Date created: 15/5/07
Last modified:15/5/07
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John Quiggin

Still, life's not bad here

John Quiggin Australian Financial Review

15 March 2007

Those who remember the policy debates of the 1990s will no doubt recall the phrase “world’s best practice”. Favored policies of microeconomic reform were promoted with the promise that they would lead to the elimination of gaps in productivity between Australian industries and their best-performing overseas counterparts. The Industry Commission was among the leading promoters of this idea.

Some sceptics (including me) argued that these potential gains were overstated. The comparisons were invalid because they failed to take account of the costs associated with Australia’s dispersed population and distance from major markets. On the other hand, a focus on second-order reforms distracted attention from the big issue of human capital formation through health and education policies (Micro gains for micro reform, AFR, September 17, 1996).

Such arguments were dismissed at the time, and for a decade or so after. Now, however, the Productivity Commission (successor of the Industry Commission) has issued a new report focusing on the productivity gap between Australia and the United States. The primary conclusion is that much of this gap is the inevitable result of our dispersed population, lack of scale economies and distance from major markets. I can only agree.

Although the PC report plays down the policy significance of increased investment in education, this is largely because, according to the report the big gains have already been made, at a time when most policy attention was focused on microeconomic reform. As the report notes, completion of education became common in the 1970s and 1980s, and Australians in the relevant age cohorts now have about the same education levels as their American counterparts. The report might perhaps have noted that the shift to a norm of school completion was the result the massive increases in education spending delivered by the much-maligned Whitlam government, but perhaps this would be asking too much.

One odd feature of the report is the exclusive emphasis on the United States as the definitive world leader even though European countries have measured productivity levels that are even higher. The report correctly notes the European income per person is lower because of generally lower levels of workforce participation. An analysis, taking account of utilisation effects shows that the US is almost exactly on a par with European countries such as France and the Netherlands in terms of structural productivity.

The failure to consider Europe is more striking because the European example gives further support to the report’s main conclusion, that most of our productivity gap with the world’s leaders is due to the brute facts of geography rather than to institutional factors. Europe’s institutions are radically different from those of the US, but that doesn’t seem to affect their productivity much compared to the benefits of a central location.

Another example illustrating this point is that of New Zealand. No country undertook more radical institutional restructuring in the 1980s and 1990s and, for quite a few years, flights into Wellington were packed with international delegations seeking to learn from the kiwi miracle. Sad to say, the miracle never arrived.

There have been some recent attempts to defend New Zealand’s record in this period. While statistics can be selected to prove almost anything, the brute facts are inescapable. Throughout the 1980s and 1990s, the rate of growth of GDP in New Zealand was well below that for both Australia and the OECD.

Performance has improved since the late 1990s. Probably coincidentally, this followed the election of the Clark Labour government, which raised marginal tax rates, and repealed the Employment Contracts Act. If there is a relationship between institutions and productivity, the New Zealand example suggests it is not a simple case of free markets good, intervention bad.

More importantly, despite recent improvements, New Zealand remains well behind Australia, and Australia and New Zealand lag the OECD leaders, a sharp contrast with the situation in the 1950s when both were world leaders. If anything, the tyranny of distance seems to be becoming more oppressive over time. This observation is surprising given reductions in transport costs and the virtual elimination of communications costs that we have seen over the past 50 years, but it is supported by other evidence.

Still, productivity isn’t everything. Australia and New Zealand may not be conveniently located for export markets but they are great places to live. I doubt that many of us would be willing to relocate to the Northern Hemisphere in return for the 20 per cent increase in income that would close the gap in average output per person with Europe and the US.

John Quiggin is an Australian Research Council Federation Fellow in Economics and Political Science at the University of Queensland.

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