RDP 9505: Labour-Productivity Growth and Relative Wages: 1978-1994 5. Summary and Conclusions

The past decade and half has seen considerable liberalisation of the Australian economy and extensive microeconomic reform. While these reforms promised a faster rate of labour-productivity growth, it is only over the past few years that we have any signs in the published data that this is being delivered. In fact, there was virtually no increase in the measured level of labour-productivity over the second half of the 1980s. In part, this reflects a number of measurement problems together with the fact that an increasing share of the work-force was finding jobs. While some of the recent pick-up in productivity growth is related to the business cycle, a number of fundamental factors, in combination with a lessening of measurement problems, gives cause for optimism that Australia's trend rate of productivity growth is now higher than that of the 1980s.

The reasons for changes in productivity growth have long presented a puzzle for economists. This paper attempts to find, and to put together, just a few pieces of the puzzle. These pieces are found in the industry-based data. These data provide insights into the industries driving the aggregate results and, combined with data on wages, raise some important measurement issues. They also provide insight into the links between industry labour-productivity growth and industry relative wages.

While measurement problems are an unfortunate fact of life in decomposing nominal output into its price and quantity components, the problems appear to have been particularly pronounced over the second half of the 1980s. In the retail industry, the extension of shopping hours increased employment and the provision of ‘convenience’, but this was not captured in the output statistics. In the finance, property and business services sector, the rapid employment growth over the second half of the 1980s appears to have been underestimated by the series that is used to extrapolate output growth. In the construction industry, output may have been underestimated due to the unusually rapid increase in the dwelling construction deflator.

While compositional effects also play some role in explaining the low productivity growth of the 1980s, the role is relatively minor. However, one area where they may have been important is in recreation, personal and other services industry. Within this sector, there was strong growth in employment in restaurants which, according to the published statistics, tend to have relatively low levels of labour productivity. Thus, as this sector expands, measured labour-productivity growth is retarded, although to date, this effect has been relatively small.

These compositional effects raise an important issue. As income levels continue to increase, activities that were once undertaken in the home (for example, preparing food) are increasingly being undertaken in the market sector. While such a move tends to increase people's living standards, it slows the increase in conventional measures of average living standards. As the service sector continues to grow, given current measurement practices, the relationship between improvements in actual living standards and the amount of output produced per hour worked may weaken further. Only by moving to some other broader concept of output – which includes convenience – might trends in labour productivity more closely match trends in living standards.

Not all industries experienced a slowdown in labour productivity growth over the second half of the 1980s. The utilities, mining, communications and transport and storage industries all recorded faster labour-productivity growth between March 1983 and June 1991 than in the previous five years. To some extent this improvement in performance reflected the reforms taking place in these industries. The macroeconomic benefits of these reforms, however, were masked by developments in other industries.

Notwithstanding the particulars of individual industries, the decline in real wages between 1983 and 1989 played an important role in underpinning the productivity growth slowdown in the 1980s. Falling real wages allowed firms to take on additional workers – whether it be in retail stores, community services, or in the hospitality sector – despite the fact that the extra output produced by a new worker was less than that produced, on average, by existing workers. This employment-induced decline in labour productivity should not be seen as a bad outcome, as unemployed workers went from producing no measured output, to contributing positively to measured national income. In doing so, they contributed to rising living standards, if not rising labour productivity.

In the longer term, the causation between wages and productivity clearly runs the other way, with increases in economy-wide labour productivity generating higher aggregate real wages. At the industry level, the picture is a little more complicated. In the short term, higher productivity growth in one industry may generate higher wages in that industry. Eventually, however, labour is mobile between industries, so that differences in wages across industries (adjusted for skill) cannot increase without bound. In the long run, even those sectors with no productivity growth must pay higher wages and thus differences in productivity growth tend to show up in relative prices, and not relative wages.

Looking forward, a critical question is whether the increase in labour productivity seen over the past three years represents a cyclical rebound or the start of a period of continuing strong productivity growth. If it is just cyclical, or a one-time level adjustment, and the pattern of the 1980s is to be repeated, then the level of labour productivity is unlikely to increase much before the end of the decade. This would have serious implications for the sort of wage increases that are consistent with maintaining a low-inflation environment.

While some slowing of the recent pick-up in labour productivity growth is inevitable, there are some tentative signs that productivity growth over the 1990s is going to exceed that in the 1980s. Labour productivity is still increasing solidly three and a half years after the trough of the recession. At the equivalent point in the mid-1980s recovery, labour productivity growth had ceased. In terms of the fundamentals, the increasing competition brought about by the Hilmer Reforms and the internationalisation of the economy should have positive influences on labour-productivity growth. The dividend from past and continuing investments in computerisation and information technologies should also help underpin productivity growth. While it is difficult to predict future measurement problems, it is quite possible that they will be less severe over the second half of the 1990s, than they were over the second half of the 1980s. This is clearest in the retail industry, where much of the adjustment to deregulation of hours has been completed. In coming years, continuing improvements in technology and the move to larger stores should allow this industry to contribute positively to measured aggregate labour-productivity growth.

While picking changes in the trend rate of labour-productivity growth is a difficult task and is subject to considerable uncertainty, there is little evidence to suggest that the experience of the 1980s is the right benchmark. While the evidence is still unclear, the signs appear to be emerging of a faster rate of trend labour-productivity growth. Such an outcome is essential if both employment and real wages are to increase in a sustainable way.