Productivity key to real wage growth, says KPMG report

Is Australia’s productivity slump a crisis, or just a normal economic cycle?

A new KPMG report sheds light on the factors driving labor productivity and offers policy solutions to boost growth. The report emphasizes that concern is warranted if the downturn extends beyond the usual period.

Cyclic Nature of Productivity Growth

KPMG’s econometric analysis, using a framework similar to that of the US Federal Reserve, indicates that high productivity growth cycles in Australia typically last around two years, while low productivity periods extend slightly longer, typically three years. The last productivity high was in December 2022 as the country emerged from COVID lockdowns, which, counter-intuitively, were a time of higher productivity.

The report offers optimism, noting a close correlation with the US economy, which shows signs of emerging from a low growth period. However, low levels of technology investment and business confidence, coupled with elevated unit labour costs, may hinder a productivity resurgence.

Key Factors Influencing Productivity

The report identifies three primary factors driving aggregate labour productivity growth in Australia:

1. Momentum Effect: Productivity gains in the last quarter.
2. Workforce Composition: New workers entering the workforce, often less experienced or lower-skilled, especially in a tight labour market.
3. Skilled Foreign Workers: Their addition boosts productivity of native-born workers and introduces new skills and innovations, though this effect occurs with a lag.

Policy Recommendations

KPMG recommends three key pillars to lift productivity:

1. Improved Education and Training: For unemployed individuals to enhance skills and employability.
2. Redesigning Migration Policies: To ensure optimal utilization of skilled migrants.
3. Flexibility in Labour Mobility: Ensuring sufficient flexibility to allow for labour market adjustments.

The current high participation rate, partly due to the inclusion of long-term unemployed individuals, has contributed to the low productivity growth cycle. The phenomenon of ‘labour hoarding’ during COVID, where companies retained more workers than necessary, also plays a role.

Impact of productivity on wage growth

The report notes mixed evidence on the impact of migration during the COVID period but underscores the clear link between skilled migration and higher productivity. Since late 2022, the return of migrants has improved skills matching in the labour market.

KPMG’s research shows that while labour productivity is crucial for wage growth, universal policy settings are unlikely to be effective. Instead, industry-specific policies for capital and labour are recommended.

Dr. Brendan Rynne, KPMG’s Chief Economist and report lead author, stated: “Productivity is the key driver of real wage growth. Policymakers should be concerned about prolonged periods of low productivity growth. Our analysis suggests Australia should emerge from the current low productivity cycle by mid-next year, mirroring trends seen in the US.”

However, Rynne cautioned that low technology investment and business sentiment could impede this rebound. He emphasized the need for targeted skilled migration and visa systems to enhance productivity.

Impact of COVID on Productivity

The report highlights that the COVID period saw high productivity levels due to reduced hours worked outpacing output declines. Smaller firms, typically with lower productivity, cut hours more substantially than larger firms. Post-lockdown, a rapid recovery in hours worked led to a decline in labour productivity growth.

Border closures during the pandemic impeded access to skilled migrants, creating labour shortages. This demand was absorbed by an increase in hours worked, leading to negative productivity growth during 2022-23. The re-opening of borders has alleviated some shortages, but sluggish productivity growth persists.

Rynne concluded: “Re-opening borders and skilled migration are crucial for productivity. Education and training programs tailored to low-skilled workers can mitigate workforce exits. Employment frameworks must balance fair treatment and labour market flexibility to ensure economic stability.”

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