Productivity or perish - the Australian challenge for the 21st century

The 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 – labour, capital, and raw materials – into income. It increases when output grows faster than inputs and is a key factor driving improved standards of living. Labour productivity in particular is important in driving growth in living standards and so cities, regions and countries devote time and effort to improving it.

Australia’s labour productivity has been growing steadily at around 1.4 per cent over the past 15 years [1] , however, 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.

FIGURE 1 LABOUR PRODUCTIVITY

Across the 20 year period, regional Western Australia has had by far the highest labour productivity, sitting at $164 per hour worked in 2017. Sydney led the major cities with productivity of $93, Perth and Melbourne followed it, both with $81, and Brisbane and Adelaide were 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 driven in large part by its strong financial services sector.

Over the past twenty years, 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 to $7 dollars 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. Growth in mining production in Regional Queensland and Regional South Australia has driven the large increases in labour productivity seen in these areas but mask structural changes in their wider economies.

FIGURE 2 INDUSTRY STRUCTURE [2] 1996-97

Productivity in big cities is diverging from the rest of the country primarily because of the relative concentration of high labour productivity industries (e.g. Information media, Financial & Insurance Services and Professional Services) located in the major cities, and the advantages of economies of scale and scope which are available to firms operating in cities.

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 & Insurance Services and Professional Services make up one quarter of the economies of the major cities but only 5.9 per cent 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 has been limited or negative.

FIGURE 3 INDUSTRY STRUCTURE 2016-17

These industries are generally knowledge intensive and benefit from agglomeration economies generated when firms locate close together. Firms in agglomeration economies learn from each other and benefit from access to a deep and highly skilled labour force. Locations with superior access to highly skilled labour and the benefits of agglomeration economies are typically in the inner-city and often generate significant employment growth. Of course, it is important to understand, it is not only location, but a range of other 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 the size of larger cities. Cities provide a deeper pool of customers, allowing firms the opportunity to sell more products, especially higher value niche products, and gain from buying in bulk from suppliers.

As well as finding it increasingly difficult to cultivate knowledge intensive employment, the regions are being impacted by the declining competitiveness of manufacturing, which has resulted in wide spread closures of factories and refineries. Major cities have also seen these types of closures, but, unlike regional areas, growth in high labour productivity industries has compensated for the loss in income. Currently, the regions are heavily dependent on agriculture and mining which can be subject to unpredictable weather and commodities price cycles.

FIGURE 4 AVERAGE GDP AND GDP PER CAPITA GROWTH RATE 2006-07 TO 2016-17

Figure 4 shows the effect of increasing productivity on per capita GDP and consequently standard of living. The areas with higher labour productivity are the areas where GDP per capita is growing. GDP per capita is far from the perfect measure of standard of living and does not measure how the income being generated is distributed. For example, the rapid growth in GDP per capita in Regional Western Australia hasn’t benefited the local residents as much as it has shareholders of BHP Billiton and Rio Tinto. And in the case of Sydney, increases in GDP per capita has been driven by knowledge intensive industries in the eastern suburbs, the benefits of which would be limited in the city’s west.

Putting aside this measurement issue, there is a link between raising productivity and improving the living standards of the community.

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

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

In the regions, creating a European style settlement pattern with fast rail transport between major regional centres and capital cities will provide some of the benefits of big city agglomeration to places like Geelong and Newcastle. Each major regional centre should provide a hub for their hinterlands, which would 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 strengths. These range from tourism/lifestyle locations, 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.

[1] Australian Treasury (2017). Australian productivity trends and the effect of structural change.

[2] As measured by industry Gross value added share of Gross Domestic Product.

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