If productivity can’t be measured (and it can’t), how can we improve it?
The great new god of economics, productivity, may have feet of clay.
The modern world is a noisy place, but you’ve probably noticed the way economists now give speeches extolling the virtues of “increasing productivity”.
Such speeches were much rarer when I became an economic journalist in the 1970s. Why? Because, back then, productivity seemed to be improving a bit each year, the way we thought it should.
In more recent times, however, productivity seems to have faltered. Hence the speeches. The feds have even renamed one of our economic quangos as the Productivity Commission, these days led by one of our rising economic stars, Danielle Wood.
Think of it: a whole commission full of economists studying our productivity performance, what’s causing the deterioration in our performance and what we should be doing to improve it.
There’s just one small problem. John O’Mahony, a partner in Deloitte Access Economics (and a mate of mine) has just published a paper questioning our newfound obsession with productivity and the economics profession’s conventional wisdom that productivity and living standards are everything we should be worried about.
The economics profession has taken up with great confidence the incessantly repeated remark of Nobel Prize-winning economist Paul Krugman that “productivity isn’t everything, but in the long run, it is almost everything”.
But first, let’s get something clear. Many normal people take increasing productivity to be just a flash way of saying the economy should increase its production of goods and services. Actually, what it means is that we should improve the efficiency of our output of goods and services relative to the inputs of land, labour and capital we use in the production process. That is, increase our output per unit of input.
How do we become more efficient? Mainly by giving workers (labour) more or better machines (capital equipment) to work with. Maybe by giving workers better training.
So far, all very obvious. It’s improved productivity that lifts our material standard of living.
So what’s the problem? Although all this makes sense in principle, it’s not measurable in practice. “The moment you introduce a real economy, with real people living in it, the claim that productivity is almost everything collapses,” O’Mahony says.
Productivity is a concept – a perfectly sensible concept, but it’s not “directly observable”. You can’t see it and touch it, meaning you can’t measure it directly.
So you start with the economy’s production of goods and services – real gross domestic product – and take away things you know aren’t relevant. What’s left – the residual – should be productivity.
Trouble is, in measuring GDP, you left out a lot of things you couldn’t measure. Such as? What economists used to call “land”. Today we call it “the natural environment”.
When you use natural resources but don’t count them, you’re counting them as though they were adding to productivity, not depleting resources. O’Mahony says Kuwait is not twice as productive as the United States, it’s just sitting on a lot of oil.
Australia’s 7.6-fold increase in energy consumption per person over the 20th century was counted as improved labour productivity.
Sometimes what we’ve taken to be a productivity slowdown is actually a reduction in greenhouse gas emissions. Something we’ve worked hard to achieve and which would leave us better off is taken to be a slip backwards.
Then we’ve got GDP’s limited ability to capture improvements in the non-market sectors of the economy such as health and education. Patients and students benefit from advances in medical science and learning, but this doesn’t show up in GDP because it’s been too hard to measure.
Even so, quality-adjusted health productivity improved at the rate of 3 per cent a year over the decade to 2019.
What all this tells us is that the economy has changed a lot over the decades without any improvement in the way we measure it.
It’s not just more goods and services that lift our standard of living. We’re working to improve our wellbeing in other, more subtle ways, but much of that does nothing to make our traditional figures look good.
In some other respects, presumably, our performance has deteriorated without that backward step being recorded.
The interesting thing to me will be how the nation’s economists respond to O’Mahony’s scarifying attack on their business-as-usual approach to management of the economy. All of them could justly claim that none of O’Mahony’s criticisms were new to them. But this would not justify anyone ignoring them.
O’Mahony concluded his report with a challenge for decision-makers. “Ultimately,” he wrote, “economic policy should aim to maximise societal wellbeing, not simply measured productivity. And in a mature, high-income economy like Australia, success may increasingly be defined not by how fast we grow, but by what we choose to value.”
The official way of measuring the economy has fallen way behind and work to update the measurement tools must begin forthwith. Productivity improvement – correctly measured – remains of great importance.
Ross Gittins is economics editor.
Ross Gittins unpacks the economy in an exclusive subscriber-only newsletter. Sign up to receive it every Tuesday evening.
