The race that will stop the nation – the budget graph that stunned the Government

Last week’s budget papers contained two charts that should put a shiver down every Australia’s spine.

The first was projected Government budget burden of people aged of 65 and equally is  more problematic one is productivity growth chart on known as Drivers of growth in incomes in Statement 4 of the Budget Papers.

It takes us a while to get the message, because the problem was not exactly new. Indeed the Vernon Report in 1966, identified the problem, and Paul Keating spoke at length about it when he was Treasurer. But as a nation we have not been very worried about it, because everything looks great. The Budget Papers show the problem has exist for much of the period since 1966 and it’s projected to get worse.

So what is this Graph?

the graph

Note: Contributions to income growth in the period 2013 to 2025 are consistent with the forecasts and projections detailed in Budget Statement 2. The hatched area represents the additional labour productivity growth required to achieve long run average growth in real gross national income per capita. Source: ABS 5204.0 and Treasury.

The chart was provided to the Government by Secretary of the Treasury Martin Parkinson and it shows the future deterioration of living standards.

The chart shows real Gross National Income growth decomposed into its source (net foreign income, labour productivity, labour utilisation, terms of trade) spanning the 1960s, 70s, 80s, 90s, the period from 2000 to 2013 and the decade to 2023. Although other factors have had some influence in certain decades, notably the terms of trade in the period from 2000 to 2013, labour productivity has been the key driver of growth in income per capita.

Understanding the chart is not easy, however Treasury offered this explanation, “The key message drawn from the chart is that, in the context of a declining terms of trade and an aging population, Australia will require a significant improvement in our productivity growth performance over the next decade to sustain growth in material living standards at the pace that we have enjoyed in the past.”

For those who wish to have the chart explained to them, click on the audio of an interview between Professor Neville Norman and Ross Greenwood.

Neville Norman 2014

 

 

 

 

 

Interview with Prof Neville Norman 

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What is productivity?

Nobel economics prize winner Paul Krugman distilled the productivity challenge to its essence when he said “Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.”

What are the drivers of growth in incomes?

 The main sources of income growth nationally are growth in productivity, changes in the terms of trade, changes in output from increased labour utilisation, and growth in net foreign income.

Growth in the total output of a modern economy such as Australia can come from just two sources:

  1. An increase in in the quantity of capital and labour used.
  2. An increase in the efficiency with which capital and labour are used.

The latter is known as productivity and, by definition, involves producing the same or a greater quantity of goods and services with less use of labour, capital and raw materials.

Importance of productivity

Australia’s future prosperity is ‘lifting our productivity and participation by investing in our most important resource, our people.

Productivity is critical to living standards since it permits an increase in real income per

worker without a corresponding increase in hours worked or foregone consumption through increased savings and investment.

Australia’s productivity performance

Over the last decade Australia’s productivity has slipped. Our commodity boom and terms of trade boost have masked that performance.

Federal Treasury figures show that during the 1990’s labour productivity grew strongly at an annual average rate of 2.1 per cent, well above the long‑run average of 1.5 per cent. Productivity accounted for about 96 per cent of annual income growth in that decade, in comparison to an average of 90 per cent of growth in incomes in the past four decades.

During the 2000’s labour productivity growth has slowed, contributing only around 60 per cent of the growth in average incomes since 2000. However, incomes have grown at similar rates over the past 10 years to that recorded in the previous decade due mainly to a significant contribution from the rise in the terms of trade.

Given the likelihood that Australia’s terms of trade will decline as the commodity price cycle runs its course, the need to improve Australia’s medium and long-term productivity performance becomes even more pressing if we are to continue to raise living standards in our nation.

Summary

Improved productivity is central to rising living standards and sustainable economic growth.

Given the prospect of declining terms of trade as the commodity price cycle runs its course, the pressure on Australia to reposition and compete globally as a ‘high cost’ economy, our living standards will be even more dependent in the future on increasing our rate of productivity growth, particularly in trade-exposed sectors.

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Disclaimer: Published by Shartru Wealth Management Pty Ltd. ABN 46 158 536 871 AFSL 422409. The advice is general advice only and we have not considered your personal circumstances. Before making any decision on the basis of this advice you should consider if the advice is appropriate for you based on your particular circumstances.

Sources:

Federal Budget :http://www.budget.gov.au/2014-15/content/bp1/html/bp1_bst4-03.htm

Radio Station 2 GB: http://www.2gb.com/search/site/ross%20greenwood

Business Spectator Magazine: http://www.businessspectator.com.au/

OECD – Defining and measuring productivity http://www.oecd.org/std/productivity-stats/40526851.pdf


 

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