Productivity Commission

The COVID-19 recovery: A view from the supply side

Speech

Chair Michael Brennan provided an online briefing to the Australian Business Economists on 23 September 2020.

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In 1977, James Tobin quipped that: ‘It takes a heap of Harberger triangles to fill an Okun gap’. What did he mean by this?

To take you back to introductory micro, a Harberger triangle is the deadweight loss in a partial equilibrium diagram — the efficiency loss due to a resource misallocation, usually due to a distorting policy (say a tax or regulation).

An Okun gap — to take you back to introductory macro — is the inefficiency due to the gap between actual and potential output — a consequence of inadequate aggregate demand in the Keynesian tradition.

Tobin’s point was that the inefficiencies from resource misallocation are pretty minor when you compare them to the consequences of a lack of aggregate demand.

Especially when you are in a recession.

As Paul Krugman put it:

… even bad microeconomic policies, which lead to substantial distortions in the use of resources, have a hard time doing remotely as much damage as a severe economic slump, which doesn’t misallocate resources – it simply wastes them.1

What does this imply for policy?

One interpretation is that when times get tough, macro dominates micro: the policy focus should be on getting demand stimulus out there, and you should worry less about whether you are causing inefficiencies or distortions in the economy along the way.

A variation on the theme would be: now is not the time to worry about distortions and inefficiency: deal with the aggregate demand crisis now, and save micro-economic reform for another day — once the recovery has been secured and life returns to some semblance of normality.

I am going to put to you an alternative view. Not because I think aggregate demand is unimportant – it’s fundamental; but it’s a necessary not sufficient condition for recovery.

My contention is that supply side policy is an important enabler of the recovery, without which demand-side stimulus is incomplete or compromised in its effectiveness. We need to take the supply side seriously.

It’s not so much about Harberger triangles — it’s more a dynamic view about the speed with which the economy can move from one state to another and how we minimise the frictions along the way. Think of it as the micro foundations of the macro recovery.

There are three main reasons why we should focus on microeconomic policy even in the midst of a recession.

  • First, because the COVID pandemic is, among other things, a reallocation shock
  • Second, we face a particular challenge around new business formation and risk appetite, and
  • Third, because a strong microeconomic lens can help us build resilience and protect against bad policy.

The reallocation shock

It’s natural to track the recession and recovery by following the trajectory of GDP(E) and its components.

But as we know, even as GDP(E) starts its climb back toward its March quarter levels, the underlying composition of the economy will have changed.

GDP(P) will look different, and beneath that, so will the constellation of firms, employees, suppliers and customers; so will the deployment of physical and financial capital across the economy, the use of land and even the use of that other finite resource — time.

Because COVID is a reallocation shock, as well as a demand shock. It is a reallocation shock partly because of the inevitably staggered lifting of restrictions. Some industries won’t be back for some time. And there is also the likelihood of enduring changes in consumer and business preferences, possibly in sectors like retail, travel, office accommodation and aviation.

Of course reallocation occurs all the time — even in times of relative macroeconomic stability but there is some evidence that it could be more salient in a recession like this one.

Economists Nicholas Bloom, Steve Davis and Jose Barrero2 tried to quantify the extent of possible reallocation through the pandemic in the US, by analysing forward-looking expectations data from firms. They calculated a metric that combined the expected gross increase in hiring by growing firms, plus the expected gross job shedding by shrinking firms (the majority) and comparing it to the absolute value of the net change.

This provides a sense of the gross flows relative to the amounts required to give effect to the overall net change in employment. They found that this metric more than doubled in the early months of the pandemic, compared to its pre-COVID average.

In other words, firms were collectively anticipating much greater reallocations of labour across the economy compared with the pre-COVID period.

Such a reallocation process is never frictionless. When looking at past shocks, they noted that there can be a lag between the destruction side of the reallocation process and the creation side. As they put it:

Reasons for the delayed creation response include the time needed to plan new enterprises and business activities, the time required to navigate regulatory hurdles and permitting processes to start or expand businesses, time to build in capital formation…and search and matching frictions in forming new relationships with suppliers, employees, distributors and customers.

These practical hurdles are an important reminder of how recovery actually occurs in practice.

Beneath the macro aggregates lie countless daily individual acts of risk taking and entrepreneurship: the decision to start a business, borrow, invest, expand, hire a new worker, or just change jobs. They are shaped by incentives.

These acts are the very essence of the creative process that underpins economic recovery, and it makes a material difference as to whether or not policy supports them.

While empirical work on this is always imprecise — not least because it is based on historical data — there is at least one study of which I am aware, that regresses the severity of past downturns and the speed of recovery against elements of regulatory policy.3

It found that economies with efficient, credible, transparent regulation experienced milder downturns and faster recoveries than those with heavier regulatory burdens. As the study notes:

[The] speed existing firms and new entrants can reallocate resources depends on the regulatory framework and the efficiency and transparency of its enforcement. Licensing requirements and similar business regulations constitute entry barriers that prevent entrepreneurs from seizing legal opportunities and thereby limiting the economic and social losses during crises.

So we need to address rigidities that prevent labour and other inputs from moving between firms, sectors and occupations.

Here’s one example: In August the NSW Productivity Commission released its Green Paper on productivity reform,4 which is an excellent piece of work, and I really commend it to you.

One of the areas they looked at was the ability to attract mid-career professionals into teaching. It’s a very intuitive idea — indeed there might be people in today’s audience who would be interested in teaching secondary maths and economics, and what a brilliant outcome that would be for preparing and inspiring the next generation to make a difference in the world.

The question is how you bring that about without requiring people to go back and do the equivalent of a 4-year teaching qualification designed for school leavers.

Teaching isn’t alone in that respect. There are similar rigidities across a range of occupations, brought about by registration, licensing and qualification requirements. In general, our skills system (or at least the funded element) is still very focused on the initial acquisition of a full qualification.

But for workers displaced by the current recession, is that always realistic? For many, the path into alternative occupations is through targeted skills acquisition (at best, components of qualifications) and recognition of existing knowledge and capability, perhaps through a system of independent assessment.

This is a complex area because context matters, so it requires a detailed look at the specifics of individual sectors to work out where and how we could remove barriers to lateral or mid-career movement.

One more obvious area is occupational licensing, where our 2010 report on mutual recognition illustrated the simplicity that could come from a system of automatic recognition of licenses across states, which the Federal and State Treasurers are now working on.

Stamp duty can also be a barrier to the movement of labour to different locations, as we noted in Shifting the Dial in 2017. It can also be a barrier to using land for new and more productive economic purposes.

So too, planning and zoning regulations — also noted in Shifting the Dial — which can slow the reallocation process by being prescriptive about where specific types of economic activity can and can’t take place.

Of course, one policy where this comes into sharp relief is Jobkeeper. In the initial stages of the downturn, Jobkeeper has been very valuable in supporting businesses, and maintaining the connection of employees to the workplace. And it provided a much needed income boost as the economy weakened. But it also creates a rigidity by tying existing workers to existing firms, and a time inevitably comes when that holds back the process of recovery.

One additional point about where efficiency considerations become relevant to the recovery.

Once a reallocation process is underway, we want to make sure that labour and capital (and land use) are gravitating towards sectors and firms where they will be more productively employed. We don’t want them gravitating to the beguiling security of sectors which benefit from inefficient and unproductive rents. If reallocation led to increased concentration and market power, then this would be a bad long term outcome.

Some of the Productivity Commission’s work explores areas where more competition or appropriate regulation could help minimise those rents, hence this work remains important even (perhaps especially) in a recession.

Risk and new business formation

My second point about the importance of a micro-economic perspective concerns risk appetite and new business formation. Again, abstracting from aggregate investment and production, we should think hard about the supply side.

In a normal year, there are around 300 to 350 thousand new businesses created in the Australian economy. A similar number exit — most of them not due to business failure.

As at June, we had over 900 thousand businesses on Job Keeper. Many of them have also benefited from interest deferral and (depending on the jurisdiction) some deferral of commercial rent. They may also have been given breathing space by measures like temporary relief from insolvent trading and higher thresholds for bankruptcy proceedings. Many will make it through, but logically some will not.

So the question arises, how can we improve the ease with which new business can get up and running? This is all the more urgent because one possible effect of the pandemic and recession is a reappraisal of risk.

A recent paper by Kozlowski, Veldkamp and Venkateswaran5 puts some framework around this. To over-simplify: lots of economic models incorporate risk — with economic agents facing a probability distribution over the value of some parameter or other.

When the parameter takes on a particular value, that affects the short term outcome in the model, but it doesn’t change the underlying probability distribution for subsequent periods. That’s basically consistent with a rational expectations assumption.

But how well does that assumption fit with extreme tail events?

As the paper notes: Isn’t it plausible that real world decision makers, when they observe a tail event, actually update their subjective beliefs about the likelihood of it being repeated? And if they do, then there is a form of long term scarring that occurs specifically because of changed beliefs: that is, a revision to their perception of future risk.

That needn’t be just a case of businesses deciding that pandemics are now more likely than they previously thought. It could apply to the whole range of disruptions that have gone along with the pandemic — border closures, lockdowns, supply chain disruptions, rent waivers etc.

Moving forward, it is possible that decision makers will face not just generalised economic uncertainty, and not just a reduced expectation about the future central scenario, but also a heightened sense of tail risk — a belief that extreme scenarios are just that little bit more likely, more believable, than they would have thought in 2019. And that could feed into their behaviour and their investment decisions.

The authors of the paper find that this ‘belief scarring’ could be bigger in its long term impact than direct impact of the pandemic shock itself.

What to do about it?

It’s easier to diagnose the problem than prescribe the medicine. (And I hear the macro-economists in my ear saying: get aggregate demand up asap — heal the wound fast and you’ll minimise the scarring). And that is no doubt true.

But supply side policy can also play an important role.

Some States have made significant efforts to streamline the approvals processes for new businesses — such as the Services NSW Business Concierge, and the Better Approvals program in Victorian local councils.

Again, the structure of the planning system plays a part, since much of the delay associated with starting new businesses can be getting planning approval.

Regulation reform more broadly is important — particularly the behaviour and culture of regulators (as distinct from the rules on the statute book). This is the subject of our current inquiry into regulation in the resources sector, which looks at best practice by individual regulators across the Federation.

Insolvency rules could also be an important policy lever, which we examined in our 2015 report on Business Set up, Transfer and Closure.

Workplace relations is another. Giving firms and employees the space to work out arrangements that achieve their shared goals while protecting minimum conditions.

One other area of policy — often neglected in this context — is the social safety net.

The safety net goes beyond income support. It includes things like rent assistance and family tax benefit, but also instruments like income protection through life insurance, access to health insurance, workers compensation, and as we have seen in the current pandemic, superannuation. It can also be extended to regulatory policy in areas like workplace relations or consumer protection.

The safety net serves a redistributive goal. But that is not its only role. It can also be an important determinant of risk appetite, as the New Zealand Productivity Commission found in its work on Technological change and the Future of Work.6

They looked at a range of designs, including the ‘flexicurity’ approach in some northern European countries. Just one example by way of observation: the US approach of linking health insurance to the employment relationship might sharpen work incentives, but could also dull the incentive to quit your job and start a business.

I am not calling for any particular reform; just noting that the issue warrants closer attention in Australia as part of the policy] mix to encourage efficient risk taking.

Our work has brought us into contact with many aspects of the safety net in the:

  • Veterans inquiry — observing a system designed around poor incentives
  • Superannuation inquiry — where we found that life insurance is, for many people, an accidental and poor value product
  • Shifting the Dial report — where we noted the limitations on private health insurance and the lack of incentive for funds to invest in keeping their members well
  • Mental Health inquiry — where we looked at the role of workers compensation arrangements.

The system is multi-faceted if somewhat fragmented.

In the current pandemic, we have seen a temporary mix of risk pooling through a higher short term payment, and a form of self-insurance through access to super. This will be a big policy question: how do we bring together the various strands of the safety net to balance the right level of redistribution with work incentives, but also to create the right incentives for efficient risk taking.

Resilience

My final observation concerns resilience.

A recent paper by the Queensland Productivity Commission7 noted the importance of past micro economic reforms in building greater adaptability and resilience in the Australian and Queensland economies, especially in the face of shocks and disruptions.

It is a reminder that in economies, as in individual businesses, risk management is not a predictive science — it’s not a question of who has the best crystal ball. It’s about having the adaptive capability to deal with unforeseen events as and when they arise.

Once the dust settles, we can assess how well Australia has responded and adapted to this pandemic. Calls for greater national self-sufficiency should be assessed in that light. My instinct is that there is a lot more value in building general resilience than there is in identifying and preparing for specific future contingencies. I accept there could be a bit of both.

Another likely conclusion is that Australia’s relatively poor productivity growth in the period leading up to the pandemic (which has been a focus of the PC’s work) could reflect a decline in the dynamism of the economy, potentially exposing one source of vulnerability when the crisis hit.

The main point is: you can’t prevent a shock. But you can prevent bad policy, and a sound micro-economic framework is one of the best protections we have.

Nowhere is this starker than in infrastructure policy. If you build things solely for demand-side stimulus, you run the risk of wasteful spending. If you do careful project assessment, you can boost productive capacity and aggregate demand.

And there is an important subtlety here: a project assessment — say a cost benefit analysis — is a microeconomic tool. It isn’t perfect, because concepts like utility, consumer surplus, welfare, willingness to pay are abstract and they are hard to measure. But they at least try to get at sources of value that aren’t captured in macro aggregates like per capita GDP.

It is this approach that has allowed economists to apply a policy framework to a broader and more complex set of questions, which happens to be a staple of the Productivity Commission’s work.

Conclusion

Recessions in Australia have been rare of late. When they do come, they can lead to policy discontinuity. After the 1890s recession we pursued a policy of protection and regulation. After the early 1980s and early 1990s recessions, we took a different path, combining sound macro-economic frameworks with vigorous micro economic reform.

Today is different in the particulars. The reform priorities have to be calibrated to the times. But the principles are enduring. One such principle is that we should avoid any crude misinterpretation of the Krugman formulation — that is, to think that somehow in the midst of recession, we can ignore efficiency considerations, so long as we are adding to aggregate demand.

I don’t think the question is so much about Harberger triangles and Okun gaps, as it is about harnessing the supply side of the economy to hasten the recovery, build resilience, speed productivity growth and tackle broader policy questions.

In achieving all that, micro still matters.

Footnotes

1 https://krugman.blogs.nytimes.com/2012/12/07/macro-trumps-micro/ Return to footnote 1

2 Jose Maria Barrero, Nicholas Bloom and Steven J. Davis, COVID-19 Is Also a Reallocation Shock , NBER Working Paper No. 27137, May 2020 Return to footnote 2

3 Christan Bjørnskov, Economic Freedom and Economic Crisis , IFN Working Paper No. 1056, 2015 Return to footnote 3

4 http://productivity.nsw.gov.au/sites/default/files/2020-08/Productivity_Commission_Green%20Paper_FINAL.pdf Return to footnote 4

5 Julian Kozlowski, Laura Veldkamp and Venky Venkateswaran, Scarring Body and Mind: The Long-Term Belief-Scarring Effects of COVID-19 , NBER Working Paper No. 27439, June 2020 Return to footnote 5

6 https://www.productivity.govt.nz/assets/Documents/0634858491/Final-report_Technological-change-and-the-future-of-work.pdf Return to footnote 6

7 https://qpc.blob.core.windows.net/wordpress/2020/08/Building-economic-resilience-in-Queensland.pdf Return to footnote 7

Opening statement

Deputy Chair Alex Robson delivered an opening statement to the House of Representatives economics committee inquiry into promoting economic dynamism, competition and business formation.

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Thank you for the invitation to appear again before this Committee, and for the opportunity to make an opening statement.

When we last appeared before this Committee, our Advancing Prosperity 1 report had not yet been publicly released, so today I will spend a bit of time discussing that. I will also discuss some recent productivity trends, the relationship between productivity and real wages, and some trends in indicators of market dynamism as set out in our submission. I will conclude by touching upon the topic of competitive neutrality.

My main messages today are as follows:

  • Australia’s productivity performance has been anaemic for quite some time.
  • Productivity growth is a key driver of real wages growth.
  • Competition and business dynamism are, in turn, important drivers of productivity growth.
  • Several aggregate indicators suggest that competition and dynamism in Australia may be declining.
  • However, these aggregate indicators should be interpreted with care, particularly when it comes to the menu of policies that might address those trends, and the tradeoffs that might be involved.
  • There is no single policy silver bullet in relation to competition, dynamism and productivity.
  • A comprehensive microeconomic reform agenda – of the kind outlined in our recent Advancing Prosperity report – is needed.
  • Finally, we consider there is scope to improve Australia’s Competitive Neutrality policy and make it fit for purpose for the years and decades ahead.

Recent productivity trends

In March this year we released our 5-year productivity report, Advancing Prosperity. The report emphasised the fact that over the decade to 2020, Australia’s productivity growth averaged just 1.1% per year – the slowest growth rate in 60 years.

Since that report was released, there have been several disappointing data releases on productivity. The recent data underscores our earlier key messages.

For example, the most recent National Accounts data from the Australian Bureau of Statistics shows that over the year to June, Australia’s level of productivity went backwards, declining by 3.6%. 2 That data also shows that productivity has declined in four of the last five quarters. As a result, GDP per hour worked is now at its lowest level since March 2016.

The outgoing Governor of the RBA recently warned that Australia’s living standards could stagnate in the face of our weak productivity performance. 3 Another view is that on current data trends, we would be lucky to achieve stagnation – it could turn out be another optimistic, “glass half full” prediction from the former Governor.

My own view is that Australia’s productivity challenge is urgent – but it did not happen overnight. It has been an urgent problem for many years. We can and must do better, but there is a way forward.

Productivity and real wages

Why does it matter? Productivity is about working smarter – not harder or longer. The recent data underscores this.

If the level of productivity is falling – as it has been over the past year – this means that on average, Australians had to work more hours just to produce and buy the same volume of goods and services.

In other words, over the past year, Australians on average have been working harder and longer – in effect, running to stand still. Real wages have also been going backwards, and this is no coincidence. Indeed, one of the very first findings in Advancing Prosperity is that in Australia, almost all sustained increases in real wages are underpinned by improvements in labour productivity growth.

Productivity Commission research released today 4 confirms this. This research examines so-called ‘wage decoupling’ – defined as average annual labour productivity growth minus average annual producer wage growth. We find that since 1995, only two sectors have exhibited strong wage decoupling: mining (4.9 percentage points) and agriculture (3.4 percentage points).

These two commodity-exporting – and highly productive – sectors account for just 4% of total employment, but around 18% of total value added. They therefore have a disproportionate impact on economy‑wide estimates of wage decoupling.

If we strip them out and examine the rest of the economy, average decoupling since 1995 has been just 0.1 percentage points. And in more than half of the sectors outside of mining and agriculture, decoupling was zero or negative.

In other words, since 1995 the wages of over 95% of Australia’s working population have risen very closely in line with productivity. And the average income gain from a productivity lift is more than eight times the potential gain from eliminating the limited decoupling across most of the economy. So productivity growth remains the main policy game.

Indicators of market dynamism

Given this, what should we do about our weak productivity performance? This committee is rightly focused on competition and market dynamism. 5

In a market-based economy like Australia, it is reasonable to expect that there would be a close link between competition, dynamism and productivity.

Business decisions are driven by the pursuit of profit and the avoidance of losses. Market prices guide those decisions, and are “a signal wrapped up in an incentive”, providing information to businesses about hiring decisions, where it invest, what to produce, how much to produce, when to sell it, where to sell, and to whom.

Well-functioning markets and healthy competition between businesses lead to lower prices, higher quality goods and services, greater consumer choice, and ultimately higher living standards.

However, if competitive forces are dulled or distorted, this can lead to incorrect price signals being provided, and poor outcomes for consumers and workers.

Australia’s economy and our markets are changing. Markets for services – which tend to be relatively labour intensive – now dominate, with 80% of activity and 90% of employment now in services. And many services are delivered without benefit of either the signal or incentives of markets. In many instances, labour is the service – think of health, aged care and disability care.

I will return to these points a bit later.

Our submission to this inquiry 6 focusses on a range of data which are proxies for market dynamism: firm entry and exit, concentration, price-markups, labour market mobility and investment.

Let me highlight some the key points of our submission in relation to these proxies.

  • While aggregate firm entry and exit rates can be an indicator of ‘creative destruction’ in the economy, they are not necessarily suggestive of broader underlying trends regarding dynamism.
  • Measures of market concentration – such as the four firm concentration (CR4) index or the Herfindahl–Hirschman index (HHI) – should be interpreted with a great deal of care, particularly at the aggregate level.
    • Indeed, the proposition that market concentration by itself must be negatively associated with productivity growth and economic well-being has been questioned by economists for at least 50 years. 7 As a matter of economic theory, it is straightforward to derive examples where a higher HHI (an indicator of greater market concentration) is associated with higher – rather than lower – overall economic wellbeing. 8 And in practice, as our submission discusses, the link between concentration and wellbeing greatly depends on the economic context.
    • In any case, at the industry level, our analysis of concentration dynamics shows that most Australian industries are not concentrated, and very few of became concentrated from 2006 to 2021. Moreover, the distribution of concentration measures across industries was relatively stable between 2006 and 2021.
  • Thus, the claim that the Australian economy is as a whole becoming more concentrated does not seem to hold up. Most Australian industries are not highly concentrated, and this has not changed much.
  • Related to this, firm mark ups – the gap between price and marginal cost – are often pointed to as indicators of market power and weak dynamism. There is some evidence that markups have been increasing in Australia.
    • However, this evidence is plagued by measurement issues. And, from a policy perspective, interpreting aggregate evidence on markups is not straightforward.
    • For example, if costs and prices are falling together (so that consumers are better off) but prices fall at a slower rate (so that markups rise), what is the appropriate policy response?
    • Or, to take another example, in the presence of large fixed costs (due, for example, to high up front capital costs), a gap between price and marginal cost may be required simply for a business to break even. In the presence of high fixed costs, higher markups could, in principle, even be associated with lower profits.
  • Some have gone further and claimed that “greedflation” abounds at the aggregate level in Australia, with firms across the economy using the recent increase in inflation to ‘unfairly’ mark-up prices over costs and increase profits.
    • The Commission does not agree with this claim. As our submission notes, overall, aggregate evidence does not suggest that high price margins associated with exploitation of market power have played a significant role in accentuating the higher input costs and supply constraints that precipitated the current inflationary episode.
  • Indeed, some may counter that the greedflation thesis seems to have been quickly overtaken by the facts.
    • Australia’s annual inflation rate appears to have peaked at 7.8% and has now declined to 6%. 9
    • Company profits declined by 13.1% in the June 2023 quarter, and fell by 11.8% over the year to June. 10
    • Some might ask: if there is greedflation, why were firms apparently greedy up until recently, but have now suddenly stopped being greedy?
  • As discussed at our appearance before this committee earlier in the year, an inflationary environment should not give businesses new opportunities for sustained exploitation of market power – if they possess this power, they will exploit it at any time.
    • And, consistent with our work on wage decoupling, our submission to this inquiry notes that stripping mining out of the corporate profits data indicates that profits have been stable as a share of total factor income. In fact, overall profits as a share of factor income declined to 30.2% in the June 2023 quarter, the lowest level since December 2021

To conclude on indicators of dynamism: while there are some indications that dynamism may be declining in Australia, it is difficult to draw specific policy implications from the data.

Advancing prosperity

However, the answer is not to sit back and declare that it is all too hard. On the contrary, there are several policy measures that the Commission believes would stack the odds in favour of greater competition and dynamism in Australia, and which would give us the best chance of meeting and overcoming our productivity challenge.

Some commentators have said that we should focus on a narrow set of policies – climate, technology and supply chains. These are obviously important, but we think the reform agenda is much broader.

In any case, it may come as a surprise to these commentators that the Commission and its predecessors have been thought-leaders in climate policy for more than three decades, with our first publication on the costs and benefits of emissions reductions appearing in 1991. 11

For all the talk about supply chains, as far as I am aware, our 2021 report on Vulnerable Supply Chains 12 remains the only rigorous, evidence-based analysis of that issue in Australia.

And of course, our annual Trade and Assistance Review 13 – now in its 49th year – provides up-to-date and cutting edge analysis of industry assistance and trade policy developments.

Advancing Prosperity sets out 71 policy recommendations across 29 reform directives. Our policy recommendations fall into five general areas:

  1. Building an adaptable workforce to supply the skilled workers for Australia’s future economy.
  2. Harnessing data, digital technology and diffusion to capture the dividend of new ideas.
  3. Creating a more dynamic economy through fostering competition, efficiency and contestability in markets.
  4. Lifting productivity in the non-market sector to deliver high quality services at the lowest cost.
  5. Securing net-zero at least cost to limit the productivity impact caused by climate change.

Our report also sets out a detailed prioritisation framework and implementation roadmap for meeting and overcoming our productivity predicament.

Many of recommendations are directly or indirectly related to competition and market dynamism, particularly given the changing structure of Australia’s economy towards services. For example in a service-based economy, fit for purpose labour market regulation is key, particularly in relation to the gig economy, which can be an important source of market entry, innovation and dynamism.

For the most part, real wages and productivity move together. Finding productivity improvements leads to increases in real wages. So labour market settings need to facilitate and indeed maximise cooperation between parties and encourage innovation, reward aspiration and effort, and preserve fairness.

Shoehorning platform work into other employment categories would put at risk its productivity impacts and its benefits for gig workers. But gig workers have genuine concerns that need to be taken very seriously. Improved safety protection and access to dispute resolution are warranted.

Our migration policy settings should be viewed through a productivity lens and focus on the composition of the intake at least as much as the aggregate quantum. In this regard, we think there is great merit in moving towards a system that places a greater emphasis on employer nomination, and less of a reliance on skill lists.

Reforms to occupational licensing arrangements would also assist with the better allocation and matching of scarce labour resources across the economy.

On digital infrastructure, we think there needs to be better regional internet connectivity, as well as policies in place to ensure that there is more transparency around digital infrastructure funding decisions and evaluation of previous investments.

And the market for internet connectivity may now be sufficiently developed to allow for a more competitive method of allocating funds.

Openness to trade, investment and international migration are key drivers of market dynamism and prosperity more generally. We recommend getting rid of our remaining tariffs, and progressively removing Australia’s anti-dumping and countervailing measures, and subjecting any new measures to an economywide cost benefit test.

We should increasingly accept product standards adopted in other leading economies as ‘deemed to comply’ with Australian standards. And we could bring application fees for proposed FDI into agricultural land assets closer into line with other forms of investment.

On taxation, we recommend a suite of reforms. In addition to abolishing Australia’s remaining tariffs, we also recommend abolishing stamp duty on insurance premiums, moving towards a more system of efficient road user pricing, and moving away from taxes that discourage encourage efficient asset transfers and capital allocation, such as stamp duty on property transactions.

Related to this, our systems of business and industrial planning and zoning could be improved, with an eye towards encouraging greater geographic competition between businesses. And there is scope for state and territory governments to improve public transport pricing arrangements.

Finally, on merger policy: we conclude that overall, there does not appear to be a strong case for the implementation of a new formal authorisation regime, of the kind proposed by the former chair of the ACCC. Instead, we think there may be more value in the ACCC further considering its internal merger review processes; and for government to consider how best to avoid perverse incentives across merger clearance procedures.

Competitive Neutrality Policy

To conclude, I would like to mention one aspect of the Commission’s responsibilities that we believe warrants a close look, and which could benefit from reform: the area of Competitive Neutrality.

It has been 30 years since the Hilmer Report on National Competition Policy – which was introduced by Prime Minister Keating as an “important contribution towards furthering competition policy in Australia”. 14

A key part of the Hilmer report dealt with the principle of competitive neutrality – the proposition that state-owned enterprises and private businesses should compete on a level playing field. Competitive neutrality (CN) policy is also concerned with government businesses that may compete with each other.

It has long been recognised that favourable conditions for government enterprises in relation to their private sector counterparts can distort all kinds of economic decisions – particularly around innovation, investment and hiring, ultimately leading to suboptimal outcomes for consumers and workers.

Those artificial cost advantages can also lead to resources (capital and labour) flowing to government businesses simply because of their government ownership rather than them being the most efficient (productive) users of resources. Where these resource allocation distortions occur, the nation’s productivity suffers.

The principle of competitive neutrality is likely to become increasingly important, particularly given the growth of the non-market sector (for example, in the care economy) and the re-entry of governments into some of the economy’s “commanding heights”, such as energy and telecommunications.

The Government's approach to operationalising CN principles is set out in the 1996 Competitive Neutrality Policy Statement 15 and the Competitive Neutrality Guidelines for Managers. 16 Unfortunately, Australian Government businesses sometimes fail to comply with these obligations and guidelines.

An integral part of competitive neutrality policy and its implementation is a competitive neutrality complaints handling mechanism, which is intended to bring some discipline to the implementation of competitive neutrality and provide ongoing accountability.

The Australian Government Competitive Neutrality Complaints Office – the AGCNCO, a separate unit within the Commission – is that mechanism. It deals with any complaints and provides independent advice to Government following its investigations.

Any individual, organisation or government body with an interest in the application of competitive neutrality may lodge a complaint. While governments are not obliged to accept the AGCNCO’s advice, we think there needs to be a strong cop on the beat in relation to competitive neutrality.

However, although our competitive neutrality policy has served Australia well over the last three decades, it is deficient in several areas. To name just a few:

  1. Australia’s competitive neutrality policy lacks a credible enforcement regime.
  2. There is a lack of guidance on what a public interest test should embody and what it should look like.
  3. There are poor processes to ensure compliance with the policy by start-up government businesses.
  4. There is little guidance or principles on what constitutes ‘government’ in significant government business activities.
  5. There is little guidance on what policy or complaints process should apply for business activities with multiple government owners.
  6. There is no mention of the full range of possible material competitive advantages (other than those relating to tax, debt and regulatory neutrality and earning a commercial rate of return), and poor guidance on methodologies for estimating the value of some advantages.
  7. There is an absence of guidance on whether any identified cost advantages should be addressed by the imposition of a CN adjustment payment, or by directly addressing the source of the advantage.
  8. There is a need to reformulate the commerciality test in CN policy.

Australia recently signed up to the OECD’s Recommendation on Competitive Neutrality. 17 In light of this renewed commitment, and given this Committee’s – and the Government’s – focus on competition and dynamism, it may be an appropriate time to look more closely Australia’s competitive neutrality regime, with an eye to reform.

In this respect we support the earlier findings of the Competition Policy Review 18 (the Harper report), which recommended all Australian governments should review their competitive neutrality policies and complaint handling mechanisms to ensure they remain fit for purpose in the 21st century.

The Government’s recently announced two-year Competition Policy Review may provide a further opportunity to examine competitive neutrality policy.

References

Commonwealth of Australia (2015) Competition Policy Review, Final Report, March.

Demsetz, H (1973) The Market Concentration Doctrine: An Examination of Evidence and a Discussion of Policy, AEI-Hoover Policy Study 7, Washington DC. http://masonlec.org/site/rte_uploads/files/GAI/Readings/Economics%20Institute/Demsetz_Market%
20Concentration%20Doctrine.pdf

Industry Commission (1991) Costs and Benefits of Reducing Greenhouse Gas Emissions, Inquiry Report No. 15, November.

Productivity Commission (2021) Vulnerable Supply Chains, Study Report, Canberra.

—— (2023a) 5-year Productivity Inquiry: Advancing Prosperity, Inquiry Report no. 100, Canberra.

—— (2023b) Submission to the Inquiry into promoting economic dynamism, competition and business formation, Canberra.

—— (2023c) Trade and assistance review 2021-22, Annual report series, Canberra.

—— (2023d) Productivity growth and wages – a forensic look, PC Productivity insights, Canberra, September.

Robson, A (2011) Law and Markets, London: Palgrave Macmillan.

Footnotes

  1. PC (2023a) Return to text
  2. ABS Cat No. 5206.0 https://www.abs.gov.au/statistics/economy/national-accounts/australian-national-accounts-national-income-expenditure-and-product/latest-release Return to text
  3. https://www.rba.gov.au/speeches/2023/sp-gov-2023-09-07.html Return to text
  4. PC (2023d) Return to text
  5. As set out in our submission, economic dynamism is concerned with “the efficient adaptation to new demand and supply trends and re-organisation of resources (labour and capital) across the economy, supported by the creation of new knowledge and its rapid diffusion.” Return to text
  6. PC (2023b) Return to text
  7. See Demsetz (1973) Return to text
  8. See, for example, Robson (2011), chapter 10 Return to text
  9. ABS Cat No. 6401.0 https://www.abs.gov.au/statistics/economy/price-indexes-and-inflation/consumer-price-index-australia/latest-release Return to text
  10. ABS Cat No. 5676.0 https://www.abs.gov.au/statistics/economy/business-indicators/business-indicators-australia/latest-release Return to text
  11. PC (1991) Return to text
  12. PC (2021) Return to text
  13. PC (2023c) Return to text
  14. Statement by the Prime Minister the Hon PJ Keating MP, 25 August 1993. https://pmtranscripts.pmc.gov.au/sites/default/files/original/00008945.pdf Return to text
  15. https://assets.pc.gov.au/about/core-functions/competitive-neutrality/commonwealth-competitive-neutrality-policy-statement-1996.pdf Return to text
  16. https://assets.pc.gov.au/about/core-functions/competitive-neutrality/2004-competitive-neutrality-guidelines-for-managers.pdf Return to text
  17. The Recommendation was formally adopted on 31st May 2021 at the Ministerial Council Meeting. All OECD members have adhered. https://legalinstruments.oecd.org/en/instruments/OECD-LEGAL-0462#adherents Return to text
  18. See Commonwealth of Australia (2015). https://treasury.gov.au/sites/default/files/2019-03/Competition-policy-review-report_online.pdf. The Commonwealth undertook a review in 2017. https://consult.treasury.gov.au/competitive-neutrality-review Return to text

Related publications

Promoting economic dynamism, competition and business formation

Advancing prosperity

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