The muscle we need to flex to bring inflation down with less pain

Australians are on a treadmill which keeps getting faster. We’re working longer hours, but the extra miles we’re putting in are keeping us from falling off, rather than moving us forward.

Last year, the Productivity Commission said we sharply increased our working hours. In fact, we pushed them up by the most on record (excluding the pandemic period), according to the commission’s acting chair, Alex Robson.

Australians are working longer hours, but that doesn’t necessarily increase our productivity.
Australians are working longer hours, but that doesn’t necessarily increase our productivity.Credit: Jason South

But extra hours don’t improve our productivity. Ideally, we want to produce more with what we’ve got, rather than using more time or resources.

If we had a collective performance review, we’d probably get a pat on the back but no pay rise – which is basically what happened for a while. From about March 2021, wage growth fell behind inflation: prices rose considerably, but wages only edged up. Then, in the three months to September last year, wage growth finally eclipsed the inflation rate.

But the Reserve Bank won’t be happy to see stronger wage growth unless it comes with higher productivity. Why? Because when companies agree to pay their workers more, but their production hasn’t increased, those businesses will probably raise prices to protect their profit margins, feeding back into inflation.

At least, that’s the theory. The extent to which wage increases really contribute to inflation is up for debate.

If we had a collective performance review, we’d probably get a pat on the back but no pay rise – which is basically what happened for a while.

The Reserve Bank’s favourite word, and its prescription for the inflation problem afflicting Australia (and much of the world) is ‘productivity’. If we can jump-start our productivity, improving our supply of goods and services, then we might be able to put a lid on inflation without dealing too much pain through interest rate rises aimed at dampening demand.

That’s of course easier said than done. Our slowing productivity problem is decades old. From the late 1980s to the early 2000s, Australia’s productivity growth, measured in output per hour (adjusted for inflation), was about 3 per cent. During the 2010s, the pace dropped to about 1.2 per cent.

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We’re not alone. Internationally, it’s as if the incline-increasing button on many countries’ treadmills has been pressed a few times. Productivity growth has slowed across most advanced economies after a strong period in the 1990s and early 2000s.

One reason for this is that our technological advances (which tend to be a major driver of productivity leaps) haven’t been as groundbreaking as some in the past, at least from a production perspective.

Nothing yet, in recent times, has been as seismic as innovations of the past such as telephones, antibiotics or the internal combustion engine. These inventions transformed our ability to communicate, the health of workers and our ability to produce and distribute goods. Our next big hope is the advancement of artificial intelligence, but we’re yet to see where it may profoundly improve productivity.

A lot of the innovation in recent decades has also been consumption-oriented. Smartphones, video streaming, social media and virtual reality are great for our entertainment, but aren’t as meaningful for boosting how efficiently we work.

In fact, these things probably work against us in some ways. When was the last time you went through an entire workday without checking social media, texting a friend, or indulging in other activities not strictly related to work? Even just the presence of a smartphone can come at a cognitive cost.

The slowing of global trade in recent years, largely a result of geopolitical tensions and protectionist policies, has also weighed on productivity. Limited trade opportunities mean countries are less able to specialise in the things they can pump out most efficiently. It also limits opportunities for the exchange of skills, technologies and ideas which can be key drivers of productivity.

The advancement of artificial intelligence is our next big hope to improve our productivity.
The advancement of artificial intelligence is our next big hope to improve our productivity.Credit: iStock

In Australia, since about the mid-2010s, there’s also been a drop in competition and what’s called “economic dynamism”, which basically refers to how much the economy can reinvent itself through having new firms enter the market, and workers and money flow towards the most efficient activities. Business entry into the market picked up, and job mobility surged during the pandemic, but they were weaker before the pandemic and have tapered recently.

It probably doesn’t help that most of Australia’s industries are more concentrated than their counterparts in the US. That is, a few big companies, in areas from banking to supermarkets, dominate the market.

Business investment, which can fuel productivity by improving quality of, or access to, tools for workers, has picked up lately in Australia. But investment in machinery and equipment has been lower as a share of our gross domestic product over the past decade compared to the 1990s and 2000s.

Then, there’s investment in education, which is less visible but proven to have a high return. If we can support some of our most disadvantaged students through improved funding of public schools, that alone will be a worthwhile start to fostering a skilled workforce.

If we want to improve our living standards and rein in inflation, let’s not exhaust ourselves on the treadmill.
If we want to improve our living standards and rein in inflation, let’s not exhaust ourselves on the treadmill.Credit: iStock

When examining productivity, it’s also important to consider how it’s measured.

The currency used to measure output, and whether we measure productivity per person or per hour, can skew exactly how well a country is performing.

Next to Australia, on the treadmills of the global gym, are several other major countries including the US, which are supplementing their productivity. There’s no such thing as protein powder for economies. But when they’re measuring up against each other, there are a couple of things which can tip the balance.

First, a unit of currency can go a lot further in some countries than others because the prices of everything, from housing to meals, can be very different from region to region. The total output of the European Union, converted from euros to US dollars, would suggest it produced substantially less than the US in 2022. But when we account for the different costs of comparable products and services across the two regions – using a metric called “purchasing power parity” – we find they’re much closer in terms of output, and therefore in terms of productivity.

Then, instead of measuring productivity per person, it’s possible to measure it per hour worked. Americans work more hours on average than Europeans. But when that’s taken into account, productivity – as measured by output per hour – is a lot closer between the two regions.

The increase in hours worked in Australia is a long-term trend. Our monthly hours worked – spread across our employed population – increased by about two hours over the past 10 years, according to the Australian Bureau of Statistics. The recent surge in cost of living has accelerated this trend, pushing Aussies to take on more hours in a bid to keep up with their bills.

But if we want to improve our living standards and rein in inflation, the key is not to exhaust ourselves on the treadmill. Instead, we should encourage more competition between firms, invest in education and perhaps upgrade our treadmill – or reinvent it.

Ross Gittins is on leave.

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