Does Productivity Growth Confirm Queensland as the Smart State? (2003)
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A long overdue breakthrough has been reported in the analysis of productivity gains within the Queensland's economy.

A government report shows that Queensland's productivity growth is almost double the national average. It is not just retired people who come to Queensland according to Treasury Department director of economic policy, Christine Williams. Over the past 15 years, Queensland with 18% of Australia's population created 25% of the nation's jobs. Labour productivity increased at an average 3.4% pa since 1995-96 compared with a national 2% average. A 5% pa economic increase over the period had been partly driven by 1.8% pa population growth. Productivity gains came in many sectors - (manufacturing, services, mining). Multifactor productivity (a broader measure of efficiency gains) averaged 1.6% pa growth over 15 years - compared with 1.2% national average. Queenslanders have been working smarter rather than harder. This confirmed the benefits of smart state policy of focus on education, technology and innovation. Research was reported in report prepared with University of Queensland economics school head, John Foster. Business R&D spending growth had helped increase productivity. Most of the difference in per capita output between NSW and Queensland could be explained in terms of lower levels of completion of year 12 education (Wisenthal S., 'Qld basks in its zestful youth', FR, 29/8/03)

This is very significant because politically-sensitive economic analysts (especially the state Treasury) have long resisted any examination of Queensland's weak per-capita production and instead pointed to a high overall rate of growth by national standards. The poor quality of that growth - which seemed likely merely to reflect rapidly increasing inputs of labour (due to population growth) and capital (associated with a high rate of investment in often low value added functions such as tourism and capital intensive mineral processing) - was discretely ignored.

New Analyses

The above media report appears to be based on a new and substantial analysis, Productivity and Regional Economic Performance in Australia, as well as on Drivers of Economic Growth in the Smart State which outlines a Treasury view of the significance of the former analysis for Queensland economic policy. Both of these documents recognize the need to do more than identify increases in aggregate output.

Amongst the significant points raised in the above analyses (which are outlined in Attachments A and B respectively) are that:

However there is a need for caution in assessing claims that Queensland has achieved above-national-average productivity gains in recent years, for reasons suggested below.

About Credibility

In the first place there is a history of presenting questionable data in order to enhance Queensland's public finances. For example:

Moreover, Queensland now has a strong financial motivation to gain an understanding of the drivers of productivity gain, because:

Thus there remain financial incentives to reach favourable conclusions (even if they are not quite economically realistic), because in negotiations about Queensland's share of Commonwealth funding Queensland would be able to argue that it can not be expected to take responsibility for doing anything about its unproductive economy and weak tax base if:

The latter completely ignores the difference between correlation (ie two phenomena occur together) and causation (one of those phenomena causes the other). This is significant as an economies' ability both to generate high value-added and to provide jobs for relatively more people who have completed secondary education is driven by its level of economic development (eg access to strategic information, sophisticated economic organization). PREPA endorsed a neo-Schumpeterian explanation of growth - which basically relates growth to the quality of enterprising leadership.  Employing more people who completed secondary school will not cause a more knowledgably and commercially skilled business leadership or higher level of economic development (ie better support to enterprise leaders), though it may correlate with them.  What is mainly required to raise productivity (and is not available in Queensland's branch-office / small business economy) is top-level knowledge and skills.

Public policy must do more than give a good impression. It must be realistic.

Australia's 'Golden' Economy

Despite claims of an economic miracle, Australia's national economic growth and productivity performance, which PREPA uses as the standard for assessing Queensland, does not seem to have been strong by international standards (see comments on Impact of Economic Liberalism in Australia).

In particular the supposed high rate of growth measured in $A must reflect (to an unknown but perhaps significant degree) the steady devaluation of the $A for many years against the $US in which most commodities (Australia's largest exports) tend to be priced. This shift devalued Australia's existing production which allowed a quite misleading impression of solid economic and productivity 'growth' for a time (especially in export linked functions) as its real international value was simply restored.

Example: Suppose goods and services with a value of A$100bn (initially $US75bn) are produced, and then, through devaluation, those goods and services are declared to be worth $A100bn ($US50bn). However the fact is that they are still worth exactly what they were in $US - and as they are bid up to that value it appears that the economy and especially 'productivity' is growing rapidly in $A terms.

Qualification: The author has not undertaken a detailed analysis of this effect - which would be quite a complex process (and neither, apparently, has anyone else). Thus all that can be said with confidence is that the actual impact is unknown (but possibly significant).

Needless to say, as Australia's exchange rate subsequently strengthened this effect would have been reversed - and a dramatic slowdown in productivity growth occurred in the first few years of the 21st century.

The emergence of commodities demand from China which significantly improved Australia's terms of trade [1] (ie the value of traditional exports relative to imports) would also have contributed to a 'free ride' increase in measured productivity levels.

Queensland's 'Superior' Productivity Performance

Queensland's economy (which is more highly commodity-export oriented) would have benefited more than the national economy from the distorted perception of rapid economic and productivity growth that ongoing devaluation and changes in the terms of trade created over many years. Furthermore:

Assume that:
  • effective $A devaluation against $US is 40% over 10 years;
  • commodity exports comprise 10% of national and 20% of Queensland production at start of the period;
  • 10% of the cost of any commodity export is imported; and
  • real total factor productivity (TFP) growth  was calculated to be 1.2% and 1.6% pa respectively (ie growth in the value of production not due to increased inputs of labour and capital or to inflation)

After 10 years:

  • national production (corrected for labour, capital and inflation increases) would have risen 12.7% - but 6.0% (ie 90% x (10% / 0.6 - 10%)) of this would be due to devaluation  - resulting in a corrected TFP growth estimate of 0.65% pa (rather than 1.2% pa).
  • Queensland's corresponding figures would show a rise in state production of 17.2% over 10 years - but 12.0% of this would be attributable to devaluation - resulting in a corrected TFP growth rate of 0.5% pa (not 1.6% pa).
Note: TFP growth calculations in PREPA (Section 5) include an allowance for changes in the terms of trade by revaluing exports using imports' price deflator to provide a measure of purchasing power of exports over imports - and substituting this value for actual constant price value of exports in developing real GDP. In practice for Queensland this adjustment increases the TFP growth estimate by 0.3% pa.

However allowing for changes in the terms of trade does not adjust for effect of devaluation, as the latter would cause $A prices of both imports and exports to go by about the same percentage (because they are international prices). To adjust for the effect of devaluation on GDP / GSP it could be more relevant to revalue exports, not in terms of import prices, but in terms of costs of domestic inputs.

Moreover Queensland's economy has been stimulated for several years by high levels of public spending associated with stripping state financial assets - and this will tend to result in an over-estimate of the value of production (except in the unlikely event that allowance for the erosion in the value of state financial assets has been made in assessing state product). Furthermore Queensland's past economic arrangements are not sustainable (see The Need to do better) because, for example :

The perceived higher productivity growth has been suggested to constitute proof that Queensland's Smart State program is a success. However it can be noted that:

Detailed Comments - INCOMPLETE

nb re productivity study qld - issue is ability of people to be productive

Australian Institute for Commercialisation seeks to develop process for commercialisation of research - which is something like what is wanted but it may take a research-push rather than market-pull approach to development of the innovation system (ie develop means to commercialize research, rather than develop an economy where innovation is central, and then networks to R&D are available). The difference in terms of growth potential and productivity will be huge.  It seeks to develop separate fragments of a commercialization capability - which will not ensure that they work as an integrated whole. This is similar to endless 'missing strategic factor' theories that do not result in components that 'fit' into the economy in an appropriate way.

Innovation primarily derives from market demand - not from R&D.

this is issue that should have been (could have been) accommodated in 1980s. The question of what has happened in leading economies in the 19990s has not yet started to be addressed.

no mention at all of competitive advantage as business consideration - productivity as value added not efficiency. Productivity definition leaves a great deal to be desired (as rate at which inputs are transformed into outputs) where key to productivity in a competitive market is competitive advantage - not output / input ratio. Competitive advantage is a transitory factor.  In so far as efficiency contributes to productivity it is the rate of gain inefficiency which matters. Differnce in business strategists viewpoint

if this analysis was complemented by serious business-like analysis of Drivers of Economic Growth then a reasonable basis on which to develop policy might be available.

 

the effect of knowledge on changing the production function is the link between equilibrium analysis and evolutionary analysis - and most NB in terms of policy - because the relationships within the production function are embodied in real relationships within the economy - and unless these are integrated then the economy does not work. The analysis in terms of inputs entirely misses the most critical element of what is required for real-world progress.

can not develop models for productivity growth if do not understand that structural incompatability in global economy makes continued growth essentially impossible - what will work in new environment?

proposals related to growth theory are that government should do things that it cannot do - anticipate risk and how it might be reduced - and adapt regulation for maturity of industry (which can never be known).

what is needed now is complementary examination of same issues from business-strategy viewpoint - then there might be some value in conclusions

Driver comments -

September 2003

Attachment A: Outline of  Productivity and Regional Economic Performance in Australia - PREPA
(Williams C., Draca M. and Smith C. (eds), August 2003)

1 Introduction (Louca J) - Queensland's impressive growth over the past decade has motivated the Drivers project. Main focus is on productivity. Economy can grow by more inputs or by productivity (ie the rate at which inputs are transformed into outputs). Productivity is the main source of economic growth. It allows producers to raise supply without raising costs. It is central to policy priorities of Queensland Government. Productivity growth is driven by efficiency and by technological advances. Capital deepening increases labour productivity. In 1980s emphasis was on market liberalization to raise efficiency - and in 1990s attention turned to innovation and human capital. Micro-economic reform has slowed - and been criticized as inadequate. The OECD has highlighted importance of innovation and human capital. This document breaks new ground in examining interstate differences in productivity. Differences in per capita incomes prompted some authors to study convergence - which suggests that developing economies face higher returns to capital and so should grow faster. The work draws on small group of economists - and on economics literature.

2. New Growth Theories and their Implications for State Government Policy Makers (Foster J). Two growth theories have become popular in 1990s - endogenous growth theory which evolved from Solow's Neo-classical growth theory' (which draws on equilibrium analysis) and neo-Schumpeterian growth theory (which draws on an evolutionary economic tradition).  Endogenous growth theory is based on the view that growth is due to factors within an economy - rather than technological change from outside as had been the neo-classical view.  Romer formalized the process of invention and innovation. He argued that ideas emerge from R&D. The model involves three sectors - final goods; intermediate goods; and research. Human capital is seen as input to production function rather than labour. The model is limited because it deals with equilibrium outcomes, not processes. Schumpeter emphasized emotional dimension of behaviour of entrepreneurs. Endogenous growth theory builds from the idea that a production function can summarize the supply side - and growth occurs because the function moves over time. The neo-Schumpeterian approach concerns ongoing dynamic processes. The process is not seen to be uniform - and variety is the source of growth which lead to cascades of innovations which are subjected to competitive selection. The growth process is primarily endogenous - and many of the factors highlighted in endogenous growth theory are incorporated.  A crucial difference is that neo-Schumpeterian theory embraces uncertainty at the start. A very specific set of knowledge is required to understand each sector and regions growth - not general principles. Neo-Schumpeterian theory is more helpful. Endogenous theory stresses dealing with market failure - while neo-Schumpeterian perspective stresses wider role for government in relation to uncertainties people face. The goal is to anticipate emerging uncertainty and make risk quantifiable. There is a need for attention to process of destruction as well as creation. There should be a focus on regulatory innovation, rather than deregulation.

3. Variations in Economic and Labour Productivity Growth among the States of Australia: 1984-85 to 1998-99 (Nguyen T, Smith C and Meyer-Boehm G) - considers per capita income convergence across states - and finds evidence of divergence which disappears when allowance is made for labour force participation

4. Economic Growth Performance of the Australian States and Territories: An Extended Shift-Share Analysis (Smith C and Nguyen T) - Queensland had an industrial structure conducive to below average growth - but had regional advantages in the faster growth of those industries which it did have.

5. Multifactor Productivity and Innovation in Australia and its States (Louca J) - States with the highest overall growth also had highest multi-factor productivity (MFP) growth. MFP contributed 30-80% to per capita incomes - depending on terms of trade and demographics. Interstate differences in capital deepening have masked an underlying process of MFP convergence across states.  Queensland, with high jobs growth, has experienced less capital deepening. States with the highest innovation indicators experienced highest MFP growth.  Stronger jobs growth in Queensland requires higher investment relative to other states. Fast growth in business R&D is seen as accounting for higher MFP growth - but there is still a need for adaptation.

6. Recent Convergence Behaviour of the Australian States: A Time Series Approach (Bodman P, Draca M and Wild P) - Examines tendency for differences in per capita output levels to stabilize. They argue that a stable gap now exists between NSW and Queensland - requiring investments in human capital that raises rate of technological progress.

7. Human Capital Investment and Economic Growth in the Australian Economy (Draca M, Foster J and Green C) - Evaluates how investment in human capital contributes to state economic growth. Particular emphasis is placed on the composition of human capital. Queensland is found to have a great deal to gain by raising its human capital stock. It is concluded that human capital (not attracting physical or financial capital) should be the basis of policy and that comprehensive early childhood programs are needed.

Unless have a developed economy - all that will happen by such investments is brain drain.

Comments:

 

Attachment B: Outline of Drivers of Economic Growth in the Smart State (Queensland. Treasury, August 2003)

Securing Queensland's Future: Improved economic performance is one of five key government priorities. Sustainable economic growth supports industries which create employment, provides the tax base for improved public services and allows engagement in higher order activities. The Drivers of Economic Growth project (undertaken with Griffith and Queensland Universities) aimed to improve performance in: providing public services; providing infrastructure and facilitating public involvement; regulation; supporting innovation and industrial development; and developing human capital. This paper reviews PREPA, and considers the policy implications.

The Importance of Productivity Growth: Economic growth is seen as a measure of a region's performance - but this can come from increased inputs (of labour, capital, resources) or of increased productivity. Growth associated with increased inputs may be beneficial - but is seen as unsustainable (eg due to environmental constraints). Problems arise from the framework - international systems of national accounting which may give rise to ambiguities between economic and other goals. Improved productivity growth (eg by enhanced services delivery, natural resource efficiency) is preferred. Key drivers of productivity growth are: increased capital (in firms and infrastructure); improved efficiency; and technological progress (innovation and human capital improvements). Productivity improvement is more important due to: aging population; low savings rate; and environmental constraints. More research is being undertaken through Intergenerational Research project.

Main Findings of PREPA: Queensland has experienced faster than national average economic growth for 15 years - and the project was to identify factors involved. Interstate differences in productivity determinants which have influenced growth include: educational attainments; R&D; industrial structure; and micro-economic reforms. NSW, Victoria and WA have higher levels of per capita income than others. Two measures of productivity are assessed - mutli-factor productivity (which measures output per joint unit of labour and capital - and is driven by increased efficiency and technological progress) and labour productivity which measures output per hour worked (and is driven by both additional capital and MFP growth). Queensland had highest rate of output growth of any state over 15 years reflecting rapid growth of labour resources, and higher productivity growth (with MFP explaining 20-45% of economic growth and 30-80% of growth in per capita income). Queensland improved its per capita income position amongst states from 6th in 1945-85 to 4th by 2000-01. The convergence hypothesis suggests that economies with lower per capita incomes should catch up - because they have higher earnings on capital employed. General convergence across Australian states has been weak. Low income states had faster MFP growth - but did not converge in capital / labour ratios (eg WA experienced capital deepening - while Queensland with rapid population growth had a slower rate. Though Queensland had less reliance on those industries which were fastest growing nationally, this was more than offset by faster growth in most industries than in the same industries nationally. Key drivers of technological progress (innovation and human capital) have driven interstate differences in productivity growth and per capita income levels - eg business R&D growth explains 75% of variation in MFP - and Queensland and WA with fastest business R&D growth have also had fastest MFP growth; human capital differences explain 87% of per capita output differences between NSW and Queensland - especially secondary level completions (with Queensland's GSP potentially being about $14.7bn higher given similar human capital to NSW).

Queensland's sound economic and fiscal environment: Future growth depends on increasing productive capacity - eg by fostering innovation and improving human capital. Policy needs to create an environment in which economic choices can be made with certainty. This is consistent with Government policy stance in 2003-04 budget. In addition to directly promoting productivity government needs to focus on infrastructure and capital investment.

Ensuring an appropriate infrastructure base: Queensland faces challenge of capital deepening in face of rapid employment and population growth. This is mainly challenge for private sector which met 80% of investment - along with public enterprises operated on largely commercial lines (8%). However governments role is to promote certainty -as well as efficient tax and regulatory framework. Government also funds infrastructure directly - and has the highest per capita capital expenditure of any state. The state infrastructure plan details 'hard'; 'smart' and 'soft' infrastructure. The government is also fostering innovative ways to increase private involvement - via PPPs.

Efficient government service delivery: This is reflected in Charter of Social and Fiscal responsibility principles - and also recent Aligning Service and Priority process. Smart Service Queensland has also been developed - for whole of government integrated services for those doing business with government. PREPA shows clear link between stable, supportive environment and specific policies to promote productivity. Queensland's economic strategy is aimed at raising the productive capacity of its labour force and industries - so productivity growth can lead to higher levels of sustainable growth. Sound economic fundamentals are complemented by a Smart State Strategy that fosters innovation and invests in human capital - which are the prime drivers of productivity growth in a service based economy. Sound economic fundamentals are the basis of the strategy. Fostering innovation is the heart of Smart State strategy - which involves providing R&D infrastructure; public private partnerships to commercialize public sector innovations; and ensuring environment that supports innovation. Enhanced human capital is also central to Smart State strategy.

Application to industry policy: PREPA showed that though Queensland is less reliant on industries that grew fastest nationally, it had faster growth in most industries - and so outpaced national growth over the past 15 years. This suggests that, as well as developing new industries, the main source of economic growth has been traditional industries. Queensland's investment attraction program also aims to promote general growth in skills and productivity. PREPA  suggests that Queensland industries have been successful in adapting to changing circumstances (eg micro-economic reform; ICT revolution; export markets). This suggests the need for market-oriented policies that assist firms to meet threats and take advantage of opportunities. PREPA suggested three examples: (a) regulatory innovation - as distinct from deregulation (noting that pro-competition regulation may hamper new industries, but be essential in mature sectors); (b) assistance to firms should focus on capacity building - by improving access to technologies. organizational advice and R&D assistance. This is focus of Queens;and's industrial development agencies - especially for ICT (c) adjustment assistance should compensate employee for loss of specific human capital - and support re-skilling. An example is Breaking the Unemployment Cycle initiative - which includes Worker Assist Program - an early intervention employment program for those involved in large scale retrenchments

Fostering Innovation: PREPA highlights the importance of innovation (the process of converting ideas into valuable goods or services) to growth. This occurs in both private and public sector. Government provides support in terms of: environment facing innovators; institutional capability of innovation system (eg availability of infrastructure, skills, collaboration opportunities); innovation culture. PREDA emphasizes supporting each stage in innovation process. Queensland government has invested heavily in R&D - and R&D spending by business, higher education as well as government has increased faster in Queensland in decade to 2001-02 than in other states - partly because the base was relatively small. PREPA suggested that 60% of labour productivity growth could be explained by interstate differences in growth of business R&D. High returns (200%) from increases in business R&D were demonstrated. Government's innovation strategy focuses on developing R&D infrastructure base, and acknowledging importance of innovation to productivity Two major initiatives are (a) BioIndustries Strategy (especially Institute for Molecular Bioscience) (b) Smart State Research Facilities Fund. PREDA stresses the importance of commercialization. Patent counts are an indicator of this - in which Queensland has done well by national standards in recent years. Start up firms are another indicator of entrepreneurship - and Queensland records 12% of adults participating compared with 8% nationally.  Policies to boost commercialization have involved: Cooperative research Centres; Innovation Start Up Scheme (to provide seed funding); Biostart program (funding proof of concept); Commercial incubators; and support for Australian Institute for Commercialization. Technology diffusion is also critical given that Australian innovation often derives from R&D conducted elsewhere - and mainly requires good business environment, intellectual property protection and availability of skills and information. Trade flows (which are strong for Queensland) are also a good source of technology diffusion. Government is supporting technology diffusion in industry clusters related to e-security and e-learning. Also QMI is nationally recognised for provider of technology diffusion services - and world class manufacturing, applied research and advanced technical training. Queensland the Smart State - Investing in Science, Research and Innovations details investments over the past 5 years - and also suggests a future 4 year strategy - related to research (medical, biodiversity and micro0-technology); tropical marine science; clan coal technology; e-health and e-security; supercomputing; business incubation; skills development; knowledge industries / community precinct; sports science

Education Training and Human Capital: This has been increasingly seen as important, and PREPA estimated that 87% of difference in GSP per capita between Queensland and NSW could be explained in terms of human capital (ie knowledge, skills and attributes available to workforce. Innovation adds to human capital - and human capital affects productivity growth through its effect on innovation. Investment in human capital is core part of Smart State strategy. PREPA recommends various keys to human capital development: early childhood education; secondary level completion. These issues are being addressed by 2010 State Education Strategy, and Education and Training Reforms for the Future package. Employment programs are also part of governments human capital strategy - under Breaking the Unemployment Cycle which focuses on disadvantaged job seekers. It has been extended with additional apprenticeships, traineeships and job placement opportunities.

Intergenerational Research Project: The effect of demographic change needs to be considered - given aging population. Research shows importance of productivity growth and workforce participation

Meeting Queensland's Future Challenges: PREPA identified factors likely to drive Queensland future growth. Other issues include: aging population; globalization; and changing industry structure. This is being addressed through proactive strategy planning. Human capital programs and development of more diversified economy are emphasized. Smart State strategy aims to continue economic diversification by supporting new technologies and skilling individuals. Two additional components include: intergenerational project, and further detailed research on improved productivity.