivity of kids at the bottom of the distribution?

Instead, the issue of human capital is airily dismissed with the line that "there is little evidence that slower productivity growth has been the result of inadequate investment in skills, education and innovation more broadly".

Maybe. But it's probably equally true there's little evidence it hasn't been. All you're really saying is that there's little evidence - because we've never been willing to run to the expense of adequately measuring such a vital ingredient in our future wellbeing.

The other key element of productivity improvement that gets short shrift is public infrastructure spending. To what extent are its inadequacies limiting the productivity of businesses and adding to commuting times (an important part of our wellbeing that doesn't show up in gross domestic product)? But do workers who spend an hour getting to work arrive at their productive best?

No discussion of our present and future productivity performance is adequate without assessment of the role being played by our policy of high immigration. But all we get is the throwaway line that "there is some evidence that" high levels of migration increase productivity because our focus on skilled migration raises the workforce's average skill level and because "migrants can be highly motivated".

This is true and quite dishonest at the same time. It minutely examines the dog in the room while studiously ignoring the elephant. What economists know but try not to think about - and never ever mention in front of the children - is that immigration carries a huge threat to our productivity.

The unthinkable truth is that unless we invest in enough additional housing, business equipment and public infrastructure to accommodate the extra workers and their families, this lack of "capital widening" reduces our physical capital per person and so reduces our productivity.

Think of it: the very report announcing that our population is projected to grow by 16 million to 40 million over the next 40 years doesn't say a word about the huge increase in infrastructure spending this will require if our productivity isn't to fall, nor discuss how its cost should be shared between present and future taxpayers.

No, none of that. Just another repetition of that peculiarly Australian doctrine that pretty much the only way to improve productivity is to engage in unceasing micro-economic reform.

Read more >>