The Joe Walker Podcast - Australia’s Productivity Stagnation: Everything You Need to Know — Greg Kaplan & Michael Brennan

Episode Date: August 14, 2025

Greg Kaplan is the Alvin H. Baum Professor of Economics at the University of Chicago. He is also the cofounder and chairman of e61, a non-partisan economic economic research institute in Australia. Michael Brennan is the CEO of e61. He was previously chair of Australia's Productivity Commission and a Deputy Secretary of the Australian Treasury.See omnystudio.com/listener for privacy information.

Today it is my great pleasure to be speaking with Greg Kaplan and Michael Brennan here at E-61 Sydney office. Greg is one of the smartest macro economists in the world. He's the co-author of one of my favourite papers on the US housing bubble. He's a professor at Chicago, but he spends part of his time back in Sydney where he's a co-founder at E-61. E-61 is a non-partisan, independent economic research institute. I'm also joined by Michael Brennan. Michael is one of the most knowledgeable economists I've met. He's the CEO at E61, but he has deep public policy experience. Prior to his role at E61, he was chair of Australia's Productivity Commission, which is a very cool institution, which is essentially like a think tank for the Australian

government, which does deep economic research. And before that, Michael was a deputy secretary in the federal treasury. He's also worked in the state treasury in Victoria and being a senior advisor to treasuries and finance ministers at both the state and federal levels. So guys, welcome to the podcast. Thanks for having us. Great to be here. Thanks, Joe. Basically, what's going to happen is for the next couple of hours, I'm going to pepper Greg and Michael with all of my untutored questions and they're going to teach me a few things about economic and productivity growth and how to get more of them in Australia. Obviously, we are three patriotic Australians, but this conversation I think will still have interest for our international

audience in two ways. Firstly, we'll be talking about productivity more broadly as sort of an economic object. And secondly, people might just generally be interested to hear how a smaller country of about 27 million people like Australia thinks about how to get more productivity growth because obviously this is a problem across the West. I actually want to pick up where we left off when we caught up a couple of weeks ago. So the three of us were chatting and you two were riffing on construction productivity and why it's stagnated.

It's interesting that it's stagnated, not just in Australia, but also in the West more broadly. I'll put these charts up on the video version of this episode for people watching on YouTube, Twitter and Substack. But here we've got Australia's housing, construction, productivity decline. This is labour productivity. So this is a report, the Productivity Commission, published several months ago. And we also have a chart for advanced economies. So we can see clearly this is a problem around the angliction.

sphere. And when we were catching up, you guys were sketching out a theoretical argument tied to fixed inputs and the durable nature of housing. And I don't think I'd heard that argument before. But could you just recap that idea and then have you taken that any further since we last quarter? So I'll have a first shot. Thanks, Joe. I mean, this, you know, theory, maybe wild conjecture. I don't know, listeners can be the judge. But one of the, the starting point for this was thinking about this paradox if you like why is it that we are so much better and we're getting so much better over time at building things in factories but no better at building things out in a field in a paddock or in a you know a dense urban environment and there may be a whole

range of reasons for that and obviously there's been a lot of speculation about the ways that we could make construction more like manufacturing and bring elements of the process into the factory through modular housing, et cetera. But one of the things we were thinking about was, is construction fundamentally different in this respect that in every other industry, say manufacturing, the annual production each year kind of gets repeated. So the most efficient producers of any given good

are producing again next year and the following year and the following year. And to the extent that the product is growing, there's an incremental bit that maybe is built by a factory that's less conducive to high productivity. but those, what we describe as economists, those inframarginal units are getting repeated every year. Construction's fundamentally different

because in construction you're not repeating those inframarginal units. You know, if in the construction sector, you've already built housing in the most propitious, easy-to-build areas, those most conducive to a high productivity build, you can't come along and reproduce that next year. That's not going to be factored into the production statistics. You're going to be building on successively,

one would expect harder and harder in harder and harder places. Now, that's an empirical claim. It may or may not be true. It might be that, you know, particularly with Greenfields, housing, it really doesn't matter. You can just move further out in co-centric circles from the city and it's just as easy. Maybe that's true.

But it just struck us as something that might be a little bit distinct about construction, that sense that you don't get to repeat the easy units each year. And therefore, it could be just a little bit. bit harder for measured productivity in the construction sector to continue to rise year on year the way we expect it might in others yeah so to make sure i understand there's there's this observation that okay you don't have these you don't have like these economies of scale in construction like you might in say car manufacturing where every model's the same because in construction most houses are almost units are bespoke in some sense

But I feel like you're, so you're taking this further to show, well, actually the units like quickly get quite different or a lot more bespoken and that sort of bakes in the productivity slowdown. Is that the idea? Yeah, well also that in cars, if the most efficient factory is in Detroit, you know, it's, or wherever it is, right, it's producing those high, high productivity amounts of output year after year in construction you might have used up the most high productivity sites if you think that sites might be conducive to a more efficient build say you've sort of exhausted them because you're you're now the distinction with construction I guess is it's an

increment to the stock that's what you're doing each year yeah you don't get to revisit the stock and and reproduce that each year so the information is don't get repeated I get in the some way yeah yeah yeah there's sort of two features of housing construction which are a little bit different than the car one is the durability of the good it's extremely durable a building relative to a car and the other one is the the the the reproducibility of the factor that goes into that which is which is which is extremely irreproducible but then also the even improved land you have to think about critical infrastructure so it's it's it is a little bit more of a of a continuum but and there is role for government there because part of what makes it

reproducible is whether or not you invest in what that infrastructure is to make a new set of green field usable but that is but that that difference means that you don't get to reproduce those um those inframarginal ones as often and when you do yeah you're kind of going down a upper marginal cost curve down the supply curve as you do it yeah so do you have like a hunch for empirically how important this might be well it's hard to know I mean we've got fact one of our researchers here at E61 Matthew Maltman's been working on a paper in relation to productivity growth in the construction sector in New Zealand at the point using exploiting the natural experiment of when planning laws were

substantially liberalised and the result appears to be that you do see an uptick in measured construction productivity poster a liberalisation like that but it does fade again over time and you know this is not a robust empirical test but that set of facts would be consistent with this sort of theory i guess that you you there's an initial kind of almost gold rush around you know here's a new opportunity the best and easiest and most productive or economically viable builds will be done first and thereby you know you see a bit of a rise in construction productivity, but it will probably obey over time as those, you know, the best sites or the best prospects are basically done and you're moving on to the next lot.

I'd have to check what the kind of percentage improvement in productivity in that instance was, but it was a noticeable uptick. Okay. So here's a thought experiment. Think of all the different levers we have to get construction productivity. growing again. There are the classic planning regulations, the kind of things that Yimbies are concerned with, like what Matt was looking at. There are also, I guess, like regulations that apply to maybe the labor side of the construction industry, things like union rules, enterprise bargaining

agreements, building codes, all of those types of regulations. There are things like work equality, things like, I guess the structure and fragmentation of the industry, how well it innovates maybe tax incentives that that cause it to be so fragmented because it is a super fragmented industry i think trying to remember the the cedar report that came out recently but i think uh in their report it's like 98.5 of australian 98.5 percent of australian construction firms are 20 employees or fewer it's just like a super fragmented industry and it's the larger firms that are more productive so i think firms of like 200 or or more employees made 86% more revenue per employee

than the firms of like 5 to 19 people. Okay, so there are all these like different levers to get construction productivity moving. Now, as a thought experiment, hold the planning regulations constant. So you can't advance the YIMB agenda. You can just pull on these other levers. If you could pull on those other levers

to get construction productivity moving, how much do you think that would move the needle on housing supply, or is housing supply basically stuck unless you first address planning regulations? So I don't have a neat answer about the relative proportions, but it is clearly a bit of both. And just to think about it in terms of a basic supply and demand diagram, if at the margin the supply curve is vertical, which is to say the planning restrictions bind, you are just prohibitive. from building that extra unit, then theory would suggest it really doesn't matter how efficient the construction sector gets.

All of that will just flow in additional rent to the supplier. It's not going to increase quantity, right? It's not going to increase volume. And I suspect that is the situation that confronts us in certain areas. So where there are restrictions on density in quite high value areas, the supply curve is essentially close to vertical. So construction productivity is not going to be a thing that really moves the needle there. There are no doubt other areas because you do hear feedback from the construction sector about, you know, it's just not economical for us to build in particular

areas, i.e. the cost of the product, the price of the product that we would be building just won't sell. There's not a market for it. And that suggests, and maybe this is more in greenfields areas or more in some density and but in some lower. value land areas that the supply curve there is upward sloping and there you would expect that if you can reduce the supply curve, move it downwards or to the right, reduce cost, there will be an increase in supply. And so I think that probably is the situation that confronts us in certain markets. So I think it is a bit of both.

I guess the only thing I'd say about, you know, the difference in quantum around that is that productivity in a sector like construction or any, any sector, if you're getting positive productivity growth, it's going to tend to be pretty incremental year on year. It might be one and a half two percent, you know, maybe it gets a bit more rapid if you get a big technological breakthrough. But it's going to be sort of hard grind and incremental over time. Relaxing supply constraints could operate more quickly if you're prepared to do it. And so I think in the near term, it's likely that the supply constraints probably would have a more appreciable effect if you're prepared to relax them than the various channels of productivity growth that you mentioned.

Interesting. Okay, so imagine we do, we get rid of all of the planning regulations that say Peter Chulip wants to get rid of. Imagine that we also get labour productivity in construction moving back to some kind of reasonable growth rate what would the new constraint on more housing supply be i i feel like at that point it becomes more of a sort of political constraint because if prices fall too much too quickly people lose a lot of equity um and you maybe even risk a balance sheet recession is that is that at that margin is that the new constraint on more supply i don't know i mean so the thought

experiment is that we've got productivity growth more broadly up that's the idea so or use meaning the construction sector let's say just in the construction sector yeah and we can it's like a yimbi utopia so we can build wherever we like so supply can accumulate i guess much more rapidly than it does today is then it like a sort of political economy problem where we don't want to bring prices down by too much too quickly well i guess that there would be that would be there would be vested interests for that for sure because right now if the supply curve is vertical as Michael is conjection which I think is right in certain areas that suggests that there's rents to be had if you can expand that and

those rents are going to accrue to the people who are currently the like the builders who are going to build there the people are going to lose are the people who are currently accruing those rents which are the current owners so in that in that situation you would think that the constraint is going to be what What are the best interests of that group and what is their political ability to wield that? But again, that's only one part, I think it's, it's only one part of the country when we think about those very high density areas that we'd like to make even more high density. I think it'd have less of an implication on smaller cities more generally than that.

It is an interesting thought experiment. I mean, when you think about what drives opposition at the moment to density, the argument that it's going to undermine property values doesn't crop up a lot, I wouldn't have thought. It tends to be about amenity and character, neighborhood character, shadowing, you know, some traffic, you know, the sort of urban amenity issues. But that's partly because we haven't had a lot of success. So I think in the world that you,

imagine, yeah, it's not impossible that you would start to get a bit of more explicit opposition. I mean, sometimes the opposition maybe would be a bit tacit and, you know, not kind of revealing the true motive. But even honest opposition around this is going to kill our property values, we don't hear that a lot, but it's not impossible you could hear that, you know, in a way. And it would, to Greg's point, it does represent a transfer from incumbent property owners to would-be entrance, I guess, because part of making housing more affordable for entry is that the price comes down.

Yeah. Yeah, I mean, I feel like there's a long way to go in the sense that prices in the areas we're talking about have got up by a lot, right? It's not clear that we're talking now about falls in prices, which is sort of the balance sheet issues you're concerned. Maybe it's slowing the growth in prices. And there there's a lot of scope before you think you could make a compelling argument that there are stability concerns or macroprudential concerns of a big drop in housing prices.

As a shorthand, let's call the concerns about loss of home equity, the home voter hypothesis, and the other stuff is like, I guess like amenity concerns. That's the, you know, I don't want noisy, ugly construction in my neighborhood. Tell me if you think this is incorrect. I feel like the second set of concerns is currently what characterises most nimbies in reality. The first set is like the mental model that federal politicians have of the average homeowner. That could be right. I think at the state level and the local level, they've probably got the NIMBY mindset a little more in mind.

It's the controversy over densification and people's cherished neighborhood character changing. But yes, you could be right. That could be the sort of, I think there is an element of, at the federal level, a bit of a tradition of and former prime ministers and senior ministers have made that observation. Nobody ever complains to me that their house is worth too much. Yeah. Yeah, the last two decades of Australian housing policy at the federal level have been bookended by leaders from me, the major party making comments like that.

There's like the famous Howard radio comment 2004 and then last year, there's Claire O'Neill on Triple J. As a, okay, to take this thought experiment one step further, and this could be pretty difficult because we don't have like data and spreadsheets in front of us. But say, okay, say labor productivity growth over the past decade, decade and a half was instead of the pretty lousy, like, what is it, 1% or whatever it's been, was actually something closer to the sort of,

in the market sector at least, closer to the 2% we had just after the reform era. So this is like late 90s, early 2000s. How much more politically palatable would house price falls be if we'd had that stronger labor productivity growth? So presumably people have higher incomes, people are rich. Does then that make them more willing to accept losses in home equity? Yeah, I'm pretty skeptical that it would change much. And so let me lay out a couple of things.

One is that let's go with your counterfactual. We had twice as fast productivity growth over the last 10 years. there's no guarantee on about where those productivity growth is going to accrue. So, you know, productivity growth is a very aggregate thing. And the distribution of how that plays out in the economy, there's many, many ways in which it could play out. And it's not necessarily obvious to me that the group that you're thinking of is they're going to be the biggest, are going to gain all of that.

So I think we need to think a little bit about what does that productivity growth look like And how did it manifest in wage income and in household income more broadly? Number one. I think the second thing is that if you look at the vested interest we were talking about earlier, for a large part, that's not a group of the population whose income sources are necessarily that's sensitive to sort of labor productivity growth you're talking about. It's a lot of passive income.

There's a lot of investment in second properties, other wealth accumulation, superannuation, those sorts of asset where it's unclear that that that would shift so much this the way the reliance on home equity as a generator of wealth. All right. So, yeah, I'll share that skepticism a bit. I mean, one observation is that although productivity growth has been pretty sluggish over the last 25 years, income growth has actually been pretty good by virtue of the terms of trade. And if you think about when, this is a totally unimperical claim, but here goes,

when have Australians, when does the general mood or Zichist suggest that Australians have felt most prosperous? It's an interesting thing to reflect because we, you know, we talk about the reform era of the 80s and 90s. My recollection living through it was much of that time, people didn't feel particularly prosperous. Even the 90s with its rapid labor productivity, TFP growth, it's not as though the headlines were telling a story of, you know, we're really going well here. I think people did acknowledge a degree of prosperity around the middle part of that first decade of the 2000s and when the terms of trade boom really took off, you know, that sense

that, you know, the budget was in balance, there were tax cuts flowing, income seemed pretty high, the dollar was worth a lot. there was, yeah, people are perhaps always a bit grudging, but I think there was more of a sense then of, you know, life felt pretty prosperous. And I don't think it really translated into moving the needle on this sort of debate. So I think it's tempting ex ante to say, yeah, if we could get greater prosperity,

maybe there'd be a greater acceptance of some of these hard choices. I'm not sure in reality or whether our expectations just adjust. I don't know. It's also not even clear to me the faster wage. growth wouldn't translate into higher house prices sure yeah if there's a scarcity constraint yeah yeah given the constraints we're talking about yeah okay so one final housing question do you both buy the standard YIMB argument that densifying our major cities particularly Sydney and Melbourne would lead to big gains in productivity so I don't I can't talk for for Michael I think

that the that there are cities which would benefit from densification I'm skeptical about that Sydney, Melbourne argument. So what's the number? Like 40%. About 40% of Australia's population is in Sydney and Melbourne. Yeah, it's hard for me to see where those productivity gains would come from. So when I think about the spatial productivity, I think about competing forces between agglomeration on one hand,

which I think what you're getting at, the YIMBY movement's getting at, versus congestion on the other hand. And what do you mean by congestion? Yeah, so congestion, in economic terms, It's sort of the negative of an agglomeration. The way economists would model this is they just stick a minus fine in front of that. But it's capturing the idea that when you have, what's agglomeration?

It's that we put more people in the same place. And as a result of the number of people, each individual person is more productive, able to produce more. Congestion is going to be the more people, makes it harder for any one individual person to produce. Okay. So can we just, before we move on, can we just unpack the channels by which those gains of agglomeration work? So there's like, I guess there's like better matching in the labor market, but are we also including things like knowledge spillovers in this? Okay. The existence of cities like New York and London in San Francisco and like the enormous knowledge spillovers there, don't the existence of those cities just like automatically refute the claim that we're not going to get net gains of agglomeration from densifying Sydney and Melbourne?

I don't think so. Firstly, it's not obvious to me that the relative size of London, relative to the rest of the UK, is a net benefit for the UK. Might be good for London. I'm not sure that it's necessarily good for the UK. So I think we need to think about even in this discussion when we talk about what we're trying to do, are we trying to improve the welfare of Australians

or the welfare of people living in Sydney and Melbourne? So let's just put that, let's put that aside. Second thing would be that, Sydney has very strong geographic constraints, which are real. I said it's not it's not immediate now Melbourne less so you know Michael knows more about this than me but so I think that it's not obvious to me necessarily that it's feasible in a in a practical way but I the those agglomeration you mentioned two right you mentioned that firms I guess you

have firms and workers can better match to each other and the other one being that there's something some development some new ideas happen somewhere it's easier to for them to be spilled overused, you work with firms in the same sort of, same type of industries. I mean, I think there's another one at a more social level, which is where do people want to locate? Where do they want to set up their lives and make plans for the future? And that requires things beyond just jobs. It requires infrastructure, healthcare systems. It requires good schools. It requires social networks and abroad different groups of people that people can form community with and connections with. And that comes from reaching a critical

size. Now, those benefits from agglomeration are going to exist at different scales than some of the other benefits. So you can tell a story, and I don't know what these numbers, I'm going to make them up, but there's something very different between living in a city with 2,000 people and a city with 200,000 people along the sorts of dimensions that I just mentioned, that are different between going from 200 to 2 million or 2 million to 20 to 20 million. So I think that when I talk about the difference between the potential gains come from increasing supply and say Sydney and Melbourne versus other parts of Australia, I'm thinking about the difference between the gain and going from a 5 million person city

to a 10 million person city versus growing some of the cities in Australia that are a couple 100,000 people to a couple of million people. And so it's some of what I'm saying is a statement about where those potential agglomeration gains will come from. And then some of it's also this congestion, which we haven't talked about, but the congestion forces working in the opposite direction. Okay. So Yimbi, Greg, would focus more on densifying places like Canberra.

I think that's a great idea. Yeah. Is there anything more you want to say on the congestion? I think just that a lot of people forget about the congestion. I mean, that's, you know, there are some, you're right, you mentioned New York and London, these are really big cities, but there's some really difficult things about living in New York. I've lived in both of those cities. I'm very happy that I live in Chicago now and not in New York or London in terms of where I am in my life with young kids and a family. I also know that there's very other big cities of the same sort of size in the world that are not as productive anywhere near as New York and New York and London. And I think we can talk about some very large cities in Asia. where people will tell you that it's the congestion that makes it very difficult when you don't have the right transport infrastructure and other types of infrastructures to be able to realize those agglomeration gains.

So it's just not an obvious thing to me that, yes, we just need to make Sydney and Melbourne bigger because they're currently more productive, therefore put more resources there. Okay. Yeah, I share a bit of the skepticism. I think up front, it feels to me the productivity argument is a bit secondary to the housing affordability argument. Which is more of a welfare thing, right?

Yeah, I think that's right. The strongest Yumbi argument for densification is that it will reduce the cost of housing or make housing more accessible and more affordable. Is there a productivity gain there? Potentially, I think one of the interesting questions, and I'm kind of pondering both New York and London now in my mind, but I think Greg's right that sometimes these agglomeration benefits operate or may well operate over slightly different scales.

So I think you're right to kind of separate out because conceptually they are a bit distinct. The matching benefit, which is about if I can get a bunch of employers and a bunch of employees together in the same location, you know, and they spontaneously have pretty good incentives to do this, right, if a firm is located in a, you know, within a, I don't know, call it a 40-minute commute of, you know, for 2 million workers or 5 million workers or whatever. It allows them to pick a very specialized worker for a niche role and vice versa for the worker. That's the matching benefit. The knowledge spillover is something kind of more mysterious.

It's this idea that there's ideas that just transmit by virtue often of physical proximity and interaction. My gut is that the matching benefit can operate over a scale of a kind of urban area. the knowledge spillover feels like it's something that operates over much smaller geographic scale. You know, it's about a cluster of workers and firms within a smaller area. And there's, you know, most of these precincts

that emerge spontaneously or sometimes government tries to create them. They're often motivated by that kind of, you know, much smaller scale sort of agglomeration. So, yeah, I think it's an interesting question know at what scale you get because you know you might be able to devise transport solutions and you know a degree of density in these cities such that um you better link a whole lot of people to firms and jobs and get the matching benefit um even if we're not in all cases dense

enough to get some of those knowledge spillover benefits yeah yeah okay i've started this off by taking us sort of all the way down the construction housing urban economics rabbit hole but actually just want to take a step back now and talk about growth and productivity more broadly, but we'll do that first by looking at some measurement issues and some of the metrics that we might want to be optimizing for here. So Greg, some of these questions might be more in your wheelhouse, but Michael, obviously, feel free to jump in at any point. So we'll start with the metrics and measurement issues. Firstly, GDP. Greg, could you just outline what you think are the most important limitations of GDP as a metric?

there are many but which are the ones that give you most pause okay i'm going to give you the economist answer it depends and if you'll let me maybe take a step even further back yeah i naturally want to ask metric for what right so i think there's a big question what is it we're trying to do what is it that we're trying to measure why are we measuring GDP so GDP was not invented as a metric to measure welfare it was meant invented as a metric to measure how much stuff we produce. Now, that turns out to be pretty well correlated with welfare, and there's a reason why then we tend to look at it,

which I'll go into. But I think, let me make two points from the outset. One is that ultimately, if what we're interested in welfare, that is a distributional issue. There's a lot of different people. There's a who. There's a lot of different things that those people are doing. So there's you and me, and then there's stuff I consume,

There's goods I buy, there's time that I spend, there's my physical and mental health, there's all sorts of aspects of me. And so we need to somehow aggregate both across the things that contribute to my welfare and then across people. And then there's sort of how, which is how do we then do that aggregation?

And so there is no going to be one right answer to that question from the outset. Let me make the case for GDP because I think before we talk about the limitations, I think it's important to be clear about what it does well. I think those two things really well. First thing it does is that it's well defined and we can measure it. So if we want a metric, those are two features that you think are pretty good.

Pretty good, right? So it's easy to come up with hypothetical things you might want to do, but we want to be able to compare across countries across time in a consistent way and we need to be actually able to do that. We need to be able to measure it. So GDP ticks that box. Second thing is that it turns out that it's very highly correlated, both across time and across countries,

with all of the other things that go into our welfare. Now, that's a statement about correlation. It's not a statement about causation. But it is a way to see what's going on. It's pretty hard to find examples. And of course, we can cherry pick some, where GDP doesn't grow, but welfare does, vice versa, over long periods of times or across very broad,

different big differences across countries. What are the limitations? So I think there's the biggest ones for thinking about this as welfare. The first is that GDP, what is it? It's trying to measure how much stuff is produced in a particular place over a period of time. First thing is that we produce a lot of stuff and GDP counts a whole bunch of things that may or may not be relevant for our welfare. So we're trying to aggregate, and so how do we do it?

We do it using market prices. We use a dollar of this and a dollar of that. We add them up. It's $2 of stuff. But whether that's a dollar spent on weapons or a dollar spent on pastries is completely irrelevant from the point of view of GDP. And so when thinking about welfare over large periods of time or across, so looking at fluctuations in GDP or across different countries,

I think that that's a big issue. The second thing is that I think the distribution issue. So fundamentally GDP is an aggregate and it doesn't necessarily tell you anything about the way in which those resources are distributed across people. And then finally, of course, we've mentioned that it only measures stuff that you can attach a market price to because we have to add things up across, add different types of goods up. So it's going to leave out things like health, mental health, environment and all the standard

things that you can read about in a textbook. Yeah. Okay. Great. So next, is there just like a growth accounting in two minutes for economists? I can try. Yeah. Okay.

Let's try it. Let's see what happens. So here's one way of thinking about stuff that we produce, GDP, how much stuff we produce. Yeah. We produce stuff by combining capital, which is things that are. reproducible so factories um maybe land to some extent and labor people it's a very sort of i would call a victorian england approach to to um production you know industrial revolution and in fact that's sort of the limitation but take that that's the way if you want to understand growth accounting

think about like we build a factory we hire some workers they come to work at the factory and widgets pop out the other side yeah and what we want to understand is why is it that over time we produce more widgets. People call that growth accounting. And why is it that some places produce more widgets than other places? Some people call that development accounting. Now, there's only three reasons why one place could produce more than another place. They either have more factories, call that capital. They either have more people showing up of those factories. We'll call that labor. Or they're able, for the same amount of people going to the same factories for the same amount of time actually to produce more widgets. And this is that thing that

we call productivity. So technically that's what productivity is. It's how much stuff can you can you produce with the inputs that you put in, inputs being capital and labor. Now, growth accounting tries to ask over time how much of the fact that we produce more stuff comes from the fact that we put more capital in. I mean, we had more factories, we had more workers, and that we just got better it using them. And so starting in the late 1950s, people started collecting the data to be able to do that, starting with a paper by Bob Solo. And the classic finding has been that capital accumulation plays some role, but in fact, surprisingly, a very large amount of the growth that we saw in the United States over the 20th century

and across countries in the world has to do not with the amount of capital but how they use that capital productivity. So when we were chatting on the phone on Friday, you mentioned that what we think of as capital in the 21st century can blur the distinction a little bit between capital or K in our production function and then A, which is what we think of as total factor productivity.

Is there anything worth putting on the table there? Yeah, I think it's just good to remember that the world doesn't look like that Victorian English factory. Yeah. And there's a lot of other inputs that go in to producing things today. And so I think the big thing there is that there actually are many other forms of capital than just factories. So the classic one that was that people figured out very soon after we started doing these sorts of calculations was that some capital is actually embodied in people. We call that human capital, right? and found out that if you actually adjust some of those estimates for how the differences

across countries, not just in how many workers, but how much capital is embodied than them by virtue of education, it accounts for a big chunk of those differences. Where I think that's playing out today is in what I'll call forms of intangible capital. So these are things like institutional know-how, organizational capital, be things like IT infrastructure and software, which are not, there's things that last over time but are not things that are captured in the traditional sort of factory approach to what capital is. And even things today like data or models or algorithms that are a form of capital that we have, we can reuse them and they help us to produce. And so my understanding is if you kind

of try, and this is a difficult now to adjust for because how do you measure them? They don't have market prices that are very easily attached to them. But people have tried. And it's something like, if you look at the last 30 years of the U.S. growth, and I think it's probably something similar for Australia as well, that if you take conventional capital, roughly 50, roughly half of that growth came from, what we call capital deepening, so we're just more capital, and 50% came from, we can just use that capital more effectively productivity. Once you incorporate these broader forms of intangible, more modern forms of capital, it's something more like two-thirds, one-third. Oh, so two-thirds capital.

deepening. Two thirds capital deepening, one third productivity. And you know, it's some level this is just semantics. And I think this is maybe over this conversation, something we should keep in mind that if you have a factory that has a bunch of better data in the machines inside and a bunch of better software and as a result, you can produce more stuff, is that because there's, you've got more, and that capital was more, that was more expensive now to build that factory versus the old one. So, you know, there was some investment in that. Would, do we want to say that we produce more stuff because we put more inputs in or because we can use those inputs better. Yeah. Yeah. It's sort of not two sides of the same coin because a lot of those

ideas, what we call productivity, is actually embodied in the capital we use. And so what that calculation I describe is picking up is that maybe some of the growth that we've seen, it's not like this magic mystery economists call it A or Z sticking out the front of their production function. It's something that it's something that's embodied in the inputs that we use. And in order to realize that we're going to have to invest in those productivity embodied inputs like intangible capital. And just to inject my own commentary here because I've been sort of reading up on this and brushing up on this over the last few days and relearning a few concepts. But I think it's important to clarify that A or total factor productivity isn't equivalent to, technology, although I think many times people talk about it as if it is. And a good

intuition pump, something I found helpful for forgetting this point, is just to notice that across some industries or some countries, TFP can have negative growth from time to time. If TFP was just technology, that would mean that those industries were suffering some kind of like technical regress. But that's not plausible as one economist. I can't remember who put it like we don't forget blueprints so there must be something else to tfp which is i guess efficiency or whatever you want to call know how yeah tacit knowledge well i mean this is just a fantastic point and i think it's indicative of a much broader uh issue that again we should have in mind when having all of these discussions yeah on the one hand we've got measurement yeah there's things

that we're trying to measure we collect data we get numbers and we try and compute some things And that's the thing, these numbers that we compare, that's what those are. Then we have economists use models. Models are simplified versions of the world that are, that have very clear and well-defined constructs in them. And then we try and map our world onto that simple model. So the model, I've been going back and forth between the two, even in this discussion, but the simplest kind of economic model, this Victorian England one, says that output,

call it Y, is equal to A, we call that productivity. or technology multiplied by some capital, some K and some labor L. And in that world, yeah, technology and productivity are the same thing because it's a pretty simple world. That's all there is there. But of course, no one thinks that's what the real world looks like. In the real world, what we do is we just go out and measure stuff. And that measurement process is going to take you quite far away from that object in the model.

So I think it's really important when we talk about or talk about. these issues, talk about productivity, are we talking about the productivity through the lens of the model? Like is it, is it like a thing like technology? Or do we mean what do you get if you count up the amount of revenue that a firm makes and divide it by the number of workers and employees? Those are the two objects. The one that we really have in our mind is somewhere in between them, but they're not on the table. It's just like the thing you measure or the thing in the in the theory yeah okay a question for both of you if you had to pick just one north star metric that policy makers should be optimizing for what would it be so imagine imagine you time travel

you go into you know a coma or something you wake up in 20 years time like say Anthony albinesey time travels 20 years into the future what's the first thing he's asking for is it real GDP per capita or what what's the north star metric charlie wheelin in his um naked economic books does exactly that thought experiment oh really yeah i haven't read them yeah yeah i think the title of chapter is you know when you wake up from a coma what should you ask and he's and he's he's answers gdp just GDP GDP per capita or something but i'm going to be annoying for a minute go ahead i just think that's like you ask the best questions joe but i just don't think that's i just don't think that's a question for policy makers to be answered because if you go back to where i started

which is what is it that we're trying to do? We're trying to improve the welfare of some group of people. It might be Australians, might be people more broadly, might be this generation, might be future generation. Ultimately, it's an aggregation exercise, and it's a big thing. And I think the mistake we make is exactly to look for one metric and then debate about whether it's the right metric. Of course, whatever, of course it's the wrong metric.

My advice to policy makers is, no, keep your eye on a whole bunch of different things because exactly if you choose one North Star and focus on it, you're going to end up you're going to end up just maximizing that and that is, remember, not a real thing. It's just a measurement that you took. Yeah.

Yeah, all good points. Look, if you absolutely had to have one, if it's ex post, like if you're wanting to look backwards on the last 20 years or something, I think rather than GDP, I probably go for something that incorporates income. So something of real disposable income growth per capita. So, you know, that would be your best proxy for welfare. But ex ante, if you're looking forward and you're asking the question,

I can maximise one thing in this stylised world. I think you can do worse than GDP per capita. Of course that is stylised and not right. I mean, and it might be subject to the odd big thing. So it might be that in the next 20 years, rational policymakers would say, well, the climate transition is something that has to be done and that may or may not add to GDP per capita, partly because in reducing emissions, we're reducing a cost that has not been traditionally counted as part of our GDP.

And therefore, you know, a rise in GDP per capita is not the main game because it's subject to this big thing that we've got to achieve. and for other reasons. But I think in normal times, yeah, if you're looking forward, and I know how that comes across, but what else is there? You know, like there is no other good, broad-based measure that's a reasonable approximation for how much better we offer,

better off we are in material terms. It's sort of strange to me because GDP was not something, it's not a fundamental thing. It's something that, it's a measurement that we came up with in the 1930s right like we could we could come up with what we could measure whatever we want but ultimately whatever so what did policymakers do before then yeah what did pit the younger you know what did he regard as his fundamental object beating the French I guess but you know it's it yeah I mean communities and their leaders had to have other perhaps intangible um

indicators or I don't know objects in mind and it's a really interesting question it does reflect something about how perhaps how mechanistic we've become in the way we think about policy and the way we think about success yeah conditional on caring about

productivity growth should policy makers look more at labour productivity or TFP well these are two very different things so let's get them on the table so if if I think it depends again of why you're looking at productivity growth. So if what you're trying to do is get a proxy for something that more closely resembles household welfare, then labor productivity is much closer

to that, right? What is labor productivity? It's how much stuff we produce divided by some measure of how much effort or work we put into producing it. It's kind of close to GDP per capita. Like the stuff on the top, how much is the output, stuff on the bottom is how much went into it. so that's people. And so if that's what you really mean is a euphemism for GDP per capita or how much stuff there is per person, then labour productivity. But if what you really want is a measure of how effectively or efficiently are we producing stuff because we think that having more stuff will enable us to be able to do

a lot of things and we're able to use that stuff, then TFP is a much better measure of how effectively we're producing. So if what we're trying to measure is, kind of really productivity, how productive we are, efficiency. Well, TFP captures that better, but it's not necessarily a good measure of welfare. You're the productivity commissioner, would you agree with that? I think TFP in a way is, in theory, the purer measure because it is distilling, how much of this labour productivity did we effectively get out of capital deepening?

And capital's not costless. And, you know, if you went back to the very early Austrian economists, they'd make observation that there was a lot of labor effectively sort of congealed in the capital it's just more roundabout mode of production right but I think the measurement issues are just so great and I think that's part of the reason why you're observing the odd fall in measured TFP and that's what it looks very volatile it's the challenge of measuring capital services you know that's what you've really got to measure the capital input is distinct even from the

capital stock yeah that's quite difficult to do it's quite stylised quite open to interpretation. So for that reason, I think labour productivity as a kind of basic heuristic GDP per hour worked, again, not perfect, subject to its own measurement issues, but probably a little bit less subject to the vagaries of really difficult measurement. And would you say that's true even like a resource sector, resource producing economy like Australia? So you have big movements in the prices of resources. We use our minds more. Labor productivity looks like it moves around a lot because the level of labor input doesn't change too much.

Yeah, I think it is complicated in very capital-intensive industries. Yeah. Certainly true. And TFP will bounce around a lot in those industries, right, because you get these big cycles of capital investment and, you know, you can see a trough in TFP as a result. Yeah, but I think yes. So you get movements in TFP because of the investment cycle.

You get movements in labour productivity because of the prices moving around. Yeah, well, in theory, the labour productivity measure, it should, you should be deflating fully for the price of the relevant commodity. So it's still, you know, ultimately it is in theory a proxy for a physical measure, literally physical hours of labour, physical inputs in and physical output out and what's the change in those things. And so in theory it's abstracting from commodity prices. It's not abstracting from second round effects, right? So to the extent that prices are high, if it draws more resources into the sector, you know, that can have effects on measured productivity. I think this is a point about, going back to my point about income versus GDP per capita.

GDP is a production-based measure, whereas income is ultimately, you know, what we get for it. The experience over the last 25 years in Australia has really confirmed the importance of prices in the Australian story. You know, so when we think about even the three P's, of the intergenerational report, population, participation, productivity. It's kind of a fourth P, which is price. And price has been incredibly important to our success.

Now, that makes it sound like it's all just good fortune, and there is a bit of good fortune in this. We happened to be a mining producer at a time when China rose and had big demand for our resources. There is something to be said, though, for the speed and nimbleness with which Australia was able to respond to that, with kind of minimal overall economic disruption.

But, yeah, prices are guiding a lot of the allocative decisions within the Australian economy in a way that productivity actually isn't. So, yeah, I think you're understanding with the role of prices, both in allocation but also in overall welfare, it's pretty important. So any other measurement issues that you really want to put on the table before we move on? Yeah, I think there's one that we should mention. So if you go back to thinking about how do we actually, measured GDP, oftentimes what we do is we just look at GDP per worker.

We say that's a pretty decent proxy for the whole economy of how much stuff people are producing. But we often go further than that and also apply something similar at the individual firm level. And so you often will hear discussions about firm level productivity with the idea being if we want to understand how does productivity operate at the aggregate level, let's look deeper into the individual firms in the economy. and there I think it becomes a little bit more challenging

because what actually we measure is something like revenue, so the amount of revenue of firm producers divided by the number of employees, so revenue per worker. And it feels sort of similar to doing it at the aggregate level, but it's actually very, very different because there's many more different ways or reasons why a firm's revenue per worker could differ from one other firms or grow over time

that get washed out when you aggregate all the firms together than look at the aggregate. So while these are both sort of imperfect proxies, it's a much less perfect proxy at the firm level. And maybe we can talk and maybe you want to come back to it, but a little bit of the reasons why we should be careful about inferring too much from the data on so-called firm level productivity, revenue per worker, for what that means for policy and thinking about what the sources of overall aggregate

productivity movements are. Give me a couple of quick examples or reasons why we should be careful about that. Yeah, so revenue per worker ultimately is just how much revenue produce per worker you employ. Now, if I'm a high revenue per worker firm and you're a low revenue per worker firm, there are many different reasons why. It could be that we both produce exactly the same stuff and we produce the same amount of stuff, but I'm just much more effective at producing it. So it really is a productivity gain.

But it could also be that I have a different, I have invested a different amount of capital in my firm than you. It could be that we operate in different product markets where the prices are different. It could be that you're able to charge a higher markup over your costs relative to your competitors. It could be that your marginal cost of production, so how much it would cost you to expand your production is different to mine. That would also be something that would generate differences in in revenues per worker. and most of the time it's that we're actually producing different stuff like it's very it's only a very very small subset of the economy

that we can actually compare to firms and say they produce exactly the same good and therefore any difference in revenue per worker we can have a clear interpretation of it most of the time we're just looking at dollars of stuff and they're produced in very different ways so it becomes much harder to know whether it is whether it is something about productivity

or something about production or something about the market. Great. Can I give one example? Yeah. Like take software. If you're a software company, you can expand,

the marginal cost of production in terms of workers is pretty small. You sell an extra piece of software doesn't actually require any more workers. So if you were able to expand that, what does that tell you about productivity? Nothing in terms of, of like the technology interpretation that we gave earlier,

but it certainly is a measured productivity increase. It's just it's capturing something very different from if we were actually to look at a firm that was actually increasing its technology, higher technology was allowing it to produce more stuff for each employee. Great. Okay, so Michael, if you were Jim Chalmers listening to this conversation and you bought all of Greg's measurement critiques, is there anything you'd do differently tomorrow?

Not really. No. I'm sure he has a high respect for Greg, but it's, I think the question is, does any of it change your fundamental strategy? And I think the point is you always take, Greg's right, you take these headline aggregates with a grain of salt. They're not the be all and end all. They're a pretty good heuristic, but they're not everything. The question is, can you replace a thing like GDP per capita or real incomes per capita or whatever with some other holistic, perfectly aggregated, but more somehow, more all-encompassing measure. And the answer is you can't, right? You can, you know, there is the human development index or these other things. And yeah, they're an attempt to bring in a measure for life expectancy for a quality of income, you know,

other things. I think you're better off just having, um, You know, that aggregate and some other things that you really care about. Have a look at life expectancy. Have a look at whether it's your genie coefficient or some other measure of the equality, the distribution of income. Have a look at incarceration rates among disadvantaged communities. Whatever it is that you want to highlight, but I think keep them fairly kind of almost segmented

as a dashboard of indicators rather than trying to heroically amalgamate these, you know, kind of do another version of GDP, but, you know, with a broader measure of welfare, I think where it really comes into sharp relief is more at the micro level, you know, obviously there are particular policy areas where prices don't fully reflect the costs or benefits of the activity concerned. And that's where policy makers, you do want to move away from the kind of, you know, price equals marginal cost assumption. That's obviously true in respect of carbon emissions. It's true in relation to road congestions, true in relation to a whole bunch of other things. So I think often, you know, policy, yeah, has to be open to where

welfare or well-being departs from what's measurable or what's observed. But I don't think it's fruitful to try and bring it all together into some kind of magical index. Okay. So I just want to quickly level set. And I think we can get through these next two topics in five minutes maximum. But firstly, I want to characterize the Australian economy, especially for any international listeners. And then secondly, I'll just give some quick statistics to provide a sort of health check on the Australian economy. So this is another question for you, Michael.

But could you share some stylized facts about the Australian economy? So say you had a friend who was an economist, but maybe they're an American or someone overseas that don't know anything about Australia. They call you up. What are like the first three to five? bullet points you'd share about Australia? I think it's a great question because I think fundamentally Australia is

quite a distinctive developed economy. I think it's quite different to much of the rest of the developed world. There are three industries where Australia is a big outlier in the sense that we are hugely overweight in those industries as a share of our overall economy. One is mining. So very few developed economies have a big mining industry. Most developed economies have traditionally had a big manufacturing industry.

Australia has not. We had more of a manufacturing industry, but it was always small and it's diminished. But mining is a big deal in Australia relative to other developed economies. But it's something we share in common with more emerging economies, right? But that means we have big exposure to commodity prices, and that leads to a degree of volatility in our budget, for example. And that's a macroeconomic management issue and fiscal management issue that's a little bit distinct. The second industry where we are overweight is financial services because we have effectively

a privatised pension system. We have this large superannuation system, compulsory contributions made by employers on behalf of their workers that get invested on their behalf. So we now have got a funds management industry exceeding $4 trillion, well in excess of GDP, well in excess of the capitalisation of our stock exchange. So this is significant. And it's an outlier in terms of financial services as a share of GDP. And the third is construction because we're a high immigration country.

We're a high population growth country. It's not often well understood even in Australia just how much of an outlier we are in that respect that we've had having had population growth of at times 1.6, 1.7, 1.8%. Again, in the developed world, that is unusual. So construction is a larger share of our overall. economy. And I think kind of accompanying those latter two, you know, superannuation and housing as being these really significant assets that characterize household balance sheets, I think that is something that is particularly, if not unique, to Australia. It's kind of distinct.

The only other kind of things which are a little more intangible, but go to the sort of policy and political culture of Australia, two things I'd point out. One is that we do have traditionally, unlike a lot of the developed world, but maybe we share this a bit with the Nordics and East Asia, but there is a kind of culture of fiscal prudence for one of a better term, a view that governments really should balance the budget, debt should be low. As I say, much of the developed world, that's not a feature of the political culture really at all. It maybe has fragmented a bit in Australia, but traditionally this has been a key litmus test by which the success of governments has been measured.

Do you know where that comes from? maybe we've had a measure of success on that metric and sort of became embedded, but certainly noticeably different to say the United States, but even, I would say much of Western Europe, right? And the third thing, the final thing is that there's, you know, our social safety net looks a bit different. In one sense, we've got quite widespread, for example, labor market regulation, which kind of relatively high minimum wage compared as a share of the average wage

compared to the rest of the world. in another sense though our welfare safety net is a highly targeted thing and that's a little different again to much of the OECD particularly where they have unemployment insurance arrangements which are contributory and everyone's paying in and then they can draw down in the event of job loss our social safety net is a highly means tested thing and I think there is a very strong culture of means testing in Australia again I think it's fragmenting a bit but traditionally the idea that um social assistance really should go primarily to low-income households to people who really quote need it i think that's been a really important part of the of the political culture so i think that you know as a result of which i think for you know in the absence of unemployment insurance that sort of thing and perhaps the the love of you know the great ozzy love of housing there is a bit of a sense in which for for many purposes australia is a bit of a self-insurance economy um you ride out the um volatilities of income or job loss or whatever often largely through um you know the offset

account which is a distinctly australian thing the offset or the redraw on the house you know drawing down on some of that accumulated wealth or whatever maybe this is part of the reason why there's so much politics in it um it's the buffer you know it's it's the it's the cushion so i and i think there's a whole kind of um research agenda around the the modes of self-insurance in the Australian economy, but I think it's something that might be maybe a little bit distinctive in our place. Neat summary. That's great.

Okay, so my job now is to provide a quick status update on the health of the Australian economy. I guess this is maybe more for our international listeners. And again, to the extent I referenced charts, we'll put these up in the video version of the episode. But for those who don't know, Australia is a country of about 27.5 million people. Last year, our GDP was about 1.75 trillion US or about 2.6 trillion Aussie. In terms of GDP per capita, I think we rank about ninth in the OECD on a purchasing power parity basis.

Labor productivity and TFP growth has been underwhelming to say the least. So since the 2017, 2018 fiscal year, both labour productivity and TFP growth have been only 0.0.4. 2% per year. Real GDP per capita growth has been declining, you could say, since the turn of the century. This is a chart looking at the five-year compound annual growth rate. And labor productivity has also been stagnating again. You could say since the turn of the century, that's labor productivity growth. and that is the RBA's stuff.

This table is probably a easier way to draw the comparison against the earlier period. So for the market sector in the two decades to the 2017-18 fiscal year, labour productivity growth was 1.6% per year. but since 2017-18 it's been only 0.6%. Anything else you would add to that? No, I guess just to return to the recurring theme in relation to GDP, average real GDP per capita growth, which was high around the early 2000s

and then steadily declined, there was a part of that period where income growth nonetheless was pretty, pretty strong because of the terms of trade. Yeah. And yeah, that's, in level terms, there's been, whilst it's been, it's fluctuated, but in level terms, you know, the terms of trade are materially higher than they were in the 1990s and that's in effect been the underpinnings of prosperity, largely given the

poor contribution from productivity growth. Okay, so let's talk about goals and growth regimes. So I just have a couple of quick questions on what we could be aiming for and then what the downside might look like. I have another chart, which I will again put up in the video. So this is Australia's global rank measured by purchasing power parity adjusted GDP per capita over the last two centuries. So as economic historians know, Australia for a time was the richest country on earth in the late 19th century. Maybe this is just a silly question, but as a thought experiment, I wanted to ask what would it take to reclaim that top rank?

Well, it's interesting to think about how it came about. I mean, obviously a couple of big causal factors were growth of the pastoral industry. You know, and where, I guess, you know, land was the big thing that became pretty plentiful, obviously at the cost of dispossession of, you know, an indigenous population. But there was, you know, that input. was able to be expanded significantly and substantial income growth came in the form of off the back of the wool industry and then gold from the 1850s onwards when I reflect on Ian McLean's book about why Australia prospered and he makes the point that the gold rush was

resulted in much more sustained prosperity than one might think is consistent with a gold rush So I think a couple of big industries that, you know, really provided some tailwinds. I think it was a period of global growth and openness, and we were linked to a massively expanding market in the United Kingdom, which was going through a period of very substantial income growth and industrialisation. But, yeah, it is an interesting thing to ponder, just the success of that economic success, of that 19th century, particularly given that the big income growth that occurred in Western Europe really didn't start until the early 1800s.

So it wasn't as though those who came in the 1780s had necessarily already experienced that big surge in income growth that then characterized the Western Europe and later the United States. I think also there were some good institutional choices that were. made early on there was a big debate about whether to extend the in effect to convert the pastoral leases that had been issued to squatters in western new south wales into freehold title uh there was a lot of resistance to that rightly and it i think in many ways prevented the creation of a sort of oligarchic pastoral class uh and i think that's part of the story of of the success over that

period that there was a kind of a sense of democracy a sense of maintaining institutions that were fairly egalitarian and I think in economic terms that also paid dividends could we achieve it again I mean that that logic in part kind of reflects you know when did we slide down the rankings well you slid down the rankings partly because some other countries developed you know and Singapore and there's that's a great thing right Singapore Taiwan, Japan, Germany, although neither of those I think outrank us at the moment in the per capita stakes. But, you know, it was important in that post-war period that much of the world recovered.

I think when you look at our relative performance too, it's sort of hard to escape the conclusion that the 18th century largely characterized by agriculture, a bit of mining, that much of the 20th century, sorry, the 19th century rather, much of the 20th century by manufacturing and Australia didn't really catch the manufacturing wave in the same way that other economies did. It just wasn't, for whatever reason, it just wasn't our thing in the way that agriculture and mining were. When agriculture was the biggest industry in the world, we were number one. When manufacturing was the biggest industry in the world, we were further down.

But we were still number 10. Yeah, that's true. And I think it's easy to look at 150 years ago and say we were number one. Well, it's a failure since then. I think we also need to look at some of the other countries' performance over that period. Argentina is the one that comes to mind, but there's others that have taken another path from the same position. Do we know what the highest growth regimes are that have been sustained by other frontier

economies in recent decades? Well, I think the key word there's frontier, right? Yeah. Yeah. And so the 2% number seems over long periods of time seems like a pretty hard number to get around. Just 2% real GDP growth. That's the long term. Yeah.

That's the long term number for the US. Right. And if you would think about that as being the frontier. Now, I may be less optimistic than others that that's even that's sustainable over long periods of time. If you put it in a much broader context, it's a pretty special period. But yeah, numbers like 5% seem difficult. Okay. So what do you think is the most ambitious growth regime that Australia could plausibly aim for?

Should we be aiming for? regimes. I mean, it feels to me a little bit like a five-year plan. Like, you know, these numbers are outputs, not inputs, right? They're the things that what we should, what we should aim for is, let's remove all the impediments that we, that we place to people producing in the most productive way. Let's foster whatever role that we, policies we can roll, we pay for government to foster that and see where we land up. You know, that seems to be a much more productive, then to start putting targets and in terms of these outcomes. Okay, let me reframe the question.

Say we make Michael Brennan and Greg Kaplan, benevolent social planners, omnipotent social planners. That's going to be a negative number. And you implement the full suite of your agenda and you remove all of the impediments that you're worried about. What kind of ballpark or range do you think we could get to in terms of our real GDP growth? I will come at a number.

Just to humor you, Joe, because, you know, I'm a pleaser. But there's a lot of truth in what Greg says, and there's a lot of contingency in it, right? So when you look over the broad sweep of history, what's driven productivity growth, a lot of it is technology broadly conceived. So the pace of technological change. And, of course, that includes everything from high-end, you know, what we think of as complex technologies right through to the quote invention of the shipping container which is not really an invention at all it's but it's an economic innovation right it was a coordination issue but

it's led to huge efficiency and you know trade which is a sort of a huge source of productivity growth countries like Australia so in a way it's the pace of those sorts of things that come along and then it's really an economy's ability to adapt to that adopt it you know etc. So there is, you think of Robert Gordon's thesis, you know, it might just be that the pace of technological change is slowed. That's just a reality and that's going to place a growth, sorry, a limit on how fast productivity growth can be kind of irrespective of the policy and institutional settings that a country's got. But logically, you would think if you're after a number, you would go back to the sorts of numbers that we achieved in the second

half of the 1990s as being ballpark, you know, if you feel that you've got your policy settings right, your broad kind of institutions of openness and adaptability, and you've got a technology that's there for the taking in the way that ICT perhaps was in the 90s and potentially AI today and maybe other things. Yeah, it feels like that's the sort of growth rate that it's not unreasonable for an economy to aspire to. Which, say, what was the growth rate? It would be sort of labour productivity growth in of these orders of magnitude. Like 1 to 2%.

Yeah, 1 to 2%. Yeah. Got it. Okay. So, again, this question might be better answered by a spreadsheet than a podcast, but say we continue with our disappointing productivity growth of 0.2% per year. Do you know how much GDP will miss out on roughly in, say, a decade's time relative to a counterfactual of more like 1 to 2%?

So you're asking what's the compound? Compound of difference to the power of whatever the Labor share is, I guess. Greg, can you just quickly work that out in your head? I don't know, the number is someone can commit it's a, it's substantial. Over 10 years? Yeah. Yeah. It might be like 30, 40, 50 percent, something like that.

Yeah. Well, I mean, to the back of the end, what are we talking, one and a half percent per year? Is that, is that, yeah, potentially? Yeah. Yeah. I don't know. 10 years, it's 20 percent or so. Yeah, okay.

So it's significant. Yeah. Okay. So let's talk about what's causing the productivity crisis and then some, some different ideas to fix it. So tell me, just as a starting point, tell me what's wrong with this view. The punchline is that the crisis is, if not non-existent, at least greatly overstated. And the argument relies on three points.

And Dietrich Volrith, the American economist, is most famous for making this argument in the American context. I'm just stealing it and applying it to the Australian context. But the first step in the argument is that, look, services industries are going to tend to be lower productivity than goods industries. And that's because of this intrinsic quality whereby services tend to involve labor. And eking out productivity gains from labor is difficult, has diminishing returns because you're constrained by the scope of people's time and attention.

So the classic example is like the listening to the string quartet. If they're playing a 30 minute piece of music, you don't want to hear that in 12 minutes. That 30 minutes is going to be pretty fixed across the centuries or the decades. So that's the first point. The second is the price of services as a result of that first point will tend to rise relative to goods. This is also known as Baumol's cost disease. And then the third observation is that more economic activity or the third prediction, rather,

is that more economic activity will shift into services because our demand for services is income elastic, whereas I demand for goods is income inelastic. And we see this in the data. If you look at the size of Australia's service sector as a evaluated share of Australian GDP, it's grown rapidly in the last several decades. At the moment, it's about 80% of GDP. This chart is actually from the Productivity Commission in 2021. So, Michael, this was when you were chair.

Thanks. So I'm giving you, giving you your own research. Look at this research I've done. So in this view, the productivity slowdown just reflects a shift in consumption from goods, which we've gotten really good at producing to services, which are lower productivity. And that slowdown is just an artifact of how productivity is measured. We wouldn't be better off if we reversed it. So everyone just needs to calm down, carry on.

There's no productivity crisis. There's no need for huge roundtables. this is just what happens to a mature economy. So what's wrong with that view? Well, I think it's a perfectly reasonable hypothesis, and every premise there makes sense. But it's an empirical question at the end of the day, and I get to get Michael's view,

but my understanding is that it's just not borne out in the data, that I think that it's clearly definitely part of it. We're shifting towards low productivity sectors, and some of those sectors are also outside of the market as well, which is contributed as well. But my understanding is that if we look within sectors, there's been big productivity slowdowns even within those sectors, within surface sectors.

So you could do a within between decomposition of changes in productivity. My understanding is that most of the changes within sectors, not across sectors. So yes, but it just doesn't account for empirically a huge fraction. I know we've done some work at E61 on this. And I don't know the OBA's done some that I've seen as well. Yeah, the rise of the care economy. And it, yeah, it does two things. So the shifting composition of the workforce towards sectors with low levels of productivity

obviously has a compositional effect, reduces overall productivity growth. But it also, there's a question about the ongoing productivity growth in these sectors as well. Like I think the cost disease story. is pretty compelling as a set of stylized facts as a starting point, but I wouldn't necessarily read into it that therefore, quote, there's no problem. I think it does help qualify it a bit, but it, to me, more just sort of characterizes a bit of the nature of the challenge.

The string quartet's interesting because so this kind of goes to, you know, can services be automated? can we achieve some productivity growth in these services? And, you know, the string quartet's kind of instructive because the original intent of that metaphor was, obviously, where you can't just automate the cellist. So it's not like manufacturing where you just can strip out labor and, you know, replace it with capital.

So you can't. You still need four people in a string quartet. But what is interesting is we have now had technological advancements that mean that people can hear that string quartet, you know, a billion people. people could hear that string quartet, you know, rather than a hundred sitting in an auditorium. So it's a failure of imagination to say that services really do depend on labour as much

as they historically have. It's about how you measure output. So what is the... So Bowmoul's idea is brilliant. He's saying the measure of output there is the 30 seconds of producing the music out to the world. An alternative potential measure of output there would be the receipt of that music by a set of is right and so now how much you produce depends on the size of the auditorium in which case one would say that maybe that sector actually there's been more productivity growth than almost any

other sector in the that you can think of okay right but you can pick other examples where there are constraints oh totally of course I'm not saying but the point is to say that it's that that innovation in services is not impossible yeah and if the one thing that we've learned from the AI changes that we're seeing is that yeah that's going to happen hard to predict where and how much but it it's not a god-given truth that services can't be produced more effectively i mean this is a i don't know how far this gets this right but just bear with me for a moment um in a way you can think of um so the string quartet good example uh think of a lot of household chores it's interesting to reflect in one sense the service economy was probably bigger in the 19th century that it is today.

Or, you know, kind of the share of time spent on people doing stuff. You know, it was a service-dominated economy. As this blue line reflects here, it's that services got kind of replaced by goods in a way via manufacturing. So a lot of the service of going, you know, having four people play a string quartet for you in the auditorium, that got kind of replaced by a record and a record. called player. So the ability of manufacturing to step in and create a substitute for the service, or in the case of household chores, a dishwasher and a washing machine. So the manufacturing

industry kind of came in and manufacturing these things got cheaper and cheaper over time because we're able to kind of automate that process. Part of what's gone on in more recent times to think of the music examples, we've actually gone back towards a service in a sense. We've God, you know, you no longer buy CDs, records, that sort of thing. We now have phones and it's, and it's a streaming service, which kind of, you know, the point being, maybe you can't forever manufacture away what is fundamentally a service. I don't know. That's an unproven thesis, right? But interesting to think about. The thing that I think is relevant to the services sector, this is, again, a forward-looking thought experiment, but I look at agriculture here that was,

it's extraordinary, right, to think in the 19th century that was 60% of the economy, of the measured economy, at least. At the turn of the century, 1900, okay, so it's down to about 25%. But it was about 25% of the workforce as well. It's now about 4% or 5% of the workforce. The output is hugely increased. So we are producing vastly more wheat and fibre and food than we were in the 1900s.

But we're doing it with many fewer people. And that's part of the, quote, cost disease story is that that's the labor that was freed up by those highly efficient, highly productive industries to sort of flow into other things that we decided we wanted, many of which are services. So it is interesting, I guess, to reflect now you think of our biggest employing industries like health and social assistance, education, some of these. and think, okay, so would we plausibly expect over the next hundred years that they're going to have a big productivity surge that's going to translate into shedding labour at the same rate where it's going to go into other sectors? And, you know, might, but at this point in time, it's hard to envisage.

But maybe that's always true. Maybe it's always hard to envisage how labour could be massively liberated. I think this is partly your point about elasticity. If health improves a lot in quality, we're just still going to want more because it's just a natural thing. Why wouldn't you? You know, more life, more quality life.

Whereas some of these goods, more inelastic, maybe once they get cheaper, you know, you want something different. But so I think it is an interesting question. You know, are we going to see the same pattern in some of our modern service sectors that we observed in, say, agricultural and manufacturing. Maybe just add, like, one observation. Now, underlying this is a blue line here, the service line,

really the two biggest, I think this is right, the two biggest sectors there are health services and financial services, maybe education services as well. Health and financial services are two sectors where the measurement, productivity measurement issues are probably most pronounced. And you, Michael, focus on the denominator, so the labor coming in and out. I think that as big a challenge is the numerator. So output, what is, how do you define output in the financial services sector?

What is it, it's very, very difficult. So it's some form of revenue, it is producing some value for maybe more efficiently allocating capital, allowing people to insure over time. those are very abstract concepts that are very hard very hard to measure same thing goes with health care I mean ultimately what we're measuring there is going to be something with dollars on the top but if we're getting better health outcomes that's something that's very hard to get into the productivity statistics is that would you agree with that absolutely yeah well all of which sort of I kind of agree with the basic premise that you're putting Joe's like unclear yeah how big

is the problem yeah but I think if at least I would say this if productivity growth looks different in the future to what it looked like in the past, including this, that more of it is quality, hard to observe, etc., the demand for these services pretty elastic, then I think it does have implications for some of the things that we have asked of productivity growth, like, for example, productivity growth has been the way that our fiscal arithmetic has added up, right? It's allowed governments to expand service delivery at a rate that exceeds population growth and inflation and still have the revenue to cover it because revenues will grow roughly

in line with the economy. So if there's productivity growth, it sort of gives you a bit of fiscal wherewithal. The story you're telling if it's right and it's not clear that we're going to get big real cost reductions in these services, you know, these things aren't going to become radically cheaper over time, then some of that fiscal arithmetic becomes. challenging so even if it's not a problem in terms of overall well-being and that sort of thing it just changes the nature of what what dividend we're going to get from productivity growth and I think that's still a challenge right yeah okay so on that actually just quickly so I'm super

clear the services bowel most cost disease story is true but the effect just isn't large enough to explain all of Australia's or most of Australia's productivity slowdown Yeah, I think it's part of the story. Part of the story, but not the dominant explanation. Yeah, I think that's probably right. Okay. So just while we're on the topic of services, what do you see is the lowest hanging fruit

for getting productivity or quality improvements in services? Yeah, it's, if I think about that conceptually, and this is me playing in my benign dictatorship or whatever. So now I've got complete, not just control over government, but I'm actually running the economy, 1940s-style Soviet era. I think it's, when I think about emerging technologies,

it's not, it's got us political challenges, got us implementation challenges, but it's really not impossible to envisage use cases in health and education for AI that are pretty obvious. productivity enhancing, potentially labour saving, quality enhancing. It's much harder in disability maybe in age care and in childcare. There are still services where it's going to be difficult, I think, to achieve the sort of productivity growth that we observed in agriculture and mining.

As, you know, there would be political and stakeholder difficulties. But I would have thought there is very substantial. scope for technological adoption in those sectors. I mean, not to be too crass, but if you kind of think about what a GP does, which is essentially like pattern matching and then giving a fairly pro forma prescription, like a lot of that you can see being at least assisted by,

if not substituted for by things like LLMs. Yeah, I think you could see a world in which a GP could achieve very similar health outcomes in less time for a larger group of patients. Yeah. Okay, so just... I'm going to ask a question about this, so maybe I misunderstood the question. So that's an answer that's really about how I'd love the economy to look as opposed to what maybe we should do as governments. Is that what you... I'm not sure if that's what you're trying to get at, but thinking about that sort of harder question of, okay, so

how do we enable that? What is the role of government in getting us to that? Would you, would you say, Michael, that one might be moving some of these service sectors in Australia that has done outside of the market back to the market so that we could get some of the competitive pressures that would be needed to adopt these technologies? Sounds like a leading question. Yeah. The answer might be no, which case. Well, it's, I think it's a qualified, I think it's a qualified, yes. So there are instances where I think, yeah, you can imagine these use cases and then you think,

but the incentives aren't really there. And it's not for me to determine, you're quite right for me to determine what GPs or teachers or education czars should be doing. But there are instances where the incentives just don't align with that. So some of the incentives are about whether something is operating in a market or not. Sometimes it's about the design of that market. I mean, the reality with GPs is they are remunerated on the basis of the time they spend with a patient. So, you know, it's a consultation of specified length.

And so that is a barrier to wanting to, as I said, as I put it, treat more patients at higher quality in less time. In other instances, you know, if you've got a school system, for example, you know, and you want to inject more technology, well, that becomes partly you've got to sort of drive that through the system. But I wouldn't be surprised if we see a fair bit of disruption from the private sector in tutoring in it's not impossible that other countries, you know, adopt technology rapidly because they don't feel they've got a high-quality teaching workforce and they achieve good education. or better educational outcomes as a result.

So, yeah, I think there is a, there are paths of disruption, but there are barriers to it as well. So maybe it'll be paid back the question a little bit. Sorry, am I allowed to go. So these are sectors in which the government plays a big role, at least in Australia and in most countries, healthcare and education. We think there's good reasons why they don't operate

in a pure market-based economy. Instead, we set up some form of quasi-market where we set rules and create how that market's quasi-market is going to operate. Is the point here that if we want to enable the types of technology adoption that we think are going to drive productivity going forward, that the role for government is to step back and rethink about how we organize those markets given the answer is not going to be, let's get out of them completely.

There's very good reasons for why we intervene in those markets that are not going to be cured by AI. So it's not going to be that we don't need any government intervention in healthcare or or in education. But it's just that the type of intervention we need is different and the trade-offs are different. You gave a perfect example there, Michael, with the idea of time, maybe not being the way that we remunerate GPs. There's no reason why that has to be the case.

It's not a market outcome. It's a rule. It's a funding model. Yeah, it's a funding model. But is that maybe where... governments should be focusing their attention in terms of productivity gains in the service industry yeah I think it's it's the age old admonition to government of just think about what are the barriers and you know is there a do I have a rule or do

I have a regulation or a funding model or just a rigidity that might stand in the way of the the operation of a different business model or a technologically enabled alternative. Okay. One more question and then I'll move to a different kind of segment. I'm just curious, to what extent do you think the causes of Australia's productivity slowdown are for Australia's specific reasons versus frontier wide reasons that are sort of plaguing all the other frontier economies? It's got to be a bit of both, right? Like I mean, productivity growth has slowed the world over and so it's hard to say this is a unique Australian phenomenon and I think it's possible we lose sight of that in Australia because we had a period of what we now historically

regard as an important and distinct period of economic reform in the 80s and 90s early 2000s perhaps that yielded productivity growth and we feel we don't have that anymore and so we have a bit of a tendency to tell an Australian-only story, ignoring the fact that this is a global phenomenon and it could be in part about either common causes in individual economies or a universal cause, like a slowdown in technology. I'd be interesting Greg's views on this, spend a lot of time in the US. I, again, this is just a kind of personal reflection born of many years in this game. But I think in around the mid to late 1990s,

there was still a lot of commentary at that point to the effect that maybe Europe had developed a kind of economic model that was ultimately superior to that of the United States. You know, maybe they would achieve, you know, similar levels of prosperity, but with greater equality and, you know, less of the sharp edges. And I look at it now and I just think that case

is getting harder and harder to make. Absolutely. There is something, it's harder and harder to ignore this divergence that we have seen between, and we used to believe in convergence as a explanatory factor in it, you know, development economics, you know, poor countries will catch up, you know, it was hard for the richest countries to grow fast, but this gap that exists now in, even in recent times, between the US and Europe, even the US and Canada, the US and Australia, I feel that it's getting. hard to ignore. And that, so that does imply that there's something that many of us need to

reflect on about what might be missing in our approach or our economic model. I don't know what you think, Greg. Yeah, I think that's right. I think that there are, I'm called the horizontal differences in choices that countries have made that are becoming starker. And so, yes, but some of those of being some of those differences that you're pointing out between Europe on the one hand and the US on the other hand are sort of partly compensated in some ways by other choices that those countries have made that I think I'm back to these initial questions that we were talking about as well what are we actually maximizing for here and it's hard to critique those trade-offs because there's a choices now does that mean that there's that

one can't achieve sort of US levels of productivity with European levels of equality and our unique Australian culture. I don't see why not, but it's a very different thing to aspire to that than to point to what are the actual role for government and policies to make. I mean, getting out of the way seems, getting out the way where you're unnecessarily in the way seems to me the easiest one. I think the US for a while was doing very well at and I think now it's not not as clear that we'll see what what happens in the next few years.

But yeah, it's a good observation. I was wondering if you could humor me again. Like what do you think is the relative importance of the Australia-specific causes for the slowdown versus the frontier-wide causes? I'm going to say it's at least half frontier-wide. I was going to say 50-50 minimum. Yeah, okay, okay, cool. At a first approximation.

Yeah, okay. So the next thing I want to talk about is what we can learn from firms, industries, countries that are currently performing really well in terms of productivity growth. So this is me using common sense and wing it a bit. Maybe it comes across as either too obvious or too simplistic to you guys, especially given your deep public policy experience, Michael. But if I are a policymaker trying to get productivity growth going again in Australia,

one of the first places I might look is, okay, which industries have been doing well, which have been doing poorly, which firms have been doing well, which countries have been doing well, and then see if there are any ideas I could borrow to apply to the laggards. So as a starting point, does this approach sound reasonable? Yeah, I'm with you so far. I think it's got us, it potentially got its limitations, but I think there are, there are some lessons to be drawn. Yeah.

What do you think, Greg? I'm being too benign. Maybe. I think that obviously you want to, obviously there's a things to look at. I still have some, maybe the Chicago in me. I just, I just have something against this idea that we can will ourselves into higher for activity and better outcomes. Like that it's not, that idea of looking at the outputs and saying, well, the output is,

they're doing well over there, they're not doing well over there. So let's copy, let's try get the guys that are doing that to do like that. That's just not how I think about how an economy works. Those are outputs. What we can control as policymakers are the settings by which private actors make input choices. And so I would be, my starting point would be to look at where are all the things, what all the barriers that are preventing people from doing the things that they want to do and that are making it hard to either adopt technologies or have best practice outputs

and then go from there, from the input side. Yeah, that makes sense. Well, we can, I mean, if I was a policymaker, I would maybe look from both directions, like the top down and the bottom up. I'm not saying you shouldn't look. I mean, it's good to know what, you know, it's, it's, it's, it's, it's, it's, it's, it's, You've got to avoid falling into the trap of looking at outcomes and then saying, well, we need all firms to be more like that firm over there.

Right, right. Okay. Well, let's just, just humor me. And we can come back to that more bottom up approach after this. But to start with industries, like what industries have been doing well, what industries have been doing poorly in Australia, again, just to sense check with you both, if I were a policymaker, I think I would be much more interested in growth rather than, you. than levels. Does that sound reasonable?

Yeah, it does to me. Cool. Okay. So, Greg, any objections? No objections. So over the weekend, Kevin Fox, the economist at UNSW, shared his latest charts with me, which are based on the ABS multi-factor productivity data. So shout out to Kevin and shout out to the ABS. So shout out to University of New South Wales. We think we have a partnership at the D61.

Absolutely. So that partnership launched a few months ago. We'll look through this again on the video. I'll put this chart up. But we've got 12 core industries in the Australian market sector. And this chart shows their total factor productivity growth from index to 1990. So the best performing sectors in terms of total factor productivity growth are firstly agriculture, forestry and fishing. Secondly, information, media, and telecommunications and thirdly financial and insurance services and the three worst performers starting with the absolute worst performer are firstly electricity gas water and waste services secondly mining and thirdly construction so first question the standout like the star in terms of productivity total factor productivity growth performance over the last three and a half decades is agriculture, forestry and fishing. My understanding is that the component there that has done the best is agriculture.

Do we know why that has gone gangbusters? I know a couple of reasons, some which aren't to do with productivity per se, but it is dependent a bit on weather conditions. Now, that doesn't explain a secular trend, but drought versus good rain conditions, those are inputs that aren't measured in the productivity stats. So obviously there's something going on there.

So sorry, just to dwell on that for a moment. Drought is an unmeasured input that is going to make, that is going to depress output. Depress output. So that's going to deflate the numerator. That's right, without deflating the. So it's going to make productivity look poor. Yeah.

And good conditions will make productivity look great. Can I just add just to double on that? If you stare at the figure, maybe viewers can see it, it has grown the most. It's also by far the most volatile. Yeah. And I think that maps to those periods of drought and good weather. I think that's exactly right. Yeah.

But, you know, has agriculture done well? I reckon it has. I think there's, look, it's hard to pin down causal factors here. But I think there has been a degree of rationalisation in the sector over this period. there is a little bit more scale in farming than there's been in the past. Farming is a much more professionalised sector, farm management, you know, even in instances where the farm passes down in a hereditary way through the family. Younger generations coming into farming typically have got much stronger managerial skills.

They've studied it. there's so so i think the the management of farm enterprises has changed and i think it's quite different to what it was in 1990 um the scale of farming because there has been more more rationalization but i think it's also a story of just it has been much the continuation of that trend that we talked about over the last hundred years it's the continued application of scientific progress to this to this sector and it's been particularly amenable to it and it fertilizes better seed varieties yeah yeah yeah things like that yeah just the two things that i think are and this goes a bit to your point gregg you can't always copy and paste from one sector to another but it might give

you a bit of a clue as to what some other sectors might be missing but and doesn't necessarily tell you what you do about it but there are two things about agriculture one is that it's internationally exposed so it's a global globally exposed business you know you you're you're no pricing power for the most part some some vineyards might and some other niche products but for the most part wool weaf cattle etc will beef sorry wheat cattle um yeah they don't have pricing power they're selling into a global market they're price takers um you've got no alternative but to just drive productivity on farm that that's how you make money that's how you make margin you you can't do it through price or better marketing or or whatever really

The other thing is I think we've had a pretty effective innovation system in agriculture. It's often rested on a lot of public R&D or R&D that's collectively funded by the farmers paying a levy and funding the wool R&D corporation or CSIRO or whomever. And then a system of extension officers that often kind of gone out and to encourage farmers to take things up and spread good ideas, help diffuse, that's right. And I think part of what has aided that, this is, Pure conjecture, but the farmers generally are not really competitors. They're selling their product on a global market,

but they're not fighting for market share among themselves or anything like that. So I think that culture of sharing information in the land care group, you know, just around town, you know, whatever it is, I think that's pretty established in that sector and that's probably aided the diffusion of ideas. And that's not to your point, Greg, it's not to say, well, everybody should do that. Well, they can't all just do that, right?

That's a thing that's probably distinctive about that industry. But it might be that there are a couple of these other sectors where that innovation system is less well developed, and particularly the ones where government's involved, maybe the government wants to think a little about how you could foster a better innovation diffusion system. Would it be right to look at this chart and say, to take the bottom one, that's, you know, electricity, gas, water and waste services,

you don't you're not exposed to international competition and it's an area with more highly regulated would you say yeah yeah a highly regulated pricing and in a way the there is where the economic regulator plays a big role in determining what investment can take place because you you take an investment proposition to the pricing regulator to have it allowed in your regulated asset base and I think it's true that we have in a couple of those areas

gone a little harder on capital investment over part of the last 20, 25 years in electricity, say, because we were interested in reliability, more so than cost in a couple of instances, big transmission upgrades, etc. So that's feeding into the MFP or TFP figures a bit that there's just more capital that's gone in in some cases.

I see. What about mining? Yeah, that's going to be my question. What about mining? It's kind of shocking. surprisingly surprising to me. They've got the international competition. Yeah. But according to this, we produce, we're less effective at producing than we were 25 years ago. Doesn't that, doesn't that not pass the smell test? It's capital intensive. It's

something Australia prides itself on. Why has TFP growth been? Before we even try and get into that, like, does it pass the smell? Like, I mean, I'm not going to doubt ABS or Kevin's numbers, but it just goes back to the, are we capturing the things? that we were trying to capture. This is a well-defined measurement. There's what rules about how you measure it. Then there's the object in our model, which is you gave the example of just forgetting blueprints.

So let's be careful about interpreting this as forgetting blueprints because it suggests that we're 20% less than worse off at actually producing mining output than we were 25 years ago. How could that be? Well, I think the clue is the period over which it declines and it declines basically from the early 2000s, which is the time when prices really went up. up. And I think that's telling the story, because remembering this is a measure that abstracts

from prices, so it deflates away a price increase, so because trying to get it physical output. It's quite plausible that the measured productivity of the mining sector is down because we've got more capital and more labour going into it for some increase in output, but maybe the increase in output hasn't quite been commensurate, but it's still highly profitable because the prices are so good. And so you wouldn't, you wouldn't not want to do it, you know, The investment of labor and capital from a macroeconomic perspective is good. The nation is richer for it, but the measured productivity comes down. And this is an instance where I think it's an important piece of information,

but it's not necessarily the whole story. Right. So maybe policymakers don't look at mining productivity measures and try to draw too much from that. Yeah. Okay. So just a quick check for completeness. We've spoken about maybe learning some things from agriculture around how they diffuse ideas. Are there any other things we could learn from the best performers to apply to the poorer performing industries? It's hard to say. A couple of the ones like financial and insurance services, which is up

there, it's just a big problem there measuring the output. The value add in the financial sector, what is it? Is it the net interest margin that a bank makes? Is it the insurance? premium that are insurer charges is it the superannuation fees that are fund charges they're the sort of proxies that we're generally reduced to to try and get a handle on what's the output and I think that's that's the challenge it you know it's not there's been productivity in in finance I mean you know we bank on these things now we don't go into branches we don't spend our time at ATMs you know there is definitely you know considerable productivity productivity growth, but I just think this is really, it's really hard to measure it.

And I worry a bit that part of what's driving that growth is just the growth of the industry itself, actually, indirectly, but who knows? All right. Here's Kevin's second chart. So this is comparing the red bars are the 2003-4 fiscal period up to. to 2324, so the last couple of decades, and then the blue bars are the sort of 15 years prior to that, so from 89.90 to 2003, 4. So what you'll see in this chart is that there's been a TFP growth slowdown in 11 out of the 12 market sectors since 2004. The exception is

arts and recreation services, although the magnitudes there are not so large that I think you would want to place too much weight on or interest in that. So the fact that we've had this TFP growth slowdown across almost all sectors over the last couple of decades suggests that there must be some common causes. But is just saying that this figure here, we're just measuring the slope of this line over the first half compared with the slope of this line over the second part? So it's the average percent growth, I think, per year. Yeah. So I think that's what it is. Yeah. I mean, again, to me, this is one of those examples where, look, it's great, it's great to take summary statistics and use them. But you look what's underneath that and it's just a mess of lines. Like it's, I don't know. I was going to say if I look across these sectors, I'm really skeptical about the measurement. Again, it's got nothing to do with how well we try and do this. But there's about four, maybe three, maybe four of these sectors where I think. think you can even start to conceptualize what it is you're trying to measure before you get

to the question of can you actually then measure it? The other ones, it's not even clear. Michael just gave the example. It's not even clear what it is you're trying to measure in financial services or arts and recreation. So why are we comparing it? And then what we're not doing is weighting these by how important they are because then when you weight them, it's all the stuff that matters for the overall economy is the ones that we don't really want to be paying much attention to and figures in charts like this. But there's something in Joe's observation isn't there?

If it tells you nothing else, it tells you something about whatever is going on, it might be more broadly based. Right. You know, if it was a some were going up, some were going down, it's a bit your point about is cost disease, the big story here, and your observation, Greg, was,

well, it feels as though there's a productivity reduction within sector, this looks like some vindication of that view? I don't know, maybe, but that second half all has 2020 in it and 2020 across all of them sort of dips down. That's got to count for something. It's also got 2008 in it in all of them where it dips down. I don't know, maybe. Or maybe there's just what it is.

We have one time series and, you know, maybe that's just what it looks like. It's not over read into it. I don't know. What do you if you if you if you started from the assumption that there's some kind of common cause or set of causes slowing down TFP growth across all these industries what's what's the most obvious candidate explanation I think it's hard I mean it's hard to find the thing that changed um around that time or or has been in continuous change are we a more regulated economy yeah there's not going to be in everything

every one of these sectors. So by virtue of looking for something that's across every sector, rules out a lot of stuff. Okay, here's one idea. You take a general purpose technology, which by definition is pervasive, so something like the ICT revolution,

and then you say that had helped lift productivity growth because it's pervasive across all these sectors, but then the effects of that had sort of petered out by the turn of the century. Yeah, I think that's a plausible explanation. It's probably the only one, because it's almost by definition, has to be something that's pervasive, has to be general. What are you left with?

I don't know. You can't tell a regulatory story. Not really. You could tell like, we've just become way worse at getting in the way of firms. But how could that be true in every sector? You could tell like a deeper idea is getting harder to find story, but I don't think that's plausible.

And it's also not that deeply different from the GPT story. But also, just empirically, I don't think the idea is getting harder to find story checks out because you would need to show that the effort we're putting into research had also dropped and I'm not sure it happened. But I mean, we've got a great test of this hypothesis coming up over the, I guess there's going to be the green bars that come up over the next 20 years. We have a GPT has just been developed. So either this story's right or it's not, we'll see what happens.

A literal GPT in this case. Yeah. This episode is sponsored by Vanta. Trust isn't just earned, it's demanded. Whether you're a startup founder navigating your first audit or a seasoned security professional scaling your GRC program, proving your commitment to security has never been more critical or more complex. That's where Vanta comes in.

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about the measurement issues with looking at revenue per employee. But do we know what Australia's single most productive company is or companies? Single highest revenue per worker? I guess. Well, it exists, but I don't know.

That's probably a show company somewhere with zero. I mean, who knows? Yeah, I don't know. I mean, such a, by definition, a maximum exists. But hard to know. So it would be interesting to hypothesize what would it be. So it could be a firm that is built around, it could be a very small firm that's built around some exceptional individuals, right? In, say, I don't know, software licensing or something. Right. Something with low marginal costs. Yeah. And, but potentially very high revenue.

It could be a firm that has high revenue per employee because it operates in a, with a, kind of regulatory moat like it's a casino and it's got a casino license or something or it could be a large company that's selling goods to people and just does it very efficiently but yeah it would be that's part of the challenge i think in well interrogating the data right is you want to why yeah yeah if you really want to maybe i'm getting us a little bit off track here but you want to deep down into some of the fund of my underlying issues facing austral probably the technically correct answer to that is it is a it's an investment shell company invested in property that has a revenue per worker of zero or infinite because

it has zero employees and it counts for a huge and generating huge amount of revenue and there's a lot of them yeah I'm being a bit condescending here but I mean cynical but I think it kind of gets to the to the some of the deeper productivity issues yeah okay okay so do we know do we know which Australian industries have the biggest productivity gaps between the frontier and the lagged companies within that same industry? So I don't think we have, we've certainly never put anything out on that, but in principle we could, right?

You could, you could assess that. Sorry, when you say we haven't put anything out? E61. Yeah. But it's something we've looked at in the aggregate and it, yes, you could in theory do it, do with by sector. Again, there's a kind of interesting question about what does it tell you? So there might be, so there would be some sectors where there is not much of a gap

between frontier and lagger. There's just a greater compression, smaller standard deviation around the mean. What is that, that could be consistent with a story that says there's really good diffusion. It could also be consistent with a story that says there's not much innovation. And equally where you do observe a big. gap it could be it's the converse that could be a story that there's very poor diffusion but it could be that that's where there's rampant innovation right and firms are you know shooting ahead and so at any point in time there's there's

some real superstars now you could look at it over time I guess and through time and see whether it's where it's changing I'm kind of reminded of you know Arnold Harberger in his presidential address to the American Economic Association I I think it was the presidential address, talked about where the productivity growth, his metaphor was, does it look like yeast or does it look like mushrooms? Yeast being, you know, everything sort of rises steadily by the same sort of amount, you know, year on year.

Mushrooms being, you know, there's just stuff going on, fits and spurts, yeah, some weird things sort of sprouting up. And his conclusion was when you look at the data, it's much more mushroom-like than it is yeast-like. And, yeah. No, I think that's right. I'm going to give the cynical view again, but I think this is really important.

So there's a lot of work that we can do now on looking at these measures across firms. The thing that you measure is a revenue per worker. That's what we mean by productivity. And there's a huge amount of variation across firms within industries. And it's also true that if you look at long run, longer run averages of that,

so extract like a persistent component to get rid of some of these, there's still huge amounts of variation across firms. Now, what I find really interesting about this conversation that we're having is that there is an underlying sense that high revenue per worker firm is a good firm and a low revenue per worker firm is a bad firm, high productivity, low productivity. So maybe some listeners will find it surprising that the way that that data has been interpreted over the last 10 years or so and it's been interpreted a lot is exactly the opposite to that. And it's played the role in the outcome of a lot, even policy discussions in Australia and policy changes in Australia, but being really important all over the world. And that's to interpret those differences as markups as reflecting differences in an ability

to extract revenue from your customers for the same amount of inputs. Market power. Market power. So here's what we can all agree on, because this is just data. If you take the distribution of firms, either in the US or in Australia, there's a huge amount of variation. The mean in that revenue per worker has gone up a lot over time. That increase over time has been driven by the firms at the top getting bigger. So some firms being driven who generate high amounts of revenue per worker are getting growing faster. And the firms

within their same industry that charge lower amounts of revenue, generate lower amounts of revenue per worker. But that's just data. And what you've pointed out here is that there's really two interpretations of that. One is a kind of benign interpretation, that there's differences in the ability to produce and in fact, or even a positive, optimistic interpretation that were shifting resources allocating them to the more productive firms. The other is a nefarious interpretation is that aggregate markups in the economy or market power has gone up and that's holding back down productivity growth exactly because firms are generating rents and exploiting market power.

And so to me, that distinction really just fundamentally epitomises why we have to be really careful about looking at this cross-firm data and trying to take away something from that that we can then use for policy purposes. Do you reckon there's a sectoral difference in that as we observe before agriculture, basically a price taker? So if you're observing that difference in Lagarde versus frontier in agriculture, maybe more likely to be productivity story, potentially. But a lot of services sort of operate in a sort of monopolistic competition kind of world,

don't they? You've got a downward sloping demand curve that you face. You've got some pricing power, not complete, but there's – and, you know, it's – the bigger question is kind of just, yeah, what market am I in, almost? Not just your product market. the input market so so the example you gave which i think great example take a take a sector where we think that private market's competitive and then there is no issue about but the factor markets are not particularly in these industries where you've got farming's a great example they've spatially very

concentrated and it's an area where they have low labor low labor inputs and then you you get the the distortion on the input margin so ideally what if you really wanted to get difference in productivity you need a sector which is competitive, both on the output margin and the input margin. The problem is that most of the economy doesn't look like that. And then you're confounding productivity and marker power. They show up together mathematically as two numbers that are multiplied together that you actually just can't tell a part in the data. So it becomes more of a political story about how you want to interpret the same data.

Interesting. Okay. Okay, so let's, I'm going to segue from talking about firms that have been doing well to countries that have been doing well. Inevitably, the country I'm going to focus on is really just the United States because they have genuinely been doing exceptionally well and they're also just the country I know most about. Do you think the median US firm is more productive than an Australian counterpart or is it just that the US average is dominated by extremely productive outliers like the, the meta, in the alphabets, et cetera. It's a great question. Yeah, and I've grappled with it a bit,

and I don't know why I've grappled with it as much as I can, because in principle it's kind of empirically answerable, I guess. The, I mean, we've looked at a little bit of data just recently that lends a bit of weight to the outlier story rather than the difference in median story, that if you abstract, and this is always dangerous, you're taking sectors out, But if you abstract from ICT, so information, communications, technology, and I think manufacturing

because Australia, you know, it's a low productivity growth sector for us or low productivity level sector, that a lot of the gap disappears, it seems. And so it appears that there are a lot of sectors where productivity levels, but the implication of that would be that productivity levels, really almost. or perhaps productivity growth, it should say from a base year, which I'll have to refresh my memory when it is, are a bit more consistent.

So, yeah, I'm thinking aloud. That's probably not answering the question about levels. It's answering a question about growth over time. So that would still be potentially consistent with a story about a divergence in median productivity of, yeah, so the realtor in Duluth, Minnesota, you know, compared to Wollongong or whatever, But are they more productive?

I've always found that a fascinating question. Look, I think at least in going back, revenue per worker, which is the thing that we measure, that is very much an answerable question that, something we could look at here. I'm sure there's someone out there listening going, oh, I've done that and I've had a look at it. I don't know the answer. If anyone's looked at that, email me. Okay, so Nick Bloom has some cross-country evidence showing that American firms are fantastically well-managed. and in the international comparisons,

Australia is sort of a middling country in terms of its management practices. What I want to know is just like concretely how different Australian management practices would look like if we converged on US management practices. It's just not obvious to me what they do that we don't do at the moment. Any ideas?

What do you think? Well, so the survey that you reference is one in which Nick and co-authors ask a bunch of firms in countries around the world a set of questions about their management practices. I should preface it by saying it's a relatively small survey. It's about 350 firms, so I wouldn't want any Australian firms out there thinking that this is indicative of the way they run their business. It's only about 650 firms in the US.

I think we just have to keep that in mind. But if you look across what the measures are in that survey that contribute towards the average amongst those Australian firms, lower than the average for the U.S. firms, it's the one that has the biggest difference is the set of questions about incentive structures. Okay. So that's a series of questions about the way in which employees are rewarded in terms of performance bonuses, etc.

Exactly. Now, for concreteness, there are differences in all of the categories, but that one's the biggest. Is that plausible? I mean, I think it feels plausible just having spent. time in both Australia in the US. But how much would that concretely change output? I don't know.

That's not something that I think that this study gets into. So then it's not obvious to me why stuff, why practices like this haven't fully diffused to Australia. I mean, everyone, like, there's plenty of Australians go and work in American companies or multinationals. people talk and share information um why like why why don't we have the they seem like like simple technologies why don't we have to the same extent i don't think there's necessarily strong evidence that's associating that change with firms performing better that's another

step that one one would have to take so yeah okay so i'm a bit hesitant to jump and say what you're saying is maybe we don't do these things for good reason maybe okay maybe our tax settings are not conducive to it. Yeah. Maybe our cultural settings amongst employees are a little different. Yeah, that would be plausible, wouldn't it? I mean, it's a, again, hard, I shouldn't just speculate in the absence of evidence. But yes, for a lot of American managerial practices would rely on a degree of receptivity, right?

And if you've got a contrary sort of workforce culture, that that's going to be a problem, right? So I don't know. Maybe that's, maybe it's an issue on it. Hard to know. So the US is nearly the only rich country to have had like a positive productivity growth experience in the last five or so years. Do we know what it is that they're doing so well? Well, you said it was mostly in the ICT industry. Is that, was that?

Well, yeah. So I think that statistically, you know, Relative to Australia, for example, that ICT seems to be a big part of it. I mean, to the extent, so hence, you know, I was going to come up with a broader. And what do you mean by that? Well, it's a combination of ICT manufacturing, but also software development. So is this just the AI boom, essentially? It could be part of it, yeah, along with chip manufacture, a bit of Moore's Law.

But I don't know how much to make of the, you know, the COVID response and the immediate aftermath. I mean, one thing about the US response that was distinct was they didn't have furlough or job retention schemes on the same scale. We did and Europe did, to an extent we had the JobKeeper scheme, probably a highly effective scheme for the first few months, but beyond a point kind of outlived its usefulness in terms of maintaining job matches, which really should have been at some point just liberated, right? US didn't really go down that path, did experience a faster productivity growth rebound coming out of COVID

that that's casual empiricism it's not causal but oh interesting so that so yeah for that reason they might have had better matching potentially greater kind of dynamism in the across the economy as a as a consequence but but you would expect that to recede over time I think that's the you know really by now it would be a bit I would have thought a bit of a stretch

for us to be blaming jobkeeper for sluggish in the labor market or poor match quality or anything. Interesting. Okay. So one more question on the US. When I did my second interview with Ken Henry at the live event this year, he mentioned that in the 1990s, Treasury had done some work to look at what level of US TFP Australia could aspire to and they'd reason that it was about 95%.

The 5% gap was imposed essentially by geography. if you think about our isolation from a lot of major markets. What I want to know is, okay, so say, I don't know this for a fact, but I think it's roughly right, say we're at about 80% the US level of TFP at the moment. So maybe we've got like 15% to play with because we can't change our geography. How much of that 15% is culture and how much of it is stuff that like policymakers could more approximately influence. Well, some of it's going to be sectoral mix as well.

Okay, so let's maybe, I see. I'm not great at numbers, so some of it's going to be that, yeah, our economy, we just do different things and there's different levels of productivity. And some sectors are more productive than others. So if an especially productive sector has a larger share of value added, then that's going to change the overall average. Correct. Yeah.

The cultural number, I mean, I would say it's bigger than zero. Having lived in the US, I live in the US and spent a lot of time in Australia, there's different, there are different cultures. Now, what does that translate to into these aggregate numbers? I don't know. I mean, Michael's happy to be fair game and throw a number, but my number's positive. Like an over under or something. Yeah.

Well, I mean, it needs to be positive. It could have been negative. So I'm giving you something. It's a positive number. Yeah. And it's a, as I said before, it's a gap that's widened relative to the rest of the world. Now, you know, query of cultural differences widened,

but, you know, it doesn't have to explain all of the movement, right? Yeah, I think there's something just a bit fundamentally different about the United States. I think it's just a fundamentally entrepreneurial society in a way that other developed economies approximate but don't fully achieve. Right. because you see where I'm going I'm trying to do almost a process of elimination to work out like okay what are all the sort of fixed what's left fixed things what's left how much can we play

with yeah and to me it feels like like culture is not I mean you can influence culture at some margins but but it's a pretty deep and persistent thing yeah I am less so I agree with that to some extent and it depends on the time horizon over which we're talking if we're talking over the next two years. Sure, I agree. Culture is maybe not something that we can change. But culture evolves and culture adapts and culture responds to economic outcomes, sometimes even temporary economic outcomes. We know a lot from people who have some of the work on this, so people have lived through hyperinflations. And 70, 80 years later, they still have very different approaches to how they invest their assets and how they perceive economic choices. So economic outcomes and the incentives

that things like the tax system give us, they do affect culture. And so I don't think it's, I don't, if the game is to raise productivity over some longer period of time, then we want to, there are policy settings that we can do that affect our collective approach to things like human capital investment, things like entrepreneurial type activity, things like how we think about incentive structures within firms as well, we're talking about earlier. Yeah. I think it's an interesting reflection. And again, this is not an empirical claim. I feel like I'm saying that a lot. But if you compare the, to just back up Greg's point, what you would think of as the canonical Australian economic cultural trope of, I don't know, 1978 compared to sort of 2003 or something like that.

like over a 25-year period, I would say it changed pretty fundamentally. And the reputation that Australians had, Australians had overseas, if we went to London in that era, early 2000, you know, the reputation of Australians, very hardworking and, you know, go-getter type young people. I don't think that was true, or certainly wasn't the kind of caricature that existed of Australia 25 years before. Do you disagree?

No, I'm too young, but... I believe it. Yeah, as I say, it's a bit of a high-level impression, but that is partly a function of policy change. And obviously culture will affect policy and vice versa. But I kind of agree with Greg. I think a sustained, you know, implementate, I mean, people probably make the same point about Britain,

you know, that there was a difference in the culture of Britain in the mid-1970s compared to what there was by the year 2000, you know. And let me point something out about the US as well on the same. So we talk a lot about the performance of the US in terms of productivity. The US is a big place. And there are a huge geographical variation in all economic outcomes, including productivity, including even in the same industry and very narrowly defined industries. It's very different across different parts of the US.

And there's a lot of different reasons for that. There's legislation. in different states. There's different cultures in different parts of the country and different types of and different types of the level of government intervention as well and different types of geographic barriers in the same way that Australia, not to the same extent, but in the in the same way. So I think that, I mean, to answer your question, that would be something that one could maybe look at to understand where these, what these maximums are. And it's not something I've done, but I think it would be super, super interesting to better understand.

Right. So let's switch from my top-down approach of looking at what industries, firms, and countries are performing well to Greg's bottom-up approach of what are some, like, silly policies or obstacles that we could just remove. And this doesn't need to be an exhaustive catalogue of all those policies, but we can just talk about a couple of the more important or interesting ones. But firstly, just as a thought experiment, another thought experiment, what do you think is like, smallest set of reforms we could implement to get back to that 1 to 2% labor productivity growth per year? I think it's not that small is the truth. My instinct is that there are probably a couple of high profile bigger levers but generally I think success in this area relies on mobilising on a lot of fronts and actually with successful periods of reform they tend, it tends to work that way I think once you've, you've moved on a couple of key areas the momentum starts to build in a few others so I think

broad-based tends to be the way to go it's more likely to be a lot of little things than it is two or three big things so that that's my instinct sort of the nature of being a frontier economy I think partly yeah and I think them I think when you think about what characterise the Australian economy in, say, 983, if you date a substantial reform chapter from that point. At that point, we did have what I would describe as significant resource allocation issues because we had high protective tariffs on trade, so we had kind of an inefficient manufacturing sector in certain industries. We had some quite big government business enterprises that were a bit bloated, that sort of thing.

We had a whole bunch of areas that didn't have a lot of competition, including banking and aviation. So I think in that world, there was, um, there were some big things that you could, that you could do that kind of improved the efficient allocation of labor and resources. You know, we had some obvious misallocations. And, and today you might make that observation say about the Chinese economy, right? There would be some obvious areas of, you know, excessive allocation of resources in, in certain sectors and that sort of thing. I think that's a harder case to make today. I mean, there are probably some sectors we would think, you know, we probably think we overweight investment in residential property. You know, we've got maybe

a couple of other sectors that have got some, you know, degree of favouritism, but it's just not on the same scale. And I think for that reason, it's more likely that what we're facing is how each of those sectors innovates to get closer to the frontier is distinct from a big improvement in the efficiency of resource allocation across the economy but that's a bit stylised but I just that's part of the reason I think it's less likely to be the one or two or three big levers yeah so it's like government as like bottleneck detective just going around and sort of tinkering with yeah I think there's obstacles a bit of that yeah yeah so we can talk about the more sensible and obvious ideas in a moment but I'm just curious are there any particularly

unusual or ambitious ideas you've come across in your travels for lifting Australian productivity growth? I mean, for me, the ambitious one comes back to geography. Moving, moving Australia up. Not moving Australia. I think Australia is in a beautiful spot. It's about, it comes back to this bigger question of that 40% of our population is sitting around in two cities.

And I think that locks up for the reasons we've discussed, the constraints on being in those, being the difficulty. and being in those cities for many people and the constraints in getting to those cities. I think if we could unleash other parts of the country to be engines of productivity growth more broadly than, say, just mining, I think it's a bit of throwing darts,

but I think the potential returns are high. And there's a role for government in doing that because it requires a huge amount of coordination, investment in infrastructure to do it. And to me that will be a long-term bet that I think is worth grappling with. So this is like potentially the major new cities thing but also just densifying existing cities like.

Yeah, and I'm not sure if the answer is that we need more cities that are two million people or we need another five million people city or the issue is that we've got a bunch of cities with 80,000 people that really should be half a million people. But right now the set of options available to a young, person ambitious wants to contribute to productivity growth in the in the country for where to live they're pretty limited and and constrained by some cost factors and so I think that there's now I might be wrong that it might blow a

bunch of money trying to do this but you know if you're asking what's ambitious and non-obvious well I don't know how non-obvious that is but I think that's ambitious and I think it's probably important if we want to have serious productivity growth over the longer run. Yeah, it's high stakes. I mean, part of the challenge is it's the sort of thing that poorly done just results in a proliferation of grants and tax incentives and relocated government departments or whatever to, you know, small places.

But yet, I think it's an interesting feature of Australia. And it's, in fairness, this is something we're comparing ourselves a bit to the US here and not to a lot of other countries, a lot of other geographies. But, yeah, where's the Phoenix? Where's the Austin, Texas? Where's the, you know, the emergent regional competitor, if you like, to the hegemony of the big CBDs?

I think that's an interesting question. I mean, Greg and I were chewing the fat on this saying, why isn't Canber a city of a million people? I mean, you could densify that point. place barely anyone would notice it's a great city it offers a great lifestyle pretty proximate to both other cities and other you know features um i don't know i don't know why it's got high skills got an anchor industry already um anyway say you say the federal government just decided to go all in on okay let's let's get camber to a million plus people

what what are the actual policy leave is do you settle is it like do you have visas and the condition for the visa is people have to settle in Canberra for two years or how do you how do you implement that no i think i think you've got to look at fundamentals i think it probably is partly about um land supply and the ability to densify in in the ac t i think that's a big part of it um in fairness that is both a commonwealth and a territory issue because there are commonwealth agencies that have some planning responsibility there and yeah it could be that transport infrastructure plays a role. I'm not a high-speed rail fetishist, but, you know, maybe.

So, yeah, I think it was, yeah, you ask for some of the more unusual left field things. Yeah, they're worth grappling with. Okay. So again, we can come to the more sensible things in a moment. But I did have a question on AI. Say you were Albo and you were bullish on AI. you were fully brought in to the AI scaling laws for large language models. What would you do?

Would you, what's the obvious thing to do? Is it to cover the Northern Territory and solar farms and data centers or where, where does Australia's comparative advantage sit in the AI value chain? So I think that's yet to emerge. I think it's yet to emerge. I mean, I don't think we yet know what are the synergies between the infrastructure piece and their, you know, AI development and AI usage piece. Remembering in the year 2000 or around that time,

we had a big debate in Australia about whether we wanted to be headlong in ICT, like chip manufacture, and there was a bit of a view that you had to be in that world in order to be an advanced economy. I think in retrospect, you know, that was wrong, and Australia was right not to go down that path. But it's really hard to know, you know, is it, do you have to be, Are there big spinoffs from being big in the infrastructure like the data centres? What is the, I think this is potentially an area where there's going to be a slightly

fuzzy boundary between being a developer of the technology and being an adopter of the technology. So we often think of Australia as being a fast adopter of technology developed overseas, but it may be with AI that you can do that up to a point, but you need some domestic capability in order to adapt it and use it well. I just don't think we know that yet. I think one of the questions for us is just what regulatory stance we're going to take. And I think we could do a lot worse than start with a mindset of not trying to, I don't know,

invent or speculate about what the harms of AI might be not to do that kind of dystopian exercise, but just to look at our existing suite of regulatory frameworks that are really aimed at protecting against existing. existing harms and work out how resilient they are to the use of AI. And do we need to keep them fit for purpose? I think that's a better place to start than any other. And then I think we will learn as we go. Another random question. I was wondering this the other week,

but does anyone know how important the CSIRO is to Australia's total factor productivity? If the CSIRO vanish tomorrow, So what does Australia's average TFP growth rate over the next decade or two look like? Yeah, no, I think it's, I mean, because they're too, you know, it could be, the answer could be zero, but it could be zero partly because of materiality, or it could be zero because it's not doing the right things. I suspect it's more a materiality issue. Like, I think a lot of the worker, the CSR are not intimately close to it,

but I suspect a lot of it is good work fits where we would generally say there's potential market failure around the doing of basic research. So it's not that it's contrary or TFP or wasteful or anything like that is probably just not of itself necessarily a big driver of it. But I'm sure it's had substantial benefits, you know, in agriculture, Wi-Fi, you know, there are a range of things that, you know, as a kind of an instrument or an avenue for advancing science in Australia, probably been pretty beneficial. I'll make a plug for the importance of institutions like the CSIRO beyond what their direct

impacts on productivity are. We want to be a productive economy. We need a place for someone in this country should know how basic science works. Okay, so I promised we would leave a little bit of space for just the more sensible or obvious ideas. Is there anything that you really want to put on the table in terms of reforms that need to happen to raise productivity growth, stuff we haven't talked about, I guess, like tax reform is an obvious one,

but I'm sort of just leaving a few minutes open if there's anything you really want to sort of register. I mean, I've mentioned tax. Yeah. I've spoken about this before. Look, obviously, tax is not going to be the route to becoming the most productive economy in the world, but the wrong tax settings can be a barrier to doing that. And I think there are things about the tax system in Australia that are acting as a barrier.

So much of future productivity growth happens within the corporate sector, particularly within large firms where there's a lot of where there's smart talented employees working together on on improving and implementing technologies we don't have a tax sitting tax setting in Australia that is conducive to encouraging smart people to want to go and work for large firms as employees right now you get taxed a lot more if you work as an employee than if you run a mum and pop business that has very very low productivity growth because of the way we tax capital gains because of other incentives around the way that we tax on financial investments. And I think that the level of our labour income taxes, we think of that as just being sort of

divorced from productivity, but I actually think plays a role in that. How big is the magnitude? I agree with everything you're saying, but I'm just wondering. what the actual effect is potentially on productivity. Well, the difference between making a choice to do the same work as an employee versus as the owner of a small business, it'd be as much as 23% of your income. So that's substantial. That's substantial.

You accumulate that over the, that's annual. So you accumulate that over a life. It's a big chunk of more money that you're paying out in tax. Now, you might be able to generate revenue, but if we think that there's externalities that come from grouping and agglomerating smart people together under the same roof, some of them have to work for not everyone can be a boss. Someone has to work for someone else. So I'm not saying that this is the thing that's going to change the issues that we've discussed, but it certainly doesn't help. Yeah, it's on the short list of just sensible, obvious things to do. And I also think it's one of those things that we typically don't think about.

tax through the lens of productivity because we don't think of human capital as being something that's invested, something we invest in and that's affected by tax rates and I think that that's maybe a mindset shift that needs to happen to start thinking about tax through the lens of human capital investment and productivity. Look I think two of the, two of the sort of emergent issues that are not, again, not the Beal and End or but would help us along the way are, the The climate transition is very important, and it's important that we do it as efficiently as possible.

So I think it is a shame that we walked away from what was a pretty sensible economic approach to this, which was pricing carbon emissions. And I understand the politics of it, but I think to think back to the goods and services tax, it went through a number of false starts. Paul Keating had option C in the mid-1980s. there was the fight back package with an electoral outcome, you know, that sort of knocked that on the head. But within five years of that, it had sort of reemerged

as an idea his time had come. It's now 12 years since the carbon price died of death and it's still showing no signs of re-emergence. But I think it's not the be-all and end-all in the climate transition, there's a lot of other things that need to go on in energy markets, etc. But I do think it's an important part of, you know, making sure that we've got the most efficient forms of carbon abatement going on. And I think it should at some point make a comeback.

The other one that's a bit more frontier and it's hard, but necessary partly because of the climate transition, is road user charging. You know, by necessity, we've got to find some replacement for the revenue loss through the fuel excise. but it is an opportunity to actually impose a 21st century pricing model on, you know, the fuel excise is a 20th century kind of pricing approach, right? It's crude and it's across the board. It's sort of industrial scale.

You know, we do have the ability now to charge more for the true cost of road use, which is congestion, at least in urban areas, particular routes, particular times of the day. That's got its political challenges. but that would have a pretty substantial productivity benefit in terms of the efficiency of the use of this shared asset, which is the road network. So I think we could do worse than put a bit of focus on that. Great.

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let this message plant a seed in your mind. Consider joining a well-funded startup like Eucalyptus or any other excellent startup. You can check out Eucalyptus' open roles at eucalyptus. To finish with, I have some questions on the reform error and the process of reform. Given your background, these are probably more questions for you, Michael, but Greg, obviously, feel free to jump in at any moment.

So the first question is, and this is something, this may be been a big update for me in the last 12 or so months, is just realizing that the 80s reforms are potentially a bit overrated. And I wanted to get your view on this, but Australia credits the high TFP growth. had in and later productivity growth we had in the 1990s to the microeconomic reforms, the 80s. But a bunch of other frontier economies had high productivity growth in the 90s as well, and they attribute it to the computer revolution diffusing through the economy and then finally winding its way into productivity statistics.

So why isn't that just the most parsimonious explanation for us as well? It's got something in it. I mean, not every economy did experience that TFP growth. in the 1990s, and so there is something to be said for Australia and US and maybe a few others, exceptionalism. So I think there is some dividend associated with the reforms of the 80s and 90s, but of course you've got to remember some of those reforms were only happening in the 90s, you know, even in the late 90s and national competition policy, for example.

So they're almost happening too late to be a part of that explanation for the TFP surge. Does that mean they're overrated? Not necessarily. I think both in terms of the difficulty of bringing about those reforms, they were pretty substantial. It required a pretty substantial effort in terms of intellect and advocacy. But I think also it's like a consistent theme that Greg's pushed throughout this discussion

that there were reasons for doing many of these things that weren't necessarily just about TFP. The idea of bringing in competition for domestic banks or the idea of reducing tariff barriers on imported cars and textiles and the like. Yeah, these were things that were partly about expanding the range of choice and opportunities for people in Australia. And so I think in many ways that sort of reform effort, I don't think it ever had an explicit productivity motivation,

and not that was sort of publicly talked about a lot at the time, there was a general sense that we were falling behind in economic performance and we needed to do something about that and we needed to be more open and energetic and, you know, have, you know, not shield ourselves behind protective barriers. But yeah, I think there were a lot of broad benefits associated with that. Can I add to that? Sure.

So I think three things. One, obviously counterfactuals are hard, but you would think on the face of it that the reforms would be more like a level effect on productivity than leading to some sort of sustained period of growth. But I also think that it's plausible to think that there's an interaction that is potentially more important, that you have, if you're going to get some big change in technology and that needs to diffuse around the economy, you need the right settings and market structure enabled to enable that to take place.

And I think you could make a case that it was the interaction of the two that contributed to it and that the counterfactual might not have been that in the absence of those reforms, it would have been much more difficult to reap the benefits going through the 90s and early 2000s. So what do you attribute the gains to? Well, it's sort of an interaction between them. Yeah, it's interesting. When we caught up a couple of weeks ago, Michael, I think you said that, well, you're

understanding of the rationale for the 80s reforms was that policymakers were thinking and speaking much more in terms of the level effects, not the growth rate. Obviously, the holy grail would be some kind of transformation to the underlying growth rate, right? If you could find policies that lift the growth rate. It's not, and this distinction, between levels and rates is not a clean distinction always, but it's not obvious to me that policymakers today or in the last few decades, but let's just say today, it's not really obvious that we have levers onto the growth rate. And so it raises the question of what the role of government is, and we've spoken about this sort of like bottleneck detective role,

and you've also written about government as sort of a final guarantor or insurer. Do you have any sort of rifts or takes on this question of does government actually have the ability to influence the growth rate or is the best we can hope that every new generation, every decade or so government has to search around for sort of the next set of reforms to raise the level? and then it's just a sort of, it's an eternal process of raising the level. Yeah, I think there are two questions embedded in it. One is what is the role of government or the role government can play in driving productivity improvement.

The other question is, does productivity improvement happen in level terms or growth rates? I'm kind of reminded of Thomas Philippon and the work around, you know, what looks like a growth rate is really just a series of level shifts and that's, you know, part of the reason and why we see plateauing because, you know, we've seen a level shift, we've approximated the new level, we're at a steady state. And I, that seems to fit the data reasonably well, actually, as an approximation. And, yeah, when you think about the underlying economics, most of our explanations tend to be a little bit more about levels than growth rates.

I mean, the exception, I guess, are sort of, you know, education as an import, you know, human capital knowledge as a key factor in endogenous growth models and that sort of thing, I suppose, that they go more to, you know, the growth rate is something that can be influenced. But I'm, yeah, I'm kind of alive to the idea that it's very difficult for government. I mean, when I talked earlier about those resource misallocations, that's fundamentally a level story, right? That's really about, and you can do this in a general equilibrium model, right? You can say, here's the resource allocation today. Here's the resource allocation. If we remove these various distortionary barriers, it's a better equilibrium and it has this level effect. The things that go to growth rates, I suppose there's a question about, you know, are we exposed to the frontier?

Are we open enough to both trade and investment flows such that we're going to be quick adopters of whatever comes along? Do we have a market that really rewards success and punishes failure? Because if you do, I guess then the best ideas are going to be spread pretty quickly. That will go to growth rate in the aggregate. But I agree, it's difficult for government, I think, to have a lever that they're going to pull and say, you know, that's going to lift growth. Yeah, I think adoption is really important.

And for adoption, you need price signals to be able to dictate to firms what to adopt and when. And there, I think, governments have a rolled away and blame both sides. Firstly, not distorting those price signals too much. And secondly, making sure that you have the right institutional environment that firms can operate and see those price signals. So, again, I'm still in the bit of the world of there's more

that governments can do to mess it. up than to actually generate benefits that wouldn't otherwise be there. Okay, so as an example of that sort of institutional setup, maybe something like floating the dollar did have like a growth rate effect. Yeah, absolutely. Yeah, yeah, yeah. So if we can look, if there are opportunities like that in the choice set, we should obviously jump at those, but once you're Australia in 2025,

some sector that's right for innovation. that's unnecessarily regulated so that it doesn't operate like a market, even a market that's with maybe significant amounts of government oversight intervention, yeah, you could see that there's issues there. I mean, one of the sectors we were looking at before was the financial services sector

as being a sector that had some of the fastest growth of the productivity growth of the last 20 years. That wouldn't have happened without the deregulation reforms because there would have been no signals or incentives in order to innovate in that sector. Okay, two final reflections on the reform error to finish with. So there's this worry, and I'm guilty of this too, because I've spoken about this in podcast interviews,

but there's this worry that Australia's economic reform error has ended. So in that period to about 2001, finishing with the introduction of a consumption tax, we had you can count, you could tally up maybe, I don't know, 10 plus significant economic reforms. And then in the last 25 years, you could count maybe one being the NDIS. And people worry that there's been some sort of secular or structural change that makes the process of reform more difficult for a country like Australia. But what's wrong with this alternative interpretation, which I'll propose?

The alternative interpretation is, no, it's just the result of, contingency and bad luck. If we had got the carbon pollution reduction schema, this was Rudd's original policy. If we'd got that up in 2009 and the Greens hadn't torpedoed it, we wouldn't be having this conversation. That in itself was a reform maybe on the same level of significance as the GST and getting it up would have had this sort of cascading set of consequences which would make future reforms, future big reforms more likely. Because when the CPRs went down, Rudd bulked. He didn't call the double dissolution election.

That set in train his loss of leadership. It set in train Malcolm Turnbull's loss of leadership. And so you had these like policy and political consequences that have really just sort of haunted the Australian federal parliament for the last 15 or so years. So you can kind of trace it. back to to this one failure which you can you can really you can really pull like understand a plausible counterfactual there where rudd calls a double dissolution and none of this

happens and we're not having any of these hand-wringing conversations about the reform error ending what's wrong with that that view i mean that that view says we just should chill out like mean let mean reversion take its course and stop worrying about things having fundamentally changed. They haven't. It's just bad luck. Is there anything wrong with that? Look, it's got a lot going for it in a way. Because I think that basic account of what happened in 2009 is about right. And I think had you right, if it had been otherwise, that would have stood the test of time pretty well. And I think Australia actually would have been a bit of a global outlier in, you know, having a, it would have been a classically pragmatic Australian

an approach to dealing with this big challenge that has, you know, polarized much of the globe and unfortunately we've become a bit polarized with it now as a result. So now, we haven't seen a lot since. Would it have, you know, all these things are path dependent, but would it have then kicked off yet further? Would this have been seen as, you know, this is how one governs, put up a bold reform, enact it, you know, all of that. And that means that the subsequent 16 years would have looked different, maybe.

But I think it still does leave us in a world. We probably can't be quite as sanguine as saying, well, therefore it'll just work its way out. I mean, I'm generally not as defeatist as many. I don't really, I don't love the argument that says, you know, we just had better political leaders or better public servants in the past. I think it's also hard to ignore the fact that there are some big public policy challenges that our current crop of politicians and policymakers have faced

that just weren't there to the same extent in the 80s and 90s. China, you know, climate transition itself. These are, you know, now what's becoming of the global trade system and the global economic order. You know, these are really hard issues. And they're, you know, challenging for policy makers. And in many ways, a lot of the bandwidth has been focused in those areas. So I want to cut them a little bit of slack.

But I do think we need to – it's the right conversation to have about how do we sort of invest in our institutional capability and the quality of our debate so that we could reclaim a bit of that past success. What do you think, Greg? I think there's something to your point, the broader point of, these are these are lumpy things. They're big things. It's history. Drawing out trends from single lumpy things is challenging.

So I'm totally with you on that, but maybe just add a couple of observations before we wrap up. So maybe this is, maybe tell me I'm wrong about this, but sort of with the exception of maybe the super guarantee, all of the sort of big reforms we're talking about, Australia was not. a world innovator on any of them. They'd all been done and tried in other places. Income contingent lines. The other one I was going to say, HECS had been. Yeah, it came a little. Yeah.

So income contingent loans, those were the two that came to mine. Hex and super guarantee. But they're not the ones, they're like the numbers 9 and 10 when people list the reforms of the 80s and 90s. So things like deregulation and floating the dollar and broad-based consumption tax, they've been tried. In 2009, emissions, carbon tax, would we have been the first major economy? We would have been among the early movies.

It was not, yeah, with an economy-wide scheme of that nature. Yeah, it's not like there are, it's not like there are these obvious things that we plucked from the Detroit and tested that we kind of can feel pretty confident about if we just get the political will to do them. They're much more contestable, the economics of the things that are on the table at the moment. So I, it's a point that's been made over and over. I do think there's something to it. And I think it's true with respect to the carbon trading, carbon pricing scheme as well. Final question.

What's the most non-obvious lesson or lessons that today's policy makers should take from the reform era? So you can't say, you can't say salient things like have courage or build a burning platform. Yeah, I don't know. I don't know. I was very young during it. But I, talking to people about it, I think one of the mistakes we often make is that we think it was more coherent than it was. I actually think it was, in reality, it was in many ways pretty chaotic and a lot of following of gut instinct as much as a concerted plan that was systematically enacted. It was highly successful.

I think that were the right instincts in many ways. but sometimes we impose an order on the past that wasn't really there really there at the time. Yeah, that. All right, this has been brilliant. Thank you, Michael. Thank you, Greg. Thank you, thank you, Joe. I hope you enjoyed this episode.

If you did, you can support the show by leaving a five-star rating on Apple Podcasts or Spotify or by subscribing on YouTube. Thanks to this episode sponsors, you can find them in the episode description. And thanks to Bill Manos and the Manos Foundation for their generous patronage of the the show. If you'd like to become a sponsor or patron, you can go to jnwpod.com slash sponsor or email me at joe at jnwpod.com. That's joe at jnwpod.com. Thanks for listening. Until next time, chow.