Why zero (multifactor) productivity growth is OK for Oz (very wonkish)

October 12, 2017
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Why zero (multifactor) productivity growth is OK for Oz (very wonkish)

I’m writing a book chapter about productivity, much of which will be a rehash of my 20-year debate with the Productivity Commission over measures of multi-factor productivity (MFP). In the process, I reread this op-ed by Ross Gittins, and the Treasury article on which it is based, by Simon Campbell and Harry Withers. As a result, I had what seemed to me like a Eureka moment. As with all such moments, of course, my insight might turn out to be either wrong or obvious.

Campbell and Withers criticise the whole idea of MFP, which, as they note, is a residual; the extra growth after changes in labour and capital inputs are taken into account. This residual is sometimes called the Solow residual, after Robert Solow, who first discovered it when he tried to estimate models of economic growth in the 1950s. It’s normally explained as technological and more precisely (this is important) as “disembodied” technical change. That is, the residual consists of technological change that isn’t embodied in new and more powerful capital equipment, which should be captured in the measure of capital input.

Campbell and Withers point out that labour productivity has risen steadily, largely as a result of capital deepening (more capital per worker) and that this has been feasible because of a steady decline in the relative price of capital goods. They don’t however spell out the reasons for the falling price of capital goods. The crucial point is that nearly all technological progress in the last couple of decades has taken the form of cheaper, faster and more powerful information and communications technology (ICT). This appears, at least from the viewpoint of a country like Australia that imports its ICT equipment as a kind of embodied technological change. So, the capital contribution to increased productivity appears as capital deepening, not as increased capital productivity.

But wait, there’s more! The standard measure of labour productivity is output per hour worked. But that doesn’t take account of the quality of labour input, which is determined largely by education (also experience, but the average experience of the workforce doesn’t change much over time). If you accept that all productivity growth is explained either by better education or better (embodied) technology, then the Solow residual (that is, the rate of MFP growth) should be zero.

What’s left out here are the putative benefits of micro-economic reform, better management and so on. If these are important, MFP growth should be significantly greater than zero.

The ABS produces quality-adjusted measures of MFP and these are the ones we should be looking at. They are in Table 3 of the most recent report, which shows that MFP growth has been almost exactly zero this century.

The latest document excludes the fabled “productivity surge” of the mid-1990s, but also the productivity slump of the recession years immediately preceding that. Adding those periods in to the picture would still leave MFP so close to zero as to be negligible.

In summary, at least according to the ABS data, we can forget about microeconomic reform as a source of productivity growth. Changes in productivity are explained entirely by better education and faster computers.

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