Australia’s productivity riddle – and what it might mean for interest rates
If the Reserve Bank’s GDP forecasts about the Australian economy are right, we should be close to a nadir with a sustainable upswing on the way – provided we can get more efficient at what we do.
Productivity growth – a concept that quickens the pulse of economists and almost nobody else – has slowed in Australia and most other developed nations for years.
The Reserve Bank governor, Michele Bullock, has regularly reminded us that productivity – how much value we can extract from a given combination of labour and machines – is flatlining. How it changes may well determine whether the central bank will tolerate annual wage increases beyond 3% without hiking interest rates to cool the economy.
“Productivity is difficult to read at the moment,” she said after the RBA left interest rates unchanged. “It has been influenced by the pandemic, it’s been very volatile.”
“We do expect it to get back towards its trend level in the next year or so, but … if productivity doesn’t improve, then even wage rises of around 3.5% might not be enough to keep unit labour costs contained,” Bullock said. Wages rose at a 4.1% clip in the year to June, the ABS said this week.
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Economists critical of the RBA’s tolerance for sticky inflation reckon the Albanese government has focused too much on energy and other rebates to tinker with the headline inflation rate. They want to see an agenda for improving productivity now.
According to the Productivity Commission, productivity growth was absent in the March quarter. Public sector workers raised output by 1% but worked 2.4% more hours, nullifying the 0.5% increase in private sector productivity.
The treasurer, Jim Chalmers, demurs, noting the “Coalition oversaw the worst decade of productivity growth in 60 years”.
“We have a big, broad and ambitious plan to boost productivity in our economy but we recognise that it will take more than one term to reverse the damage done to our economy by successive Liberal governments,” he said.
The government’s five-pillar agenda would lift productivity including via improvements to the National Competition Policy, merger reform, investing in renewable energy and even artificial intelligence and quantum computing, the government says. Still, it’s hard to see how these boost productivity in the near term.
Indeed, as Westpac noted this week, the RBA’s own forecasts for non-farm labour productivity have been revised lower by a full percentage point for this year compared with its prediction just three months ago.
According to Westpac’s chief economist (and previously the RBA’s top economist), Luci Ellis, and her colleague, Pat Bustamante, the revision was critical to the central bank’s view that supply was more out of kilter with demand than earlier thought.
“[T]he economy and labour market have been further away from potential output and full employment than previously thought, the RBA’s quarterly statement on monetary policy states. “All else equal, this starting point of greater imbalance between aggregate demand and supply implies that it will take longer for inflation to return to target.”
Ellis and Bustamante reckon the RBA may be taking too dim a view: “Prior to the June quarter, we had seen a turnaround in labour productivity, particularly in the non-mining sector of the economy where it had increased by 2.2% over the three quarters from the June quarter 2023, to be 2.3% above prepandemic levels.”
“Whether the RBA’s pessimistic view of supply capacity turns out to be correct will only become clear over time,” they said.
More reason, then, for the RBA to be patient before deciding its next steps.