Date posted: 4/11/2019 8 min read

Is there any scope for multifactor productivity growth?

Productivity has stagnated in Australia and New Zealand, but does that mean we have reached the limit of working smarter?

In Brief

  • GDP growth and productivity across the advanced world has slowed over the past 30 years.
  • Australia used to get a 1% a year gift to living standards from higher multifactor productivity growth, but that has slowed.
  • Australia and New Zealand have many low productivity businesses that aren’t exposed to competition.

All over the developed world, people are worried about economic growth slowing down. Policymakers are concerned that the outlook for living standards for millennials will be nothing like the big rise in prosperity the baby boomers enjoyed.

Here’s the big picture for GDP growth in the advanced world over the past 30 years. Long-term trend? Obviously down. The chart at Figure 1 includes the International Monetary Fund’s forecasts for the next five years, and it sees even slower growth ahead. It’s no surprise then that if you google ‘secular stagnation’ – in econospeak ‘secular’ means ‘long term’ – you’ll get more than a million results (in less than 0.3 seconds).

What’s causing it? In most countries, it’s a slow down in productivity growth. To unpack that, we need some definitions, as ‘productivity’ is one of those terms that can mean anything, and even economists use it in different ways.

‘Labour productivity’ is the one that tends to crop up for international comparisons. Akin to how GDP measures the value of what a nation produces in a year, labour productivity is the value of what people produce per hour worked. Brain surgery, managing Google, conducting Mahler – upmarket levels of productivity, high incomes, all good. Sewing T-shirts by hand, not so much.

Labour productivity can be split into two components. One bit reflects how much capital equipment we have to help us. The guy with the big truck can deliver more in an hour than the guy on the motorbike. This capital deepening boosts labour productivity. On one estimate, for example, New Zealand’s productivity gap with Australia could be closed by 40% if the typical Kiwi had the same amount of capital gear as the typical Aussie.

The other bit is what is creating the existential policy angst. It goes by a name only economists could love – multifactor productivity, MFP for short – and is the bit that comes from working smarter.

Figure 1: GDP growth in advanced economiesFigure 1: GDP growth in advanced economies. Click image to enlarge.

The ‘working smarter’ factor

As an example of MFP, suppose you haven’t hired any more people, and staff aren’t working longer hours, and you haven’t installed any more equipment, but nonetheless your business has managed to produce 2% more. That’s MFP growth for you: increased productivity that seems to have come out of nowhere. One way or another, the existing combination of labour and capital can be tweaked to produce more.

Managerial process innovation can be a big part of it. As far back as the 1770s, for example, Adam Smith spotted ‘the division of labour’ in a pin-making factory: you could have 10 people each laboriously making the whole pin or, much more productively, you could divvy up the job so one person sharpened all the ends and another stuck all the heads on. Another relatively low-tech improvement in more recent times was the shipping container, which revolutionised the ease and cost of international trade.

Trouble is, that well is running dry. Here’s what the Aussie experience has been. In the chart in Figure 2, the bars are labour productivity and the blue bits are capital deepening. The problem that has got everyone bothered is where have the green bits gone? Australia used to get roughly a 1% a year free gift to living standards from higher MFP, but that is now down to little or nothing. Over time, the squeeze makes a big cumulative difference.

Figure 2. Market sector labour productivity decomposition (Australia)Figure 2. Market sector labour productivity decomposition (Australia). Click image to enlarge.

The CSIRO’s Australian National Outlook recently calculated that if GDP growth were 2.75-2.8% a year rather than the 2.1% expected from a business-as-usual scenario, real wages would be 90% higher by 2060, rather than 40%.

New Zealand’s story is different. It’s done better at keeping MFP growth going, but it has its own problems. The MFP growth (Figure 3) has been way too small to close the wide gaps to what other countries can produce. And, in recent years, New Zealand has failed to give people more equipment to work with.

Figure 3. Contributions to labour productivity growth in New Zealand 1997-2007Figure 3. Contributions to labour productivity growth in New Zealand 1997-2007. Click image to enlarge.

What’s causing the productivity slowdown?

It would be nice to think that the policy wonks have the productivity slowdown sussed. They don’t.

Some argue that it may be a statistical mirage. We have whizz-bang new social media, for example; maybe we’re not counting this media’s true value when we calculate GDP. If these new digital industries are actually providing us with more services than the statisticians think, GDP would be higher than currently measured, and we’d actually be more productive than the official numbers show. The experts who’ve investigated it, however, think that miscounting isn’t the issue. The productivity slowdown appears to be real, but it’s not well understood.

Some experts think the slowdown is because recent tech breakthroughs are nothing like the scale of previous ones. Others think the big payoff from newer tech still lies down the track. Then again, maybe competition isn’t as effective as it might be: both Australia and New Zealand have long tails of inefficient, low productivity businesses that aren’t being pressured by competitors to perform better. Maybe we’re drifting: we used to be up for change, but now we’re not.

"Maybe we’re drifting: we used to be up for change, but now we’re not."

As the Australian Productivity Commission has said, “Much of the marked MFP growth during the 1990s has been attributed to the macroeconomic and microeconomic reforms of the 1970s and 1980s, combined with the adoption and effective use of information and communications technologies.” But these days, there’s little electoral appetite in Australia or New Zealand for ongoing reform.

How can we boost productivity?

If you can’t diagnose, you can’t be sure of remedies, but there are some proposed solutions that look worth trying. The CSIRO Australian National Outlook update suggested faster tech adoption. You’re not going to get the productivity benefit of new tech if you’re a slow follower, and you’ll fall further behind the countries that have already got on with it. It also suggested more investment in modern skills – not only the STEM subjects (science, tech, engineering, maths) but also softer skills such as creativity, collaboration and business management.

CSIRO also recommended developing export-facing growth industries. Shifting resources into higher rather than lower productivity sectors is a no-brainer, plus there’s evidence businesses raise their game when they have to compete overseas. Another idea was to get the agglomeration benefits of dense, well-provisioned cities: innovation thrives from networking, Silicon Valley style.

Similar shopping lists have been proposed for New Zealand, with the addition of doing something about low capital investment: “Make investment easier and more effective,” as one NZ Productivity Commission economist summarised it.

If they solve the productivity slowdown, terrific, but they’re a good each-way bet even if they don’t. They look like good ideas in their own right.

Donal Curtin is an Auckland-based economic consultant. He served for 12 years on the New Zealand Commerce Commission, and was previously chief economist at BNZ.