Dean Parham1 Assistant Commissioner



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Microeconomic reforms and the revival in Australia’s growth in productivity and living standards

Dean Parham1

Assistant Commissioner

Productivity Commission, Canberra




Paper presented to the Conference of Economists, Adelaide, 1 October 2002


Session on Microeconomic Reform Revisited
Abstract

Microeconomic reforms were introduced from the mid-1980s to stem the slippage in growth in Australia’s productivity and living standards. Productivity growth more than doubled in the 1990s to reach a record high. A range of possible explanations for the productivity surge are examined in the paper. The three most plausible are microeconomic reforms; education and skills in the workforce; and the rapid uptake and smart use of information and communications technologies. To a certain extent, these three factors have interacted. The surge in productivity growth has underpinned growth in average incomes that is strong by both historical and international standards.


Microeconomic reforms and the revival in Australia’s growth in productivity and living standards


1. Introduction


Raising Australia’s growth in productivity has been a principal aim of policy reform. And Australia has experienced a productivity resurgence since the early 1990s. But that change in productivity trend does not, by itself, establish that reforms have been successful. The productivity trends, the estimation procedures and a range of possible explanations have been subjected to a lot of scrutiny, from different points of view some of it quite sceptical. The scrutiny, of course, is a healthy part of developing understanding of economic trends, the influence of policy and the implications for Australians. The examination and scrutiny has now got to the stage that there is fairly widespread acceptance that Australia has experienced a productivity resurgence and that microeconomic reforms have played a major role (IC 1997, Edwards 1999, Parham 1999, PC 1999, Bean 2000, Dowrick 2000, Forsyth 2000, Treasury 1999, OECD 2001). But that acceptance is not universal and reservations on a few issues remain.

This paper attempts to draw together what we now know about microeconomic reforms and Australia’s productivity performance. Clarity on this issue helps to inform future policy making. There are costs as well as benefits to reforms, but examination of productivity and income benefits is more than enough for this paper. The paper takes a broad perspective on microeconomic reforms and their effects. Reforms are examined as a broad stream, rather than individually and specifically.

The next section examines the rationale for introducing reforms — to meet the growing concern, heightened in the 1980s, that growth in Australia’s productivity and living standards was in decline and that there would be no recovery without a change in policy direction. Section 3 examines Australia’s productivity performance and finds robust evidence of a strong productivity surge insensitive to changes to official methods and data revisions and common to a variety of methodological approaches. Section 4 examines the range of explanations for the productivity surge. A number of suggested explanations turn out to be largely unimportant. Microeconomic reforms do appear to provide the major explanation. But uptake of information and communication technologies, as well as education and skills, also appear to have played an important but relatively modest role. Section 5 examines trends in living standards. It shows that the productivity acceleration has translated into faster growth in average income. Concluding remarks are made in section 6.

2. The motivation for policy reform


Australia’s rate of productivity growth was comparatively weak over most of the 20 century. At the beginning of the century, Australia had the highest level of labour productivity in the world (Maddison 2001), reflecting the combination of a relative abundance of natural resources and a relatively small population. Governments subsequently traded this high productivity position for ‘national development’ as, with widespread popular support, they encouraged population growth, diversification of the economic base and redistribution of income through a set of policies that had the (perhaps unintended) consequence of holding back growth in productivity and living standards. The policy set included an active immigration program (although this probably did not adversely affect productivityth), protective trade barriers, a centralised industrial relations and wage bargaining system and development of economic infrastructure through government funding and ownership.

Australia still enjoyed a relatively high productivity ranking in 1950. Australia’s GDP per hour had slipped to 81 per cent of the level of the productivity leader — the USA — but it still ranked 4 among a group of 22 developed or high-income countries (table 1).



Table 1 International ranking of USA and Australia on average income, labour productivity and labour utilisationa




1950







1960







1973







1990







2001







Rank

% USA




Rank

% USA




Rank

% USA




Rank

% USA




Rank

% USA

GDP per capita (1996 $USb)




























USA

2

(100)




2

(100)




2

(100)




1

(100)




1

(100)

Australia

5

(78)




7

(78)




9

(74)




15

(74)




7

(78)

GDP per hour worked (1996 $USb)































USA

1

(100)




1

(100)




2

(100)




5

(100)




5

(100)

Australia

4

(81)




5

(75)




10

(74)




15

(77)




14

(83)

Labour utilisation (Annual hours worked per capita)c



















USA

14

(100)




19

(100)




11

(100)




4

(100)




2

(100)

Australia

16

(96)




17

(104)




7

(104)




6

(96)




5

(94)

a Rankings are among 22 of the 24 OECD pre-1994 membership countries. b At purchasing power parity. c Labour utilisation explains the gap between average income and labour productivity. GDP per capita is equal to GDP per hour worked multiplied by hours worked per capita.

Data source: University of Groningen and The Conference Board, GGDC Total Economy Database, 2002; http://www.eco.rug.nl/ggdc, accessed 7 March 2002.

The post-war era was a period in which high-income countries tended to catch up on the leader, bringing closer convergence in productivity levels across countries (figure 1). Southern European countries, Japan and Korea2 were the particularly strong movers. They showed faster productivity growth not only during the post-war ‘golden age’ but also during the post-1973 slowdown. Some countries even overtook the USA, which slipped in ranking to 5 by 1990 (table 2).



Figure 1 Labour productivity in OECD countries, 1950, 1960, 1973, 1990 and 2001

GDP per hour (US$ at purchasing power parity)



Source: Data sourced from University of Groningen and The Conference Board, GGDC Total Economy Database, 2002; http://www.eco.rug.nl/ggdc, accessed 7 March 2002.

Australia did not participate in this ‘convergence club’. Its productivity growth was relatively weak, especially during the golden-age productivity boom (table 2). Many countries overtook Australia and, by 1990, its ranking had dropped to 15.



Australia’s relatively poor productivity growth also meant relatively poor growth in average income. Growth in average income is also influenced by labour utilisation — average hours worked in the population at large — but Australia’s growth in labour utilisation has been above the OECD average (table 2). Australia’s per capita GDP grew at about two-thirds of the OECD rate during the boom 1950-73 period and was still below the OECD rate during the post-1973 slowdown (table 2). Australia’s average income ranking slipped from 5 in 1950 to 15 in 1990 (table 1).

Table 2 Average annual growth in average income, labour productivity and labour utilisation

(per cent)




1950-73




1973-90




1990-2001

GDP per capita
















USA

2.4




1.9




2.0

Australia

2.3




1.7




2.5

Europea

3.8




1.7




1.1

OECD

3.6




2.0




1.5

GDP per hour worked
















USA

3.0




1.3




1.6

Australia

2.5




1.5




2.3

Europea

4.6




2.4




1.7

OECD

4.0




2.0




1.8

Labour utilisation (Annual hours worked per capita)b













USA

-0.6




0.7




0.4

Australia

-0.2




0.2




0.2

Europea

-0.8




-0.6




-0.6

OECD

-0.5




0.0




-0.3

a Includes the former East Germany from 1990. b Growth in labour utilisation explains the difference between growth in GDP per capita and growth in GDP per hour worked.

Data source: As for table 1.

Why did Australia perform poorly?


A string of economic and policy reviews in the 1960s, 1970s and 1980s3 attributed Australia’s relatively poor productivity performance to a number of structural weaknesses in the economy:

  • lack of specialisation and scale;

  • manufacturing focused on the domestic market with dependence on agricultural and mining commodities for export earnings;

  • poor investment decisions and excess manning in large areas of infrastructure (including electricity, gas, water, communications, transport);

  • poor work practices, labour relations, management;

  • outdated or inappropriate technologies, combined with low innovation and skill development; and

  • a production culture that resisted change rather than rose to meet it.

These, however, were the symptoms of highly regulated product, capital and labour markets and the inefficient provision of economic infrastructure, where the performance of government-owned enterprises was determined in large part by political overlays on their operations.

The growing imperative for reform


Even though there was growing realisation that Australia’s growth in living standards was below potential, politically, the rate of progress up to the second half of the 1970s was considered to be sufficient. There was also a fairly widespread belief at the end of the 1970s that there was another commodities boom just around the corner to reinvigorate income growth.

However, a more widespread unease developed in the 1980s as pessimism about the outlook for the terms of trade took hold, competition from Asian manufactures strengthened and Australia slipped further in the international league table of per capita incomes. Australia was being overtaken not only by OECD countries, but by non-OECD countries as well.

This galvanised community support for governments to take policy action to address structural weaknesses in the economy and to raise productivity growth. The approach was not to attempt to raise productivity growth via a ‘targeted’ or industry-specific strategy. Rather, the approach was largely to release the shackles that had previously restricted productivity growth and to pursue social objectives through more targeted and less-distortionary instruments.

Policy reforms were introduced progressively from the mid-1980s and continued through the 1990s. Reforms have included: deregulation of access to finance; floating the currency; marked reductions in barriers to trade and foreign direct investment; commercialisation (and some privatisation) of government business enterprises; strengthening domestic competition; and changing institutional arrangements to allow greater labour market flexibility.4 The hallmarks of macro policy have become to rein in budget deficits and to vest the central bank with the clear responsibility to adjust monetary policy settings to target inflation.

The general direction of reforms has been clear, even though the implementation has not always been smooth or seamless. There have been examples of stalling, backtracking and even implementation of measures in the name of reform that have questionable relationship to reform. But such counterexamples do not undermine the general thrust of governments’ policies.




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