Showing posts with label reform. Show all posts
Showing posts with label reform. Show all posts

Saturday, December 14, 2013

Multi-factor productivity not what it's cracked up to be

Figures for the economy's productivity performance haven't looked good for the past decade, causing consternation among economists and business people. But a careful study by the Productivity Commission has failed to find any particular problem, nor anything we could do to make the figures look better.

Productivity is a measure of the efficiency with which the economy turns inputs of labour and capital into outputs of goods and services. Thus productivity is measured as output per unit of input.

The more we can improve productivity the better off we are. We have in fact being increasing it a little almost every year since the Industrial Revolution, and this is what has made us so much more prosperous. So if you believe the goal of economic management should be to increase our material standard of living (which I don't), nothing is more important than ever-improving productivity.

The simplest (and probably least inaccurate) way to measure productivity is to take the quantity of goods and services produced during a period (real gross domestic product) and divide it by the number of hours of labour required to achieve that production.

Doing this each year shows that our "productivity of labour" improved unusually rapidly in the second half of the 1990s, but then showed little further improvement during most of the noughties. Over the past two or three years, however, it has returned to a reasonably healthy rate of improvement.

But you can improve the productivity of labour simply by giving workers more machines to work with. And this tells us nothing about the efficiency with which the economy's physical capital is being used. So in recent years it has become fashionable to focus on a more sophisticated measure called "multi-factor productivity".

This is the growth in real GDP (output) that can't be explained by any increase in inputs of both labour and physical capital. So, in principle, multi-factor productivity represents "technological progress" - the invention of better physical technology and the discovery of better ways to organise the production of goods and services. It's technological advance that does most to raise material living standards.

When you look at our performance over the past few years you find that, though the productivity of labour has been improving at a reasonable rate, multi-factor productivity hasn't improved. It was this that staff at the aptly named Productivity Commission set out to investigate in a study published last week.

They found that the flat performance of multi-factor productivity in the market economy was explained mainly by an actual decline in the multi-factor performance of manufacturing. So they focused their investigation on manufacturing.

Estimates by the Bureau of Statistics show that between 1998-99 and 2003-04 multi-factor productivity in manufacturing improved at a rate of 1.3 per cent a year. But between 2003-04 and 2007-08 it fell by 1.4 per cent a year. Since then (up to 2010-11) it has deteriorated at the slower rate of 0.8 per cent.

Delving further, the researchers found that two-thirds of the deterioration between the first two periods could be explained by just three of manufacturing's eight sub-sectors. From worst to least worse: petrol and chemicals, food and beverages, and metal products.

Trouble is, they could find "no overarching systemic reason for the decline". That is, no problem or problems you could tell the government it needed to fix.

What they found were several factors that made the figures look bad but weren't actually bad themselves, plus one factor we all know about, can't do much about, but have reason to hope will improve soon: the high dollar.

The metal products industry's poor performance was explained mainly by a big expansion in alumina refining capacity which had yet to come on line. Obviously a temporary problem.

The petroleum and chemicals industry's poor performance was explained to a significant extent by increased investment by petroleum refineries to meet new environmental standards. That is, there was an improvement in the quality of their output which the figures didn't pick up.

The food and beverages industry's poor performance was partly explained by a change in consumer preferences in favour of products made in smaller-scale, more labour-intensive bakeries. No probs if that's what the punters want.

In both petroleum and chemicals and food and beverages the poor performance was explained also by reduced use of production capacity, caused largely by the effect of the high dollar in reducing exports and increasing competition from imports.

But now I must give you the product warning economists keep forgetting. Like so many other concepts in economics, multi-factor productivity is simple in principle but as ropey as hell in practice. Putting a number on the concept requires you to make a lot of unrealistic assumptions (perfect competition, equilibrium, for instance) and use statistics that don't accurately measure what they're supposed to measure.

As the researchers acknowledge, multi-factor productivity is measured as a residual: after you estimate the amount of production you subtract an estimate of the amount of labour used and an estimate of the amount of capital used (particularly dodgy) and what's left is multi-factor productivity.

It's what a modeller would call an "error term" - the net result of all the mismeasurement of output, labour input and capital input. So, as the researchers acknowledge, the figures they have used can't be taken as a reliable measure of technological progress.

My word for it is ragbag: technological progress may be in there somewhere, but so will be a lot of other things, real and non-existent.

You can work out the figures for multi-factor productivity, but if they look good you don't know whether they really are, nor why they are. If they look bad it's the same.

What the Productivity Commission's study tells me is that even with figures that look really bad, it can find nothing amiss. Worrying about measures of multi-factor productivity is jumping at shadows.

Thursday, October 3, 2013


Australian National Conference on Resources and Energy, Talk to conference dinner, Canberra, Wednesday, October 3, 2013

I suppose I should start by warning you I’m an adherent to the Paddy McGuinness school of public speaking, which holds that there’s no point in speaking to an audience unless you say something that makes them sit up, challenges their comfortable assumptions and gives them something uncomfortable to think about. This has become, I admit, a terribly unfashionable way to engage an audience. The fragmentation of the media that’s occurring in the digital age is increasingly allowing consumers of the media to customise their news and opinion, selecting those items they’ll find congenial and reinforcing, and selecting out anything that jars with their long-held view of the world. And it’s certainly the case that the main organs of business news have switched to a strategy of only ever telling the captains of industry what they want to hear, of echoing their own opinions back to them.

Sorry, but I’m too close to retirement and too comfortably off to be bothered abasing myself in such a way. In Paddy McGuinness’s heyday the business bible saw its role as being devil’s advocate to business and that’s a role I’m much more comfortable with. And since I didn’t ask to be paid to talk to you tonight, I’m going to do it my way. So I imagine many of you won’t enjoy what I’ve got to say and may even heartily disagree with some of it. Feel free to think of some disparaging label to attach to me and use as an excuse to close your mind to the challenging things I say. I’ll still bother saying them in the hope at least some of you are bosses who don’t want to be surrounded by yes-men and do want to be challenged to rethink some of your more comforting beliefs.

Perhaps among all the labels you could use to dismiss my views the least abusive is that I’m ‘anti-mining’. I assure you I’m not. I’ve spent the past decade singing the praises of the resources boom to my readers, arguing staunchly that this reinforcement of Australia’s comparative advantage in the provision of minerals and energy to the rest of the world is a blessing, and that the rest of our economy has to cop the painful structural adjustment this new stroke of good fortune makes necessary.

What I’m not, however, is pro-mining. I’d like to think I’m not pro any particular sector of industry. When I got into the economic commentary business 40 years ago it was the farmers and the manufacturers who were always trying to tell us they were special, that the rest of the economy rode on their back and that this entitled them to special consideration. It was self-serving self-delusion then, and it still is. What’s changed is that, these days, we also have the miners trying to tell us they’re special, that the rest of the economy rides on their back and that they’re entitled to special consideration. Sorry, not buying that one, either.

With the change of government I’m sure you’re a lot happier about the prospects for the economy and its management, and a lot more confident of a sympathetic hearing from the new government. I wouldn’t be so sure. I suspect the mining industry’s lobbying success is reaching its zenith as we speak. It won’t surprise me if, looking back on the life of the Abbott government, you come to realise the big gains the industry made actually occurred under the Labor government. They occurred no thanks to Labor, and all thanks to the Coalition, but they occurred in reaction to the policies of Labor as part of Tony Abbott’s successful four-year campaign to fight his way back into office. Why did Abbott immediately oppose the mining tax and promise to repeal it? Because he genuinely believed it would wreck the mining industry and do great damage to the wider economy? I doubt it. He did it primarily because he saw opposing the tax as a popular cause and was hoping for a lot of monetary support from the big miners in the 2010 election campaign. Why did he set his face against the carbon pricing scheme? Because it was the price of getting the backing within the party that allowed him to wrest the Liberal leadership from Malcolm Turnbull and because he could see what a popular cause it would be to oppose this ‘great big new tax on everything’.

Now, I have no doubt that keeping his promises to get rid of the mining tax and the carbon tax - delivering on the commitments he made as a result of policies pursued in Labor’s term - will be among his highest priorities. But my point is this: Having delivered so handsomely for the mining industry, I doubt if he’ll feel in any way indebted to the miners. Indeed, he may well feel he’s the one that’s owed. Certainly, he’ll feel the miners have had enough favours to be going on with. And it won’t surprise me if that’s the attitude other industries take: that the miners have had their turn and it’s time to give other industries a go. I suspect the mining industry’s lobbying power has just reached its zenith.

Does this analysis shock you? Does it seem extraordinary cynical? Sorry, it’s just being brutally realistic. We all pursue our self-interest, but we all cloak our self-interest in arguments about how this would be in the best interest of the economy. All I’m doing is stripping away the bulldust.

Most people in business are hoping that with a more enlightened government in power with a big majority in the lower house and a reasonably workable Senate after July, we’ll now see some major economic reform - if not in Abbott’s first term then certainly in his second. I think this is an idle hope.

In a prophetic speech he delivered in May - and which he’s in the process of expanding into a short book - Professor Ross Garnaut argued that our political culture has changed since the reform era of 1983 to 2000, in ways that make it much more difficult to pursue policy reform in the broad public interest. ‘If we are to succeed, the political culture has to change again,’ he said. Policy change in the public interest seems to have become more difficult over time as interest groups have become increasingly active and sophisticated in bringing financial weight to account in influencing policy decisions, Garnaut said. ‘Interest groups have come to feel less inhibition about investment in politics in pursuit of private interests. ‘For a long time, these past dozen years, it has been rare for private interests of any kind to be asked to accept private losses in the interests of improved national economic performance. When asked, the response has been ferocious partisan reaction rather than contributions to reasoned discussion of the public interest in change and in the status quo,’ he said.

I would remind you that, though John Howard’s introduction of the GST is a notable exception, the many reforms of the Hawke-Keating era were achieved with bipartisan support - something that’s unthinkable today. Much of that reform, particularly in the area of taxation, involved packages of measures in which particular interest groups suffered some losses, offset by other gains. As Garnaut argues - and I’m about to demonstrate - this kind of co-operative give-and-take between interest groups willing to accept reforms in the wider public good simply isn’t conceivable today.

My way of making Garnaut’s point is that since the reform era of the 1980s and 90s we’ve regressed to a culture of rent-seeking. You can see this at the level of the political parties and at the level of the industry lobbies. When Howard had the courage to propose introducing a GST, Labor saw its chance to regain office by running a populist scare campaign against it, and came within a whisker of winning the 1998 election. At the time it professed to be righteously opposed to such a regressive tax, but when it finally regained power seven years later, the idea of doing something about that supposedly abhorrent regressivity never crossed its mind. When, in turn, the Rudd government - in its own quite ham-fisted way - attempted the risky reforms of installing the ‘economic instrument’ most economists recommend for responding to the challenge of climate change, and rebalancing the tax system by reforming the taxation of mineral deposits and using the proceeds to reduce taxes elsewhere, Abbott lost little time in deciding to take advantage of Labor’s vulnerability.

Do you really think the events of the past three years will have no bearing on the Labor opposition’s attitude to any controversial reforms Abbott might propose in the next six years, or that Abbott’s foreknowledge of this attitude will have no bearing on his willingness to propose such reforms? The truth is the nation has fought itself to an impasse on controversial reform - of the labour market as well as taxation - and, among the industry lobbies, the miners have played a more destructive role than the rest.

Now, you can respond that the miners did no more than what you’d expect them to do: oppose two new taxes they perceived to be contrary to their industry’s interests. But this is making my point: the reason the outlook for major economic reform is now so bleak isn’t solely because the two sides of politics have regressed to short-sighted, self-interested advantage seeking, it’s also because the industry lobby groups have done the same thing. There’s nothing new about industry lobbying but, as Garnaut says, in the past dozen years it’s become far more blatantly self-interested and far more willing to devote large sums to advertising campaigns to oppose whatever government reforms an industry sees as contrary to its interests.

What hasn’t yet occurred to many business people - but you can be sure is well understood by the politicians and their advisers - is that when industries lobby governments for favours or in opposition to new imposts, the various industries are in competition. It’s easy to imagine the government’s coffers are a bottomless pit but, in fact, there’s only so much rent to go around. As an economist would say, all concessions have an opportunity cost. It’s easy to believe all industries could pay less tax if the pollies would only make households pay more tax, but I wouldn’t hold my breath waiting for it to happen. I doubt either side of politics would see that as consistent with their own self-interest. The truth is, when one industry gets in for a big cut, there’s less left in the pot for the others.

That industries don’t understand this simple point about opportunity cost - don’t realise they’re in competition with each other - is easily demonstrated by the demise of Labor’s mining tax package. Think about the original package: the big three miners were going to pay a lot more tax on their resource rents, but pretty much the whole of the proceeds was going to be distributed to other industries. In particular, all companies (including miners, big and small) were getting their company tax rate cut by 2 percentage points, small miners were getting a resource exploration rebate, small business was getting instant write-off of most assets, the banks were getting more concessional taxation of their depositors’ interest income and the financial services industry was getting its great dream of having compulsory super contributions jacked up from 9 per cent to 12, a one-third increase in contributions. So three big miners had a lot to lose, but the rest of industry had a lot to gain. So what was the rest of industry’s attitude to the resource super profits tax? Didn’t like the sound of it. And what did they do when the miners sought to scuttle the new tax? Precisely nothing. What happened then? The exploration rebate was to first thing to disappear and, in several stages under Labor, the cut in the company tax rate got whipped off the table. Now, with Abbott’s plan to abolish the cut-down mining tax, the small business concessions are being withdrawn and the phase-up of compulsory super contributions has been deferred for two years. With all the pressure on the Abbott’s budget, and the super industry extracting a promise from Abbott not to make any further savings on the concessional taxation of super, I’m prepared to bet the two-year deferment will become permanent.

Thus did the rest of business allow the miners to screw them over. And thus did the miners destroy faith in one of the techniques tax reformers believed made major tax reform possible: put together a large package with a mixture of wins and losses and the various industry lobbies keep each other on board in the wider interest.

But it doesn’t stop there. When the miners and the rest of business dream of further tax reform under the Abbott government - perhaps after yet another root-and-branch tax review - what do they have in mind? Mainly, a big cut in the company tax rate. Do you really see the Abbott government daring to fund such a cut by increasing the GST? Had the minerals resource rent tax survived and got past its accelerated depreciation phase, the fact that the most highly profitable part of the corporate sector (along with the banks) was paying a lot more tax on its profits, would have greatly strengthened the argument for a general cut in the company tax rate (this is particularly so because mining is so heavily foreign-owned). So the absence of the resource rent tax makes a cut in the company tax rate a lot less likely. One way a cut in the rate could still be afforded is if was covered by a broadening of the base by the removal of sectional concessions. But the bitter experience of the demise of the mining tax package makes it less likely any government would risk proposing such a compromise.

We can continue going down the road of ever-more blatantly short-sighted and narrowly self-interested behaviour by political parties on the one hand and industry lobby groups on the other, but while we do so it’s idle to dream of major, controversial reform. What we can do - as the miners have shown - is veto any reform we don’t fancy.

Monday, June 3, 2013

Garnaut cries from the economic wilderness

Professor Ross Garnaut, now at the University of Melbourne, is our most prophetic economist. In a much-discussed speech last week he prophesied that the easing of the resources boom would bring "hard times after more than two decades of extraordinary prosperity".

He says we face three big challenges if we're to avoid the end of the long boom leaving us with much to regret. The first is that our real exchange rate now needs to fall a long way to be consistent with full employment.

The second big challenge, he says, is to change entrenched expectations that living standards will rise inexorably over time; that household and business incomes and public services will rise and taxes will fall, as they have done for a generation.

"Those expectations must be reversed in the process of dealing with the legacy of the boom, or our efforts in reform will be defeated by bitter disappointment with political leadership and eventually political institutions," he says.

I think he's making two points. One is that economic life consists of downs as well as ups, losses as well as gains, and anyone who imagines governments should or even could shield them from all unpleasantness is destined for disillusionment. The need for income earners not to be compensated for the higher cost of imports caused by a fall in the dollar is a case in point.

The other point is we must disabuse ourselves of the notion economic life is about sitting around waiting for another serve of prosperity to be handed to us on a plate. Outside of resources booms, we have to make our own luck.

The third big challenge we face is that our political culture has changed since the reform era of 1983 to 2000, in ways that make it much more difficult to pursue policy reform in the broad public interest. "If we are to succeed, the political culture has to change again," he says.

Policy change in the public interest seems to have become more difficult over time as interest groups have become increasingly active and sophisticated in bringing financial weight to account in influencing policy decisions, he says.

"Interest groups have come to feel less inhibition about investment in politics in pursuit of private interests.

"For a long time ... it has been rare for private interests of any kind to be asked to accept private losses in the interests of improved national economic performance. When asked, the response has been ferocious partisan reaction rather than contributions to reasoned discussion of the public interest in change and in the status quo.

"A new ethos has developed in which there can be no losers from reform. Business has asserted a property right to continuing benefits of regulatory mistakes. It demands compensation for corrections to errors in policy.

"Households have been led to expect that no policy changes will cause any of them to be worse off."

Garnaut says that whether comprehensive public interest reform is possible depends a great deal on the quality of political leadership. Quality of leadership is partly about capacity to explain to citizens the nature of the choices that must be made on their behalf. He's no doubt right about the need for better leadership, but when the rest of us dwell on that lack it becomes a cop-out. It's actually a symptom of the very easy-prosperity syndrome Garnaut is warning about.

The Business Council in particular is prone to sitting around praying for God to send us leaders "prepared to lose their jobs to get things done". That's a quality as rare among politicians as it is among chief executives. If we wait for a policy suicide bomber we'll be waiting a while.

In truth, politicians are more followers than leaders. They deliver those changes being urged on them by what I'd call the nation's opinion leaders and Garnaut calls "a substantial independent centre of the national polity".

Pollies make risky reforms when they know these people have already done much educating of community power-holders on the necessity for the reforms in the public interest, and when they're confident the urgers will stand by them when the flak is flying. (The Business Council always finks out at that point.)

And Garnaut offers a further warning to those who, like the Business Council, dream of "reforms" that advance their private interests at the expense of the rest of us. Reform must be clearly in the public interest if certain groups are to be persuaded to cop losses for the greater good.

Finally, "it is a lesson of Australian history that successful periods of restraint require the equitable sharing of sacrifice". Developing a framework of equity will be important to the success of a choice by the nation to put the public interest ahead of business as usual.

Monday, November 12, 2012

What business needs to learn about politics

The way big business sees it, economic reform has ground to a halt because the politicians on both sides have lost the political will to make the tough decisions. But I think big business must share the blame for the stalemate we've reached.

Business leaders have lost confidence in the Gillard government and, having concluded its days are numbered, are uncharacteristically willing to attack it in public. In private, though, most would doubt an Abbott government would be any more willing to grasp the nettle.

Consider the GST. Despite all the good sense Nick Greiner was talking last week about the need to fix it, both sides refuse even to discuss the topic. It was specifically excluded in the terms of reference for Ken Henry's "root and branch" review of the tax system (which didn't stop him proposing a similar tax with a different name).

It's not hard to see what the problem is. Each side is afraid that, if it showed the slightest interest in considering the topic, the other side will use this as a pretext to launch a scare campaign.

Or, consider the mining tax. Although it's not true the tax raised no revenue in its first quarter, it is true it raised less than expected, mainly because of the fall in commodity prices.

But prices have recovered from their lows in the first two months of the quarter. As well, the nature of the quarterly instalment process means collections are likely to pick up in later quarters.

Even so, it is true that the compromise tax Julia Gillard negotiated with the big three mining companies was both badly designed and too generous to the miners.

Why did she give in to them? Because the opposition had sided with the miners in opposing the original tax and, in their efforts to destroy the Rudd government, the big miners would have given the opposition huge funding in the 2010 election campaign.

One reason the miners were so opposed to the original tax was that the government caught them off guard with a strange tax they didn't understand. This would not have happened had Labor released the Henry report for discussion well before it made up its mind about which recommendations to accept, reject or modify.

So, why didn't it? Because it was so afraid the opposition would run a scare campaign claiming that Labor intended to implement all of Henry's most controversial proposals.

Next, consider company tax. For reasons I can't fathom, big business has its heart set on a cut in the company tax rate. Labor promised a cut of 2 percentage points, but the deal with the miners obliged it to reduce the cut to 1 point.

Then the combined opposition to this from the opposition and the Greens allowed Labor to renege completely. Although all previous cuts to the rate have been funded by the removal of concessions, big business can't agree on which concessions it's prepared to give up.

This has allowed Labor to shelve the idea. And I wouldn't hold my breath waiting for an Abbott government to find the revenue needed to fund a cut.

Finally, consider all the reform the Hawke-Keating government undertook during the 1980s and early '90s: deregulating the financial system, floating the dollar, phasing out import protection, deregulating more industries than you can remember and decentralising wage-fixing.

What do these reforms have in common? They went virtually unchallenged by the Liberal opposition of the day, under the dominant influence of John Howard and John Hewson.

Are you starting to see a pattern? All the reforms that aren't getting up (or, in the case of the mining tax, got badly botched) have become party-political footballs. And almost all the reforms we did get were bipartisan policy - with the GST and the carbon tax as the notable exceptions (although in both these cases the lack of bipartisanship led to inferior policy).

The point is, it's not so much unhappy voters governments fear, it's their political opponents seeking to take advantage of the voters' unhappiness.

What many business people don't understand about politics is the power of oppositions to influence what governments do and don't do. It's rare for governments to make controversial reforms when they know their opponents are waiting to pounce.

The bipartisan support for micro-economic reform lasted throughout the Hawke-Keating government's 13 years, but broke down after Paul Keating's defeat in 1996. Since then, both sides have gone for short-term political advantage at the expense of the nation's longer-term interests.

So, the first lesson big business needs to learn is that it's not enough to pressure the government of the day to show "political will". You must also pressure the opposition to resist the temptation to score cheap political points.

That's particularly the case when it's the opportunism of a Liberal opposition that is discouraging a Labor government from doing what it knows it should.

The second lesson is that big business won't get far until it abandons its code of honour among thieves. That is, when one industry goes into battle with the government to resist a new impost or get itself a special concession, all the other industries keep mum, even though they know the first industry is merely on the make.

Big business looked the other way as the three big miners connived with the opposition to destroy the Rudd government. Its reward was to have its precious cut in company tax snatched away.

Saturday, September 1, 2012

Productivity more about technology than reform

A while back I met a businessman who'd been a big wheel in IT. He expressed utter amazement that the Productivity Commission and other economists could attribute the whole of the surge in productivity during the 1990s to micro-economic reform, without a mention of the information and communications technology revolution.

He was right; that's exactly what they do. And he's right, it's pretty hard to believe that computerisation and the digital revolution could make such a big difference to the way so many businesses go about their business without that making any noticeable difference to the nation's productivity.

Can the economists prove the productivity surge in the late '90s and early noughties was caused by the delayed effect of all the micro reforms of the '80s and '90s - floating the dollar, deregulating the financial system, phasing down protection, privatising or corporatising government businesses, reforming taxes and decentralising wage-fixing?

No they can't. The plain truth is so many factors influence productivity, and the figures themselves are so ropey, you can't say what's driving them at a particular point with any certainty.

I think the best you can say is all that reform must surely have had some positive influence. But most economists are great advocates of micro reform, so you've got to allow for salesman's bias.

But here's the big news for that incredulous businessman: for the first time, to my knowledge, the econocrats have acknowledged that IT may have played a significant part in the productivity surge.

The likelihood is accepted in an article on Australia's productivity performance by Patrick D'Arcy and Linus Gustafsson in the most recent issue of the Reserve Bank's Bulletin.

"One possible explanation for the surge and subsequent decline in multi-factor productivity growth in Australia ... over the past two decades is the pattern of adoption of information and communication technologies, which are primarily developed and produced offshore," they say.

"The widespread adoption of these technologies through the 1990s was largely complete by the early 2000s. Assuming that the introduction of computers created a gradual upward shift in the level of productivity of some workers ... this would have been reflected in strong multi-factor productivity in the 1990s, with the contribution to productivity growth moderating in the 2000s once rates of usage had stabilised."

In case you're rusty, "multi-factor productivity" growth measures the increase in the amount of output for a given amount of both labour and capital inputs.

Over the 20 years to 1994, it improved in the market sector at the rate of 0.6 per cent a year. Over the 10 years to 2004, the rate surged to 1.8 per cent a year. Over the seven years to mid-2011, it contracted at the rate of 0.4 per cent a year. Exclude mining and the utilities industry, however, and the underlying improvement was plus 0.4 per cent a year.

If you're a glass-half-full kind of guy, you can say our productivity performance in recent years is only a little worse than our long-term average. But on this score most economists prefer the half-empty view: the rate of productivity improvement has suffered a significant and worrying slowdown in recent times.

Again, that's a salesman's line. The authors observe that what's exceptional is not our present underlying performance but the unprecedented surge in the '90s.

If you're new to the productivity business you could be forgiven for thinking it occurs mainly as a result of economic reform. That's what many economists have been implying, but - as they well know - it's nonsense.

Particularly over the longer term, the primary driver of multi-factor productivity improvement - and the rise in material living standards it brings - is technological advance. That's why it never ceases to surprise me how little interest most economists take in technology and innovation.

But the authors outline what economists do know. "At a fundamental level," they say, "productivity is determined by the available technology (including the knowledge of production processes held by firms and individuals) and the way production is organised within firms and industries."

Conceptually, economists often view technology as determining the productivity "frontier". That is, the maximum amount that could be produced with given inputs.

Factors affecting how production is organised - including policies affecting how efficiently labour, capital and fixed resources are allocated and employed within the economy - determine how close the economy actually is to the theoretical maximum.

This means "trend" (medium-term average) productivity growth is determined by the rate at which new technologies become available (that is, how fast the frontier is shifting out) and also the rate of improvement in efficiency (how fast the economy is approaching the frontier).

"Overall, there is some evidence that both a slowdown in the pace at which the frontier is expanding and the pace at which Australia is approaching the frontier have contributed to the decline in the rate of productivity growth relative to the historically high growth of the 1990s," they say.

However, there is little evidence a lack of incentives to invest in physical capital has been significant in explaining the slowdown in multi-factor productivity growth, we're told.

The authors note that the slowdown in multi-factor productivity improvement has occurred despite continued strong growth in investment. In many cases, new investment involves increasing the stock of physical capital based on existing technologies. And although this "capital deepening" may improve labour productivity, it doesn't necessarily improve multi-factor productivity.

For investment to drive gains in multi-factor productivity, there need to be "spillover effects" that generate a more than commensurate increase in output than the increase in capital.

In practice, this typically requires the introduction of a new technology to be associated with some fundamental reorganisation of production processes, or the development of a genuinely new technology that has benefits greater than the research costs required to develop it.

For these reasons, economists generally view the likely drivers of multi-factor productivity as being research and development spending, investment in human capital (education and skills) and investments in capital equipment that can fundamentally change the way firms operate, such as information and communication technologies.

Figures show a fairly universal slowing in productivity growth in the noughties among the members of the Organisation for Economic Co-operation and Development.

This suggests part of our slowdown may be related to common global factors, such as the pace of technological innovation and adoption.

Monday, May 31, 2010

Tax battle will show if reform is still possible

Look at America and Europe and it's clear Australia has benefited hugely - in a material sense, at any rate - from the painful micro-economic reforms of the 1980s and '90s.

Look at our performance in the noughties, however, and it's clear the momentum of reform has dissipated. You see that in the business community's unrelenting white-anting of Kevin Rudd's emissions trading scheme, which ended in a bipartisan rejection of the use of "economic instruments" (putting a price on carbon) to combat climate change.

You see it now in the mining industry's bitter resistance to Rudd's latest attempt at major micro-economic reform, the replacement of inefficient mineral royalties with the far more efficient super profits tax.

The big miners - particularly BHP Billiton and Rio Tinto - are doing all they can to break the back of this measure, if not kill it. The newer and smaller miners, which would benefit most, seem cowed into silence.

The big boys' first success has been the opposition's - the Liberal Party opposition's - decision to again set its face against an economic-rationalist reform, one almost all economists endorse as good policy.

Professor Ross Garnaut believes the decision the nation takes on the reform of mineral royalties will either "confirm the descent of Australian political culture into a North Atlantic malaise, or represent a revival of the capacity of the Australian polity to take positions in the national interest, independently of sectional pressures".

Just so. The big miners are doing what all sectional interests attempt to do in these circumstances, persuade you and me that their problem (the government wanting to take a bigger bite out of their profits) is actually our problem (the miners will take their money elsewhere and leave us to rot).

To this end they're using a host of high-sounding, but actually unconvincing, arguments, the first of which is that the planned change in the royalty arrangements has greatly increased Australia's "sovereign risk" in the eyes of miners.

This is over the top. The sovereign risks faced by foreign investors in many countries - mainly developing countries - constitute things like having your company expropriated by the government, a breakdown in the rule of law, or the government defaulting on its debt.

Are BHP and Rio seriously putting us in that company? Turns out their definition of sovereign risk is merely "do you trust the government not to change the rules?" And what rule would that be? The price at which we're prepared to sell them our non-renewable resources.

The contract price of iron ore has increased by a factor of more than six since 2004. The contract price of hard coking coal has more than quadrupled. Do you reckon we're going to be the only country putting up the price it charges?

Far more likely that a lot of countries follow our example - which may well be what's adding extra vehemence to the big miners' fightback.

And name one country that's prepared to give foreign investors a guarantee it won't at some stage decide to change a tax or other law affecting those investors' businesses. If that's your definition of sovereign risk then it's a risk you face in every country - and many of them would be a lot rougher about it than us.

What's more, if that's sovereign risk, the only answer to it is national governments promising to give up their sovereignty. This is silly stuff.

It's curious that BHP and Rio, which purport to be so offended when anyone calls them foreigners rather than Australian, keep on about sovereign risk. Sovereign risk is the perspective of an outsider, not a local. A company with no loyalties, prepared to go wherever in the world it can get the best deal.

Every Australian business, big and small - and every individual, for that matter - faces the continuous risk that one of our nine governments will "change the rules" in ways we consider contrary to our interests.

We don't like it but, for the most part, we accept it. One of the rules that doesn't change is that democratically elected governments retain the right to change the rules. How else could you run a country?

Allied with the sovereign risk argument is the claim the resources tax would be "retrospective". This, too, is an abasement of the term. A true retrospective change involves subsequently declaring an act that was legal at the time it was undertaken illegal. That's what John Howard did with his outlawing of the bottom-of-the-harbour tax scheme.

Similarly, it would be reasonable to say a decision to change the tax on income earned (or minerals mined) before the announcement of the tax change was retrospective. But these guys are claiming a decision to increase the price of the minerals we sell them in the future - of which we're giving them more than two years' notice - is retrospective.

Huh? Apparently, any change to a mining project that's already established is a retrospective change. Had we known you were going to do this we might never have dug the mine. Yeah sure. Nor did you know the world price of the mineral was going to quadruple or sextuple in six years.

This is silly stuff. If that's your definition of retrospective, then every tax change (or other change) affecting every existing Australian business (and every person already born) is retrospective and thus improper.

As Professor John Freebairn of Melbourne University has said, "the idea that government cannot take actions that create losers ... would have stood in the path of tariff reform and most of the micro-economic reform of the past 20 years".

And if we let the big miners' pleading dissuade us from going ahead with this reform we'll be going the same way as the morally corrupt US Congress and the effete Europeans.