Statement on Monetary Policy – August 20254. In Depth – Drivers and Implications of Lower Productivity Growth

4.1 Why productivity growth matters

Productivity measures how much output the economy creates for a given quantity of inputs, such as capital, natural resources and labour.

Productivity growth occurs when the economy finds new and better ways of using its resources, including through discovering and investing in new technologies, shifting resources to better uses, and increasing the skills of its workforce.¹ So productivity growth is about working smarter, not harder, to produce more in the same amount of time with the same resources. Many of the biggest productivity improvements have come from things that have made work easier, like computers, robots and the internet.

Productivity is a key determinant of the economy’s supply capacity. As productivity increases, the economy can produce more goods and services for a given set of scarce resources (capital, natural resources and labour). So productivity growth expands the supply capacity of the economy – often referred to as potential output. It is therefore important for a central bank to understand productivity growth in assessing the balance of supply capacity and actual demand in the economy.

Productivity growth also contributes to demand. Productivity growth tends to support consumption and spending in the economy: when productivity and therefore incomes are growing more strongly, people can spend more and businesses have a greater incentive to invest.

As productivity growth allows us to create more from the same inputs, it makes us richer as a country and raises living standards.

Productivity is the key driver of growth in living standards over time. Productivity growth makes goods and services cheaper to produce and consume. In the 1960s the average worker needed to work for 10 minutes to afford a loaf of bread, but today it takes four minutes.² It also supports higher wages and incomes, as the overall economic pie is larger and workers can get paid more without raising costs for businesses. So productivity growth drives growth in per capita incomes over time (Graph 4.1).

4.2 Productivity growth has slowed in Australia (and many other advanced economies)

Productivity growth has slowed in Australia, weighing on supply capacity, incomes and demand.

Looking through volatility in the data, growth in aggregate productivity has slowed over recent decades. Productivity growth has been volatile in recent years, reflecting pandemic-related factors such as lockdowns and supply chain disruptions.³ Looking through this volatility though, growth in productivity has slowed over recent decades. For example, labour productivity (output per hour worked) currently sits around its 2016 level, whereas it grew very strongly from the mid-1990s to mid-2000s. The slowdown in labour productivity growth over recent decades reflects both:

• slower growth in the amount of capital (such as machinery, equipment and workspace) for each worker to use – known as ‘capital deepening’
• slower growth in multifactor productivity (MFP), which captures improvements in technology and skills, and more generally how efficiently we are combining all the resources in the economy (Graph 4.2).

Slower growth in economic capacity appears to have weighed on incomes and demand. Slower productivity growth has coincided with slower growth in incomes and as a result consumption (Graph 4.3). As such, it appears that wages, household incomes and spending have adjusted in response to the slower growth in the supply side of the economy.

Other countries have also experienced a slowdown in productivity growth over recent decades.

Productivity slowed over recent decades in many advanced economies. This continued into the post-pandemic era, with the United States being a notable exception (Graph 4.4). As a result of the slowdown, several central banks have revised down their assumptions around the medium-term outlook for trend productivity growth in recent years, including the Bank of England, Bank of Canada and Reserve Bank of New Zealand.

The global slowdown in productivity growth reflects various persistent factors. The drivers of this productivity slowdown have been explored extensively in the economic literature, though it is still not fully understood. For Australia, some factors that have been found to be important, though may not account for the entire slowdown, include:

• declining business and labour market dynamism, with it now taking longer for inputs to move to higher productivity firms
• slower technological diffusion, with firms now taking longer to catch up to the global technological frontier
• declining competition, meaning there has been less pressure on firms to grow and improve, or exit
• regulatory barriers, including in the construction industry.⁴

Other potential explanations for the global slowdown in productivity growth include slowing growth in skills (human capital) in the labour force, declining trade integration, and measurement challenges.⁵

In Australia, the medium-term slowdown has been broadly based across sectors of the economy.

Some of the weakness in productivity growth over the past five or so years has reflected idiosyncratic, temporary factors in certain sectors. Namely:

• The non-market sector – which includes the health care, education and public administration industries – has grown as a share of the economy over recent years at a fairly rapid pace. Measured productivity (as defined in the National Accounts data) is low in these industries, and this has weighed on aggregate productivity.⁶ We estimate that growth in this sector mechanically subtracted around 0.3 percentage points from aggregate labour productivity growth on average between 2017/2018 and 2023/2024, compared with subtracting 0.15 percentage points on average over the previous decade.⁷
• Productivity in the mining sector has also fallen sharply over recent years, declining by around 20 per cent over the past five or so years. Some have argued that this reflects attempts to take advantage of recent high prices by tapping potentially less productive resource deposits by using additional labour, rather than additional capital investment. Similar dynamics were evident in previous commodity cycles.⁸

Even abstracting from these potentially temporary factors, productivity growth has slowed. For example, growth in the market sector excluding agriculture and mining has slowed notably over recent decades (Graph 4.5). As such, the slowdown in productivity appears to be a broad-based and persistent trend, rather than reflecting potentially temporary idiosyncratic outcomes in a few industries alone.

4.3 We are downgrading our productivity growth assumption

Consistently weaker-than-expected productivity growth has led us to revise down our productivity assumption.

For some time, our forecasts have implicitly assumed that productivity growth was temporarily weak and would gradually return to, and be sustained at, higher historical growth rates. More often than not, this has not eventuated, resulting in the RBA’s implied productivity forecasts consistently overestimating the actual outcomes (Graph 4.6). In recent years, our GDP growth forecasts have also been weaker than forecast, while unemployment and inflation outcomes have been broadly in line with forecasts.⁹ This is consistent with labour productivity undershooting our forecasts: as labour productivity is the ratio of output to labour inputs, if output undershoots but labour inputs are in line with forecasts, labour productivity must undershoot.

In recognition that some of the lower productivity growth in recent decades is attributable to persistent factors, we are downgrading our medium-term trend productivity growth assumption. We now assume that productivity growth will return to 0.7 per cent by the end of the forecast period, rather than 1.0 per cent. The new assumption equates to the 20-year average growth rate for non-farm labour productivity.

We continue to assume that some of the recent weakness reflects temporary factors, and that productivity growth will pick up as they abate, but to a lower rate. In particular, we assume that the recent falls in mining sector productivity come to an end, and that the rate of output growth in the non-market sector returns to around its historical average. The unwinding of these temporary factors accounts for around half of the rebound. We also assume that the rest of the economy returns to longer run average productivity growth rates, having slowed over the past decade: one-year and 10-year average annual growth rates for the non-farm non-mining market sector are currently 0.4 per cent and 0.6 per cent, respectively, compared with a 20-year average of around 1.1 per cent.¹⁰ With these new assumptions, our forecasts for productivity in the very near term are largely unchanged, but are noticeably lower at the end of the forecast period.

The downgrade brings our assumptions in line with other Australian policy institutions. The new assumption is broadly in line with NSW Treasury’s recently revised long-term growth assumption of 0.8 per cent.¹¹

The downgrade balances the risks around our productivity assumption, but significant uncertainty remains.

Assessing future productivity outcomes is extremely difficult and uncertain. There is a risk that our new trend productivity assumption remains too optimistic. Temporary, sectoral factors may not abate as assumed, or productivity growth in the rest of the economy could return to the very low rates observed over the five or so years leading up to the pandemic when there was almost no growth. However, there is also scope for some (transitory) boost to productivity growth if some of the temporary factors not only stop detracting but unwind, or if the fundamental drivers of productivity become more favourable, such as faster adoption of technologies like AI or increased economic dynamism.

4.4 Implications of the downgrade for our forecasts and assessment of spare capacity

Slower productivity growth means slower growth in the supply capacity of the economy in the future, and slower long-term growth in wages.

We have revised down our assessment of the rate of growth in potential output at the end of the forecast period from 2¼ per cent to around 2 per cent (Graph 4.7). By way of comparison, the median estimate of potential output from a survey of market economists is around 2¼ per cent.

Productivity growth underpins long-term growth in real wages. Productivity growth is the key driver of real wages growth in the long run as it allows for wages to increase without the (real) costs faced by firms rising. So while real wages can grow more quickly than productivity for a period without this necessarily driving up inflation, over time productivity growth underpins real wages growth. As such, we assess that the rate of wages growth over the long term that is consistent with inflation at the target and the labour market at full employment is equal to the midpoint of the inflation target plus productivity growth.

Slower productivity growth implies that the rate of wages growth that can be achieved over the long run without generating inflationary pressure is lower. When measured using Average Earnings in the National Accounts (AENA), our assessment of long-term wages growth consistent with full employment and inflation at target falls from 3.5 per cent to 3.2 per cent due to the productivity downgrade. When measured using the Wage Price Index (WPI) – which abstracts from some growth in wages that reflects productivity growth (e.g. workers moving to higher productivity, higher wage sectors) and so is less affected – our assessment is that it drops from 3.0 per cent to around 2.9 per cent.¹² This does not suggest that wages growth above these levels will necessarily drive up inflation. But these rates remain a useful indicator of what wages growth would look like on average in the long run when the economy is at full employment.

The implications for inflation depend on how economic activity adjusts to lower productivity growth.

The implications of the downgrade for our view of inflation depend on what we assume about business and consumer expectations for productivity and income growth. Namely:

• If we assume that business and consumers implicitly share our expectation of persistent, moderately lower productivity growth, they will also expect weaker growth in revenues and household incomes (including wages). As such their planned investment and consumption will be lower than we have been assuming until now, but will be in line with our new lower expectation for growth in the economy’s supply capacity. So, our assessment of the balance of supply and demand, and therefore inflation, would be unchanged.
• If we assume that households or businesses haven’t yet adjusted to the lower productivity environment, this would mean that demand will grow more quickly than our revised view of supply, so our assessment would be that there will be additional inflationary pressure.
• If we assume that households and businesses have taken signal from the recent very weak productivity and income growth, and implicitly expect productivity growth to remain very low rather than picking up towards 0.7 per cent, demand would grow more slowly than our revised view of growth in supply, so our assessment would be that there would be less inflationary pressures.

Businesses and households do not need to explicitly think about productivity to make these adjustments. Instead, they may experience the effects of productivity growth in their daily lives – through slower growth in wages, incomes and profits – and use these past outcomes to shape their expectations and behaviour in the future.

The productivity downgrade does not change the inflation outlook, as we assume the economy adjusts quickly.

We assume that growth in demand in the medium term will be lower than previously forecast and in line with the lower growth in supply capacity, and so by assumption there are no implications for inflation. Forecasts for annual GDP growth at the end of the forecast period have been lowered by 0.3 percentage points to reflect the lower productivity growth assumption (see Chapter 3: Outlook). As such, we now assess that there is less scope for the rate of growth in activity to pick up going forwards. Forecasts for wages growth have also been lowered, consistent with the longer run relationship between productivity and real wages. The assumption that demand slows in line with supply capacity represents a two-sided risk to our inflation forecast; expectations for productivity and income growth could ultimately sit above or below our forecast for productivity and actual productivity outcomes.

Our assessments of the neutral interest rate and labour market tightness are unaffected. The productivity downgrade has no implications for our assessment of the NAIRU and full employment, so our assessment of labour market tightness remains unchanged. Our forecasts for activity and potential output growth have been revised down together so our assessment of the evolution of the output gap is unaffected, while our current assessment of the output gap already accounts for past low productivity growth. While in theory lower productivity growth would imply a lower neutral interest rate, in practice our model estimates of the neutral interest rate derive from the observed data, which already reflect the historical slowdown in productivity, and so are unaffected by the change in our forecast assumption.

Endnotes

For more details around the concept and measurement of productivity, see RBA (2025), ‘Productivity’, Explainer. 1

For more information and a broader discussion of the importance of productivity, see Productivity Commission (2025), ‘Growth Mindset: How to Boost Australia’s Productivity: 5 Productivity Inquiries’, Australian Government; Plumb M (2025), ‘Why Productivity Matters’, Speech at the Australian Business Economists Annual Forecasting Conference, Sydney, 27 February. 2

For a detailed discussion, see Productivity Commission (2025), ‘Productivity Before and After COVID-19’, Research paper, Australian Government; Bruno A, J Dunphy and F Georgiakakis (2023), ‘Recent Trends in Australian Productivity’, RBA Bulletin, September; Bruno A, J Hambur and L Wang (2025), ‘A (Closer to) Real Time Labour Quality Index’, RBA Bulletin, July. 3

On dynamism, see Hambur J and D Andrews (2023), ‘Doing Less, with Less: Capital Misallocation, Investment and the Productivity Slowdown in Australia’, RBA Research Discussion Paper No 2023-03; Andrews D and D Hansell (2021), ‘Productivity-Enhancing Labour Reallocation in Australia’, Economic Record, 97(317), pp 157–169. On technology diffusion, see Andrews D, C Criscuolo and P Gal (2016), ‘The Best versus the Rest: The Global Productivity Slowdown, Divergence across Firms and the Role of Public Policy’, OECD Productivity Working Paper No 5; Andrews D, J Hambur, D Hansell and A Wheeler (2022), ‘Reaching for the Stars: Australian Firms and the Global Productivity Frontier’, Treasury Working Paper No 2022-01. On competition, see Hambur J (2023), ‘Product Market Competition and its Implications for the Australian Economy’, Economic Record, 99(324), pp 32–57. On construction sector regulation, see Productivity Commission (2025), ‘Housing Construction Productivity: Can We Fix It?’, Commission research paper, Australian Government. On occupational entry regulations, see Bowman J, J Hambur and M Markovski (2024), ‘Examining the Macroeconomic Costs of Occupational Entry Regulations’, RBA Research Discussion Paper No 2024-06. 4

On slowing human capital accumulation, see OECD (2024), ‘From Decline to Revival: Policies to Unlock Human Capital and Productivity’, OECD Economics Department Working Paper No 1827. On trade, see Goldin I, P Koutroumpis, F Lafond and J Winkler (2024), ‘Why is Productivity Slowing Down?’, Journal of Economic Literature, 62(1), pp 196–268. Note that it has been argued that mismeasurement is unlikely to account for the slowdown globally and in Australia. See Syverson C (2017), ‘Challenges to Mismeasurement Explanations for the US Productivity Slowdown’, Journal of Economic Perspectives, 31(2), pp 165–186; Burnell D and M Elsnari (2020), ‘Does Measurement of Digital Activities Explain Productivity Slowdown? The Case for Australia’, Institut National de la Statistique et des Etudes Economiques (INSEE), 517-518-5, pp 123–137. For a broader discussion of the slowdown and its causes, see Duretto M, O Majeed and J Hambur (2022), ‘Overview: Understanding Productivity in Australia and the Global Slowdown’, Treasury Working Paper No 2022-05. 5

Measurement of productivity in these sectors is difficult, due to a lack of market prices and difficulty capturing the quality of the output. For example, healthcare sector productivity growth in the National Accounts only captures changes in the inputs (e.g. number of days in hospital), but not improvements in the quality of the outputs (i.e. health outcomes). Alternative measures of non-market productivity that try to overcome these issues often find higher non-market output and productivity growth: see Cornell-Farrow S (2019), ‘Improving Measures of School Education Output and Productivity in Queensland’, QPC Staff Research Paper, July; Luo Q (2020), ‘Hospital Output Measures in the Australian National Accounts: Experimental Estimates, 2004-05 to 2017-18’, ABS Research Paper, September; Burnell D and Q Luo (2021), ‘Experimental Capital Service Indexes for Non-market Industries’, ABS Research Paper, July; Nguyen BH and V Zelenyuk (2021), ‘Aggregate Efficiency of Industry and its Groups: The Case of Queensland Public Hospitals’, Empirical Economics, 60, pp 2795–2836; Productivity Commission (2024), ‘Advances in Measuring Healthcare Productivity’, Research paper, April. 6

For further discussion, see Plumb, n 2. 7

See, for example, Productivity Commission (2023), ‘PC Productivity Insights’, Bulletin, July; D’Arcy P and L Gustafsson (2012), ‘Australia’s Productivity Performance and Real Incomes’, RBA Bulletin, June. 8

See, for example, RBA (2024), ‘Box D: Annual Review of the Forecasts’, Statement on Monetary Policy, November. 9

Growth in market sector productivity was boosted by a large reallocation of resources to more productive industries at the start of the pandemic. This is likely to be a one-off boost, and so the gap between the recent underlying growth trend and the longer run average may be even larger. 10

See NSW Government (2025), ‘Budget Paper No.1 – NSW Budget 2025–26’, June. 11

The rate of long-term AENA growth consistent with full employment and inflation at target is assessed to be the middle of the target band plus productivity, as this means that, with inflation at 2.5 per cent, the real unit labour costs faced by firms will be constant as will the labour share of income in the economy. It is harder to assess this level in terms of WPI, as WPI tracks wages growth for a fixed basket of jobs, while some of the productivity growth in the economy could reflect shifts in the basket of jobs (e.g. sectoral changes). Estimates suggest that, on average over history, around half of growth in (trend) productivity is captured in the WPI. 12