Transcript of Question & Answer Session Demographics, Productivity and Innovation

To what extent, I mean it’s a very interesting presentation, what extent do you think that what is commonly called the global financial crisis has had a negative impact on innovation, there’s a feeling that people don’t want to take risks in this current climate or is what you’re talking about may well occurred without the global financial crisis?

Well I think that’s a very good question it’s no doubt the case that the financial crisis caused both households and businesses everywhere to become more risk adverse. And you see this in many countries around the world the corporate sector at the moment is actually very profitable in many countries, corporations are sitting on large amounts of cash and they’re really saying that the best thing they can do with that cash is to leave it in banks earning very low interest rates. And I think that’s partly because they’re very cautious about the future. The hope from a cyclical perspective is that that caution will gradually lift and then firms will start employing that capital and investing and creating jobs; so that’s the cyclical dimension. But I do think there is a deeper structural thing going on and that’s coming about from both aging and changes in people’s perception about risk, it’s kind of structural, it’s very slow moving, but as I said in my remarks I see lots of evidence of things … Or things that I see as evidence of it in our society where we’re prepared as a society to spend more on risk mitigation. I think part of its structural and my fear is that it’s going to become much more pronounced as the population ages, and that’s going to create a big challenge for us all because in Australia - in the last 20 years per capita real income has grown 2¾ per cent a year for 20 years. If you look at every other western country it’s much lower than that I think the average for advanced economy as a whole is about 1¼ per cent. Now we’ve got used to very strong growth in our real effective living standards in this country, and we can only continue to do that if we have growth in our living standards of anything like that if we really lift productivity growth and this is why I think there this focus on innovation of creating a climate where people are prepared to take risk and be rewarded for that is incredibly important to our future prospects.

Question here.

John Campbell from the Members Council. Thanks Phil for a very thought provoking address. Can I just pick up on another mention of the financial crisis though and that’s around innovation and financial products given your sort of deep background in financial stability. I mean arguably there’s a view that the finance sector was too innovative and in fact the steady growth in the economy and you need the finance sector to be the hand maiden of the real economy and perhaps doing the same thing over and over again in the finance sector isn’t such a bad thing after all. So could I get you to perhaps explore a bit further financial product innovation, financial innovation more generally and what are the pay offs or risks around that as you see them now getting on to I guess five or six years on from the GFC.

Well in a slightly different context the one that I was speaking about, you can see just how important the risk culture is to the economic outcomes, kind of both in Australia and the globe. Because the risk culture in financial institutions turned out to be dreadfully inappropriate, the incentive structures that were setup within financial institutions to take risk were poorly designed, people misunderstood the risk and there were very large macroeconomic consequences of that. So risk culture it really matters and it’s clearest in finance because if things go wrong with highly leveraged institutions which is what financial institutions are, there can be big nonlinearities, so the risk culture really, really matters. And my broader point is that it’s not just true in finance, the risk culture in our society really matters and the financial sector just showed kind of that in a very unhelpful way. The other part of your question really is do we have too much financial innovation and I suspect the answer is yes but there are a lot of good things that can come from good financial innovation as well, right so I don’t hope for a world in which the financial sector does not continue to innovate, we want that innovation though to serve business and consumers and not the insiders in the financial sector which sadly that happened for too many years, but it’s just the culture of innovation, the culture of risk taking really matters.

Phillip I agree with all of your comments about what’s driving some of this behaviour, but I wanted to throw one more hypotheses at you just get your reaction, a lot of the industries that all the western countries have, from the 1900s up till now are quite mature industries and in a lot of mature industries you get a collapsing down of a number of competitors into a handful whether it’s car making, or steel making or mining or banking or retail grocery, and often I see when you get a small handful of players they spend a lot of time defending market share and not often as much time trying to innovate. And I wonder if you would comment on at least my hypothesis that part of this has to do with the fact that we’re just experiencing the tail end of 100 years of growth in a lot of industries that are now pretty mature and that to expect them to wake up and completely trash their business models with some innovation is sort of unlikely?

Well, I don’t know the answer to that. It’s certainly the case that, well you’re really arguing the same thing that Robert Gordon was arguing, that there was this kind of burst of technical innovation, huge inventions and then we took a better part of a century to work out how to do it, and industries have become stale and we haven’t got the new round of innovations to drive the next round of growth in our economy. It’s just very hard to know whether that’s going to turn out to be correct because I do have some sympathy for the view of Joel Merkel, because he is saying and I think this is right that there are a whole bunch of new industries actually coming forward and the probability of those coming forward now has risen because information can flow around the world so quickly, people can discover something in one place in the world and the results of that are immediately available to people elsewhere in the world whereas a decade ago or two decades ago that just wasn’t the case. I was telling my colleagues at the Bank the other day that when I came back from MIT in 1991 I had just been using this thing called email, and I went to the IT Department and said we don’t have that here can you look at it. And they said well can you write a business case and I – why would people want – we can have faxes. Anyhow we gradually got email, it’s kind of an illustration where the world is changing and information now flows around so quickly we can have access to stuff, and that could actually be the catalyst for a new round of innovation. So the old industries sit there, not particularly dynamic but new ones open up, I don’t think anyone should claim the answer to how that’s going to work out. But what I feel much more comfortable in arguing to you is that whether a new range of technical possibilities is or technical advances is possible or not the culture that we have is key. If those possibilities are out there we’ve got to go and find them and so the culture is key, if they’re not out there we’ve got to really do the best with what we can so the culture is key. So I think anyone who says they know the answer to that is really kidding, and probably not a very good answer to your question, but it’s the best I can do.

Thanks very much Deputy Governor. I just was curious I was sent research from Finland and they have this program that was called Start I think it was, where the Government instead of loaning money or giving grants out to start-up businesses they would actually do something similar to like the convertible note, more like an investment program into the shares of the start-up, and they’ve got this entire program where they help to improve the entrepreneur, help them out. I know Australia does a few of those things but my question is really that they helped out some Nokia subsidiary companies grow to billions of dollars and they reaped the profits and rewards of it, so it’s … The question is could maybe that be a great way in which Government can assist start-ups hence assist productivity growth and maybe that could be I don’t know that inquiry you mentioned about access to capital.

Well I don’t know enough about the specific example that you’re talking about to comment on that. It is an issue that the Financial System Inquiry is going to look at, it’s ready to be looked at. I hear from a lot of businesses or prospective business we talk to how difficult it is to start up and one can understand that because it is risky, so what’s the right balance between equity and debt and who supplies the debt, they’re kind of important issues, but I don’t know enough about the particular scheme you’re talking about.

Question down the back of the room.

Dr Lowe, Clancy Yates from the Australian Financial Review. You mentioned the hope for some upswing in a cyclical sense and last week the Reserve Bank said some of the recent economic figures were pointing to a stronger economy, since then we’ve had a plunge in the iron ore price, and then much weaker consumer and business confidence figures. Has that changed your reading on the economy?

I think the tradition of the Institute is to ask questions on the topic, but it’s up to the Deputy Governor.

I’m happy to answer any question, briefly. If you look across the whole suite of economic indicators they’re gradually improving and I think what we see is the interest sensitive sectors of the economy gradually picking up and even some of the exchange rate sensitive sectors of the economy now being a bit more optimistic as well. So I think it’s inappropriate really to kind of be reacting to every single piece of short run data that comes out but the combination of low interest rates and a lower exchange rate I think have set the preconditions for a gradual recovery in the economy and there will be obviously fits and starts in that but I think the general trend is an improving one.

I’d appreciate a comment on two areas, one how do you see our superannuation system either working for or against productivity going forward. Also looking at the education system I see a lot of debate in education but I don’t see a lot of involvement by economists, and my feeling is that there is scope for say improving creativity in our education system, and I’m wondering if you see a role for economists in that area going forward.

Well maybe if I take that second one first, because I see a role for economists everywhere, because they’re basically thinking about how to make the best of what we have, how to allocate our resources to get the best outcome, but I don’t know enough about the specifics of the education industry to kind of offer you a comment on that. Superannuation, it is an incredibly important source of funding for the economy and so the way in which the super industry employs that capital is very, very important. We’ve seen over recent years the super fund, well really over the history of the superannuation industry, have very, very heavy investments in firm equity, when you look at the composition of the Australian superannuation funds balance sheet and they’re very, very heavy in equity, and that’s providing corporate funding, risk capital for firms so that’s a positive way in which they’re supporting firms in the economy. I think the other area where there is scope to look at this more carefully is in the role in financing infrastructure, because another important contributor to productivity is having the infrastructure that our cities really need, and I have a particular interest in transportation infrastructure, because I think that’s incredibly important for the way that people move around our cities, the way they connect with one another, the way the competition is brought to various markets and there are obviously social benefits from having good transportation networks as well. So there is a role for – perhaps an important role for superannuation in the transport infrastructure space, but as I’ve said on previous occasions the issues there are not the willingness of - in principle superannuation of other investors to finance this, it’s the project selection, the governance of it, the way that the thing is actually constructed, they’re the kind of the key issues, so if you can get those right, then I think that does create the possibility of super funds and other investors that come and be prepared to fund infrastructure, which I think would be a good thing for the economy.

There’s a question over there.

Robert Dunn Dr Lowe, on the weekend I read an interesting article which said that we have these corridors of innovation in our city, I wasn’t aware of that I was pleased to read about it, I was surprised to read about it, but it caused me to wonder just how good are we at innovation in Australia relative to the rest of the world. So is there a measure of quantitative measure about innovation and any relative measures against other countries?

Well it’s really, obviously it’s a really hard thing to measure. The OECD I think has tried to come up with indices of innovation and whether we believe them or not I think we rank not near the top, not near the bottom somewhere in the middle. But I think there are two aspects of this that are important, one is kind of basic new science, kind of coming up with new products, advancing the technical frontier and Australia can do that a little bit in certain key industries and we do, do that, but I think the bigger potential gain for us – gains for us is not kind of pushing out the technical frontier but in actually doing the day to day things that we do, doing them better, and to do them better you’ve got to change existing processes and that’s another form of innovation, taking advantage of inefficiencies in the existing processes, managing your workforce more effectively, and dealing more effectively with your customers and suppliers, they’re all forms of innovation. So when I talk about innovation it’s not just pushing out the technical frontier it’s making sure that we change in a way that makes the best of what we can actually do with the given technology and I see many possibilities in our economy to do that. Even if we at 23 million people in the South Pacific can’t really be the ones that push out the global technological frontier, there are plenty of ways that we can use our existing resources more effectively if only we chose to do that, and that’s innovation.

Question up the back.

Thank you very much two quick comments and your reaction please. When Professor Christiansen from Harvard was out recently, and he of course focusses on disruptive innovation, he gave the example of a company, a new start up in the car industry in America that was doing fantastically well because instead of producing a product and then trying to convince people to buy it, it actually looked at what people needed and wanted and so it produced a car for commercial travellers, so that there was broadband, there was a table, they could spread their papers and their laptop instead of having to go to McDonald’s in between meetings, that was one aspect, and it follows on from what you were saying about doing things better and a mindset. The second …

Briefly.

… sorry the second is very brief and that is the lack of attention to science and technology in the primary school level to get teachers who are passionate about it and to get kids passionate about it when you look at our production of engineers versus our production of lawyers and investment bankers, I’m a lawyer but we try to innovate, but we really need some scientists, more scientists and more technologists and we look at China and the amount they’re producing thank you.

Well I can only but agree with you really, I mean who could disagree with the principle that businesses need to look at what their customers need and want, it seems so obvious doesn’t it, but apparently it’s so hard to implement. And the teaching of science I think is obviously important, very important, but I’m a humble Central Banker, I’m not an expert on every aspect of our education system. I just want to come back though, we shouldn’t just be thinking about innovation just as pushing out the technical frontier. So if we think the push to improve productivity to do that we’ve got to lift the technological frontier and we should spend a lot of resources as a country doing that, and I think that’s kind of a debate we had about whether doing that … I think that the really big gains for us are actually not in pushing out the frontier at least the next little while but actually doing things better. Examining existing practices, managing our workforces more effectively, having flexibility in the way we do that, having proper pricing of infrastructure, having general flexibility in business, that’s … And allocating the resources that we have as a society as efficiently as we can. There are big benefits to be gained there and if you look at the list of things that the Productivity Commission has suggested there is a long list there, and implementing that list or a fair chunk of it would make a difference to our collective living standards, but many of the issues here are difficult because everyone would agree with pushing out the technological frontier, who could disagree with that, but taking on distortions in the economy really not doing things appropriately or as efficiently as we can, that’s very difficult. There’s always someone who benefits from a distortion of course and they don’t like it, so I’m trying to use innovation here not just in a technical frontier sense but in the way we manage our businesses and allocate the resources domestically.

It seems to me I’d like your comment on this that in the new normal, all the technology is going to result in a need for fewer and fewer workers, and each company, that certainly I deal with, seems to be in a race to the bottom to get the most possible customers and fewest number of workers. I’m just wondering going forward what they’re going to do with all those workers, particularly with the increase in immigration.

Well with the greatest respect I think I fundamentally disagree with you. Because what technical progress does is allows firms to produce output with fewer workers but it produces output and that output generates wealth and then that wealth gets spent in the economy, and what happens over time is that wealth increasingly gets spent on services. So what we’ve seen as our society has grown and become more wealthy, the services share of the economy has grown because we need to spend less resources now making carpet and tables and chairs and clothing, that’s true, and globally we don’t need to spend as many resources doing that. But that’s correct, the fact that we can do that all more efficiently is there’s income generated from that and that income is generated on a whole range of services, and so in every country that’s gone through this technological progress, there are fewer people in production of goods but many more in the production of services. And you see that even in our own economy the huge growth in the service sector employment, now hundreds of thousands of new jobs created in education and health and in the restaurant and accommodation sectors, and we’ve only been able to do that, Australia and other western countries, have only been able to do that because they have become more productive in producing goods, in having fewer workers and more capital and better technology producing the goods. So I think in the longer run this technological improvement and fewer workers in manufacturing is great, it’s great for our collective living standards, and it’s not a threat to employment.

Down the back.

This may be off your planet but you’re a banker and you’re talking about the way to do more production and whatever and I’m wondering what’s the role of Government? More or less giving confidence, we’re having a discussion at the moment about the taxation system which many people think is desperately in need of review, what would be your advice to Government, because after all we’re all the masses we can only do so much, and the rest of it has to be done by the Chief Executive which is the Government.

Well I’m not in business of giving advice to the Government. I think that’s a dangerous thing for central banks to do. I think the general observation I would make though is that it’s incredibly important for the Government to act consistently with policy so that people understand where the Government is coming from on the policy framework, because I think that does reduce uncertainty, and if you reduce uncertainty that allows businesses to plan, to be prepared to take a risk, what I hear and I am happy to stand corrected by the business people in this room, but what I hear is that kind of uncertainty from the political level, does bear on their willingness to take a risk. So I think consistency of policy, and predictability in policies is very important. I’d also make the observation that the culture of the political class is quite important because if the politicians can create a culture that promotes entrepreneurship, that facilitates change, it makes it easier for resources to flow around the economy, that’s going to be a better world for us, and they can promote that culture both through their policies and their language. Beyond that I don’t think I’m prepared to go any further thank you.

We’re getting very close to the end now, question down there.

Rory Robertson, Dr Lowe thank you for a really interesting talk, you worry about, we’ve got really used to rapid growth in living standards and you worry that so much energy is being put into risk litigation now in our playgrounds and in our classrooms and in our transport systems and business and finance, I wonder if a big part of the story isn’t simply that as we’ve got wealthier, so each decade we’ve grown, living standards have grown by 2 per cent per year for five decades and we’ve got to a living standard where most of us here and many downstairs, don’t want for much, sort of solved the problem of putting food on the table and roofs over our heads, what if it’s just a natural development for wealthier economies to actually spend more time, giving priority to risk mitigation, we’ve only got one, two, three, four kids, if you had 10 if you lost one it didn’t matter very much, there’s a whole literature now about how we feel the pain of losses much more than we sort of enjoy gains, I wonder if that’s not part of the story.

Well as I tried to indicate in my remarks, I think that is possible, that wealthy societies just have different preferences and really what we’re seeing through the various things that I’ve talked about is really just a reflection of those preferences and this is entirely optimal. I don’t know whether that’s the case. I think we’ll probably get a better answer if we have a kind of society wide conversation that we talk about these issues openly and widely in our society and I think kind of thank you for giving me the opportunity to do that. I just don’t know but if this is optimal then we should be making the decision consciously and we shouldn’t just be drifting into this and I fear that as the population ages we could drift into a society that’s much less tolerant of change much less embracing of doing things differently. And that may be okay but if we’re going to do that then we should do it consciously and we should understand the consequences of doing that.

Thank you, you’ve got to be very quick.

All right, yes hello some analysts disagree that you can’t actually decree productivity according to the demographics or even ordain innovation but only reward it or punish it. So if that is not true and my question is that how do we actually measure the productivity or the new invention in your thoughts and if we’re only relying on experts of existing businesses aren’t we confining ourselves to the past? How can [inaudible] that does not exist thank you.

Well I agree with your first point you can’t ordain it, I mean you’ve got to create the environment in which people are prepared to invent a new technology or do something more effectively, that’s all you can do, you can’t kind of demand that this be taken, it’s the result of the private sector might be taking decisions to do things better. The measures of productivity that people normally talk about is GDP per hour worked, both of those things are fairly easy to measure and maybe kind of follow up into Rory’s comment that maybe what he’s really getting at is that kind of what we measure of GDP is not a good summary statistic of economic welfare and so we can do things that actually increase our collective welfare but don’t increase that measured output, and that raises a whole set of much more complicated issues because how do you measure welfare with the economics profession has really got quite good at measuring physical output and output of services but we’re not very good at measuring welfare. Lots of people have … You could imagine kind of setting up a system of accounts that measured welfare per unit of hour worked, it’s just much harder to do that, maybe one day we’ll get there, maybe we’ll have some innovation in measurement but I think we’re still a long way from being able to do that with any great science.

Just a final question on your demographics, and I’m not asking you to predict what might happen, but if that figure on the aging of the population and the resignation of many members of the workforce and drop in that participation rate, if that continues and on that kind of graph you would expect it would, then you might it be a reasonable and think that the unemployment level would at least suggest stabilise, it might increase but is that the way you’re thinking about unemployment of those … That trend goes the way it’s currently going.

Not necessarily, because I view the … Are you talking about the unemployment rate?

Yes

In principal the change demographics needn’t have any implication longer term implication for the unemployment rate because ultimately the unemployment rate is determined by the level of wages in the economy and relative to the ability of firms to produce goods and services. So it’s really a question of what wage rates go with the change of demographics and people who look at Japan where this is much more advanced, predicting rises in relative wages in Japan, if that were not to occur then you could have excess demand for labour, if it were to occur too much but very large wage rises and you could have unemployment so it’s really an outcome of the wage process rather than demographics but as I said in Japan people worry about a shortage of workers pushing up wages and just how far that process goes will determine what happens to the unemployment rate, and I think that analysis is probably applicable here as well.