RDP 2023-03: Doing Less, with Less: Capital Misallocation, Investment and the Productivity Slowdown in Australia 7. Conclusion

Over recent decades non-mining investment in Australia and elsewhere has been weak and economic dynamism has declined. Both of these had negative implications for productivity, and in turn very real implications for wages, growth and the welfare of the Australian people.

Our paper links these two important macroeconomic phenomena and shows that the slowdown in non-mining capital accumulation has an allocative component: not only has investment declined, but the decline has been larger amongst more productive firms. This means that capital has also been allocated less productively. The weaker link between investment and productivity, and slower reallocation of capital towards more productive firms, has weighed on incomes. Accounting only for the very direct effect this would have in lowering aggregate MFP, our estimates suggest that in 2017 GDP was around $13 billion, or $550 per person, lower than it would have been otherwise. And this is on top of any direct effects it may have had in lowering the aggregate capital stock, or indirect effects in lessening firm-level productivity growth.

In terms of what has caused this, we find evidence that increasing market power has played a role, muting incentives for better firms to invest and grow their capital stock. This finding complements earlier work that found declining competition had limited incumbent firms' incentives to reallocate labour to more productive firms (Hambur forthcoming) and to innovate and adopt technologies (Andrews et al 2022). It reinforces the need to understand why competitive pressures may be declining, and whether that reflects competition policy or other frictions that prevent new firms from growing and challenging incumbents.

We also find evidence that the slowdown was worse in more debt-dependent sectors, suggesting that frictions in debt markets contributed to slower reallocation of capital to more productive firms. This is not evident when examining labour reallocation, which highlights the value of examining the allocation of investment.

While we only explore competition and financing frictions, the results are consistent with other frictions in the economy increasing, making firms less responsive to economic conditions and opportunities. More work is required to understand these frictions and potential policy responses, as they appear to be holding down overall productivity growth and living standards in Australia.