Australia Economic Trends Report: Productivity Crisis Overstated, But Downturn Needs to End Soon

Productivity growth goes in cycles and Australia is currently within the normal bounds of a low productivity growth period, rather than a “crisis” as commonly characterized, according to a research report from KPMG.

However, there would be cause for concern if this downturn continues to drag on. This is the conclusion of a new KPMG policy paper, Trends in Australia’s productivity growth, that also identifies the key factors “driving labor productivity and makes suggestions for policy intervention.”

KPMG econometric analysis – using “the same framework as the US Federal Reserve –shows Australia’s high productivity growth cycles tend to last for around two years, while lower productivity periods tend to last slightly longer, typically three years.”

The previous high was in December 2022 as they “emerged from the Covid lockdowns, which were – perhaps counter-intuitively – a time of higher productivity.”

The paper says there are some reasons “for optimism, given the close correlation with the productivity cycles of the US economy, which is itself showing signs of emerging from a low growth period.”

However, low levels of technology investment and business confidence “coupled with persistently elevated unit labor costs may impede a productivity growth uptick.”

The analysis shows that more than half of aggregate labor productivity growth in Australia can be explained by three factors:

  • The productivity that occurred in the last quarter – a momentum effect
  • How many new workers entered the workforce – they are likely to be less experienced or lower-skilled than the existing workers. When the labour market is tight, as at present, marginal new workers will come from the pool of long-term unemployed, who are likely to require additional support to be as productive as other employees
  • The addition of skilled foreign workers helps because they boost the productivity of native-born workers and bring in specialization, new skills, ideas, or innovation. This effect occurs with a lag.

Given that the structure of the labor market has played “a central role in the current slowdown, the paper points to labor and migration levers that can be pulled to mitigate the cyclicality of productivity growth.”

It recommends three ‘key pillars’ to lifting productivity:

  • improved education and training for unemployed people
  • a re-design of migration to ensure supply and best utilisation of skilled migrants
  • ensuring sufficient flexibility to allow for labor mobility.

The current, historic, low level of unemployment has “led to an unusually high participation rate, which has meant an influx of marginal new workers, some of them previously long-term unemployed, who during softer employment markets may have faced challenges finding work.”

This has contributed to the current low productivity growth cycle, the paper argues.

There is also the ongoing impacts of ‘labor hoarding’, a COVID-era phenomenon “where companies held on to workers, perhaps unnecessarily.”

On net overseas migration, the report points to “some mixed evidence during and after the COVID period, where the sharp fall in migration levels may have disproportionately impacted low-skilled workers or those in sectors less relevant to productivity growth.”

However it also points to longer-term studies “which demonstrate the clear link between skilled migration and higher productivity.”

The paper argues that the return of migrants “to Australia since late 2022 has helped improve the skills matching rate in the labor market, although this is still a prevalent issue.”

KPMG research shows that while labor productivity “is the key factor influencing wage growth across all industries, adopting universal policy settings is unlikely to generate optimum outcomes.”

Instead, the adoption of tailored policies “for capital and labor – and an appropriate sharing of returns between them – on an industry-by-industry basis, is likely to increase economic potential.”

The analysis also shows there is “an inverse relationship between the rates of growth of the real producer wage and of employment.”

Higher real wages, unless backed up by strong productivity growth, “can lead to lower employment levels. Industries using high-tech assets in their production processes are more likely to be able to sustain wage growth.”

Dr Brendan Rynne, KPMG Chief Economist and report lead author, said:

“Productivity is the key driver of real wage growth and so policymakers are right to be concerned about periods of low productivity growth, as we are experiencing currently. Our analysis indicates strongly that fluctuations in productivity are a normal part of economic cycles across nations, but there should be concern where those periods become extended and stretch beyond what history shows us is a typical downswing cycle.”

As noted in the update:

“Australia should be looking to emerge from the current low in the productivity cycle by the middle of next year. Encouragingly, recent data from the US is indicating a resurgence in productivity and, given the numerous economic parallels between the two countries, including similar industrial structures, technological adoption rates, and labor market dynamics, it is reasonable to anticipate that Australia will follow suit and experience a similar productivity rebound in the near future.”

However, he added:

“While some positive indicators, like increased demand for skilled workers, offer some hope, other signs are less encouraging. Technology investment remains low, potentially hindering the adoption of productivity-enhancing tools and processes. Business sentiment also remains low, indicating a lack of confidence that could impede investment and innovation.”

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