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The Productivity Commission and National Competition Policy

April 18th, 2005

I spent a good deal of my academic time in the 1990s arguing with the Industry Commission (now the Productivity Commission) about their estimates of the benefits of microeconomic reform and, in particular the ‘Hilmer reforms’, enshrined in National Competition Policy. My main target was their estimate that NCP would raise Australia’s national income by 5.5 per cent relative to the level that would be obtained without reforms. I suggested that the likely benefits were less than 1 per cent.

In their latest report, available as a PDF download, the PC splits the difference, claiming a net benefit of 2.5 per cent. Reading a bit more closely, the ground they’ve conceded is even greater. The PC estimates cover not only NCP but the entire program of microeconomic reform including tariff reform, financial deregulation, labour market reform and so on. And, whereas the earlier estimates were for a five-year time frame, with more to come in future, the PC implicitly concedes that Australia’s productivity growth, after rising substantially between 1993-4 and 1998-9 fell back to the historical average rate, or below, from 2000 on.

One point on which the PC is holding its ground is that of work intensity. I’ve argued consistently that the upsurge in measured productivity in the middle and late 1990s was due, at least in part, to increases in the pace and intensity of work. They say

Further, contrary to the contention of some commentators (see, for example, Quiggin 2001), greater work intensity — manifest in longer working hours and an increased pace of work — does not provide a credible explanation for the sustained improvement in Australia’s productivity performance. The impacts of changes in hours worked are explicitly accounted for in measures of productivity growth. And claims that the productivity improvement would be temporary because of an unsustainable pace of work are inconsistent with the extended period of strong productivity growth that has been observed in Australia.

This argument fails because the supporting premise “an extended period of strong productivity growth” is false. As I’ve already observed, above-average productivity growth ceased after 1998-99. This is exactly consistent with a once-off increase in work intensity.

There’s some fancy footwork going on with levels and rates of change here. I’ve asserted that productivity growth based on increased work intensity is unsustainable in the sense that while you can increase work intensity for a few years, the process has to come to a halt. If the higher levels of intensity are maintained, productivity growth will return to its previous rate, but the increase in productivity level will be maintained. A stronger notion of ‘unsustainable’ is that the increase in effort will be reversed, and productivity growth will be below-average until the temporary increase in levels is lost. There is some evidence of a reduction in work intensity over the past few years, but it’s clear that much of the increase in the 1990s has been sustained.

What’s left in the case for microeconomic reform is not the productivity gains that were originally[1] promoted but the proposition that microeconomic reform has contributed to our good macroeconomic performance over the past fifteen years. There are a lot of problems with this claim. Most obviously, we were well into the micro reform push when the 1989-90 recession began. More importantly, our current strong performance seems heavily dependent on low interest rates, and it’s hard to see how these can be sustained with a large trade deficit and an expanding current account deficit. Still, this is one area where I’ve been overly pessimistic in the past, and we’ll just have to wait and see whether we can get back on to a sustainable trade path without a recession or serious slowdown.

fn1. Actually, this isn’t quite right. In the early 1980s, microeconomic reform was promoted on macroeconomic grounds, as providing the increased flexibility that would permit a sustained macro expansion without running into export bottlenecks and current account deficits (at that time, assumed to be unsustainable). These claims were abandoned after the 1989-90 recession and attention focused on productivity growth.

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  1. gordon
    April 18th, 2005 at 12:20 | #1

    Well, justifications come and go, but the real motivation for microeconomic reform was always to reduce the influence of the union movement. The only difference between the ALP and the Coalition in pursuit of this aim was that the ALP was prepared to offer a deal (the Accord), whereas the Coalition was not. The ALP’s preparedness to deal, oddly enough, arose from actual belief in many of the economic justifications thought up to justify the attack on unions. You had, particularly in the Hawke period, a lot of agonizing analysis of economic/policy variables in connection with firm behaviour, particularly by the EPAC, the BIE, Industry Councils and the Dept. of Industry and Commerce, all of which is now forgotten. A good part of this work explored a new role for unions, and unions took part in it.

    It was funny in a way, because the people who were keen to use economic justifications for policy changes to reduce the influence of unions really didn’t give a damn about the economics as such. Economists need to remember that they will be popular as long as they think up plausible reasons for people to do what they already want to do, and no longer. Economists with other ideas need to remember the times when to be a Keynesian was almost physically dangerous.

  2. Mark Upcher
    April 18th, 2005 at 18:51 | #2

    “And, whereas the earlier estimates were for a five-year time frame, with more to come in future, the PC implicitly concedes that Australia’s productivity growth, after rising substantially between 1993-4 and 1998-9 fell back to the historical average rate, or below, from 2000 on.”

    John, you have switched here referring to estimates of the increase in national income over a specific time frame to a statement on the rate of growth in productivity. These are not the same thing. Just because productivity growth falls back to an historical average rate of increase does not mean we do not continue to benefit from the gains made between 1993-94 and 1998-99.

    “As I’ve already observed, above-average productivity growth ceased after 1998-99. This is exactly consistent with a once-off increase in work intensity.”

    Alternatively, if you don’t accept that work intensity is the major explanation (the PC view) this could reflect the period in which the gains from micro reform were realised.

  3. Andrew Norton
    April 18th, 2005 at 19:11 | #3

    We might have been into the micro reform ‘push’ by the time of the recession, but actual policy change was modest – banking, very modest moves in industrial relations, the beginning of the first Hawke tariff phase-down at the end of the 1980s. The main reform period was the first half of the 1990s – more phase-downs of tariffs, widespread privatisation, utility reforms, national competition policy, continued and more radical IR reform, end of two-airline policy and one phone company policy, plus lots of other less high profile changes.

  4. John Quiggin
    April 18th, 2005 at 20:01 | #4

    Mark, on the first point there’s a once-off change in levels. On the second, a lot of reform continued after the period (privatisation, the GST, IR and so on)

    Andrew, at the time, financial deregulation and tariff reform were seen as the big issues. The activity of entrepreneurs like Bond and Skase arising from deregulation was seen as transforming the economy. It was widely thought that the economy had become flexible enough to handle macro shocks like the high interest rates taht gave us the recession.

  5. Mark Upcher
    April 18th, 2005 at 23:11 | #5

    John.

    On the first point you make exactly my point that there was a once off change in levels from 1993-94 to 1998-99, which could be attributed to micro reform. We do not lose these gains just because productivity growth has returned to average levels.

    On the second point, I would not expect a huge gain from privatisation especially given that the major and huge one was only a partial privatisation with the government maintaining majority ownership. The IR reforms have been fairly minor (they left intact the extensive award system that protected wages to over $1000 per week, the award system constrains the enterprise bargaining process, and AWA coverage is still very narrow). The GST is not, in my view, a micro reform but a tax reform and given the large increase in the tax take could be viewed as a net negative for economic prospects.

    Finally, at the time of the high interest rates that led to the 1989-90 recession, I do not recall any view expressed that the economy was flexible enough to handle macro shocks. That view came much later when we surviced the Asian crisis.

  6. April 18th, 2005 at 23:28 | #6

    Well done John. I’d like to see this fully written up at some stage.

  7. John Quiggin
    April 19th, 2005 at 07:29 | #7

    Mark, the same kind of optimism emerged from the successful management of the banana republic crisis. The obvious evidence for this is that, despite the very high interest rates of 1989, no-one in policy circles anticipated a recession.

    As a related point, relevant to Andrew’s comment, in 1989, Chris Higgins, who was then Treasury Secretary said, in 1989,

    We have had a decade of remarkable and fundamental economic and social policy reform; reform which in all its major contours and, arguably, in 99 per cent of its detail, is efficiency-enhancing.

  8. Andrew Norton
    April 19th, 2005 at 08:53 | #8

    In my reference to the 1980s I was making a point only semi-related to the post about common perceptions on the timing of economic reform. When I started work researching public opinion on economic reform I was surprised to find that my own perceptions about micro reform were wrong – very little happened in the 1980s compared to the 1990s. Chris Higgins might have thought there was a lot by 1989, but his comparison point was presumably the Fraser government, and by that standard he was engaging in only modest hyperbole. But most of the work was done later, so I would not start macro evaluations until the early to mid 1990s.

  9. John Quiggin
    April 19th, 2005 at 09:25 | #9

    I agree that the peak period for reform was 1990-95. But there was a lot in the 80s, and plenty in the period 95-00. As well as the GST and a lot of privatisation, most of the actual rollout of NCP took place in this period.

    The crucial point is that for the whole 20+ years since the dollar float, there’s only been one period of above-average multi-factor productivity growth, with a net contribution of 2.5 per cent of GDP. And unless you think work intensity hasn’t changed at all, at least some of that is spurious.

    Actually, I’d say that, for most of the pre-reform period work intensity was decreasing, so the baseline rate of productivity growth was understated. People really were working smarter not harder in those days.

  10. Mark Upcher
    April 19th, 2005 at 16:06 | #10

    John you said, “despite the very high interest rates of 1989, no-one in policy circles anticipated a recession”.

    There were many inside the policy tent who questioned the high interest rate policy in the late 1980s but they were rolled. And bureaucrats do not have the freedom to make public statements opposing the official line unless they have an alternative job in the private sector lined up.

    While there were some reforms in the 1980s, they were primarily in financial markets (floating the dollar, financial market deregulation). Reforms in product markets (eg. reform of government owned enterprises, NCP) and factor markets (eg. shift to enterprise bargaining) did not get underway until the late 1980s and early 1990s.

    It is possible that the benefits of reform were only noticeable when reforms became sufficiently widespread across the economy.

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