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Australian Economic Comment - 2024 in one chart
- It’s always a tough ask, to choose just one chart…
- …but for us, a key story for the Australian economy in 2024 has been weak productivity…
- …and this could be critical for the 2025 outlook
Australia’s productivity performance has been very weak. Not only has measured labour productivity fallen recently, but, as the chart shows, a longer-term perspective indicates that it is no higher now than it was in 2016.
One country looks unlike the others, and Australia is bottom of the pile
As is well understood, lifting productivity is the main way that most countries lift national incomes and living standards. As it turns out, there is another way to do this – that is, to sell what you produce for an ever-increasing price – and this other way is what Australia has done for much of the first two decades of this century.
Over that period, Australia has benefitted from a substantial rise in its terms of trade (higher export prices and lower import prices) and the boost to iron ore, gas and coal production that came about because of the massive mining investment boom in the early 2000s. Australia’s resources exports have risen in value by a stunningly large 750% in the past two decades.
But this luck may be starting to run out. Mining investment is much lower than it was, prices for these products are well down from their peaks and we may already be past ‘peak steel’.
A focus on productivity is needed if Australia is to continue to lift its living standards meaningfully. Part of this is about getting more output for every input. But it is also about improving the competitiveness of the economy, lowering costs and hurdle rates for new investment, to attract investment in the next growth engines.
As we see it, the key opportunities are in renewables, the green transition and education exports with a keen focus on trading with Asia.
US exceptionalism
As the chart shows, many other countries have similar productivity challenges, with one key exception – the United States. We see this divergence as having played a role in explaining why the RBA has been in a different spot to most other developed market central banks – having not cut its cash rate in 2024.
Part of the reason the US has managed such a soft landing is that it has had much stronger productivity growth than elsewhere. Our US economist, Ryan Wang, has continued to expect that the US would avoid a recession at the end of the pandemic. In short, demand has not needed to weaken much to get inflation to fall because the supply-side of the economy has improved substantially, partly because productivity growth has been strong.
The US is a clear outlier
As the chart shows, the US is a clear outlier. The US seems to have a stronger structural trend in productivity growth and had a cyclical upswing in productivity in the post-pandemic period that has not occurred in the other countries.
We have argued that part of the explanation for the divergence in the recent cyclical productivity performance across these countries could reflect the design of the pandemic policy response. In most Western countries policy measures aimed to put the economies into a ‘deep freeze’ through the pandemic; these included using wage subsidy schemes to keep workers in the same jobs – widely used in Europe, the UK, Australia and New Zealand.
This no doubt offered great protection for these economies, but is also likely to have limited business dynamism. As a result, many workers retained their jobs through the pandemic and corporate insolvencies were exceptionally low. This also meant that these economies were not shaken up as much as during a typical recession.
By comparison, the US had a hard recession through the pandemic, but is also seeing the typical cyclical pick-up in productivity that comes after a hard recession, following significant jobs market and business sector churn.
Australia is at the other end of the spectrum in this regard. Productivity has been weak and with growth in demand slowing, but not declining – as has been seen in other countries like New Zealand, the UK and some European economies – Australian inflation has been sticky and elevated. Australia needs productivity to pick-up not just to improve living standards but also to help dis-inflate and allow the RBA to cut rates.
Australia’s weak productivity seems to be both a cyclical and structural story.
So what should be done to help to lift productivity?
Part of the challenge is that an increasing large share of economic activity has become publicly provided services, and productivity tends to be lower in public sector. Public demand rose to a multi-decade high as a share of the economy in Q3 2024, 28.3% of GDP. Employment growth is also increasingly being driven by public sector job creation recently – 40% of the job creation over the past year has been in the public sector, despite only 15% of employment being public jobs. A part of this shift is a boost to big programmes for aged care, health and the national disability insurance scheme, which by their nature tend to have lower productivity.
15%
Of jobs are in the public sector
2.7%
Of job creation over the past year has been in the public sector
However, if you dig a little deeper into the industry composition, it shows that productivity has been quite weak across the board – with, for example, the mining sector having the biggest fall in productivity of any industry over the past six years. The shifting composition of the economy towards a larger share of public demand has contributed only a small amount to the marked slowdown in productivity.
As we have set out in our research, a broad-based policy approach is needed to help support a lift in productivity. This should include a focus on tax reform, competition policy, deregulation and improving the availability of skill workers.
As the chart shows though, Australia is not alone. Many other countries face similar challenges.
As Australia heads towards a Federal election in 2025 (by 17 May at the latest), a key focus ought to be how to lift productivity.
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