American economist Paul Krugman once famously said, “Productivity isn’t everything, but in the long run, it’s nearly everything.”

Productivity is the efficiency with which firms, industry, and the economy, convert inputs such as labour, capital, and raw materials, into income. It increases when output grows faster than input and is a crucial factor driving improved standards of living. Labour productivity, in particular, is essential in driving growth in living standards. Therefore, cities, regions, and countries devote extra time and effort to improve in this area.

Australia's labour productivity has grown steadily at approximately 1.4% over the past 15 years. [1] The performance of its regional and metropolitan areas, while positive, has been varied. Figure 1 shows labour productivity for Australia's capital cities and regional areas in 1997, 2007, and 2017. It reveals considerable differences in performance between the capital cities and regions.

Over a period of 20 years, Regional Western Australia has by far enjoyed the highest labour productivity, at $164 per hour worked in 2017. Sydney led the major cities with a productivity of $93, Perth and Melbourne followed, both with $81. While Brisbane and Adelaide came in last with $77 and $74 respectively. The remaining regions' labour productivity range between $67 (Regional Victoria) and $94 (Northern Territory). These patterns in productivity reflect the different economic structures of regional and city economies. Regional Western Australia's high productivity is driven by iron ore and other mineral production. While Sydney's is largely due to its strong financial services sector.

In the last two decades, the productivity of Australia's cities and regions has diverged significantly. Excluding Regional Western Australia, the standard deviation of labour productivity across the country increased from $4-7 over the period. This divergence is mostly due to major cities increasing their labour productivity at a faster rate than smaller cities and regional areas. Mining production growth in Regional Queensland and Regional South Australia is responsible for the significant increases in labour productivity seen in these areas. This growth masks structural changes in their broader economies.

Productivity in big cities is diverging from the rest of the country. Primarily because of the relative concentration of high labour productivity industries. For example, Information Media, Financial and Insurance Services, and Professional Services located in the major cities. Add to this, the advantages of large scale and scope economies which are available to city-operating firms.

Figure 2 and Figure 3 present the industry structure of the major cities (Sydney, Melbourne, Brisbane, Adelaide, and Perth) and Regional Australia (the balance of each State, Northern Territory, ACT, and Tasmania) in 1996-97 and 2016-17 respectively.

As shown in Figure 3, Information Media, Financial and Insurance Services, and Professional Services make up one-quarter of the economies of the major cities but only 5.9% of the economy of Regional Australia. They have also grown to comprise a much larger proportion of city economies while their growth in regional economies is limited or negative.

These industries are generally knowledge-intensive and benefit from agglomeration economies generated when firms locate close together. Firms in such economies can learn from one another and benefit from access to a large and highly skilled labour force. Locations with superior access to highly skilled labour and the benefits of agglomeration economies are typically within the inner-city. These companies often generate significant employment growth. Of course, it is crucial to understand; it is not only location but also a range of factors which help to enhance innovation and productivity growth.

The growth of these industries and their increasing concentration in cities reflects the advantages of economies of scale and scope offered by larger-size cities. Cities provide a deeper pool of customers, allowing firms the opportunity to sell more products, especially higher value niche items. They may also gain from buying in bulk from suppliers.

As well as finding it increasingly difficult to cultivate knowledge-intensive employment, the decline of manufacturing's competitiveness has impacted the regions. This factor has resulted in the widespread closure of factories and refineries. Major cities have seen these types of closures too, but unlike regional areas, growth in high labour productivity industries has compensated for income losses. Currently, the regions are heavily dependent on agriculture and mining, which are subject to unpredictable weather and commodity price cycles.

Figure 4 shows the effect of increasing productivity on per capita GDP and the consequent standard of living. The areas with higher labour productivity show GDP per capita growth. GDP per capita is far from the perfect measure of standard of living as it doesn’t take into account the distribution of generated income. For example, the rapid growth in GDP per capita in Regional Western Australia has benefited the shareholders of BHP Billiton and Rio Tinto more so than its local residents. In the case of Sydney, knowledge-intensive industries in the eastern suburbs have driven increases in GDP per capita. The benefits of which would be limited in the city's west.

Measurement issue aside, there is a link between raising productivity and improving the community’s standard of living.

The question now, is how can a region improve productivity across various parts of the country?

In the major cities, there are some measures that could enhance urban productivity. These include transport improvements to increase business to business connections and improving access to workers, development of high-density employment, and residential clusters that leverage off new and existing transport links. In addition to transport and land-use improvements, including the provision of affordable housing and open space, there is a range of other activities required to unlock the economic benefits of clusters.

Creating a European-style settlement pattern with fast rail transport between major regional centres and capital cities will provide big city agglomeration benefits to places such as Geelong and Newcastle.

Each major regional centre should provide a hub for its hinterlands to focus on health, education, government, and cultural services.

Areas not served by fast rail connections to the big cities would need to focus on existing industries. Such industries include tourism/lifestyle, agriculture and food production, mining, and specialised manufacturing.

These types of actions will help to enhance productivity growth and lessen the negative impact of uneven economic growth dividing Australian society.