7

The lost golden age of productivity growth?

First published in 2011 as Quiggin, John. The Lost Golden Age of Productivity Growth? Sydney: Reserve Bank of Australia, 367–77.

Productivity was both the Holy Grail and the founding myth of economic reform in Australia. Established in 1989 at the peak of enthusiasm for micro-economic reform,¹ the government authority responsible for promoting reform is the Productivity Commission. From the 1980s to the Global Financial Crisis (GFC) of 2008 and beyond, no discussion of Australian economic conditions was complete without an invocation of the need for Australians to ‘increase their productivity’, a phrase that rapidly became recognised as code for ‘work harder for less pay’.²

The founding myth of micro-economic reform was the claim that the nation’s economy experienced a surge in productivity in the mid-1990s following the round of reforms that began with the floating of the Australian dollar in 1983.³ The putative surge was particularly welcomed by advocates of micro-economic reform, given that the decade following the float was characterised by relatively weak productivity growth, macro-economic performance that began well but ended in the deep recession of 1989–91, and the prolonged period of high unemployment that followed.

The case for the surge was based on estimates of multifactor productivity (MFP) calculated by the Australian Bureau of Statistics (ABS). The striking finding of the ABS estimates was that the rate of MFP growth had accelerated to more than 2 per cent per year. This was seen as proof that micro-economic reform was working, and that the economy had entered a new era of sustained productivity growth.

At the time, I argued that the supposed surge in productivity reflected an increase in work intensity (Quiggin 2000), and predicted that:

[m]uch of the apparent productivity growth of the 1990s is likely to dissipate as workers find ways of winding back the increase in the hours and intensity of work extracted through the unilateral repudiation of implicit labour contracts in this period. (Quiggin 2004, 23)

This prediction was borne out. The ABS estimate of quality-adjusted MFP declined over the period 2003–04 to 2007–08. For the entire period since 1998–99, the average annual rate of MFP growth has been 0.08 per cent, statistically indistinguishable from zero. Despite the accuracy of the predictions it generated, the view that measured changes in MFP growth rates are driven by changes in work intensity was ignored in the broader policy discussion around micro-economic reform.

The idea that the productivity miracle of the 1990s might instead have been a mirage is almost never raised. Instead, two contradictory accounts have emerged. Although they share an unquestioning acceptance of the measured productivity surge of the 1990s, they differ in their accounts of the 2000s.

The dominant view among economists is one of a ‘lost golden age’. The disappearance of measured productivity growth in the 2000s is taken as a reflection of a real deterioration in economic performance, which is attributed to a slowdown or reversal of the process of micro-economic reform. In this analysis, the favourable terms of trade associated with globally high prices for minerals and strong demand from China are seen as having cushioned Australians from the harsh realities of the need for continued productivity growth.

An alternative view is that while the measured productivity surge of the 1990s was real, the reversal in measured productivity growth in the early 2000s was primarily attributable to special factors and measurement problems. This view was maintained vigorously by the Productivity Commission during the early 2000s and is maintained to some extent in its ongoing discussions of this issue.

The conventional wisdom implicit in most discussions of the Australian economy is a somewhat incoherent mixture of these two ideas. On the one hand, in discussions of micro-economic issues, the lost golden-age view dominates. It is reflected in calls for a new round of micro-economic reform. On the other hand, in discussions of Australia’s strong macro-economic performance during the Global Financial Crisis (GFC), a considerable share of credit is commonly attributed to the flexibility derived from micro-economic reform.

Productivity: a problematic concept

Confusion about productivity growth is largely due to the problematic nature of productivity as a concept. At first sight, productivity seems like a simple generalisation of straightforward concepts such as crop yield (the output of a given crop per unit of land) or the number of units of a given good that a worker can produce in an hour. In national accounting, the single good in these examples is replaced by an aggregate output index such as gross domestic product (GDP). More importantly, aggregate measures of both labour and capital⁴ are taken into account as inputs to production.

The starting point for the theory of productivity is the growth accounting framework developed by Solow (1956). In the standard model, the technology at time t is given by:

Y(t) = AK(t)^α L(t)^−α

log(Y(t)) = α log (K(t)) + (1 − α) log (L(t)) + log(A(t))

in which Y is output, K is capital input and L is (quality-adjusted) labour. The weighted average K(t)^α L(t)^1−α is an aggregate measure of labour and capital inputs. The third term, A, is the ratio of output to this aggregate and is therefore referred to as MFP. Since MFP appears as a residual in econometric estimates of growth equations, it is often called the Solow residual.

Within this model increases in output per worker can be caused by:

• an increase in capital stock per worker (capital deepening).
• an increase in the quality of labour input (education/experience).
• an increase in effort per worker.
• an increase in MFP.

Except in the context of debates over micro-economic reform, the Solow residual is normally taken to reflect technological change or, more precisely, ‘disembodied’ technical change. To the extent that technological change takes the form of more powerful and efficient capital equipment, it should be represented by an increase in the capital stock—that is, by capital deepening.

When Solow models were first estimated in the 1950s, the residual was found to be very large. However, the residual—that is, the estimated rate of MFP growth—has fallen over time. In part, this is because early estimates failed to take account of labour quality. More significantly, the mid-20th century was a period of steady technological progress for the economy as a whole. By contrast, recent decades have seen rapid technological change in information and communications technology (ICT), along with relative stagnation elsewhere. Improvements in ICT are embodied in faster, more powerful and cheaper devices; they, therefore, take the form of capital deepening. This means that, in an economy in which technological progress is embodied in capital equipment and the effects of education on human capital are properly taken into account, these two factors should fully explain observed growth in output. That is, the rate of MFP growth should be zero.

The central claim of micro-economic reform is that the standard growth model fails to account for inefficiencies caused by bad public policy. These inefficiencies mean that the actual level of output is below the potential level given by the above equations. If reforms remove these inefficiencies, productivity growth will be greater than can be accounted for by technological change alone. Particularly in the case in which all technological change is embodied, so that the underlying rate of MFP growth is zero, micro-economic reform is the sole source of MFP growth. The converse is also true. If the effect of public policy is to reduce technical efficiency, this will make a negative contribution to MFP growth.

Problems with the growth accounting framework

Standard productivity measures fail to take account of the intensity with which capital and labour are used. To understand this problem, it is useful to consider the ways in which sustainable improvements in living standards can be generated. The most important improvement, by far, is technological progress—the introduction and adoption of technological innovations such as new products and improved production technologies. There is a much-cited statement of Krugman’s (1997, 11) that:

productivity is not everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.

His assertion would be equally valid if the word ‘productivity’ were replaced by ‘technological progress’.

For a small country like Australia, the rate of technological innovation is essentially exogenous. Furthermore, to the extent that innovation takes the form of a reduction in the cost of imported ICT equipment, it is measured as capital deepening. National policies can affect the rate of adoption of new technologies. In particular, new technologies are usually more skill-intensive and knowledge-intensive than old technologies, meaning that rapid adoption of new technologies is feasible only with a skilled and educated workforce. Hence, investment in human capital can yield high returns.

The second potential source of improvement in living standards is a more efficient use of endowments of capital and labour. This may be achieved either as a result of good macro-economic outcomes (full or optimal employment of labour and capital) or good micro-economic outcomes (output closer to the technological frontier for individual enterprises and industries).

Productivity measures, at least conceptually, exclude benefits arising from good macro-economic outcomes but include the benefits of good micro-economic outcomes. In practice, however, the two are intertwined. Capital utilisation generally declines during recessions, while capital may be operated to yield unsustainably high service flows during booms. Standard productivity measures are based on the assumption that capital services are proportional to the capital stock. As the Organisation for Economic Co-operation and Development (OECD) (2001, Section 5.6) observes, attempts to include proxies for capital utilisation have proved problematic.

Measurement of labour input is even more problematic. On the one hand, labour hoarding during recessions tends to reduce productivity, producing a pro-cyclical pattern of labour productivity. On the other hand, increased employment during expansions results in the recruitment of more marginal workers, producing anti-cyclical productivity. Historically, the first of these tendencies has predominated, producing pro-cyclical productivity. But, as labour hoarding has declined, notably in the USA, productivity has become more anti-cyclical.

The use of a measure designed to include the benefits of good micro-economic outcomes and to exclude the benefits of good macro-economics is consistent with the thinking that has dominated Australian policy discussions since the 1980s, but it is deeply misleading. The primary reason for Australia’s relatively strong growth in income per person since the early 1990s is the fact that, through a combination of good luck and good policy decisions, we have not experienced a recession.

MFP estimates from the ABS

The ABS began reporting estimates of MFP growth in the 1990s, calculated back to the 1960s. The initial estimates of MFP growth for the mid-1990s were in excess of 2 per cent per year, a very high rate. These were subsequently revised downwards to 1.6 per cent. Unfortunately, the ABS currently reports MFP only for the period beginning 1998–99, although older estimates are given by Campbell and Withers (2017).

The issue is further clouded by the fact that the ABS reports MFP estimates in productivity cycles that typically last about five years. The productivity cycle is a data-driven concept with no explicit theoretical basis. Productivity cycles do not necessarily correspond to business cycles, and productivity cycles in different industries are largely uncorrelated. Nevertheless, as I have shown elsewhere for the Australian economy as a whole, the MFP cycles reported by the ABS largely reflected the phases of the business cycle (Quiggin 2000). A typical business cycle contained two productivity cycles, with productivity growth stronger in the cycle corresponding to the expansion phase and weaker in the cycle corresponding to the contraction phase (Dolman, Lu, and Rahman 2006).

The productivity cycle plays a crucial role in the myth of the 1990s productivity surge, since it allows the years of strong productivity growth from 1993–94 to 1998–99 to be treated as a distinct period, while the weaker years at the beginning of the decade are discarded. The result is a widespread but false impression that the 1990s was a period of exceptionally strong measured MFP growth. In reality, the average rate of MFP growth for two ABS productivity cycles from 1988–89 to 1998–99 was 1.6 per cent—above average but not exceptional compared to preceding decades.

In summary, MFP growth over a productivity cycle is not a particularly useful measure of economic performance. Even when measured correctly, productivity estimates combine the effects of long-term technological growth with a subset of the factors that determine variations in short-term performance. In practice, accurate measurement is impossible. In the case of Australia’s supposed productivity surge, the crucial problem is the failure to take account of changes in work intensity.

Work intensity and productivity

Labour productivity is typically measured in terms of output per hour worked. However, this measure can be problematic. For example, enterprise agreements and individual contracts adopted in place of awards commonly eliminate breaks such as tea breaks, which were treated as working time under the award system. On the other hand, employees have always taken unauthorised and unrecorded breaks of various kinds. A notable example that has emerged in the last 10 to 15 years is the use of office computers to visit internet sites that are not work-related. Of much longer standing is the practice of making private phone calls during paid time at work. Conversely, employers may demand unpaid overtime or contact their employees with work requests outside of paid hours.

Although these practices are regularly the subject of dispute, the normal situation is one of equilibrium, in which some deviation from official hours is part of the wage bargain tacitly accepted by both parties. The hours of work reported to statistical agencies will reflect some, but not all, of the deviations from award-determined or contractually agreed hours. How should these features of the labour market be reflected in productivity measures? At least conceptually, it seems clear that the appropriate measure is actual hours worked rather than paid hours.

Consider the case in which the number of hours worked remains unchanged, but the pace of work varies. In some industries, such changes can be observed directly and are the subject of explicit wage bargaining. The archetypal case is that of production-line work, in which employers typically seek to increase the rate at which the line moves, while workers and unions try to slow it down. The development of the word processor in the 1980s provides another example. Since the number of keystrokes could be measured directly, employers demanded higher rates, thus precipitating an epidemic of repetitive strain injury, a problem that had existed previously but was typically diagnosed as an individual pathology rather than a broader occupational hazard.

There is, in principle, no difference between an increase in the number of hours worked and an increase in the pace of work. In both cases, standard economic logic implies that an equilibrium wage bargain will typically involve a commitment of hours and effort greater than the level that would be chosen by workers in the absence of a monetary incentive.

In particular instances, depending on labour market institutions, the bargained outcome may involve more or fewer hours and more or less effort than would characterise a Pareto-optimal bargain. However, the general assumption is that at the margin, increased hours and increased effort are equally costly to workers when they are normalised by the payment required to elicit them. It follows that, to the extent that increases in output are derived either from unmeasured increases in hours of work or from increased intensity of work, there is no corresponding increase in productivity. If the hours or intensity of work were previously sub-optimal (or above the optimal level), there will be a net welfare gain (or loss), but this will be of second-order magnitude relative to the change in output.

Australian economic policymakers have shown considerable confusion on this point. Some have explicitly asserted that working harder is a genuine source of productivity gains. For example, the Productivity Commission (1996, 24) asserted that productivity gains could be achieved not only through resource reallocation but through people ‘working harder and working smarter’. More than a decade later, the chairman of the Productivity Commission repeated an almost identical formulation (Banks 2011 20): ‘whether productivity growth comes from working harder or working “smarter”, people in workplaces are central to it’. The appearance of scare quotes around ‘smarter’ is revealing. Whereas in the 1990s this phrase was used in all seriousness, ‘working smarter’ is now understood as a piece of management jargon, typically decoded as ‘We’re giving you more work to do with fewer resources, and it’s up to you to figure out how to do it.’

The association of reform with harder and less pleasant work is usually implicit. Standard discussions of micro-economic reform and workplace reform are full of references to ‘cutting out fat’, the ‘chill winds of competition’ and so forth. It is not hard for workers to discern where there is fat to be cut, or to observe that CEOs are usually equipped with well-padded windbreakers, even in cases where their mismanagement leads to an early (but generously compensated) departure. By contrast, in debates over the validity of MFP statistics, most mainstream economists—particularly those associated with the Productivity Commission—have denied that changes in work intensity are an important source of changes in measured productivity.

The mid-1990s saw an upsurge in public concern about the pace of work, work–life balance, stress and related issues, which persisted into the early 2000s, leading to John Howard’s description of the topic at an electorate dinner in Melbourne in 2002 as a ‘barbecue stopper’ (Treguer 2023). In the context of a strengthening labour market from about 2000 onwards, community resistance to work intensification, and to employer demands for longer hours of work, became increasingly successful.

While the intensity of work is difficult to measure, there is sufficient evidence to support the general perception of an increase in work intensity in the 1990s. First, as discussed above, increases in work hours and in work intensity are substitutes both as inputs to production and as sources of disutility for workers. It follows that, when the equilibrium wage bargain involves an increase (or decrease) in hours, it will also involve an increase (decrease) in work intensity. The data on working hours are unequivocal and exactly consistent with the idea that fluctuations in MFP growth may be explained largely in terms of work intensity. As the ABS (2010) notes, the proportion of full-time workers working more than 50 hours per week increased from 13 per cent in 1978 to 19 per cent in late 1999 and early 2000, before falling to around 15 per cent in 2010.

There is some direct evidence on work intensity. The Australian Workplace Industrial Relations Survey undertaken in 1995 (Morehead et al. 1997) found that a majority of employees reported increases in stress, work effort and pace of work over the previous year, while less than 10 per cent reported reductions in any of these variables. This is consistent with evidence from the UK and some, although not all, other European countries (Green and McIntosh 2001). Moreover, Green and Macintosh observe that the increases in work intensity are associated with higher productivity (as would be expected) and are positively correlated with exposure to competition and reductions in union density.

Defences of the productivity surge

As I have discussed elsewhere (Quiggin 2006), believers in the productivity surge produced a variety of stories to explain the observed outcomes.

Asymmetric measurement error

During the 1990s, the Productivity Commission was the most prominent proponent of the claim that the strong growth in MFP reported by the ABS reflected the emergence of a ‘new economy’ as a result of micro-economic reform (Parham 1999). Unsurprisingly, the Productivity Commission rejected claims that the apparent surge in MFP growth was due, in part or in whole, to measurement error or cyclical factors.

By contrast, as low rates of MFP growth emerged in the 2000s, the commission became much more sympathetic to the idea that measurement error might be a problem. The poor productivity growth of the early 2000s was blamed on, among other factors, the Sydney Olympics, capital expenditure associated with the Y2K fiasco (also referred to as the Millennium Bug), the transitional effects of the introduction of the GST, and the drought that began in 2002 (Parham 2005). The drought persisted well into the decade, but the other factors should have been transitory.

As measured MFP performance deteriorated even further, attention has shifted to the mining sector. It seems clear that measurement problems associated with mining are significant. Investments in new or expanded mines count immediately as part of the capital stock but contribute to output only with a delay of some years. Moreover, high mineral prices have led to the exploitation of less productive resources that would otherwise be uneconomic.

Since the quality of the resource is not measured as an input, this produces an illusory decline in productivity. Richardson and Denniss (2011) estimate that the measured growth rate of labour productivity over the first decade of the 2000s was reduced by one percentage point as a result of distortions in the mining sector. This is a significant effect, but it is not sufficient to explain the decline in measured MFP growth rates.

The view that the disappointing performance of measured MFP is primarily due to measurement error has gone out of favour over time as disappointment has persisted. However, it frequently re-emerges in discussions of Australia’s strong macro-economic performance during and after the GFC.

The idea that market-oriented micro-economic policies provide significant flexibility in response to macro-economic shocks has been influential in Australia since the beginnings of micro-economic reform in the 1980s. This idea contributed substantially to the policy misjudgements that produced the 1989–91 recession, when it was supposed that the economy was flexible enough to handle a ‘short, sharp shock to interest rates’ and then to bounce back rapidly from ‘the recession we had to have’.

Counter-examples to this idea abound. The most striking is that of New Zealand, which has followed broadly similar micro-economic policies since the 1980s, although with more radical micro-economic reform until the mid-1990s and a sharper reaction against some aspects of those policies subsequently. At the same time, New Zealand has adopted far more restrictionist macro-economic policies. From its initial position of approximate income parity with Australia in the early 1980s, New Zealand fell sharply behind, experiencing an even deeper recession from 1987 to 1991 and two subsequent recessions interspersed with periods of mostly sluggish growth. By 2000, income per person in New Zealand had fallen to around two-thirds of the Australian level, and it has remained there since. While it is unwise to attribute such a huge gap to any single factor (Hazledine and Quiggin 2006), poor macro-economic performance is an important part of the story.

The lost golden age

The dominant interpretation of the MFP statistics today is of a lost golden age. The surge in measured MFP growth is attributed to the micro-economic reform process that began in the 1980s and the slowing down to ‘reform fatigue’ in the 2000s.

The major problem with this story is timing. It is difficult to see how a series of reforms undertaken over 20 years or more can have produced substantial productivity benefits confined to a single period of five years. It is even harder to see how the benefits of those reforms can have dissipated so rapidly, having been already on the wane when the reform process was still under way.

The beginning of the process of micro-economic reform is usually dated to the float of the Australian dollar in 1983. There is less agreement on the end of the process. As far as I can determine, I was the first to offer an explicit end date suggesting that the era of micro-economic reform in Australia ‘began with a big bang—the floating of the dollar in 1983’ and ‘ended with another big bang—the package of tax reforms centred on the goods and services tax (GST), which came into force in July 2000’ (Quiggin 2004).

There have been retrospective attempts to backdate the end of micro-economic reform, sometimes as far as the election of the Howard government in 1996, but these do not stand up to scrutiny. Although it is true that the Howard government took a less consistent approach to reform than its Labor predecessors, it nevertheless introduced several major reforms in its first few years in office. Many of the reforms implemented under Howard were measures that had long been demanded by advocates of radical reform but resisted by the Labor government because of political sensitivities. These included the Workplace Relations Act 1996, the partial privatisation of Telstra in 1998 and 1999, waterfront reform in 1998 and, most notably, the GST, legislated in 1999 and implemented in 2000.⁵

Moreover, many reforms introduced by the Hawke–Keating government did not begin to take effect until after the MFP surge. The most notable of these is the National Competition Policy (NCP). Most states did not even complete their legislative reviews or set up their general regulatory bodies until the late 1990s, and the NCP process, with associated payments to the states, was not completed until 2005, when it was succeeded by the National Reform Agenda. Even after 2005, the push for micro-economic reform continued through a proliferation of free-trade agreements, which were less focussed on trade than on constraining government intervention in the domestic economy.

The timing issue becomes more acute when we consider that the measured productivity surge did not begin until a decade after the float of the dollar. In fact, the years during which ‘even the resident galah in the pet shop’ was talking about micro-economic reform were characterised by the lowest productivity growth of the entire period for which data are available. Hence, the story of the lost golden age relies on the long-delayed benefits of the reforms of the early 1980s, combined with an instant (indeed, in some cases, retrospective) benefit from the reforms of the late 1990s. Even if we were to accept the story of the lost golden age, the whole rationale of micro-economic reform is called into question. Far from generating sustained growth, the lost-golden-age myth suggests that the decade or more of micro-economic reform that began with the floating of the dollar in 1983 produced only five years of above-average productivity growth before requiring a renewed burst of reform merely to sustain past gains.

Conclusion

In the economy of the 21st century, increases in productivity arise almost entirely from capital deepening and improvements in education. Economic theory, therefore, predicts that the rate of MFP growth, properly calculated to take account of labour quality, should be close to zero. This prediction is borne out by the data. Nevertheless, the mythical productivity surge of the mid-1990s continues to dominate the thinking of policymakers, leading to incessant demands for more micro-economic reform to generate higher productivity.

The correlation between demand for higher productivity and increases in work intensity is so evident to most Australians that we take it for granted. What is striking in this context is the failure of (most) Australian economists and economic commentators to accept the evidence on this point. Unlike virtually everyone else in Australia, economists have resolutely denied that the higher measured labour productivity growth evident in the mid-1990s was largely due to increased work intensity, and that the reversal of those measured gains in the 2000 was due to the fact that this intensification could not be sustained.

A belief that large increases in annual productivity growth rates can and should be achieved through micro-economic reform is not supported by the data and can lead to bad public policy decisions. Most notably, the belief lends support to the idea that ‘Australians must work harder’. On the contrary, evidence from the labour market is that the work intensification of the 1990s was undesired and unsustainable. Genuine improvements in productivity should permit reductions in working hours and work effort, rather than demanding more and harder work.

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1. 1 Treasurer Paul Keating, the politician primarily responsible for micro-economic reform, declared at the time: ‘I guarantee if you walk into any pet shop in Australia, the resident galah will be talking about micro-economic policy’.

2. 2 A striking illustration of this took place in 2011, when then Treasury Secretary Martin Parkinson gave a speech on productivity. Although Parkinson did not mention work intensity, his speech was reported on by two different news organisations under the headline ‘Australians must work harder’.

3. 3 The Whitlam government’s tariff reforms, and its replacement of the old Tariff Board with the Industries Assistance Commission, the precursor of the Productivity Commission, are generally seen as a false start and were largely reversed by subsequent protectionist measures.

4. 4 The question of whether, and how, heterogeneous items of equipment could be aggregated into a single capital input was the subject of the famous Cambridge capital controversy in the mid-20th century. Felipe and Fisher (2003) provide a summary of the issues.

5. 5 Following the surprising achievement of a Senate majority in 2004, the last term of the Howard government included the passage of a package of labour market reforms called Work Choices. These reforms were mostly repealed by the Rudd Labor government and cannot be regarded as a successful renewal of micro-economic reform.