Without productivity gains, Australia may be about to experience its worst decade of national income growth in almost 50 years. That’s the sobering message from NAB Group economists James Glenn and Riki Polygenis.
In a new piece of research exploring Australia’s potential growth rate the pair say that potential growth in Australia has now fallen to 2.5% from 3.25%, which was seen as the previous potential growth rate for the economy.
This figure of 2.5% is close to IMF estimates Glenn and Polygenis say. Crucially though it is “below recent estimates from the Treasury and the RBA” of 2.75%.
A lower rate of potential growth in the economy has all sorts of implications for monetary policy, as well as budget forecasts and balances. Critically the pair say that as the temporary productivity gains of the mining boom wane “if nothing else fills the gap, Australia may experience its worst decade of national income growth (and potentially a deterioration in living standards) in nearly half a century”.
Productivity gains in the non-mining economy are the answer. But the current run rate in the Australian economy would need to lift from 0.75% to 1.5% – a doubling.
That’s a challenge because “productivity has slowed globally (pointing to complex structural factors) and without an unexpected technological advancement or significant progress on the reform front, raising productivity growth will be challenging” Glenn and Polygenis wrote.
The easy work on productivity improvement in the Australian economy – the “low hanging fruit” as the pair call it – has been done, “meaning further progress may prove more difficult”.
Labour productivity in particular has been slowing sharply in Australia.
Theoretically, whatever the rate of inflation, a worker can only really claim a pay rise if their productivity – their contribution – to the business they work in has increased. So it’s not hard to see why wage growth has also slowed and pay rises are hard to come by.
But it’s not all bad news the NAB says. The low hanging fruit might have been picked but “firms continue to highlight pain points such as industrial relations and taxation where more progress can be made”.
IMF research also shows some Industries that could benefit “from efficiency gains” Glenn and Polygenis say.
Equally, the “NAB’s research on innovation provides encouraging signs that business – particularly small business is working hard to lift productivity and efficiency”.
Sunshine on a rainy sky, perhaps.
But as esoteric as the topic of productivity may seem it has – like wages growth – real world impacts in Australians’ daily lives and the operation of the economy.
There’s a thing economist call the “output gap”. That’s the difference between current and potential growth. Central banks try to run monetary policy to keep this gap as close to zero as they possibly can so to have the economy growing as close to its potential as possible.
Think of it along the lines of when you encourage your kids, or your parents encourage you, to make the most of their talents. It’s conceptually the same thing – we want to be the best we can be as a nation.
But if the potential growth rate is lower that means the output gap is smaller, which means monetary policy – RBA rates – should be tighter for any given level of economic growth. One of the reasons that is expected to be so is that in theory the smaller gap implies inflation can accelerate at lower levels of growth.
That impacts on what the RBA will see as the neutral rate at which it sets its official cash rate. Thankfully they won’t have to raise rates in a hurry if the NAB’s right and potential growth is lower because a mechanical rule central bankers use to determine that rate – the Taylor rule – also falls.
Mixing that all up means that rates in Australia are very accommodative as the RBA has told us because the NAB says its “working assumption for the neutral cash rate in Australia is currently approximately 3.5% (compared to around 4.25% to 5.25% in the pre-GFC period), based on lower potential growth and higher private sector leverage”.
Along with wagess growth for Australian workers, the cost of borrowing for homes and businesses in the economy the lower potential growth rate has implications for fiscal policy as well.
“Previous modelling work undertaken byFederal Treasury suggested that a 25bp fall in potential growth would subtract around $9 billion from the underlying cash balance over four years,” Glenn and Polygenis say.
Australia clearly needs a productivity revolution.