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A productive economic boost

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Small businesses play a key role in the Australian economy and productivity is a critical element in the success of these enterprises. Vicki Stylianou reports on the challenges ahead to raise productivity levels.

The Institute of Public Accountants (IPA) released its second Australian Small Business White Paper in September. Its purpose is to improve Australia’s living standards by boosting small business productivity. There are 12 chapters of substantive policy recommendations covering productivity, regulation, taxation, access to finance, workplace relations, job creation and job destruction, innovation, competition policy, family firms, internationalisation, mental health and cybersecurity.

Below is an excerpt from the introduction chapter, “Revitalising the Australian economy: navigating the headwinds”, which provides context for the recommendations.

When the first Australian Small Business White Paper was released in 2015 we stated that its principal purpose was to present policy options for Australia to deal with the emerging economic challenges confronting the Australian economy. We posed the fundamental proposition that while the government grapples with ways to address Australia’s budgetary problems, a much more profound and urgent challenge was emerging – a productivity crisis. In the three years since we made that statement, developments have accentuated this challenge, creating a greater imperative for urgent government action.

These challenges have been compounded by a global environment that has seen the election of Donald Trump as US President, the uncertainty in Europe and possible contagion effects attributable to Brexit, rising protectionism, the implications from the rise of China as a superpower (including geopolitical issues and the so-called ‘trade war’), ongoing technological advances with the advent of the Fourth Industrial Revolution, continuing demographic shifts, transnational cybercrime, the impacts of climate change and continuing refugee crises. At the same time, our world has continued to become increasingly interconnected and interdependent with scientific, technological and logistical advances in countless countries simultaneously driving economic growth globally.

These events have all combined to create an environment of even further uncertainty and change.  What we need to consider is the impact of these events on the Australian economy and the need to develop appropriate domestic policy responses.

Being a small, open economy, Australia is particularly susceptible to the rise in global protectionism. This could damage future economic growth and undermine the global rules that underpin our trade and investment status. Moreover, at a time when productivity remains stagnant, Australians should be concerned of the potentially serious consequences of stagnant productivity on the Australian economy and future living standards.

These economic ‘headwinds’ continue to strengthen and present potential challenges for the Australian economy going forward.

Successfully navigating these headwinds will be essential to maintain, if not boost, Australian productivity growth, improve national income and raise living standards. The challenges for Australian policymakers are increasing, making the need for action immediately.

Vicki Stylianou

At a time when productivity remains stagnant, Australians should be concerned of the potentially serious consequences of stagnant productivity on the Australian economy and future living standards.

Vicki Stylianou

Small business continues to be the engine room of economic growth. The latest Australian Bureau of Statistics (ABS) Business Counts data for 30 June 2017 indicates that of the 2.24 million businesses in Australia, there were 2.18 million (97.3 per cent) micro and small businesses (those with less than 20 employees). Of these, there were 1.4 million (64.2 per cent) micro businesses that did not employ any staff. Small business contributes one-third of gross domestic product, employs 44 per cent of all workers and generates 40 per cent of new jobs. The annual turnover for 60 per cent of these small businesses is less than $200,000.

However, if small business is to prosper, some things need to change. Innovation processes are less common in small businesses, with 60 per cent engaged in innovative activity compared to 67 per cent for medium-sized businesses and 80 per cent for large businesses. Small businesses also report slower rates of productivity improvements compared to large firms (28 per cent compared to 36 per cent). While small businesses represent 44 per cent of all businesses that export goods, they only account for 0.5 per cent of exports by value (Australian Small Business and Family Enterprise Ombudsman, “Small Business Counts: Small Business in the Australian Economy, 2016”). Despite increases in the number of small businesses that are ‘born global’, significant scope exists for them to become more dynamic, innovative and efficient.

Recent research by the Organisation for Economic Co-operation and Development and others indicates small business can play an important role in lifting national productivity growth and, more importantly, national living standards through a variety of ways, including improved diffusion of knowledge, products, processes and technologies across businesses.

It is for these various reasons that we look to Small Business: Big Vision to frame our ‘reform agenda’ to tackle these strengthening headwinds confronting the Australian economy.

After all, more prosperous small businesses are good for the Australian economy.

Productivity is critical for improving Australian living standards

Productivity growth is vital to improving per capita incomes and living standards, especially over the longer term. Indeed, as stated by Nobel Laureate Paul Krugman:

“Productivity isn’t everything, but in the long run it is almost everything.  A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.” (Paul Krugman 1994, The Age of Diminishing Expectations)

As stated in the first Small Business White Paper, productivity is about how well businesses, industries or countries combine resources to produce goods and services. This includes resources such as raw materials, labour, skills, capital equipment, land, intellectual property, managerial capability, technology, financial capital, knowledge and ideas.

Productivity growth not only leads to higher living standards, but also enables society to choose from a wider range of options for improving living standards and wellbeing. Simply put, growth in productivity is vital for growth in national income and living standards into the future.

Productivity growth in Australia is measured by the ABS and others using one or two interrelated measures. The first is labour productivity, which is defined as output per unit of labour input (typically measured in terms of hours worked). The second is multifactor productivity (MFP), which is a residual measure after taking out the contribution made by the increased use of capital inputs per unit of labour input in production (termed ‘capital deepening’). MFP is generally interpreted as a measure of the efficiency with which labour and capital inputs combined are used in productivity. Most analyses typically assesses changes in productivity growth rates over time rather than focusing on the underlying level of productivity.

Productivity headwinds are gathering

The long-term trend in Australian labour productivity growth has been steadily declining over the last half-century.

The declining trend is more clearly indicated by the downward revisions to the 30-year average growth rate made by the Commonwealth Treasury in its successive Intergenerational Reports, falling from 1.75 per cent in its 2002/03 report to 1.5 per cent in the 2015 report.

More recently, as noted by the Productivity Commission (PC) in its report, “Shifting the Dial, 5 Year Productivity Review” released in August 2017, annual productivity growth has been ‘flat’ for over a decade.

However, sluggish productivity growth in the Australian economy is not unprecedented, nor is weak national income growth. The recent strong growth in Australia’s terms of trade boosted growth in Australian national income to the envy of most other developed countries and gave rise to the mining boom. Unfortunately, the mining investment boom is now behind us. Looking ahead, it is growth in the non-mining sector that will largely determine the prospects for Australian incomes and living standards.

The declines in productivity growth partially reflect the effects of longer-term structural changes in the Australian economy that has seen a decrease in the relative importance of many traditional ‘goods producing’ industries such as manufacturing and agriculture, and an increase in many service sector industries. The lower rates of measured growth in labour productivity in many of the service sector industries compared to the generally higher rates in the traditional goods-producing industries has contributed to the decline in national labour productivity growth identified in the Intergenerational Reports. This trend is expected to continue as stated by the PC in its “Shifting the Dial” report. In other words, this long-term trend in labour productivity is expected to continue unless significant productivity-enhancing reform is undertaken and undertaken now.

The use of capital in production (capital deepening) has been the main source of longer-term labour productivity growth in the Australian economy over the last century accounting for roughly 60 per cent. This means that each use of Australian output tends to be produced using less labour than it did 50 years ago. MFP growth accounted for the remaining 40 per cent of historical labour productivity growth.

Vicki Stylianou

Being a small, open economy, Australia is particularly susceptible to the rise in global protectionism. This could damage future economic growth and undermine the global rules that underpin our trade and investment status.

Vicki Stylianou

More recently, MFP has underpinned labour productivity growth in most industries, with nine of the 16 industries for which MFP is reliably measured, experiencing positive average MFP over the current productivity cycle (that is, 2007/08 to 2016/17). This contrasts with the previous productivity slowdowns that have been generally broad based. (PC, “Shifting the Dial”, 2017).

Yet productivity headwinds are strengthening and have the potential to make it harder for Australia to maintain, let alone improve, living standards into the future.

Governments have an essential role to play in addressing these headwinds.

Productivity – governments have a vital role to play in boosting productivity and living standards

Governments play a significant role, directly and indirectly, in the effective operation of the Australian economy. Governments set the rules by which markets operate, they regulate and enforce the rules; levy taxes; and provide or fund significant services and infrastructure for the community. These rules, taxes and expenditures affect business profitability and may create artificial incentives for them to alter their behaviour in search of higher returns which can result in unintended consequences or excessive compliance costs.

Governments also exert significant influence on wider productivity in the private sector. The PC notes governments can exert influence on both MFP performance and capital deepening over time, both of which are desirable sources of productivity growth.

Given the myriad of ways and mechanisms that governments, directly and indirectly, impact productivity growth, it is essential that their initiatives and actions are selected, funded and managed as efficiently and effectively as possible to ensure the significant potential benefits are realised.

New and improved policies are also important. For example, significant scope exists to improve productivity growth in the delivery of education and skills development, as would updating regulatory settings to reflect the current economic realities.

As noted in this White Paper and elsewhere, technology simultaneously creates and destroys jobs. To the extent that technological shifts require more advanced or new skills from workers, there is a role for government to ensure education and labour market policy settings enable upskilling and retraining. The first White Paper makes a significant case for government to support vocational training, which has an important role to play in this process.

Government also has a role to play in enabling research and providing access to data. We note that recent improvements in data collection and research, such as the development of the BLADE (Business Longitudinal Analysis Data Environment) framework, which was boosted by funding in the 2017/18 budget, offers great potential for improving productivity growth through better targeting of government policy and the effectiveness of government programs at the firm level.

Australia should follow the lead of New Zealand in promoting more collaboration between the public sector, private sector and academia to improve the contribution of policy to increasing productivity growth ‘by connecting people, shaping research agendas and sharing research’. This will improve the evidence base needed for robust policy development.

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