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Statement 4: A More Productive Australia - Policy and Technology

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Part III: The Australian productivity acceleration

Australia's economic performance in the 1990s and particularly in the second half of the decade was as remarkable as that of the US. Economic growth was strong and sustained, the unemployment rate fell to around the lowest level in a decade, yet inflationary and wage pressures remained subdued.

As was the case in the US, this exceptional performance was underpinned by very strong productivity growth rates.

During the 1990s, productivity growth rates in Australia returned to levels not seen since the late 1960s. The pick-up in productivity growth has been particularly noteworthy because it has occurred across all measures of productivity: labour, capital and MFP - Table 1.

Table 1: Productivity growth rates in Australia (annual average)

Table 1:  Productivity growth rates in Australia (annual average)

Source: ABS Cat. No. 5204.0.

Capital productivity in any modern economy is usually in secular decline, as new investments are added to a slowly growing labour supply. But Australia's capital productivity fell very rapidly from the 1960s to the 1980s, because of inefficiency in allocating and operating investments. In the 1990s, capital productivity declined at a much slower rate than previously, as sharpened competition and more flexible markets (including labour markets) permitted more efficient resource allocation and more intensive use of the existing capital stock - see Box 4.

Box 4: Capital productivity

Traditionally, capital productivity has declined due to increasing capital intensity. The capital-to-labour ratio has increased in all but a few years since the mid-1960s, reflecting a greater reliance on the use of machinery in the production process. By definition, this has the effect of increasing the relative productivity of workers and lowering the relative productivity of capital.

Chart 1: Capital productivity

Chart 1:  Capital productivity

Source: ABS Cat. No. 5204.0

However, in the 1990s capital productivity growth has been relatively stable, a clear break from the downward trend of previous decades.

This moderation in the decline of capital productivity can be attributed to the widespread structural reform that has been implemented since the mid-1980s. It provides evidence that resources are now being directed into more productive and efficient areas, increasing economic returns to investment within the Australian economy, with economic benefits to all Australians.

This strong productivity performance has gained both domestic and international recognition. The May 2001 OECD Report of the Growth Project highlighted Australia as one of only three countries (together with the Netherlands and Ireland), to experience markedly stronger trend growth of GDP per capita in the 1990s, largely as a result of improvements in productivity.

The strong growth in MFP in the 1990s also highlights the fact that Australia's productivity surge did not simply reflect an increase in capital investment - commonly referred to as capital deepening - Chart 2. Instead, it reflected underlying improvements in the overall efficiency of the economy: the skill with which capital and labour were combined and managed.

Chart 2: Decomposition of Australian annual labour productivity growth

Chart 2:  Decomposition of Australian annual labour productivity growth

Source: US Federal Reserve Board.

Structural reform and productivity growth

Despite the similarities between the magnitudes of the Australian and US productivity accelerations, there are important differences. Following a period of weak growth in the 1980s, Australian productivity growth accelerated strongly in the early-1990s. This initial surge began too early to have been initiated by the diffusion throughout the economy of those recent ICT breakthroughs that powered the US surge. Instead the Australian productivity improvement was triggered by a wide-ranging structural reform programme.

Reforms such as the reduction of external barriers to trade and increased access to essential infrastructure through the National Competition Policy (NCP), began the process of increasing competition and improving the underlying efficiency of the Australian economy.

The effects of this reform can be seen by examining an industry breakdown of labour productivity growth rates in the early 1990s. Those sectors that were the primary focus of reform, including financial services and those sectors previously dominated by government owned monopolies, experienced very rapid productivity growth - see Chart 3.

Chart 3: Industry labour productivity growth 1989-90 to 1994-95

Chart 3:  Industry labour productivity growth 1989-90 to 1994-95

Source: ABS Cat. No. 5204.0

In the second half of the 1990s, Australia stepped up the reform process. The New Tax System replaced a range of narrowly-based indirect taxes, reducing the distortion of production and consumption choices. Enterprise bargaining replaced the centralised setting of wages and conditions of employment, with wage rises now set in a more competitive, flexible environment and more dependent on productivity improvements in particular workplaces.

The Government also established a transparent, medium-term macroeconomic policy framework. In August 1996, the Statement on the Conduct of Monetary Policy formalised the objective of `keeping underlying inflation between 2 and 3 per cent, on average, over the cycle' and gave the Reserve Bank of Australia (RBA) operational independence in meeting that objective. The Government also adopted a medium-term fiscal objective of achieving underlying budget balance, on average, over the economic cycle. The credibility of fiscal policy was also enhanced through accrual accounting and superior transparency arrangements legislated into the Charter of Budget Honesty.

This combination of a sound and responsible macroeconomic policy framework and ongoing structural reform has continued to directly improve the underlying productivity of the Australian economy by creating a more dynamic and competitive environment.

The role of new technology in Australia

In pursuing productivity improvements within this highly competitive environment, Australian firms have applied new technology. Indeed, Australia is now amongst the most intensive and sophisticated users of new technology in the world, with recent OECD estimates ranking Australian spending on ICT as a percentage of GDP amongst the highest in the OECD - see Chart 4.

Chart 4: ICT expenditure as a per cent of GDP

Chart 4:  ICT expenditure as a per cent of GDP

Source: OECD Science and Technology Outlook 2000.

The OECD noted that Australia trails only the US and Iceland in the density and rate of growth of secure servers (a measure of preparedness for encrypted e-commerce). Of seven leading economies reviewed by the OECD, Australia had the second highest home Internet access among the richest quartile of household incomes, and the highest access among the poorest quartile.

More generally, ICT investment has also been growing rapidly, with the shares of capital income accruing to software and hardware owners in Australia - a measure of the importance of ICT investment in the capital stock - rising rapidly in the 1990s, towards US levels.

In Australia's case, as a result of the reform-driven increases in domestic and international competition, investments in ICT have been practically and commercially focused. Indeed there has been a fundamental interplay between improved competition and the efficient adoption of new technology.

This rapid and efficient adoption of new technology by world standards, combined with Australia's long history of innovation, makes Australia very well placed to experience a second wave of productivity growth, as all sectors of the economy harness the benefits of new technology. As an example of Australia's ability to focus scientific research on new innovations, Australia is third to only the US and Canada within the OECD in the citation rates of research in patents taken in the US. As the OECD's Report on the Growth Project notes:

Early evidence of this can be seen in those industries where ICT has been adopted most heavily. Both the wholesale and retail trade industries experienced very strong productivity growth in the second half of the 1990s. These industries have been quick to adopt new management and ICT techniques (drawing on computers and bar code scanners) in order to cut down on inventories and improve customer service.14

The benefits of ICT are also being felt in traditional industries such as mining and agriculture. By the end of March 1999, close to half of all farms in Australia owned or used a computer.15 This technology is being used to help overcome the communication and distribution problems posed by the isolated geographic nature of many of Australia's rural industries. It is also being used to access and compete effectively in new markets, particularly overseas.

These examples of a range of industries across the economy effectively harnessing the benefits of new technology, again highlight the long-run differences between the use and the production of new technology. Australia's small ICT-producing sector is not competing in the `commoditised' chip production and PC assembling end of the market, but rather in specialised software applications that build on Australia's other commercial comparative advantages. Australia is also benefiting from our openness with the world's best in this intrinsically globalised industry, as illustrated in the recent success of `Radiata', whose alertness to the world potential for wireless LAN applications would be hard to envisage without its key Australian personnel's own experience in US academia and Silicon Valley.

Australian firms will continue to benefit from applying ICT productively throughout a competitive and flexible economy long after the apparent obsession with Internet start-up companies has faded away. This is the true test of a so-called `new economy', and in the long-run Australia is well placed to compete in this new global arena.

13 OECD (2001), p 12.

14 The application of the ubiquitous bar code scanner together with the computer is another example of how competition drives innovation in unpredictable directions through unforeseeable linkages, with application rather than production being the key. Bar code scanners use lasers. When Bell Laboratories invented the laser in 1957, it did not bother patenting it, regarding it as only a specialised scientific and potentially military tool. The barcode scanner (and other commonplace applications, such as the Compact Disc) awaited the pairing of the laser with complementary developments in the semiconductor industry.

15 Use of Information Technology on Farms, 1998-99, ABS Cat. No. 8134.0.

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