Productivity vs population in driving the US and Australian economies

The strong post-COVID rebound in the US economy has been driven by stellar productivity growth, while Australia has continued to rely on strong population growth to prop up activity. Strong US productivity reflects firms investing more to keep their workforce well-equipped and to remain at the cutting edge of technology, with Australia lagging on both counts. The growing public sector has been a recent drag on total Australian productivity, although other factors are also at play, where persistently weak productivity growth in the non-mining private sector might be hard to turn around.

CCI recently analysed the economic performance of the US, the euro area and Australia through the lens of labour productivity, extending the work by exploring whether the public sector is to blame for Australia’s poor productivity performance.

Labour productivity – which is measured as output per hour worked – is a key contributor to several important economic variables that influence financial markets, with the Riksbank recently putting it neatly by noting that,

“Productivity is crucial for a country’s prosperity and GDP growth. Weak GDP growth and high levels of public debt may require tough priorities to be set and lead to a failure to make necessary investments. … In the shorter term, there is a link between productivity growth and inflationary pressures in the economy. From a longer-term perspective, productivity is also important for monetary policy as it influences the long-term growth rate of the economy, which, in turn, influences the normal level of the real interest rate.”

Closer to home, the RBA has regularly emphasised the importance of productivity to inflation, stressing earlier this year that,

“ … if you want inflation at around about 2½% and you get productivity [growth] of about 1%, then wages can rise by about 3½%. But, if you don't get the productivity growth, then they’re not necessarily consistent.”

From this perspective, we first examined how economies have recovered from the world-wide COVID recession of 2020.

Strikingly, the US and Australia have both rebounded strongly and are back growing in line with their simple pre-pandemic trends. This contrasts with the euro area, whose economy has staged only a weak recovery from the pandemic.  

However, the US and Australian recoveries have been driven by different forces, with the US economy propelled by strong productivity growth and Australia riding on continued strong growth in its population. The euro area has lagged on both fronts, with slow growth in its population and poor productivity.  

Australia’s reliance on strong population growth is nothing new, as its population has expanded at a faster rate than most advanced economies for decades.

In terms of comparable-sized advanced economies, only Canada has posted faster recent growth than Australia, with Australia mostly surpassed by rapidly-growing emerging market populations in Africa and the Middle East.

Historically, the US population also grew at a faster rate than many other countries, but its growth has slowed recently. The euro area has been at the other extreme, with growth in its population nearly always lagging most other advanced economies.  

There is nothing wrong with population-driven economic growth, but it can cause problems if infrastructure and the like fail to keep pace.

For example, Australia is not building many homes despite strong migration, such that an inflexible supply of housing has underpinned extremely high house prices.

Productivity-driven economic growth is more beneficial and the US experience of recent years has been outstanding, with labour productivity growing more quickly than its simple pre-COVID trend.

Moreover, the US has left both the euro area and Australia well behind, with labour productivity stagnating for the past five years in the euro area and for the past eight years in Australia.  

Analysing the drivers of productivity, most of the difference between the US and the euro area and Australia is due to American firms investing more to well-equip their workforces and investing in, and adopting, technology.

The first point is captured by the rising ratio of the capital stock to the hours worked by American employees, while the same ratio has broadly stagnated in the euro area and Australia, with European and Australian companies only investing enough to keep pace with growth in their workforces.

The second point is harder to gauge, but using total factor productivity as a measure of technological progress, the US represents the technological frontier for the world. Use of technology in the US has grown strongly, while it has increased in the euro area at a slower rate and languished in Australia.  

These two points are brought home by the divergence in private-sector investment in computers, software and research and development, where the US leads the euro area by a large margin and Australia is a long way behind.  

Concentrating on Australia’s poor productivity performance, we next assessed the widely-held view that the public sector is responsible for this weakness.

This involved estimating the relative contributions to labour productivity from the mining sector, the non-mining private sector and the public sector.

The public sector was broadly defined as the public administration, health and social assistance, and education industries, while total productivity was tweaked to ensure the additivity of the results.[1]

Like other countries, the public sector has grown in importance over time reflecting increased demand for health and aged care services and it now accounts for over 30% of total employment.   

Labour productivity varies considerably across industries, but has been little changed for many years in the public sector.

Using a shift-share methodology developed by the Fed, our calculations suggest that it is correct to say that the public sector has contributed to the recent weakness in total productivity.

However, the story is more nuanced, in that the mining sector has also subtracted from overall growth in productivity, along with more workers taking jobs in low-productivity industries in the public and non-mining private sectors.

The non-mining private sector has added to productivity growth, albeit at a slower rate than in recent decades, as has more workers taking jobs in the high productivity mining sector.  

Slower growth in the non-mining private sector may seem surprising, but the level of productivity has stagnated across several key private sector industries, such as financial services (mainly the banks), manufacturing and construction.

This weakness predates COVID and could be hard to turn around, although artificial intelligence will likely boost productivity over the coming years.