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;;;;;.;;National Bureau of Economic Research
13th Annual East Asian Seminar on Economics
Melbourne, 20-22 June 2002
Australia’s 1990s Productivity Surge and its Determinants
Dean Parham
Productivity Commission
Australia
Revised Draft, May 2003
Abstract:
Australia’s annual rate of productivity growth surged by over 1 percentage point in the 1990s. Three major possible explanations have been put forward: the use of more advanced information and communications technologies (ICTs), increases in workforce skills, and policy reforms designed in large part to drive and enable productivity improvement. The paper examines the contribution of ICTs in a productivity growth accounting framework. The USA is used as a comparator, given the similarities between the two countries in ICT uptake in the 1990s. Particular attention is paid to removing cyclical influences in the growth accounting, a factor overlooked in most other studies. The use of  ICTs is found to have only small effect at the aggregate level, accounting for 1 or 2 tenths of percentage point of productivity acceleration. This aggregate view, however, masks larger productivity linkages at the industry and firm level, depending on the extent to which ICTs enable complementary product and process innovations. The contributions of skills and policy reforms are also briefly assessed from evidence provided by other studies. The most plausible explanation is that the bulk of Australia’s productivity acceleration is due to much-delayed catch-up that has been facilitated by policy reforms focusing on competition, openness and flexibility.
Acknowledgements and disclaimer:
This paper partly draws on and updates previous work undertaken with colleagues Paul Roberts and Haishun Sun (Parham, Roberts and Sun 2001). Paula Barnes, Paul Roberts and Tracey Horsfall assisted with the preparation of the paper. Richard Snape made comments on a previous draft. Helpful comments from discussants at the seminar and the editors and referees of the volume of proceedings are gratefully acknowledged. Any remaining errors are mine. The view expressed do not necessarily reflect the views of the Productivity Commission.
Productivity Commission website: 	www.pc.gov.au
Productivity page: 	www.pc.gov.au/work/productivity/index.html

1.	Introduction
Australia’s growth performance since the early 1990s has been exceptional. Over the last 10 years, annual GDP growth averaged just under 4 per cent — a performance not seen since the 1960s and early 1970s. Strong growth even persisted in the midst of the 1997 Asian financial crisis and the 2001 global downturn.
A surge in productivity growth has underpinned Australia’s good performance. After showing its weakest rate in the 1980s, Australia’s productivity growth accelerated by a little over 1 percentage point to new highs in the 1990s — labour productivity growth at an average 3.2 per cent a year and multifactor productivity (MFP) growth at 1.8 per cent a year.
The much improved performance has stimulated a search for reasons. A few commentators have disputed the significance of the evidence of a productivity surge by speculating about the influence of recovery from the early 1990s recession and measurement error. But the length and strength of the productivity resurgence — controlling for cyclical influences — demand some ‘structural’ explanations. Most attention has focused on three candidates:
•	a shift in the production frontier due to the introduction of new technology — specifically information and communications technologies (ICTs);
•	a shift toward the frontier through efficiency improvements stimulated by a set of microeconomic policy reforms — ‘catch-up’ gains from firms moving toward best practice and from resources shifting to where they can be used more productively; and 
•	an increase in average education attainment and skills that would increase human capital deepening and promote innovation through the absorption and development of technologies and efficient business practices.
This paper concentrates on the first possible explanation, particularly since there has been worldwide interest in ICTs as a source of productivity growth. A comparison with US experience, using a growth accounting framework, provides the basis for assessing the contribution of ICTs to Australia’s aggregate productivity acceleration. Productivity growth and the ICT contributions to it are sensitive to cyclical effects. This study is distinguished from others by the attention paid to selection of periods that minimise cyclical effects. The paper also draws on other empirical work to briefly assess other possible explanations. 
2.		An overview of Australia’s productivity performance
Australia’s recent productivity performance needs to be set in a broad historical and international context to highlight some of the developments that should be covered in a comprehensive explanation of the 1990s surge. 
2.1	A broad sweep across countries and the decades
Australia’s rate of productivity growth was comparatively low over most of the 20th century. At the beginning of the century, Australia had one of the highest levels of labour productivity in the world (Maddison 2001), reflecting the combination of a relative abundance of natural resources and a relatively small population. Governments subsequently traded this high productivity position for nation building as, with widespread popular support, they encouraged population growth, diversification of the economic base and redistribution of income through a set of policies that (perhaps unintentionally) held growth in productivity in check.
Nevertheless, Australia still enjoyed a relatively high ranking at the start of the post-war era. In 1950, Australia’s GDP per hour was 81 per cent of the productivity leader — the USA — and it ranked 4 among a group of 22 developed or high-income countries (figure 1 and table 1). 
The next four decades were a period of catch-up to the leader and convergence in productivity levels. European countries, in particular, started to catch up and in some cases overtook the USA (figure 1).
Australia did not participate in this ‘convergence club’. Many countries also overtook Australia as it slipped further behind the USA in the 1950s and then merely maintained its position relative to the USA until 1990. Australia’s ranking slipped to 15 by 1990.
Figure 1	Labour productivity in OECD countries, 1950, 1960, 1973, 1990 and 2001
GDP per hour (US$ at purchasing power parity)
	
Source: Data sourced from University of Groningen and The Conference Board, GGDC Total Economy Database, 2002; http://www.eco.rug.nl/ggdc, accessed 7 March 2002.
A string of policy reviews in the 1960s, 1970s and 1980s attributed this relatively poor performance to highly regulated product, capital and labour markets and the inefficient provision of economic infrastructure (energy, water, transport, communications), which was dominated by government-owned enterprises operating without clear commercial imperative or performance regulation.
As a consequence of relatively poor productivity growth, Australia’s ranking on the international league table of GDP per capita also dropped — from 5 in 1950 to 15 in 1990 (table 1).  
Table 1	Australia’s rankings on productivity, average income and labour utilisationa levels among 22 OECD countries 
	1950	1960	1973	1990	2001	
GDP per hour						
	Australia’s rank	4	5	10	15	14	
	% of US level	81	75	74	77	83	
GDP per capita						
	Australia’s rank	5	7	9	15	7	
	% of US level	78	78	77	74	78	
Labour utilisationa						
	Australia’s rank	16	17	7	7	5	
	% of US level	96	104	104	96	94	
a Labour utilisation is the number of hours worked per head of total population. It explains the difference between GDP per hour and GDP per capita.
Source: As for Figure 1.
2.2	The productivity surge in the 1990s
Figure 2 shows the rates of labour productivity growth over productivity cycles in the market sector of the Australian economy. Measurement over productivity cycles — from productivity peak to productivity peak — neutralises the spurious influence of the business cycle. The latest period, 1998-99 to 2001-02, is not a complete cycle. Since productivity growth over this period cannot be taken confidently to be an underlying rate, attention is focused on the most recent completed cycle, 1993-94 to 1998-99.
The figure shows that Australia’s productivity growth rebounded in the 1990s, with underlying rates reaching record highs. The record 3.2 per cent annual average labour productivity growth in the 1993-94 to 1998-99 cycle compares with an average of 2.0 per cent in the previous cycle and 1.7 per cent over the cycles from 1981-82 to 1993-94. 
Figure 2	Growth in labour productivity over productivity cyclesa and contributions from capital deepening and multifactor productivity, 1964-65 to 2001-02 
Average annual rates of growth (per cent)
	
aProductivity cycles are the intervals between productivity peaks, as identified by the Australian Bureau of Statistics (ABS). 
b Incomplete cycle.
Source: ABS 5204.0 and Productivity Commission estimates.
MFP growth was the major contributor to improved labour productivity growth. With the rate of capital deepening stable at around 1.4 per cent a year, better MFP growth has accounted for all of the acceleration in Australia’s underlying labour productivity growth (figure 2). Record MFP growth of 1.8 per cent a year accounted for around two-thirds of labour productivity growth in the 1990s cycle. MFP accelerated from 0.7 per cent a year — the average over both the previous cycle and the three cycles between 1981-82 and 1993-94. 
The start of the surge cannot be pin-pointed with precision because of recession‑related effects. Figure 3 suggests that the Australian economy took a new growth path, based on higher MFP growth, in the early 1990s, around 1993. Even without precision, it would appear that Australia’s productivity surge pre-dated the uplift in US productivity growth from 1995.
Strong productivity growth in the 1990s fuelled relatively strong growth in average incomes and raised Australia’s GDP per capita ranking to 7 by 2001 (table 1). Australia’s level of GDP per head had recovered from 74 per cent of the US level in 1990, to regain its very long-term position at around 78 per cent by 2001.
In summary, Australia’s productivity and average income growth were relatively poor when there was a world-wide productivity boom in the catch-up and convergence era of the post-war period. Australia only started to catch up on the USA during the 1990s — a period of mixed performance across countries. The USA itself accelerated, contributing to a breakdown in convergence. Australia not only kept pace with, but exceeded, the US acceleration to record one of the highest accelerations in the OECD area (OECD 2001a). 

Figure 3	Australia’s growth path, 1964-65 to 2001-02a
Indexes 2000-01 = 100
	
a The years in brackets correspond to troughs in the business cycle.
Source:  ABS 5204.0.
The 1990s brought an important change in the industry sources of aggregate productivity growth. Figure 4 presents MFP growth rates in industry sectors over the past two aggregate productivity cycles. Some caution about the precision of industry estimates is appropriate, particularly in view of the value-added method of estimation, which has been used in the absence of data to support a KLEMS approach.
In the 1988-89 to 1993-94 cycle, there was relatively strong productivity growth in the ‘traditional’ contributors to aggregate productivity growth — Agriculture, Mining, and Manufacturing (left-hand side of Figure 4). Two other strong performers — Communication services and Electricity, gas & water — joined these traditional sectors in this cycle. Their improved performance stemmed from the major efficiencies (eg better investment decisions and reductions in excess manning) achieved in government enterprises, as well as technological advances in some activities. 
Figure 4	MFP growth in selected industries over the last two aggregate productivity cycles
Average annual rates of growth (per cent)
	
Source: Productivity Commission estimates based on unpublished ABS data.
Whilst productivity growth remained relatively strong in this most of these industries in the 1990s cycle (Mining and Manufacturing being exceptions), all these industries experienced a deceleration compared with the previous cycle. On these estimates, none made a contribution to the productivity surge from 1993-94. 
A new set of service industries emerged in the 1990s. The stand-out performer was Wholesale trade. Other service industries — for example, Construction and Finance & insurance — also increased their rate of productivity growth significantly. Because of their relative size, Wholesale trade, Construction and Finance & insurance made the most substantial contributions to the aggregate acceleration (table 2). 

Table 2	Industry contributions to the acceleration in market sector MFP
Percentage points  and per cent
	MFP accelerationa	Output shareb	Contribution	
	(% pa)	(%)	(% pt)	
Agriculture	0.0	6	0.0	
Mining	-2.2	8	-0.3	
Manufacturing	-1.5	22	-0.5	
Electricity, gas & water	-2.2	5	-0.2	
Construction	2.7	9	0.4	
Wholesale trade	8.0	9	1.1	
Retail trade	0.7	9	0.1	
Accom., cafes & restaurants	2.8	3	0.1	
Transport & storage	1.0	9	0.1	
Communications	-1.0	5	-0.1	
Finance & insurance	1.7	11	0.3	
Cultural & Recreational services	-1.7	3	-0.1	
Market Sector	1.1	100	1.1	
a Acceleration is the change in growth from the period 1988-89 to 1993-94 to the period 1993-94 to 1998-99.
b Output shares are calculated from estimates of current price value added for 1993-94.
Source: Productivity Commission estimates based on ABS data.
2.3	Key features of the productivity surge
This sketch of Australia’s productivity performance has highlighted the following key developments that need to be explained: 
•	From an international perspective, Australia’s productivity growth switched from being relatively slow over at least four decades to become relatively fast in the 1990s.
•	The acceleration in labour productivity growth came through improved efficiency (MFP growth) rather than increased capital deepening.
•	The 1990s surge in MFP growth originated in a new set of service industries, in particular Wholesale trade, Construction and Finance & insurance.
The absence of a worldwide productivity boom, the relative strength of Australia’s productivity acceleration and its starting point in the early 1990s suggest that some specifically Australian factors must form at least an important part of the explanation.
The contribution of ICTs is now assessed. There was an ICT boom in the 1990s in a number of countries, including Australia.
3	The role of ICTs in Australia’s productivity surge
ICTs are widely considered to be the major productivity-enhancing technological advance of the 1990s. Advances in ICTs have brought widespread and, in some cases, quite fundamental changes to businesses and households. ICTs have been linked to labour productivity growth through three avenues.
Increases in capital deepening. Labour productivity can rise as a result of higher capital use per unit of labour, as firms invest in more ICTs (where measurement of ICT volumes takes into account increases in quality). Many analysts have noted this mechanism affords ICTs no special qualities. As they have become cheaper, firms have substituted ICTs for labour and other forms of capital — as could happen for many other inputs.
Productivity gains in ICT production. Producers’ ability to manufacture much more powerful ICT equipment, with relatively little increase in inputs, generates substantial MFP gains. If the gains are of sufficient magnitude and production is on sufficient scale, they can show up as contributions to aggregate MFP growth.
Productivity gains in ICT-using industries. This is the more controversial source of ICT-related productivity gains. It requires that use of ICTs generates MFP gains. On the one hand, ‘new economy’ enthusiasts have pointed to MFP gains from such sources as increasing returns from ICT use and spillovers from network economies. On the other hand, sceptics have either denied or found little evidence to support the existence of MFP gains from use. 
Australia cannot access productivity gains from ICT production. The ICT equipment production sector is not of sufficient size to generate productivity gains of national significance. 
However, Australia has become a high ICT user. In 2000, Australia ranked 3 (behind the USA and Finland) among OECD countries on expenditure on ICTs as a proportion of non-residential investment — a marked step up from its 1980 ranking (OECD 2002). Investment in ICTs became a sizeable proportion of total investment in Australia from the mid-1980s.  Since then, the growth of investment has been very strong, especially in the second half of the 1990s, when investment in hardware grew by 35 per cent a year and software investment by 20 per cent a year in real terms. 
As an importer of ICTs, Australia has benefited from a sizeable terms of trade gain through the rapidly declining prices of ICTs. Strong international competition has meant that MFP gains in production have been passed on to purchasers. The Australian Treasury (2002) stated that ICT prices have fallen in domestic currency terms by 9.5 per cent a year and raised the terms of trade by 0.3 per cent a year between 1985 and 2001. Since 1995, ICT prices have fallen by nearly 15 per cent a year and raised the terms of trade by 0.75 per cent a year.
3.1	Aggregate growth accounting
A conventional productivity growth accounting exercise is now used to assess the influence of ICTs on Australia’s productivity performance. A comparison with the USA is used to infer the likely contribution of ICTs to Australia’s aggregate productivity growth.
The estimates of Australian labour productivity growth and the growth accounting contribution to it are based on national accounts data constructed by the Australian Bureau of Statistics (ABS). In keeping with modern practice, the ABS uses hedonic (or constant-quality) price deflators to estimate real volumes of ICTs produced and purchased. Hedonic prices have not been specifically generated for Australia. The ABS uses the US price deflator for hardware, adjusted for exchange rate movements and a time lag, and a price deflator for software that shows a nominal 6 per cent a year decline. The US and Australian deflators are shown in figure 5.
Figure 5	ICT hardware and software price indexes, USA and Australia
Index 1995-96 = 100
Hardware	Software	
Source: Unpublished ABS data, and BLS data.
There has been a string of US studies of ICT contributions to productivity growth. For brevity, however, this paper focuses on comparisons with the USA, based on Bureau of Labor Statistics (BLS) data. Using BLS data brings two advantages:
•	the ABS models its methods closely on BLS methods, and this enhances comparability; and
•	access to the BLS dataset assists flexibility in choosing periods for comparison.
A capital services measure of capital input is used and labour input is measured by hours worked. US studies also include a labour composition or ‘quality’ component, but this component cannot be estimated on a comparable basis or for the entire period for Australia. Consequently, this component is added back into the US MFP growth estimates presented below to assist comparability with Australian estimates.
There was a big step up in contributions from ICT capital deepening from 1995 in the USA and Australia (figure 6). The timing and strength of the ICT capital deepening contributions in the two countries are remarkably close.  This suggests that there have been similar rates of increase in ICT use in the two countries and supports the validity of using the USA as a comparator for the assessment of the impacts of ICT use in Australia.
Figure 6	Contributions of ICT capital deepening to labour productivity growth in the USA and Australiaa, 1961 to 2002
(Percentage points)
	
a Years refer to 12 months ended 30 June.
Source: Productivity Commission estimates based on unpublished ABS data (to 2001-02), and BLS data (to 2001).
Our work at the Productivity Commission has paid particular attention to selection of periods that identify underlying rates of productivity growth. Focus on underlying trends, rather than pre- and post-1995 rates of growth, presents a departure from nearly all other previous Australian and US studies.
It is not surprising that most studies have used 1995 as the dividing year between periods for comparison of productivity growth and ICT contributions to it — for example, accounting for productivity growth in the second half of the 1990s (1995‑99) compared with the first half (1990‑95). The 1995 year corresponds to the take-off point in more rapid advances in ICT technology, declines in ICT prices, growth in investment in ICTs and, as just seen, growth in ICT capital deepening. Using 1995 as a break point between periods therefore highlights the ICT takeoff and its effects.
But using 1995 as the break point creates problems in identifying and accounting for underlying rates of productivity growth. US labour productivity was in a trough in 1995, at a point below trend  (figure 7). Estimates of average growth from 1995 to the end of the 1990s are from a trough to a peak and therefore overstate the underlying rate of labour productivity growth. Moreover, the size of the estimated labour productivity acceleration is quite sensitive to minor variations in period selection around 1995 (Parham, Roberts and Sun 2001). 

Figure 7	Identifying peaks in US and Australiana labour productivity
Index 1996=100
United States	Australia