In worrying about productivity growth, the RBA has strayed beyond its remit
It’s official: the Reserve Bank of Australia will have its board split in two, and two new appointees will join the reconfigured monetary policy board, whose job it is to make decisions on interest rates. The move was recommended by an independent review panel in 2023. The new members of the monetary policy board, one a former top banker and the other a senior academic economist, were chosen after bipartisan consultation.
In making his announcement, the treasurer Jim Chalmers said that Marnie Baker and Renee Fry-McKibbin would balance the experience of existing members with “fresh perspectives”. That the RBA needs fresh perspectives is surely not in doubt.
The recent national accounts showed an Australian economy on the precipice. GDP grew by just 0.3 per cent in the third quarter of this year, and just 0.8 per cent over the past twelve months. Thirteen interest rate rises have dramatically reduced private sector demand and investment. As Greg Jericho noted in The Guardian, were it not for public spending, ‘we would now be in a recession and close to 100,000 more people would be out of work.
Not even those figures were enough to move the bankers’ hearts. In its announcement of another rate hold in early December, the existing RBA board said that ‘underlying inflation is still high’ and ‘labour market conditions remain tight’.
Productivity
Another recent statistic clearly caught their eye. Labour productivity – measured in GDP per hour worked – has been looking especially bad lately.
On the face of it, they look worse than in the depths of our last major recession in the early 1990s. In the year to September 1991, labour productivity actually grew by 3.6 per cent. By way of comparison, our labour productivity declined by 0.8 per cent over the last twelve months.
The RBA has been watching those figures carefully. In February, the board poor productivity growth alongside persistent inflation and weak consumption as the most ‘material risks’ to Australia’s economy. In May, they put it more explicitly:
A higher cash rate might also be required, even with ongoing weakness in aggregate demand, if other factors slowed the pace of disinflation. […] this could occur if trend productivity growth turned out to be weaker than assumed, unless wages growth were to moderate in response.
Clearly, they are keeping these figures in mind when they make decisions about interest rates. There are several reasons why they shouldn’t do this.
Imperfect Measurements
First, productivity is notoriously hard to measure. Aggregates of labour productivity are simple enough, but when capital stocks, technological growth and improved managerial practices are part of the equation, it can get messy. As David Peetz recently noted, ‘estimates are highly creative’ and the ‘potential for error is huge’.
Second, it’s a pretty unreliable indicator for short-term decision-making. It can be wrapped up in various layers of meaning and deployed to justify all kinds of decisions. At the February meeting of the board, talk turned to the ongoing effects of the pandemic and the rise of AI on productivity growth, but the only available conclusion was that it was ‘too soon to determine’ these things.
Economists often cite a famous quote from Paul Krugman, who said that ‘Productivity is not everything, but in the long run, it’s almost everything’. But in the short run, productivity is hard to calculate, let alone explain. Adam Smith said as much in his classic treatise The Wealth of Nations – and that was back in the 1770s.
Third, as Saul Eslake (no bleeding heart on these matters) has noted, aggregated national figures ‘cannot be used for comparing levels of labour productivity across different industries, or across states and territories’. According to the Productivity Commission, Australia’s recent average was dragged down largely by the retail, administrative services and education sectors.
Commentators have recently slammed the state of Victoria for its high employment in low-productivity industries like hospitality, healthcare and retail. It’s a facile way of understanding work and output in a modern services-based economy. Do we want people to lose jobs in these sectors? Surely not.
What about Jobs?
Whenever we talk about productivity, unemployment is the elephant in the room. In good times, a firm can expand productivity through capital investment and without shedding labour. In hard times, that’s difficult to do.
Those productivity rates from 1991 look pretty good, certainly by the much poorer standards of recent years. But if you zoom out, you also see a level of unemployment that was unsustainable, and painful for those it affected.
Instead of keeping staff on their books for as long as possible (‘labour hoarding’, as economists call it), firms instead sacked workers in their thousands and gave the Australia an unemployment rate of 12 per cent by 1992. Productivity grew because there were fewer people working.
There is a clear trade-off to be made between reduced productivity and low unemployment in the short term. Recent analysis by KPMG points to the fact that we have a ‘tight labour market’ and high participation rates. This means that there are plenty of low-skilled workers who have come in from the margins of the labour force, and who ‘require additional support to be as productive as other employees’. We need these workers, and their training today is our national productivity tomorrow.
Focus on Full Employment
Productivity growth isn’t in the RBA’s formal remit and never has been. By law, its mission is to work for the ‘greatest advantage of the people of Australia’ to ensure a stable currency, full employment and ‘economic prosperity and welfare’.
Its mission has evolved over the years to meet the needs of a more internationally exposed and financially deregulated economy. Since the mid-1990s, its prime mission has been that of inflation targeting, managing demand to keep price rises somewhere in the order of 2 and 3 per cent.
That mission hasn’t always led to popular decisions. The public have often bemoaned interest rate rises, as have the politicians who bore the electoral cost. In recent months the board has taken that aspect of its mission to extremes. But at least it’s part of their job.
As former minister Craig Emerson rightly says, the RBA has been creating ‘misery for vulnerable working Australians and small business owners that is entirely avoidable’. The new appointees will succeed if they ask bold questions and challenge the predominance of unhelpful indicators in the board’s discussions. The time has come for the RBA to put productivity figures to one side and stick to the script.
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