Restoring the rate of productivity growth is critical to future living standards, but unless technological change accelerates living standards may not increase as fast as we are used to in future.
Recent history of productivity growth
Through history the reason why living standards have risen over time is almost entirely due to increased labour productivity. Furthermore, the most dramatic increase in living standards ever has been since the Second World War when productivity increased very rapidly in the developed economies of the OECD countries and later in much of Asia.
However, in the last decade or so, productivity growth in the OECD has slowed. Indeed, in Australia’s case real GDP per hour for the year ending in June 2024 was only 2.3 per cent higher than it was ten years earlier – a negligible increase – and in the last two years real GDP per hour has fallen by nearly 4 per cent.
An obvious reason for this recent fall in Australian productivity is the fight against inflation. Monetary policy has been directed to bringing inflation down, but fiscal policy has also been broadly supportive with Budget surpluses recorded in each of the last two years.
Essentially the authorities have been trying to stay on a narrow path. To reduce inflation, they must reduce demand, but they want to do this while maintaining employment. Largely the authorities have succeeded in this endeavour, but if employment is maintained while demand falls then productivity is inevitably the loser.
But even if macroeconomic policy settings explain much of the recent fall in productivity growth, they don’t explain the stagnation of productivity previously. Over the fifteen pre-Covid years from the year ending in June 2004 to the year ending in June 2019 labour productivity in Australia only increased at an average annual rate of 1 per cent. This compares with an average annual growth rate for labour productivity over the previous sixteen years of 2.8 per cent; almost three times as fast as in the subsequent fifteen years.
The Productivity Commission is planning to release a research paper in early 2025, which will unpack the factors which led to the slow-down in labour productivity.
One possibility, raised by the Productivity Commission, is first that the progressive shift to being a service economy could be slowing productivity growth as the value of services is typically less per employee than for goods production. Second, the opportunities for mechanisation leading to increased productivity are less for services than for goods production. Third, the official statistics are often not able to measure the increase in service quality when extra teachers or policemen are hired, leading to the data showing a misleading fall in their productivity.
But the analysis by the Productivity Commission in its latest Bulletin indicates that productivity declined in both the market and non-market sectors. Thus, most of the slow-down in productivity growth is probably real and is impacting people’s living standards.
Can productivity growth be restored?
It is therefore not surprising that, to coin a phrase, every galah in the pet shop is clamouring for reforms that allegedly will increase productivity. But how much difference are these reforms likely to make, especially when all too often they are intended to further the particular interests of their proponents.
The truth is that throughout history the rate of productivity growth has been overwhelmingly determined by the rate of technological change. Governments can influence the rate of business innovation by supporting research and development, education and training, and various incentives. Regulatory changes to improve the organization and flexibility of individual workplaces can also help.
Nevertheless, the experience over centuries is that the new technological breakthroughs that make a major difference to productivity have owed little to government support. This is perhaps a little less true in modern times when governments have played a leading role in the development of digital technologies, but there are still limits to what governments can achieve in trying to accelerate productivity growth if there are fewer scientific breakthroughs.
If government policies could make much difference to the rate of productivity growth then we would expect to see more difference between the experience of different countries. As Table 1, however, shows the slowdown in productivity growth has affected all the developed countries whose economies are similar to Australia’s.
Table 1 Productivity growth rates compared
Average annual growth rate %
In almost all these OECD countries the increase in productivity in the 2010s was much less than in the previous decade. The only exception was New Zealand, and that is hardly a compelling example. And most recently, in the last four years or so, productivity growth has been close to zero everywhere in the OECD except the US.
The reality is that most developed economies quickly adopt the same technologies and the general slow-down in productivity is indicative of a slow-down in technological innovation. The US exception in the last few years is interesting because a possible explanation is the US leadership in digital technology, but even US productivity is increasing at only half the rate experienced between 1997 and 2007.
Conclusion
We have grown up in a culture where we expected to be better off than our parents, and better off over time. However that is no longer as true, and that may explain much of the success of populism in the developed economies.
Maybe the AI revolution will restore productivity growth and enable us to better pursue our dreams. But it would also be prudent to plan for how we live in a society where productivity and living standards are not increasing much at all.
Michael Keating is a former Secretary of the Departments of Prime Minister and Cabinet, Finance and Employment, and Industrial Relations. He is presently a visiting fellow at the Australian National University.