A PRODUCTIVITY TURNAROUND REQUIRES A MORE DYNAMIC, COMPETITIVE ECONOMY
The Australian, 26 August 2022
Productivity growth is the key driver of living standards over the long run. Yet over recent decades, productivity growth has slowed from a canter to a saunter. Slower productivity growth means lower real wages and less buying power for households. It constrains the ability of the budget to build infrastructure and help poor people here and overseas. Whether your priority is paying down debt or boosting teacher quality, Australians should be worried about the drop in productivity.
In a recent analysis, I worked with experts at the Australian Treasury to analyse data on productivity and economic dynamism. With access to data on millions of businesses and workers, Treasury now has an unprecedented ability to study the health of the economy. Although these datasets have been constructed relatively recently, some go back nearly to the start of the century – allowing powerful insights into how the Australian economy has changed over time.
Crunching the numbers, it appears that the slowdown in productivity growth has been partly driven by a decline in economic dynamism. One measure of this is a drop in the share of workers switching to more productive firms. As you might know from your own career, the biggest wage gains come from starting a new job. Australian Bureau of Statistics surveys allow us to calculate the share of workers who started a new job in the past quarter. This figure dropped from 8.7 per cent in the period from February 2002 to May 2008 to 7.3 per cent in the period from August 2008 to November 2019. The pandemic caused new job statistics to jump around a little, but even in the most recent data, the share of workers starting a new job is lower than in the past.
Another crucial measure of the health of an economy is the startup rate: how many new companies are being created every year? We can think of this as the business equivalent of the number of babies being born. Focusing on employing businesses, the new business entry rate dropped from 13 per cent in 2005-06 to 11 per cent in 2018-19. Even if we include the pandemic years, there is a clear downward trend. Australian firms aren’t being created at the same pace as in years past.
Just as productivity depends on the creation of new enterprises, and the shift of workers to high-productivity firms, so too competition matters. Competitive pressures encourage firms to improve quality and offer attractive prices. Competition spurs businesses to develop new products and services. Competition encourages firms to innovate in their business processes, and use their staff more effectively.
Unfortunately, the reverse is true too. Monopolists tend to charge higher prices and offer worse products and services. They might opt to cut back on research, preferring to invest in ‘moats’ to keep the competition out. If they have plenty of cash on hand, they might figure that if a rival does emerge, they can simply buy them out and maintain their market dominance.
Analysing a huge dataset of Australian firms, we calculate the market share of the biggest players in each industry. This exercise shows an increase in market concentration, with the largest four firms in each industry increasing their market share from 41 per cent in 2001-02 to 43 per cent in 2018-19. Across the economy, from baby food to beer, the top four firms hold a high and growing share of the market.
What does this lack of market dynamism mean for consumers? One way to answer this question is to look at what has happened to mark-ups. A mark-up measures the price that a company charges for its product or service, relative to the marginal cost of production. Under perfect competition, mark-ups should be small – reflecting only the need for business owners to make a return that compensates for their risk. Under a monopolised economy, mark-ups might be massive.
Drawing on work by economist Jonathan Hambur, we find that average firm markups increased by around 6 per cent between 2003-04 and 2016-17. That’s a 6 percent increase in the gap between costs and prices, and it’s unequivocally bad news for shoppers. Looking across the economy, we find that the increase in mark-ups is relatively broad-based, and highest among digitally-intensive companies.
So let’s sum up. Over recent decades, the job-switching rate has fallen. The business start-up rate has declined. The biggest firms have increased their market share. Mark-ups have increased. The Australian economy has become less competitive.
If we’re to turn this around, economic reformers will need to focus on competition and dynamism across the economy, from labour markets to government regulation to financing decisions. Competition policy will be important to upcoming reviews, including the Australian Competition and Consumer Commission’s digital platforms inquiry, the Productivity Commission’s five-yearly productivity review, and Treasury’s next Intergenerational report.
As someone who spends a lot of time speaking to businesspeople, I love nothing more than hearing about the new innovations and fresh approaches being taken by our best companies. The good news is that there’s a lot of dynamism in the economy. The bad news is that on some measures, there’s less than there used to be. A productivity turnaround requires a more competitive economy.
Andrew Leigh is the Assistant Minister for Competition, Charities and Treasury, and his website is andrewleigh.com. This is an edited extract of the F.H. Gruen Lecture, delivered at the Australian National University.