Showing posts with label technological advance. Show all posts
Showing posts with label technological advance. Show all posts

Monday, October 9, 2023

It's time for more sensible thinking on productivity

When will we tire of all the bulldust that’s talked in the name of hastening productivity improvement? We never do anything about it, but we do listen politely while self-appointed worthies – business people and econocrats, in the main – read us yet another sermon on the subject.

Trouble is, when the sermons come from big business – accompanied by 200-page reports with snappy titles – they boil down business lobby groups doing what lobby groups do: asking the government for special favours – aka “rent-seeking”.

You want higher productivity? It’s obvious: cut the company tax on big business, and give us a free hand to change our workers’ pay and conditions as we see fit.

When the sermons come from econocrats, they’re more like professional propagandising: calls for “reform” – often of the tax system – that are usually theory-driven and lacking empirical evidence that they really would have much effect on productivity.

What we get in place of genuine empiricism is modelling results. Models are a mysterious combination of mathematised theory, sprinkled with ill-researched estimates of elasticity and such like.

We’ve become so inured to all this sermonising that we’ve ceased to notice something strange: although in a market economy it’s the behaviour of business that determines how much productivity improvement we do or don’t get, any lack of improvement is always attributed to the government’s negligence.

This is where the business rent-seekers and the econocrat propagandists are agreed. The econocrats willingness to point at the government comes from the biases in their neoclassical theory, which assumes, first, that businesses always respond rationally to the incentives they face and, second, that government intervention in markets is more likely to make things worse than better.

Big business is happy to use this ideology to hide its rent-seeking. (If you wonder why neoclassical economics has been dominant for a century or two despite surprisingly little evolution, it’s partly because it suits business interests so well.)

The other strange thing we’ve failed to notice is that the modern obsession with the tax system and regulation of the labour market has crowded out all the economists’ conventional wisdom about what drives productivity improvement over the medium term.

But before we get to that wisdom, a health warning: there’s a famous saying in economics that the sermonisers have stopped making sure you know. It’s that, for economists, productivity is “a measure of our ignorance”.

Just as economists can calculate the “non-accelerating-inflation rate of unemployment”, and kid themselves it’s next to infallible, when you ask them why it’s gone up, or down, all they can do is guess at the reasons, so it is with calculations of productivity. Economists can’t say with any certainty why it’s up or why it’s down. They don’t know.

Even so, in the present opportunistic sermonising, all that the profession thought it knew has been cast aside.

Such as? That productivity improvement is cyclical and hard to measure. Recent quarterly results from the national accounts will probably change as better data come to hand, and the accounts are revised.

It’s true that the measured productivity of labour actually has fallen over the three years to June this year, but it’s likely this is, to a great extent, a product of the wild swings of the pandemic and its lockdowns. As Reserve Bank economists have argued, these effects should “wash out”.

It’s well understood that the main thing that improves the productivity of labour is employers giving their workers more and better machines to work with. But Australia’s level of business investment as a share of gross domestic product is low relative to other rich countries.

Growth in non-mining business investment has declined from the mid-2000s and stagnated over the past decade. It’s grown strongly recently, but it’s not clear how much of this is just tradies taking advantage of lockdown tax concessions to buy a new HiLux ute.

Point is, why do the sermonisers rarely acknowledge that weak business investment spending does a lot to help explain our weak productivity improvement?

Another factor that should be obvious is our recent strong growth in employment, the highest in about 50 years, with many people who employers wouldn’t normally want to employ, getting jobs. This will lower the workforce’s average productivity – but it’s a good development, not a bad one.

Again, why do the sermons never mention this?

Yet another part of the conventional wisdom it’s no longer fashionable to mention is the belief that productivity improvement comes from strong spending – by public and private sectors – on research and development. Have we been doing well on this over the past decade or so? I doubt it.

And, of course, productivity improvement comes from giving a high priority to investment in “human capital” – education and training.

So, why no sermons about the way we’ve gone for a decade or more stuffing up TAFE and vocational education, or the way school funding has given “parental choice” for better-off families priority over the funding of good teaching in public schools?

Too many of those sermons also fail to mention the small fact that all the other developed economies are experiencing similar weakness – suggesting that much of our poor performance is explained by global factors, not the failure of our government.

Related to this, the preachers usually compare our present performance with a much higher 30- or 40-year average, implying our weak performance is something new, unusual and worrying.

Or, we’re told that, whereas productivity improved at an annual rate of 2.1 per cent, over the five years to 2004, it worsened to 0.9 per cent over the six years to 2010, and improved only marginally to 1.2 per cent over the nine years to 2019, before the pandemic.

This is all highly misleading. The fact is that periods of weak improvement are more common than periods of strong improvement, which are rare.

Our period of unusually strong improvement from the late 1990s to the early noughties is paralleled by America’s strong period from 1995 to 2004, which the Yanks usually attribute to rapid productivity improvement in the manufacturing of computers, electronics and semiconductors.

We usually attribute our rare period of strong improvement to the belated effects of the Hawke-Keating government’s program of microeconomic reform. Maybe, but computerisation and the information revolution are a more plausible guess.

Either way, contrary to the sermonisers’ implicit claim that the present period of weak improvement is unusual, it may be closer to the truth that weakness is the norm, interspersed by occasional bursts of huge improvement, caused by the eventual diffusion of some new “general-purpose technology” – the next one likely to be generative AI.

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Friday, September 22, 2023

AI will make or break us - probably a bit of both

Depending on who you talk to, AI – artificial intelligence – is the answer to the rich world’s productivity slowdown and will make us all much more prosperous. Or it will lead to a few foreign mega tech companies controlling far more of our lives than they already do.

So, which is it to be? Well, one thing we can say with confidence is that, like all technological advances, it can be used for good or ill. It’s up to us and our governments to do what’s needed to ensure we get a lot more of the former than the latter.

If all the talk of AI makes your eyes glaze (or you’re so old you think AI stands for artificial insemination), let’s just say that AI is about making it possible for computers to learn from experience, adjust to new information and perform human-like tasks, such as recognising patterns, and making forecasts and decisions.

Scientists have been talking about AI since the 1950s, but in recent years they’ve really started getting somewhere. It took the telephone 75 years to reach 100 million users, whereas the mobile phone took 16 years and the web took seven.

You’ve no doubt seen the fuss about an AI language “bot”, ChatGPT, which can understand questions and generate answers. It was released last year and took just two months to reach 100 million users.

This week the competition minister, Dr Andrew Leigh, gave a speech about AI’s rapidly growing role in the economy. What that’s got to do with competition we’ll soon see.

He says the rise of AI engines has been remarkable and offers the potential for “immense economic and social benefits”.

It “has the potential to turbocharge productivity”. Most Australians work in the services sector, where tasks requiring the processing and evaluation of information and the preparation of written reports are ubiquitous.

“From customer support to computer programming, education to law, there is massive potential for AI to make people more effective at their jobs,” Leigh says.

“And the benefits go beyond what shows up in gross domestic product. AI can make the ideal Spotify playlist for your birthday, detect cancer earlier, devise a training program for your new sport, or play devil’s advocate when you’re developing an argument.”

That’s the optimists’ case. And there’s no doubt a lot of truth to it. But, Leigh warns, “it’s not all upside”.

“Many digital markets have started as fiercely competitive ecosystems, only to consolidate [become dominated by a few big companies] over time.”

We should beware of established businesses asserting their right to train AI models on their own data (which is how the models learn), while denying access to that data to competitors or new businesses seeking to enter the industry.

Leigh says there are five challenges likely to limit the scope for vigorous competition in the development of AI systems.

First, costly chips. A present, only a handful of companies has the cloud and computing resources needed to build and train AI systems. So, any rival start-ups must pay to get access to these resources.

As well, the chipmaker Nvidia has about 70 per cent of the world AI chips market, and has relationships with the big chip users, to the advantage of incumbents.

Second, private data. The best AI models are those trained on the highest quality and greatest volume of data. The latest AI models from Google and Meta (Facebook) are trained on about one trillion words.

And these “generative” AI systems need to be right up-to-date. But the latest ChatGPT version uses data up to only 2021, so thinks Boris Johnson and Scott Morrison are still in power, and doesn’t know the lockdowns are over.

Which brings us, third, to “network effects”. If the top ride-hailing service has twice as many cars as its rival, more users will choose to use it, to reduce their waiting times. So, those platforms coming first tend to get bigger at the expense of their rivals.

What’s more, the more customers the winners attract, the more data they can mine to find out what customers want and don’t want, giving them a further advantage.

This means network effects may fuel pricing power, entrenching the strongest platforms. If AI engines turn out to be “natural monopolies”, regulators will have a lot to worry about.

Fourth, immobile talent. Not many people have the skills to design and further develop AI engines, and training people to do these jobs takes time.

It’s likely that many of these workers are bound by “non-compete” clauses in their job contracts. If so, that can be another factor allowing the dominant platforms to charge their customers higher prices (and pay their workers less than they should).

Finally, AI systems can be set up on an “open first, closed later” business plan. I call it the drug-pusher model: you give it away free until you get enough people hooked, then you start charging.

Clearly, the spread of AI may well come with weak competitive pressure to ensure customers get a good deal and rates of profit aren’t excessive.

Just as competition laws needed to be updated to deal with the misbehaviour of the oil titans and rail barons of 19th century America, so too we may need to make changes to Australian laws to address the challenges that AI poses, Leigh says.

The big question is how amenable to competition the development of AI is. In other, earlier new industries, competition arose because key staff left to start a competing company, or because it made sense for another firm to operate in a different geographic area, or because customers desired a variant on the initial product.

“But if AI is learning from itself, if it is global, and if it is general, then these features may not arise.” If so, concentration maybe more likely than competition.

Get it? If we’re not careful, a few foreign mega tech companies may do better out of AI than we do.

Read more >>

Friday, August 4, 2023

NSW Treasury's new realism: productivity won't be speeding up

Have you noticed how people keep banging on about “productivity” these days? That’s because it’s the secret sauce of economics, the bit that comes closest to giving us a free lunch. But also because we haven’t actually been getting much of it lately.

Unfortunately, that’s made productivity a happy hunting ground for bulldust propositions. So let’s spell out exactly what productivity is.

A business – or a whole economy – improves its productivity when it finds ways to produce more outputs of goods and services with the same inputs of raw materials, labour and physical capital.

Sounds a great idea, but how is it possible? Short answer: advances in technology. Workers become more productive when they’re given tools and machines to work with. Many improvements in technology are designed to make workers more productive.

Better education and training make workers more productive by increasing their “human capital”. Even finding better ways to organise factories and offices can improve productivity. So can be teaching bosses better ways to jolly along their troops.

In my writing about the topic, I always focus on the simplest and least inaccurate way of measuring productivity. The productivity of labour is just output per worker or, better, output per hour worked.

Another approach would be to measure the productivity of the other main “factor of production”, capital equipment and constructions: output per unit of capital employed.

But economists often prefer to focus on “total-factor productivity” (or “multifactor productivity” as the statisticians prefer to call it): the growth in output (gross domestic product) that can’t be explained by increased use of labour and capital.

Economists have discovered that most of the improvement in people’s material standard of living over the years and centuries has come from improvement in total-factor productivity. This is why economists seem so obsessed by it. Keep productivity improving and we get wealthier.

But, as you see, total-factor productivity can’t be measured directly. It’s measured as a residual – what’s left when you take GDP and subtract two different things – which increases the chance your measurement is wrong.

And the truth is, economists don’t know as much about what causes productivity improvement as they ought to. That’s why they’ve spent the past decade debating the reasons that productivity growth has slowed significantly in all the advanced economies, not just Australia.

Theories abound, but there’s no agreement. And while we’re hearing plenty of tub-thumping sermons from business people (and central bankers) with their own axes to grind, there’s no agreement on what we should be doing apart from blaming the government and demanding it do something.

But last year, Professor Thomas Philippon of New York University wrote a working paper that offered a quite different explanation for the weak productivity growth we’ve been experiencing.

Conventional economic theory assumes that total-factor productivity grows “exponentially”, but Philippon has examined America’s productivity figures since 1947 – and done the same for a large group of other advanced economies – and found the growth has merely been “linear”.

Huh? Try this. If you have $100 growing 2 per cent each year, that’s exponential. If instead it just grows by $2 a year, that’s linear. Exponential growth is a fixed percentage rate; linear growth is a fixed absolute amount. The first $2 is 2 per cent of $100, but over the years the percentage rate of growth slowly declines.

So Philippon is saying we’ve been expecting productivity to grow at a much faster percentage rate than we should have been. Because its growth is “additive” rather than “multiplicative”, its annual percentage growth is declining.

The assumption that productivity improvement is exponential implies that innovation today makes further discoveries easier in the future. Philippon, however, finds that new ideas add to our stock of knowledge, but they don’t multiply it.

In the NSW Treasury’s new research paper, Trends in productivity: What should we expect, Keaton Jenner and Angus Wheeler have replicated Philippon’s exercise for Australia, getting similar results.

Whereas the standard exponential model implies that total-factor productivity should have grown at the annual rate of 1.7 per cent between 1983 and 2019, they find this significantly overshoots actual productivity growth.

But the new, additive model implies that productivity increases by 0.024 points per year, with an annual growth rate that tapers down from 1.25 per cent in 1984 to 0.9 per cent in 2019.

So, Philippon’s additive model yields what would have been a much more accurate – though still slightly optimistic – forecast.

This suggests that, without some major new “general-purpose” technological advance (such as the spread of electricity, or the internal-combustion engine), the model predicts that total-factor productivity growth will slowly fall to zero per cent.

But this doesn’t mean living standards wouldn’t continue to improve. Because living standards are powered by the productivity of labour, the authors find, they would grow by increasingly larger absolute amounts, but not at a steady, exponential rate of growth.

In the NSW government’s intergenerational report in 2021, productivity projections were based on the historical 30-year average exponential rate of 1.2 per cent a year. Other assumptions meant that real gross state product was projected to grow at an average rate of 2.2 per cent a year out to 2041.

The authors repeat this exercise using an additive productivity model and find that annual growth in labour productivity declines from 1 per cent to 0.8 per cent over the 20 years to 2041. This means an average annual rate of growth in real gross state product of 1.9 per cent – 0.3 percentage points lower that projected in the 2021 report.

The authors point out that, if realised, the NSW economy would be about 7 percentage points smaller in 2041 than was projected in the report two years’ ago. This, in turn, would have “material implications” for the government’s revenue base and budget balance, assuming no offsetting reduction in government spending.

It will be interesting to see if Victoria and the other state governments recalibrate their projections using this new, more pessimistic – but more realistic – view of the future.

Read more >>

Sunday, April 2, 2023

Climate choice: cling to past glories or strive for prosperous future

The big question facing our political leaders is: are we content to allow climate change to turn us from winners into losers, or do we have the courage and foresight to transform our mining, energy and manufacturing industries into clean energy winners?

For most rich countries, playing their part in limiting global climate change is simply about switching from fossil fuels to renewable energy. For us, however, there’s a double challenge: as one of the world’s biggest exporters of fossil fuels, what do we do for an encore?

When it comes to deciding how we can earn a decent living, economists are always telling politicians to pursue our “comparative advantage” – concentrate on doing what we’re better at than other people, and they want to buy from us; then use the proceeds to buy from them what they’re better at than we are.

Turns out our “natural endowment” makes us better at farming and mining. Climate change will be bad for farming (not that the world will stop wanting to eat), and the only future for fossil fuel exports is down and out. It may take a decade or two to reach zero, but there’ll be no growth from now on.

Most economists have little to say about what you do when your natural endowment becomes a stranded asset and our comparative advantage evaporates. Except for Professor Ross Garnaut, who was the first to realise that nature has also endowed us with a bigger share of sun and wind.

If we tried hard enough and were quick enough, we could not only produce all the renewable energy we need for our own use, but find ways to export it to less well-endowed countries, probably embodied in green steel and aluminium.

This, of course, involves innovation and risks. We’re talking about technological advances that haven’t yet been shown to work, let alone commercialised. Doing things that have never been done before.

When it comes to technology, Australia is used to following the leader, not being the leader. Until now, this has been sensible for a smaller economy like ours. But we’re facing the impending loss of our biggest export earner. If we can’t find something just as big to sell, we’ll see our standard of living rapidly declining.

The threat we face isn’t quite existential. We’ll still be alive, just a lot poorer – and kicking ourselves for not seeing it coming and doing something about it.

The solution’s in two parts. First, the federal government must make clear to the coal and gas industries, the premiers, the mining unions and the affected regions that there’ll be no further support or encouragement for anyone pretending they haven’t seen the writing on the wall. Anyone trying to stop the clock and keep living in the past.

There’ll be plenty of support and encouragement, but only for those industries, workers and regions needing help to move from the old world to the new. As part of this, the government must do what now even the UN secretary-general says every country must do: end subsidies of fossil fuels and use the money to assist the move to renewables and green production.

Help coal miners relocate or retrain – whatever. Promise that, wherever it made sense, the new renewable and green industries would be set up near the old mines.

Ideally, the policy of ending the old and moving to the new should be bipartisan. No opposition should take the low road of courting the votes of those preferring to keep their head in the sand.

But if that’s too much to ask of a two-party duopoly, Anthony Albanese and the Labor premiers should take their lives in their hands and overcome their life-long fear of what the other side will say when you put the national interest first.

Second, pick winners. Econocrats spend their lives telling governments not to do that – not to subsidise new industries you hope will become profitable.

Trouble is, politicians being politicians, you can be sure they’ll be putting taxpayers’ money on some horse in the race. And if they’re not trying to pick winners, they’ll be doing what they’re doing now: backing losers. Which would you prefer?

More importantly, it’s a neoliberal delusion that new industries just spring up as profit-seeking entrepreneurs seek new ways to make their fortunes. Doing something never done before is high risk. The chance of failure is high. Banks won’t lend to you.

We don’t stand a chance of becoming a green superpower without a lot of government underwriting with, inevitably, some big losses. But I can think of many worse ways of wasting taxpayers’ money.

Read more >>

Friday, March 31, 2023

Our days of productivity improvement may be gone for good

The Productivity Commission’s five-yearly report on our productivity performance seems to have sunk like a stone but, before it disappears without trace, it has one important thing to tell us: the obvious reason productivity improvement has slowed, and why, ceteris paribus, it will probably stay slow.

Economists like trying to impress people with Latin phrases. Many conclusions in economics depend on the assumption of ceteris paribus – all other things remaining unchanged. Economists are always holding all other variables constant while they see what effect a change in variable A has on variable B.

Trouble is, in the real world, all else almost never stays unchanged. In which case, the relationship between A and B that you thought you could rely on has been stuffed up by some other variable or variables between C and Z.

Back to the point. Everyone thinks they know what productivity means, but they often don’t. The commission’s report says productivity improvement is “the process by which people get more from less: more and better products to meet human needs, produced with fewer hours of work and fewer resources”.

“In many cases this growth occurs with lighter environmental impact” – a truth many scientists just can’t seem to get their heads around.

The report says that over the past 20 years, the rate of improvement in productivity has slowed in all the rich countries, but with Australia slowing more than most.

Why? Many reasons, no doubt, but one big one that ought to have been obvious, since the American economist William Baumol noticed it in the 1960s.

The fact is that most improvements in the productivity of labour come from advances in technology. You give workers better, “labour-saving” machines to work with, which allow them to produce more in a typical hour of work.

(The other big one is giving workers more education and training, which allows them to work more complicated machines – including computers and software – design more complicated machines and programs, and service complex machines.)

Trouble is, it’s easier to improve productivity in some industries than others. In particular, industries that produce goods – on farms, in mines and in factories – can, and have, hugely increase their productivity by mechanising and computerising. Same in utilities, transport and communications.

In the production of services, however, it’s much harder. Although some services can be delivered digitally – streaming video, say – with little involvement by workers, most services are delivered by people, from less-skilled services delivered by waiters, cleaners, bedmakers and shop assistants, to highly skilled teachers, nurses, doctors, lawyers and prime ministers.

You can give these workers a car or a mobile or a screen, or give a hairdresser a better pair of clippers, but there’s not a lot you can do to speed them up. As Baumol famously remarked, it takes an orchestra just as long to play a symphony today as it did in 1960 – or 1860.

After two centuries of playing this game, we’ve ended up with goods industries that are highly “capital-intensive” – lots of expensive equipment; not many workers – and service industries that are highly “labour-intensive”: many workers; not much equipment.

Which means the productivity of labour is sky-high in the goods sector, but not great in the services sector.

But here’s the trick. You might expect that wages will be much higher in the high-productivity goods sector and much lower in the low-productivity services sector. But no. Wage rates do vary according to the degree of skill a worker possesses, and on the demand for that particular skill.

But a cleaner in a factory gets paid pretty much the same as a cleaner in a lawyers’ office. And a doctor gets much the same working in a big factory’s clinic as in a hospital.

Why’s that? Because, if an economy is working properly (which ours isn’t at present), it’s the economy-wide improvement in productivity that tends to increase all real wages by about the same percentage.

This is brought about by market forces. Despite their low productivity, employers in the services sector have to pay higher wages to stop their workers moving to higher-paying jobs in the goods sector.

Remember too, that over time, mass production lowers the prices of manufactured goods. That’s particularly true if you judge it by how many hours of labour it costs to buy, say, a car or a restaurant meal.

What we’re saying is that, in rich, high-productivity economies such as ours, labour is the more expensive resource, and capital the less expensive resource.

It’s also true that there’s a limit to how much you can eat, how many cars you can drive and how many TV sets you can watch, but no yet-discovered limit to how many services you can pay other people to perform for you.

Put all that together and the goods sector’s share of the economy keeps getting smaller, while the services sector’s grows – to 80 per cent of the economy (gross domestic product) and 90 per cent of total employment.

But it also means that the sector which has little ability to improve the productivity of its labour also has to keep paying more for its labour as the goods sector increases the productivity of its labour.

Gosh, that’s not nice. No, which is why Baumol said that the services sector suffers from “cost disease”. And the services sector’s huge and growing share of the economy explains why productivity in the economy overall is improving more slowly than it used to.

But it could become even worse. If, as it seems, the goods sector has finally exploited almost all its potential to become more productive, and there’s not a lot of obvious scope to improve the services sector’s productiveness, it’s hard to see how we’ll get much more productivity-driven growth in the economy.

What a dismal prospect. Talk about the problems of affluence. You know, I don’t think the world’s poor have any idea how hard life will become for us.

Read more >>

Wednesday, March 22, 2023

Most of us don't really want to be rich, for better or worse

When it comes to economics, the central question to ask yourself is this: do you sincerely want to be rich? Those with long memories – or Google – know this was the come-on used by the notorious American promoter of pyramid schemes, Bernie Cornfeld. But that doesn’t stop it being the right question.

It’s actually a trick question. Most of us would like to be rich if the riches were delivered to us on a plate. If we won the lottery, or were left a fortune by a rich ancestor we didn’t know we had.

But that’s not the question. It’s do you sincerely want to be rich. It ain’t easy to become rich by your own efforts, so are you prepared to pay the price it would take? Work night and day, ignore your family and friends, spend very little of what you earn, so it can be re-invested? Come unstuck a few times until you make it big? Put it that way and most of us don’t sincerely want to be rich. We’re not that self-disciplined and/or greedy.

The question arises because the Productivity Commission’s five-yearly report on our productivity performance has found that, as a nation, we haven’t got much richer over the past decade – where rich means our production and consumption of goods and services.

When business people, politicians and economists bang on about increasing the economy’s growth, they’re mainly talking about improving the productivity – productiveness – of our paid labour.

The economy – alias gross domestic product – grows because we’ve produced more goods and services than last year. Scientists think this happens because we’ve ripped more resources out of the ground and damaged the environment in the process.

There is some of that (and it has to stop), but what scientists can never get is that the main reason our production grows over the years is that we find ways to get more production from the average hour of work.

We do this by increasing the education and training of our workers, giving them better machines to work with, and improving the way our businesses organise their work.

But the commission finds that our rate of productivity improvement over the past decade has been the slowest in 60 years. It projects that, if it stays this far below our 60-year average, our future incomes will be 40 per cent below what they could have been, and the working week will be 5 per cent longer.

It provides 1000 pages of suggestions on how state and federal governments can make often-controversial changes that would lift our game and make our incomes grow more strongly.

So, this is the nation’s do-you-sincerely-want-to-be-rich moment. And my guess is our collective answer will be yeah, nah. Why? For good reasons and bad. Let’s start with the negative.

If you think of the nation’s income as a pie, there are two ways for an individual to get more to eat. One is to battle everyone else for a bigger slice. The other is to co-operate with everyone to effect changes that would make the pie – and each slice - bigger.

For the past 40 years of “neoliberalism”, which has focused on the individual and sanctified selfishness, we’ve preferred to battle rather than co-operate.

Our top executives have increased their own remuneration by keeping the lid on their fellow employees’ wages. Governments have set a bad example by imposing unreasonably low wage caps.

Then they wonder why their union won’t co-operate with their efforts to improve how the outfit’s run. Workers fear there’ll be nothing in it for them.

It’s the same with politics. Governments won’t make controversial changes because they know the opposition will take advantage and run a scare campaign.

But there are also good reasons why we’re unlikely to jump to action in response to the commission’s warning. The first is that economists focus on the material dimension of our lives: our ability to consume ever more goods and services.

We’re already rich – why do we need to be even richer? There’s more to life than money, and if we gave getting richer top priority, there’s a big risk those other dimensions would suffer.

Would a faster growing economy tempt us to spend less time enjoying our personal relationships? How would that leave us better off overall (to coin a phrase)?

How much do we know about whether the pace of economic life is adding to stress, anxiety and even worse mental troubles?

If we did go along with the changes the commission proposes, what guarantee is there that most of the increased income wouldn’t go to the bosses (and those terrible people with more than $3 million in superannuation)?

What we do know is that we should be giving top priority to reducing the damage economic activity is doing to the natural environment, including changing the climate. If that costs us a bit in income or productivity, it’s a price worth paying.

And there are various ways we could improve our lives even if our income stopped growing. Inquire into them.

Read more >>

Monday, March 20, 2023

Handle with care: Productivity Commission's advice on getting richer

If you accept the Productivity Commission’s assumption that getting richer – “advancing prosperity” – is pretty much the only thing that matters, then the five priority areas it nominates in its five-yearly review of our productivity performance make a lot of sense.

But when you examine the things it says we should do to fix those five areas, you find too much of its same old, same old, preference for neoclassical ideology over empirical evidence.

And you find no acknowledgement that part of our claimed failure to improve the productivity of the “government-funded non-market services sector” has occurred because, over recent decades, governments have acted on the commission’s advice to keep the public sector small and taxes low by outsourcing the provision of human services to profit-motivated businesses.

Which, if anything, has made matters worse rather than better. As witness: the mess we’ve made of aged care and vocational education and training, and the ever-growing cost of the National Disability Insurance Scheme.

The report is quick to explain that improving productivity does not mean getting people to work harder. Perfectly true. It’s supposed to mean making workers more productive by giving them better training and better machines to work with.

Except that when you see the commission recommending a move to “modern, fit-for-purpose labour market regulation” – including, no doubt, getting rid of weekend penalty pay rates – you realise the commission has learnt nothing from the failure of John Howard’s Work Choices, nor from the failure of the reduction in Sunday penalty payments to lead to any increase in weekend employment, as had been confidently predicted.

So, what the commission is really advocating is that the balance of power in wage bargaining be shifted further in favour of employers and away from workers and their unions. Which probably would lead to people working harder for little or no increase in pay.

What the commission should have said, but didn’t, is that workers would be more co-operative with bosses’ efforts to improve the productivity of their firms if they were more confident they’d get their fair share of the benefits.

At present, they have good reason to doubt that they would.

What’s conspicuously absent from all the bemoaning of the slowdown in our rate of productivity improvement, is any acknowledgement that there’s also been a huge fall in the rate of the flow-through to real wages of what improvement we are achieving.

Until that’s fixed – until the capitalist system goes back to keeping its promise that the workers will get their fair share of the benefits of capitalism – Australia’s households have no rational reason to give a stuff about what’s happening to productivity.

Back to the point. Productivity improves when you produce the same things with fewer inputs of labour or capital, or produce more – either more quantity or better quality – with the same inputs.

And the report is exactly right to say that steadily improving our productivity is the key to improving the nation’s material standard of living. The rich world has more than two centuries of proof of that truth.

The first of the report’s five priority areas is achieving a “highly skilled and adaptable workforce”. Dead right. This is economics 101. Economists have known for yonks that investing in “human capital” is the obvious way to increase productivity.

(And it’s the better-educated and trained workers who can most easily adapt to the changing demand for labour that the digital revolution and other technological advance will bring.)

But the commission long ago stopped pointing this out, while state and federal governments put their efforts into quite different objectives. The Howard government, for instance, spent hugely on expanding parents’ choice of private school.

“I’m a Callithumpian, and I’d like to send my kid to a Callithumpian school, where they won’t have to mix with sinners.” Next, we had the limited success of the Gonski-inspired push to fund schools based on student need rather than entrenched privilege and religion.

And then we wonder why school results have got worse and so many kids leave school with inadequate numeracy and literacy. How they’ll be advancing our prosperity in an ever-changing world I hate to think.

Which raises a recent “learning” by economists, that doesn’t seem to have reached the commission: if you ignore what your “reforms” are doing to the distribution of income between the top and the bottom, don’t be surprised if your productivity goes off.

For some inexplicable reason, growth in the number of the downtrodden makes the average look worse.

Meanwhile, with universities, the highest priority of successive federal governments – Labor and Liberal – over the past 30 years has just been to get them off the budget.

The feds have made them hugely dependent on attracting overseas students and charging them full freight. One way they’ve coped is by making university teaching by the younger staff part of the gig economy.

Apart from putting the public unis (but not the few private unis) on a starvation diet during the lockdowns, the Morrison government’s last effort to punish what it saw as a hotbed of socialism was a hare-brained scheme to encourage students to choose courses that made them “job-ready” by, among other things, doubling the tuition fees for a BA.

Fortunately, this failed to discourage the students, but did make the humanities a far more profitable product for the unis to push.

To be fair, another recent “learning” does seem to have got through to the commission. It’s third priority for attention is “creating a more dynamic and competitive economy”.

Research by Treasury has found strong empirical evidence that our economy has become less dynamic – less able to change and improve over time. Fewer new firms are being created, and fewer workers are being induced to change their jobs pursuing higher pay.

Our industries have become more oligopolised – allowed by our permissive takeover laws - and, not surprisingly, their profit margins (“markups,” in econospeak) have been creeping up.

No official will admit it, but it seems pretty clear that the reason the Reserve Bank has been raising interest rates so far and so fast – despite falling real wages – is the part that oligopolistic pricing power is playing in our high inflation rate.

And now further Treasury research has confirmed that our high degree of industry concentration (markets dominated by a few huge firms) has given employers greater power to limit the rise in wages.

All this makes it unsurprising that our rate of productivity improvement has weakened. It also helps explain why, over the past decade, virtually none of what improvement in the productivity of labour we have achieved has been passed on to real wages.

Read more >>

Friday, February 10, 2023

Globalisation has stopped, but it's not actually reversing - yet

In case you’ve been too worried about your mortgage to notice, the era of ever-increasing globalisation has ended. There’s a backlash against greater economic integration and a risk it will start going backwards, causing the global economy to “fragment”.

The process of globalisation involves the free flow of ideas, people, goods, services and financial capital across national borders, leading to economic integration. But, as a new post on the International Monetary Fund’s blog site reminds us, globalisation is not new, and the process has ebbed and flowed over many decades.

The post charts the progress of globalisation back more than 150 years. Using openness to international trade – measured as global exports plus imports as a proportion of world gross domestic product – it divides that period into five successive eras.

First came the era of industrialisation between 1870 and 1914, when increasing trade between Europe and the “new world” of North America, Argentina and Australia was driven largely by technological advances in transportation – including steel-hulled, steam-driven ships and refrigeration for shipping meat – which lowered the cost of trade.

The laying of undersea cables to improve communication between countries also helped.

Then came the era of wars and protectionism, beginning with the start of World War I in 1914 and finishing with the end of World War II in 1945.

In between came the Great Depression of the 1930s, which was made much worse than it needed to have been by governments trying to protect their domestic industries by using high import duties (“tariffs”) to keep people buying local.

It sounds like a great idea when you do it to other countries. It turns into a stupid idea when they retaliate and do it to you, leaving everyone worse off.

After trade had increased from 30 per cent of world GDP to more than 40 per cent during the era of industrialisation, it had fallen back to about 15 per cent by the end of World War II.

Third came the era of tariff reform between 1945 and 1980. Even before the war had ended, the Allies knew they’d have to fix the world economy. They decided to move to a system of fixed exchange rates and establish the IMF and the World Bank. Most importantly, they set up the General Agreement on Tariffs and Trade (now the World Trade Organisation).

The GATT arranged eight successive “rounds” of multilateral trade negotiations, in which the developed countries agreed to big reductions in their barriers to imports. Thanks to all this, trade doubled from 15 per cent of world GDP to 30 per cent.

This led on to the era of “hyperglobalisation” between 1980 and 2008, with the fall of the Berlin Wall in 1989 and collapse of the Soviet Union, bringing the Cold War to an end.

The eighth, biggest and final, “Uruguay” round of the GATT, in 1994, focused on increasing trade between the developed and developing countries, with many poor economies joining the WTO.

China’s economy began growing rapidly after it was opened up in the late 1970s, and in 2001 it was permitted to join the WTO, hugely increasing its trade.

The era also brought a move to floating exchange rates and deregulation of banking systems, leading to much increased investment between rich and poor countries.

As well, big advances in telecommunications, computerisation and the advent of the internet allowed a surge of trade in digital services, including data processing.

Resulting from all this, trade reached a peak of more than 55 per cent of world GDP in 2008, on the eve of the global financial crisis and the ensuing Great Recession.

The IMF bloggers label the present period, with figures from 2008 up to 2021, the era of “slowbalisation”. To date, those figures bear this out: trade has reached a plateau of about 55 per cent. More recent figures show world trade has largely bounced back from the initial effects of the pandemic’s global coronacession.

It seems the combined effect of the Great Recession and rising protectionist sentiment has stopped trade from continuing to shoot up relative to world GDP, but not caused it to fall back – or not yet.

Less optimistic observers, however, refer to present as the era of “deglobalisation”. They worry that we’re in the early stages of a period of “policy-induced geoeconomic fragmentation”.

It’s not hard to see what’s worrying them. First we had Britain deciding to leave the European Union, then the election of Donald Trump, vowing to “make America great again” by whacking up tariff barriers against the exports of friend and foe alike, and starting a trade war with China.

Now we have the use of trade and other economic sanctions by many countries to punish Russia in its war against Ukraine, which is fragmenting world trade.

US President Joe Biden has toned down his predecessor’s excesses, but not abandoned the trade war. This doesn’t seem to be about protectionism so much as America’s desire not to be overtaken by China as the world’s dominant superpower. In particular, the US wants to stay ahead of the Chinese in advanced digital technology, by denying them access to the latest and best semiconductors.

The risk is that the two could end up dividing the global economy into separate trading blocs, America and its democratic friends versus China and its autocratic friends. This would almost certainly slow the economic growth of both groupings.

And, as economist Dr John Edwards has written, dividing the trading world into good guys and bad guys would not suit us, nor our region. Our exports to China greatly exceed our exports to the US and other close security allies.

And all the East Asian economies – including Japan and South Korea – have China as a major trading partner. For that matter, China and the US are major trading partners of each other.

Fortunately, and despite all the sparring we’ve seen, Edwards and others find no evidence that the US and China have yet started to “decouple”.

Let’s hope economic sense prevails, and it stays that way.

Read more >>

Sunday, October 9, 2022

Creative destruction: Even pandemics have their upside

There’s nothing new about pandemics. Over the centuries, they’ve killed millions upon millions. But economic historians are discovering they can also have benefits for those who live to tell the tale. Take the Black Death of the 14th century.

In October 1347, ships arrived in Messina, Sicily, carrying Genoese merchants coming from Kaffa in Crimea. They also carried a deadly new disease. Over the next five years, the Black Death spread across Europe and the Middle East, killing between 30 and 50 per cent of the population.

What happened after that is traced in a recent study, The Economic Impact of the Black Death, by three American academics, Remi Jedwab, Noel Johnson and Mark Koyama, and summarised by Timothy Taylor in his popular blog, the Conversable Economist.

The immediate consequences of all the deaths were severe disruptions of agriculture and trade between cities. There were shortages of goods and shortages of workers, so those who did survive had to be paid well. This will ring a bell: with shortages of supply but strong demand, inflation took off.

In England, the Statute of Labourers, passed in 1349, imposed caps on wages. It was highly effective during the 1350s, but less so after that. Similar restrictions were imposed elsewhere in Europe.

Over the next few decades, after economies had adjusted to the worst of the disruptions, the continuing shortage of workers resulted in many rural labourers moving to the cities, which had vacant houses as well as jobs. Farmers had to pay a lot to keep their workers, so real wages had grown substantially by the end of the century.

Since many noblemen had died, the distribution of income became less unequal. Ordinary people could afford better clothing. So, many countries passed “sumptuary” laws under which only the nobility were allowed to wear silk, gold buttons or certain colours. Nor could the punters serve two meat courses at dinner.

Sumptuary laws were an attempt by elites to repress status competition from below.

The authors say the economic effects of the Black Death interacted with changes in social and cultural institutions – accepted beliefs about how people should behave. Serfdom went into decline in Western Europe because of the fewer labourers available.

People became even more inclined to marry later and so have fewer children. Stronger, more cohesive states emerged and the political power of the church was weakened.

It’s widely believed that all these developments played a role in the economic rise of Europe, particularly north-western Europe.

Taylor notes that one of the great puzzles of world economic history is the Great Divergence - the way the economies of Europe began to grow significantly faster than the economies of Asia and the Middle East, which had previously been the world leaders.

This divergence began soon after the Black Death.

“Of course, many factors were at work. But ironically, one contributor seems to have been the disruptions in economic, social and political patterns caused by the Black Death,” he concludes.

Fortunately, advances in medical science mean our pandemic has cost the lives of a much smaller proportion of the population. And believe it or not, advances in economic understanding mean governments have known what to do to limit the economic fallout – even if we didn’t see the inflation coming.

Governments knew to spare no taxpayer expense in funding drug companies to develop effective vaccines and medicines in record time.

One consequence of our greater understanding of what to do may be that this pandemic won’t alter the course of world economic history the way the Black Death did.

Even so, it’s still far too soon to be sure what the wider economic consequences will be. Changing China’s economic future is one possibility. Come back in 50 years and whoever’s doing my job will tell you.

Even at this early stage, however, it’s clear the pandemic has led to changes in our behaviour. Necessity’s been the mother of invention. Or rather, it’s obliged us to get on with exploiting benefits from the digital revolution we’d been hesitating over.

Who knew it was so easy and so attractive for people to work from home – with a fair bit of the saving in commuting time going into working longer. And these days many more of us know the convenience of shopping online – and the downside of sending back clothes that don’t fit.

Doctors were holding back on exploiting the benefits of telehealth, but no more. Prescriptions are now just another thing on your phone. And I doubt if the number of business flights between Sydney and Melbourne will ever recover.

Read more >>

Friday, February 25, 2022

Here's a novel idea: Australia needs more competition, not less

Business has many tired ideas for reforming the economy and improving productivity, most of which boil down to: cut my tax and give me more power to keep my wage bill low. But a veteran econocrat has proposed a new and frightening reform: make our businesses compete harder for our custom, thus making it harder for them to raise their prices.

Treasurer Josh Frydenberg has asked the Productivity Commission to undertake a five-yearly review of our (dismal) productivity performance. And this week Rod Sims, who’s departing after 11 years heading the Australian Competition and Consumer Commission, offered a few helpful hints in a speech to the National Press Club.

Sims says “the Australian economy suffers from high levels of market concentration [markets dominated by a few big firms] to the detriment of consumers, small business and productivity”.

He argues that the pandemic-related supply shortages and logistics problems we’re facing are worsened by market concentration in so many areas and by our infrastructure bottlenecks.

“We need to address this through competition law, to prevent anti-competitive abuses of market power, and through general infrastructure reform,” he says. He’s referring mainly to road, rail, air and sea transport facilities, and also to utilities – electricity, gas and water.

Australia’s infrastructure is generally high cost, he says, compared with other countries. “Why do we keep privatising assets and claiming success when huge amounts are paid for the asset?”

My answer: when state Treasuries are run by bankers rather than econocrats, that’s what they think they’re supposed to be doing.

Sims says that often, “these huge prices are the result of closing off competition, or because a monopoly was deliberately sold without any regulation of the prices that can be set for users who have no alternative but to use the monopoly asset”.

“Such behaviour can dramatically affect existing users and could be considered a continuing tax on the community,” he says.

Governments need to sign up to a checklist before infrastructure assets are sold to avoid provisions which restrict competition and to ensure there is appropriate regulation where monopoly or significant market power will exist after the sale to private interests, he says.

“Let’s acknowledge this issue and fix it so that Australia can avoid even higher priced infrastructure in future.”

Another infrastructure challenge is ensuring the regulatory arrangements for the National Broadband Network are appropriate.

“After [the federal government] spending $50 billion on the NBN, the objective must not be a commercial return on the [$50 billion] sunk investment. It must be making the best use of this great asset.

“The prices that allow the NBN to get a commercial return on all its outlays, and the prices that make best use of this expensive asset, are very likely quite different,” he says.

We all saw the benefit of having the NBN completed in time for the pandemic lockdowns. That’s just a taste of the benefits if we get the NBN’s pricing right. Prices must allow the NBN to keep investing as needed, but must also see optimum use made of the network.

That is, the goal should be maximising the network’s benefit to the whole economy, not creating a new business that can exploit the pricing power that usually goes with a monopoly network, then selling it off to the highest bidder (or continuing to own it while overcharging customers).

Another area where we’re not getting enough competition, are paying prices that are too high (often in ways that aren’t visible) and are crimping productivity improvement is “digital platforms”.

Sims says we have an internet dominated by a few gatekeeper companies: Google has 95 per cent of searching activity, Facebook dominates social media, and Google and Apple dominate the app market, particularly on mobile devices.

“I am proud that the ACCC is at the forefront of world efforts to identify the harms from digital platforms and potential solutions to them,” he says.

While it’s true that these giants innovated their way to success - bringing many benefits to ordinary internet users – it’s equally true they also acquired a huge array of companies that could have been competitors, which has extended their reach and cemented their power.

They also engage in many activities, from “product bundling” (where to get the ones you want, you have to pay for stuff you don’t want) to “self-preferencing” (where they put their own products at the top of a list, and rival firms’ products at the bottom). Over time, this has lessened competition in various important digital markets.

The digital giants also have access to, and control, a massive amount of data, which has seen harms ranging from that seen with Cambridge Analytica, to profiling people so as to maximise sales by exploiting consumers’ vulnerabilities.

Then there’s the many examples of inadequate competition in banking. Sims quotes just three. First, the price of the most important financial product, a home mortgage, is unknowable without huge effort and cost, which benefits banks and harms borrowers.

The still-being-rolled-out “consumer data right” (that is, it’s your data so you should be able to have it forwarded to a rival business) should help this a lot. And Sims wants consumers to be continually informed by a “prompt” of what typical borrowers are paying, so they know when to start shopping around.

Second, to reduce “debanking” – where banks find excuses to refuse to move money that has been arranged through the new “fintechs” and money remitters – the government should set up a scheme these digital non-banks can use to prove their controls are adequate to detect money laundering.

Third, now the digital giants are getting into the now largely cashless world, outfits such as Apple Pay must be stopped from preventing other providers of digital wallets making use of its “near field technology”.

Funny how it’s never occurred to the Business Council and other business lobby groups wringing their hands over weak productivity that an obvious solution to the problem is to make firms compete harder for their profits.

Read more >>

Friday, October 29, 2021

Praying for costless climate change: Lord, send down a miracle

Picture Scott Morrison kneeling by his bed, hands together, eyes closed, asking God to send him another miracle. Or maybe just giving Santa a list of all the things he’d like for Christmas.

Five things, actually. First, technology not taxes. That is, a sudden, unforced flowering of new technology that allows us to go on selling our fossil fuel to the world while – at negligible cost – the technology eliminates all our net emissions of carbon dioxide and other greenhouse gases.

Second, we reach net zero emissions by 2050 with “expanded choices, not mandates”. That is, no one should be forced to do anything. They’ll just choose to implement the new technology because it’s so wonderful.

Third, somebody somehow will “drive down the cost of a range of new energy technologies”. That is, reduce the cost of doing things without emissions so that it’s lower than the cost of doing things by, say, burning coking coal or burping methane. This, however, won’t destroy any jobs.

Fourth, we keep energy prices down with affordable and reliable power. That is, the solar and wind energy that we disparaged for many years is now cheaper than the coal-and-gas-fired power that we’re still trying to prop up, so you can thank us when electricity prices fall.

Fifth, we are accountable for progress. That is, just because we won’t show you our modelling, or tell you how much the deal with the Nationals will cost or what it’s going on, doesn’t mean we won’t tell you after the media’s lost interest.

We’re assured that Australia’s Long-term Emissions Reduction Plan will “achieve net zero emissions by 2050 in a practical, responsible way that will take advantage of new economic opportunities while continuing to serve our traditional export markets.

“This plan does not rely on taxes and it will not put industries, regions or jobs at risk. No Australian jobs will be lost as a result of the Commonwealth Government’s actions or policies under the Plan.”

As Energy Minister Angus Taylor summarised it, the plan “won’t impose new costs on households, businesses or regions.” Morrison says it will not “shut down coal and gas production”.

Other countries are pondering long and hard about how on earth they’re going to get to net zero. Until this week we had no idea either. Now, however, we have a plan that tells us how it can and will be done – at no perceptible cost to anyone or anything.

And if that isn’t hard enough to swallow, try this: the plan doesn’t involve announcing any new policy. So what’s changed since Monday? What’s different? What’s new is that Morrison now has modelling that says we’ll get to net zero with a bit to spare – without the need for any more changes.

The boffins added up the numbers and – surprise, surprise – we’re already on track to net zero. Is ScoMo lucky or what? The Americans, the Europeans, the Chinese, they’re all still struggling with it, but we’ve got it figured.

Funny thing is, it has the feel of Amateur Hour. Who wrote the report? The experts in the Energy Department? No, it was written by management consultants – McKinsey, and has all the colourful diagrams and big type and blank pages you expect from management consultants.

I hadn’t heard that McKinsey was expert on energy or climate science or technological innovation, but maybe I’m wrong.

So who did the modelling? Well, not Treasury – what would they know about modelling? We’ve been given the impression the modelling was done by McKinsey, but my guess is they contracted it out to some outfit that actually knows about modelling.

But management consultants and modellers do share a common temptation: to find out what bottom line the client’s after, and work back from that – a thought that came to me when I saw all the nice round figures in McKinsey’s lovely chart showing how net emissions in 2005 will be reduced to zero by 2050.

Reductions to date – 20 per cent (mainly from once-off land clearing restrictions in Queensland and NSW, which occurred before the 2005 starting point and the 2030 target were chosen). Next, reductions projected to arise from the government’s technology investment road map - say, 40 per cent.

Then reductions from “global technology trends” - say, 15 per cent. Reductions from “international and domestic offsets” – 10 to 20 per cent, but make it 10 per cent. Next, reductions from “further technology breakthroughs” - say, another 15 per cent.

Okay, you can stop there. We’ve made it to a neat 100 per cent. (I think I’m starting to see why Morrison isn’t keen to let the experts see the modelling.)

In a new paper from the Australia Institute, Bending the Curve, Dr Richard Denniss and colleagues assess the plausibility of the Morrison government’s belief that the course of our economy can be significantly altered without changes in policy, without the introduction of taxes and without new regulation or even legislated targets.

The authors say the plan “is based on the assumption that it is not just possible to forecast which technologies will be developed in the decades ahead, and the cost of deploying those technologies, but that such development is inevitable.

“In reality, as those who have pursued ‘carbon capture and storage’ in Australia for the last 30 years have clearly shown, it is not just possible that new technologies might be more expensive than expected, it is possible that they will fail completely to eventuate.”

The plan is just the latest iteration of “techno optimism,” albeit at the more optimistic end of the spectrum, they say.

“White it is inevitable that the cost of some existing technologies will fall rapidly, and that some new technologies will be developed, there is nothing inevitable about the timing of such improvements,” they conclude.

Morrison says his plan involves delivering net zero “the Australian way”. That bit I believe. This is the “no worries – she’ll be right, mate” way of doing it.

Read more >>

Saturday, December 12, 2020

Productivity is magical, but don't forget the side effects

Something we’ve had to relearn in this annus horribilis is that the state governments still play a big part in the daily working of the economy. Another thing we’ve realised is that the Productivity Commission is so important that some of the states are setting up their own versions.

When you put the word “productivity” into the name of a government agency, you guarantee it will spend a lot of its time explaining what productivity is – a lot of people think it’s a high-sounding word for production; others that it means we need to work harder – and why it’s the closest economics comes to magic.

Earlier this year the NSW Productivity Commission issued a green paper that began with the best sales job for the concept I’ve seen. Its title said it all: Productivity drives prosperity.

Its simple definition of productivity is that it “measures how well we do with what we have. Productivity is the most important tool we have for improving our economic [I’d prefer to say our material] wellbeing,” it says.

“Our productivity grows as we learn how to produce more and better goods and services using less effort and resources. It is the main driver of improvements in welfare and overall [material] living standards.

“From decade to decade, productivity growth arguably matters more than any other number in an economy . . . Growth in productivity is the very essence of economic progress. It has given us the rich-world living standards we so enjoy.”

Productivity improvement itself is driven by increases in our stock of knowledge and expertise (or “human capital stock”) and by investment in physical capital (“physical capital stock”).

But by far the biggest long-term driver of productivity is the stock of advances known as “technological innovation” – a term that covers everything from new medicines to industrial machinery to global positioning systems.

Technology’s contribution to overall productivity growth has been estimated at 80 per cent, the paper says.

“Our future prosperity depends upon how well we do at growing more productive – how smart we are in organising ourselves, investing in people and technology, getting more out of both our physical and human potential.”

The (real) Productivity Commission has pointed out that on average it takes five days for an Australian worker to produce what a US worker can produce in four. (That’s not necessarily because the Yanks work harder than we do, but because they have fancier equipment to work with, and better organised offices and factories – not to mention greater economies of scale.)

The paper notes that productivity improvement hinges on people’s ability to change. “Unwelcome as it has been, the COVID-19 episode has shown that when we need to, we can change more rapidly than we thought. There is no reason we can’t do the same to achieve greater productivity and raise our future incomes.”

Technological innovation is the process of creating something valuable through a new idea. You may think that new technology destroys jobs – as the move to renewable energy is threatening the prospects of jobs in coal mining – but, if you take a wider view, you see that it actually moves jobs from one part of the economy to another and, because this makes our production more valuable, increases our real income and spending and so ends up increasing total employment.

“All through history,” the report adds, “[technological innovation] has been a huge source of new jobs, from medical technology to web design to solar panel installation. And as these new roles are created and filled, they in turn create new spending power that boosts demand for everything from buildings to home-delivered food.

But the thing I liked best about the NSW Productivity Commission’s sales pitch was the examples it quoted of how technology-driven productivity has improved our living standards.

Take, medicine. “The French king Louis XV was perhaps the world’s richest human being in 1774 – yet the healthcare of the day could not save him from smallpox. Today’s healthcare saves us from far worse conditions every day at affordable cost.”

Or farming. “In 1789, former burglar James Ruse produced [Australia’s] first successful grain harvest on a 12-hectare farm at Rose Hill. Today, the average NSW broadacre property is 2700 hectares and produced far more on every hectare, often with no more people.”

Or (pre-pandemic) travel. About “67 years after the invention of powered flight, in 1970, a Sydney-to-London return flight cost $4600, equivalent to more than $50,000 in today’s terms. Today, we can purchase that flight for less than $1400 – less than one-30th of its 1970 price.”

Or communications. “Australia’s first hand-held mobile call was made at the Sydney Opera House in February 1987 on a brick-like device costing $4000 ($10,000 in today’s terms). Today we can buy a new smartphone for just $150, and it has capabilities barely dreamt of a third of a century ago.”

There are just two points I need add. The first is that there’s a reason we’re getting so many glowing testimonials to the great benefits of productivity improvement: for the past decade, neither we nor the other rich countries have been seeing nearly as much improvement as we’ve been used to.

Second, economists, econocrats and business people have been used to talking about the economy in isolation from the natural environment in which it exists and upon which it depends, and defining “economic wellbeing” as though it’s unaffected by all the damage our economic activity does to the environment.

As each month passes, this not-my-department categorisation of “the economy” is becoming increasingly incongruous, misleading and “what planet are you guys living on?”.

What’s more, the growing evidence that all this year’s “social distancing” is having significant adverse effects on people’s mental health is a reminder we should stop assuming that ever-faster and more complicated economic life is causing no “negative externalities” for our mental wellbeing.

Read more >>

Friday, October 30, 2020

How inflation became a big problem, but has disappeared

Treasury Secretary Dr Steven Kennedy observed this week that there’s been “a fundamental shift in the macro-economic underpinnings of the global and domestic economies, the cause of which is still not fully understood”. He’s right. And he’s the first of our top econocrats to say it. But he didn’t elaborate.

This week we got further evidence of that fundamental shift. The Australian Bureau of Statistics’ consumer price index for the September quarter showed an annual “headline” inflation rate of 0.7 per cent and an “underlying” (that is, more reliable) rate of 1.2 per cent.

This is exceptionally low and is clearly affected by the coronacession, as you’d expect. But there’s more going on than just a recession. Since 1993, our inflation target has been for annual inflation to average 2 to 3 per cent. For the six years before the virus, however, it averaged 1.6 per cent. And most other rich countries have also been undershooting their targets.

So, part of the “fundamental shift” in the factors underpinning the global economy is that inflation has gone away as a significant problem. But why? As Kennedy says, these things are “still not fully understood”. Some economists are advancing explanatory theories, which the other economists are debating.

Former Reserve Bank governor Ian Macfarlane, who has form for being the first to spot what’s happening, offered his own explanation of the rise and fall of inflation in a recent Jolly Swagman podcast.

Macfarlane says that, though every developed economy’s experience is different, they’re all quite similar. If you stand well back and look at the rich countries’ experience over the past 60 years, he says it’s not too great a simplification to say that two phases stand out: inflation rose in the first phase to reach a peak in the mid-1970s to early 1980s, but then fell almost continuously until we reached the present situation where it’s below the targets set by central banks.

In our case, we had double-digit inflation in the ’70s and rates of 5 to 7 per cent in the ’80s, then a long period within the target range until about six years ago. Since then it’s been below the target “despite the most expansionary monetary policy [the lowest interest rates] anyone can remember”.

So how is this experience of roughly 30 years of rising inflation, then 30 years of falling inflation explained? Macfarlane thinks there are about half a dozen reasons for the worsening of inflation in Australia.

For a start, the growth of production and employment during the 30-year post-war Golden Age was stronger than any period before or since. We had high levels of protection against imports, with little or no competition from developing countries.

We had a strong union movement, confident that in pushing for higher wages it wasn’t jeopardising workers’ job prospects. We had a centralised system for setting wages, with widespread indexation of wages to the consumer price index.

Our businesses took a “cost-plus” approach to their prices. If wages or the cost of imported components rose, this could be passed on to customers, confident your competitors would be doing the same. That is, firms had “pricing power”.

Finally, businesses’, unions’ and consumers’ expectations about how fast prices would rise in future were quite low at the start of the period, but they picked up and, by the end, had become entrenched at a high rate.

“This macro-economic environment was clearly conducive to rising inflation, and it took one policy error to push it over the limit,” Macfarlane says.

Under the McMahon government – predecessor of the Whitlam government – fiscal policy was made expansionary even though the inflation rate was already 7 per cent. Monetary policy was eased, with interest rates remaining below the inflation rate. And the centralised wage-fixing system awarded 6 or 9 per cent pay rises.

So, that’s how we acquired an inflation problem. What changed in the second 30-year period of declining inflation? Macfarlane thinks “the defining feature of the later period was that, in the long struggle between capital and labour, the interests of capital took precedence over those of labour”.

That is, the bargaining power of labour collapsed. In most countries the labour share of gross domestic product has declined, with the profits share increasing. Wage growth has been restrained, union membership has shrunk and the inequality of income and wealth has increased.

“These features have been most pronounced in the US, but many other countries, including Australia, have shown most of the same signs,” he says.

Two main developments account for this change. First, globalisation. The rapid growth of manufactured exports from China and the developing world pushed down consumer prices. More importantly, businesses and workers in the rich world realised that firms or whole industries could be shifted to countries where wages were lower.

Businesses had lost pricing power and sought to maintain profits by cutting costs and reducing staff levels. Union members became more concerned with saving their jobs than pushing for higher wages.

Second, labour-saving technological advance. In manufacturing, sophisticated machines started replacing workers. In the much bigger services sector, advances in information and communications meant that armies of state managers, regional managers and other middle management were no longer needed. Clerical processes were automated. Call centres were cheaper than a network of offices. Customers could buy on the internet, without the need for shop assistants.

As the period of high inflation passed into distant memory, Macfarlane says, inflationary expectations fell. Inflation expectations – whose importance comes because they tend to be self-fulfilling – change very slowly. It took decades for them to rise in the earlier period and, now, after nearly three decades of moderate and low inflation, it will take a long time before higher inflationary expectations are rekindled.

I see much truth in Macfarlane’s explanation. But it certainly means there’s been a “fundamental shift” in the factors bearing down on the economy – the implications of which we’re yet to fully realise, let alone fix.

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Wednesday, August 12, 2020

Technology is amazing, but human nature is unchanging

When momentous events such as the coronavirus pandemic occur, it's tempting to conclude they'll change our lives forever. Even if we don't think it, you can be sure there'll be some overexcited journalists saying it. Just as there were after the attack on the Twin Towers on 9/11 in 2001.

Even then I was too old to believe it would "change our lives forever" and – although it did have lasting effects on international relations and our fear of terrorism – it didn't really.

This time people are telling us we'll all be working from home (with city office blocks and streets turning into ghost towns), doing our shopping online, learning online, seeing doctors online, and no longer doing business travel.

Somehow, I doubt it will be that radical. But I don't doubt there'll be change in all those directions. Most of them were already happening as part of the continuing digital revolution, and this will accelerate those trends.

The revolution's usual pattern is to bring modest benefits – greater "functionality" (machines that do more and better tricks) and convenience – to an industry's customers, while turning the industry on its head, with considerable disruption to the lives of many of its workers.

There was a time when watching television meant seeing only what the few available channels happened to be showing at the time. These days, recorders and catch-up apps and a multitude of free-to-air and for-the-small-fee channels and streaming video have given us vastly more choice.

This has meant huge upheaval for the industry, but improved our lives only to a small extent – something we've soon come to take for granted.

Some people (and not just Victorians) are finding it hard to imagine the pandemic will ever be over. But, though we can't be sure when, it will end. And when it does, far more aspects of the way we live and work will go back to the way they were than will change forever.

Truth be told, and unless we do a lot more to correct it, the biggest and baddest continuing effect of the pandemic will be on the careers of young people leaving education during the recession and what looks like being a long and weak recovery.

Staying serious, we can expect more concern about problems in health than in education. More concern about physical health than mental health. More concern about the problems of the old than those of the young.

Nothing new about any of that – except that Scott Morrison's heroic condemnation of those on his own side of politics suggesting that the lives of the elderly should have been "offered up" in the interests of the economy sits oddly with his and all federal politicians' tolerance of decades-long neglect and misregulation of aged care.

(As economists make themselves unpopular by pointing out, every time politicians decide to spare taxpayers the expense of fixing a level-crossing or in some other way saving "just one person" they are implicitly putting a dollar value on human life. They do so on our behalf and we rarely tell them to stop doing it. The term "cognitive dissonance" comes to mind.)

But I'm determined to keep it light this week, so on with happy chat about the pros and cons of new technology.

It's worth remembering that advances in digital technology have made the lockdown and social distancing tolerable – indeed, doable – in a way that wouldn't have been possible 20 years ago. Far more of us work as "symbolic analysts" (people who spend all day making changes on a screen) these days. Get access to all the office's programs on your laptop at home? Easy. Zoom to endless and unending meetings? Feel free.

The virus is likely to hasten technology-driven change because the crisis has broken through our fear of the new and unfamiliar. Both workers and bosses now understand both the pros and the cons of working from home relative to working from work.

We've tried buying groceries online. Doctors, departments of finance and patients have overcome their hang-ups about telemedicine. Online learning suits uni students better than school pupils.

But all these things do have their advantages and disadvantages. And most of the disadvantages are social. For the human animal, social distancing is a deeply unnatural act. We get a lot of our emotional gratification from face-to-face contact.

We communicate more efficiently and we learn things we wouldn't otherwise learn that help us do our job better. Relationships with suppliers, customers and consultants work better when we come to know and like each other.

So I think we'll do more digital remote working, but not turn our working lives over to it. Surveys show most people would like to work from home some days a week, but not all week. Business people may do less travel between capital cities – it could easily become the latest business cost-cutting fad – but it would be amazing if executives stopped wanting to shake hands with the people they deal with.

Technology can change what we do, but it won't change human nature.
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Monday, March 2, 2020

Productivity problem? Start at the bottom, not the top

Whenever we’re told we’re not achieving much improvement in our productivity, a lot of people assume it must be something the government’s done – or more likely, failed to do. Such as? Isn’t it obvious? Failed to cut the tax on companies and high income-earners.

But though the national rate of productivity improvement is merely the sum of the performances of all the industries that make up the economy, no one ever imagines the problem might be something the nation’s businesses have been failing to do.

This, however, is where a lot of research is pointing, as summarised by the Labor shadow minister and former economics professor, Dr Andrew Leigh, in a recent speech. He starts by explaining that productivity measures how efficiently the economy turns labour and capital into goods and services.

"Last year, Treasury’s Megan Quinn revealed that researchers in her department, led by Dan Andrews, had been investing in a new analysis that links together workers and firms, and delving into fresh data about the dynamics of the Australian economy," he says.

"Since 2002, Quinn showed, the most productive Australian firms (the top 5 per cent) had not kept pace with the most productive firms globally. In fact, Australia’s 'productivity frontier' has slipped back by about one-third. The best of 'Made in Australia' hasn’t kept pace with the best of 'Made in Germany', 'Made in the Netherlands' or even 'Made in America'."

And then there’s the other 95 per cent. In the past two decades, their output per hour worked has barely risen. So 19 out of 20 Australian firms don’t produce much more per hour than they did when Sydney hosted the Olympics.

What’s going wrong? "Part of the problem is that many firms aren’t investing in new technologies," Leigh says. "Less than half have invested in data analytics or intelligent software systems. Only three in five have invested in cyber security, making them vulnerable to hacking and ransomware attacks.

"It’s not just that companies aren’t investing simply in technology – they’re not investing in anything at all." In the Productivity Commission’s regular report, it measures how the amount of capital equipment per worker has increased, a process known as "capital deepening".

The commission has had to invent a new term to describe what happened last financial year – "capital shallowing". For the first time ever, the amount of capital per worker went backwards. "Given that capital deepening has accounted for about three-quarters of labour productivity growth, this is frightening," Leigh says. (To which Scott Morrison might well respond: do I look frightened?)

Across the economy, businesses are cutting back on research and development and investing less in good management. Just 8 per cent of our firms say they produce innovations that are new to the world, down from 11 per cent in 2013.

A Productivity Commission study has found that half the slowdown in productivity improvement in the market economy in recent years is accounted for by manufacturing. A separate survey of management practices in manufacturing firms found that Australia’s managers rank below those in Canada, Sweden, Japan, Germany and the US.

Leigh argues that newborn firms are as critical to an economy as newborn babies are to a society’s demography, bringing fresh approaches, shaking up existing industries, and offering new opportunities to workers.

Yet our new-business creation rate isn’t accelerating, it seems to be stopping. Defining new businesses as those that employ at least one worker, Treasury estimates that the new-business formation rate in the early 2000s was 14 per cent a year. Now it’s down to 11 per cent a year.

"Another sign that the economy may be stagnating comes from figures on job-switching," Leigh says. "Workers who switch jobs typically experience a significant pay increase. In the early 2000s the rate of job switching was 11 per cent of employees a year. Now it’s down to 8 per cent. And "Treasury’s analysis finds that a drop of one percentage point in the job-switching rate is associated with a 0.5 percentage point drop in wage growth across the economy".

The drop we’ve experienced is "not the fault of employees: there are simply fewer good opportunities available. According to Treasury’s analysis, much of the drop in job-switching is because workers are less likely to transition from mature firms to young firms. With fewer start-up firms, it stands to reason that there are fewer start-up jobs."

It’s all pretty dismal – and, of course, all the fault of the government. But I know just the reform we need to fix the problem. Morrison should offer chief executives of ASX200 companies a cut in their tax rate, provided they can show they were too busy during the financial year sticking to their knitting to attend any meetings of the Australian Business Council called to discuss lobbying the government for favours.
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Wednesday, February 26, 2020

Don’t forget: we all benefit from the magic of capitalism

The human capacity for adaptation – our ability to soon get used to our changed circumstances – is one of our great strengths. It means we can suffer a major misfortune – the death of a spouse, divorce, loss of a limb – and yet eventually get back to being pretty much as happy as we were.

But this pillar of human resilience has a big downside. It means when good things happen to us – even things we’ve long strived for – we soon stop being gratified and grateful, and within days or weeks start taking our advances for granted, part of the status quo.

It’s this adaptability that keeps many of us caught on what psychologists call the “hedonic treadmill”. The new house we moved to a few months back is fine, but now we really need a new car. I’ve got more clothes at home in the wardrobe than I can wear, but I’d really get a kick from buying a new jacket. All I need is a bit more money and then I’ll be happy.

With the media continually reminding us of all that’s wrong with our economy – weak wages growth, still-high unemployment and underemployment, a government not game to tackle climate change – it’s too easy to take for granted all that’s right with it. We’re the richest generation of Australians who’ve ever lived, and we shouldn’t forget it (especially when our politicians try to tell us we can’t afford to help the poor).

Enter Michael Brennan, chair of the Productivity Commission. If you think Reserve Bank governor Dr Philip Lowe is our only top econocrat who sees our glass as two-thirds full, you need to meet Brennan. He’s on a mission to show us how well we’re doing thanks to . . . productivity improvement.

In his speeches in recent months, Brennan has noted that it’s “been the great fortune of humankind, particularly in . . . the developed economies, to have experienced rapid growth in incomes and living standards over the last 200 years”.

Before and after Federation in 1901, we were the richest country in the world – thanks to our “wealth for toil”, mainly in the form of gold and wool. As the American Century got under way, we lost that lead.

In the period after World War II, our real gross domestic product per person went from being nearly $6000 a year above the rich-country average in 1950, to below the average in 1990.

But we began opening up and modernising our economy in the mid-1980s. Over the past 30 years our real GDP per person – that is, after allowing for inflation and population growth – has out-performed all of the G7 economies of North America, Europe and Japan, and our incomes have risen back to being well above the rich-world average. (Take a bow, Paul Keating.)

We have one of the strongest budgetary positions (which remains true even if we don’t make it “back in the black” this year) and the most progressive tax-and-transfers system in the Organisation for Economic Co-operation and Development.

Contrary to any impression you may have gained, our inequality of income hasn’t worsened a lot over the past 30 years. And, although our household wealth (assets minus debts) is a lot more unequal than our incomes, it’s low by rich-world standards.

Brennan says our life expectancy is high, for spending on healthcare that’s modest as a share of GDP. We face neither the budgetary and demographic problems of the Eurozone, the inequality of the US or the stagnation of Japan.

Average incomes in Australia today are seven times higher than they were in 1901. Environmentalists should note is that only some of this growth has come from increased exploitation of natural resources and damage to the environment (which is certainly something we need to correct).

No, the great majority of this growth has come from the magic of the capitalist system: improved productivity (the very magic Brennan is paid to promote). The average worker today can produce hugely more value in goods or services per hour than the average worker in 1901. Why? Because we’re healthier, better educated and more highly skilled, and we’re not only given far more equipment to work with, but those machines can do tricks that were never dreamt of a hundred years ago. And factories and offices are more efficiently organised.

That’s the capitalist magic of productivity improvement.

Brennan’s party trick is to demonstrate what a seven-times higher real income means in concrete terms. He calculates, for instance, that whereas the average employee had to work 22 hours to rent the average Australian three-bedroom house for a week in 1901, today it takes 12 hours (and it’s a much better house).

The cost of a bicycle – which in those days was the main form of transport – has dropped from 527 hours of work to less than eight hours. The cost of a kilo of rump steak has gone from 143 minutes work to 38; a loaf of bread from 20 minutes to six; a litre of milk from 31 minutes to just over two.

It’s noteworthy that whereas the wage cost of manufactured goods has fallen hugely, the wage cost of services hasn’t – because the wage of the person delivering the service has gone up with the wage of the person buying it.

But Brennan says the point of economic progress isn't just having more and cheaper "stuff", but also having qualitatively different stuff thanks to innovation and technology. That includes all the stuff we take for granted around the home - television, refrigeration, indoor plumbing and airconditioning - not to mention cars, air travel, the internet and smartphones. Then there's statins, the polio vaccine, a much lower likelihood of dying in childbirth, and antibiotics, which can be bought with as little as a quarter of an hour's work.
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Saturday, August 3, 2019

Star pupil Philip Lowe gives tips on why inflation is so low

Reserve Bank governor Philip Lowe started his study of economics at high school in Wagga Wagga and finished it with a PhD from the Massachusetts Institute of Technology. Much thanks to his teacher, Mrs King, whose teaching style convinced him economics was interesting as well as important.

The great attraction of high school economics is its emphasis on linking theory to current events.

According to a speech he gave last week, when Lowe did the HSC in 1979, the standard exam question was: why does Australia have both high inflation and high unemployment ("stagflation") and what’s the government doing about it?

In those days there was much interest in the "misery index", which adds the inflation rate to the unemployment rate. We got to peaks well above 20 per cent. Today, however, it’s below 7 per cent.

As the Australian Bureau of Statistics advised this week, the consumer price index rose by just 1.6 per cent over the year to June. Which means it’s been below the Reserve’s inflation target of "between 2 and 3 per cent, on average, over the medium term" for almost five years.

So Lowe’s guess is that, these days, exam questions are likely to ask: why is inflation so low at the same time as unemployment is also low – and what’s the government doing about it?

Just to be of help, he told us how he’d answer the question – which is one of interest and importance to all of us, not just youngsters preparing for their finals.

He started by noting that very low inflation has become the norm in most economies. At present, three-quarters of advanced economies have an inflation rate below 2 per cent.

There’s no single answer, he says, but there are three factors that, together, help explain what’s happened.

First, the credibility of the monetary "frameworks" that central banks eventually adopted when, in the second half of the 1970s, they realised inflation was way too high and needed to be got under control.

It wasn’t until the early '90s that our Reserve Bank adopted its present target for inflation which, as Lowe says, helped cement low inflation “norms” in the economy. In econospeak, it provided an anchor for business and unions’ expectations about how much prices were likely to rise over the next year or two.

"Many people understand that if inflation were to pick up too much, the central bank would respond to make sure the pick-up was only temporary,” Lowe says.

It would do so by raising interest rates and so discouraging borrowing and spending, of course. Economists call this the "monetary policy reaction function".

(It’s one of the reasons for the old view among economists that attempts to use the budget to stimulate demand by cutting taxes or increasing government spending wouldn’t achieve much. The central bank, fearing the stimulus would push up inflation, would react by raising interest rates and so stymie it. In the new world of continuing weak demand and too-low inflation, however, central banks are most unlikely to react to budgetary stimulus in such a way, meaning the new view is that budgetary stimulus is very effective.)

Has inflation targeting worked? Well, annual inflation has averaged 2.4 per cent since the target was adopted, so it certainly seems to have.

The second part of Lowe’s explanation for very low inflation is that spare capacity to produce goods and services (including spare workers who are unemployed or under-employed) in many advanced economies means there’s little upward pressure on prices.

That certainly seems the case in Australia. Our unemployment rate could go a lot lower than its present 5.2 per cent without causing wages to take off – especially with our under-employment rate of 8.3 per cent.

Our labour market seems to be more flexible – and less inflation-prone - than it used to be.

The third part of his explanation is that changes in the structure of the economy caused by technology and globalisation seem to be keeping prices low.

For one thing, digitisation and globalisation seem to be lowering the cost of producing many goods. The entry of China and other emerging economies into the global trading system has added hundreds of millions of factory workers to the global market.

The prices of manufactured goods in the advanced economies have barely increased over the past couple of decades.

For another thing, globalisation and advances in technology are making markets more contestable and increasing competition. This is extending beyond manufacturing to almost every corner of the economy, including the services sector.

Historically, most services couldn’t be traded across national borders. But globalisation – driven mainly by advances in information and communication technology – means many services can now be delivered by somebody in another country.

Examples include preparation of architectural drawings, document design and publishing, and customer service roles (a nice name for call centres). As well, many tasks such as accounting and payroll have been automated.

The internet and its digital “platforms” have revolutionised services such as retail, media and entertainment, and transformed how we communicate, and search for information and compare prices.

"These changes are having a material effect on pricing, with services price inflation lower than it once was. Many firms know that if they don’t keep their prices down, another firm somewhere in the world might undercut them," Lowe says.

"And many workers are concerned that if the cost of employing them is too high, relative to their productivity [an important qualification], their employer might look overseas or consider automation."

More broadly, using the internet for better “price discovery” keeps the competitive pressure on firms.

The end result is a pervasive feeling of more competition. And more competition normally means lower prices.

What’s the government doing about low inflation and the deficient demand that is part of its cause?

Well, if you mean the elected government, the short answer is: not nearly enough. Especially when you remember how little scope the Reserve Bank has left to cut interest rates.
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