Guest post by Saul Eslake

This article originally appeared in AIM for Leadership and Management Excellence, AIM's bi-monthly magazine for AIM Members.

Between 2002 and 2011 Australia’s real per capita gross national income – a measure (albeit an imperfect one) of the average Australian’s material standard of living – rose at an average annual rate of 2.9 per cent – a pace well above that of the previous four decades.

Of that growth, only half came from increases in employment, in average hours worked or in output per hour worked (‘productivity’, as economists call it) – which together resulted in real per capita GDP growing at an average annual rate of 1.4 per cent. The other half came from a 93 per cent increase in our ‘terms of trade’, that is in the ratio of the prices we obtained for our exports (in particular, of iron ore and coal) to the prices we paid for our imports (of motor vehicles, fl at-screen TVs, mobile phones and the like).

This was an extraordinary piece of good luck, resulting as it did not from any decisions made by Australian governments or firms, but rather primarily from the rapid industrialisation and urbanisation which China has been experiencing since the late 1970s, which by the early 2000s, began to generate unprecedented demand for some of the commodities with which the Australian continent has been so richly endowed.

It helped underwrite steady positive growth in real wages and contributed to the resilience of the Australian economy in the face of the global financial crisis. It also allowed successive federal governments to offer large tax cuts and an expanding range of cash handouts while still running budget surpluses until the onset of the financial crisis, and then to run large deficits without running public debt to the potentially dangerous levels reached in many other ‘advanced’ economies.

It also concealed from most Australians a significant deterioration in the rate of productivity growth, from an average of 2.3 per cent per annum between 1992 and 2002 to just 0.9 per cent per annum between 2002 and 2011.

But China’s economy has been slowing. And, partly as a result, our ‘terms of trade’ have fallen by more than 20 per cent since 2011. That has, in turn, resulted in a signifi cant turnaround in Australia’s fortunes. Although real per capita GDP has grown at an average annual rate of 1.1 per cent since 2011 – only 0.3 percentage points per annum below the average from 2002 to 2011 – Australia’s real per capita gross national income has risen by just 0.1 per cent per annum over the past three years.

This is one of the principal underlying reasons for the stagnation in average real wages over the past couple of years. And it also largely explains why successive federal governments have found it so diffi cult to return the budget to surplus, as each of them had previously promised to do.

Almost certainly, the prices of our most important commodity exports will decline further – so that this drag on the growth rate of Australia’s national income will continue. The Intergenerational Report published earlier this year makes it clear that the only way Australians can continue to enjoy improvements in their material standards of living at the pace to which we have become accustomed since the turn of the century is to improve our productivity performance.

And that is hard work. It is work that, with only few exceptions, Australian firms have been able to shirk over the past dozen or so years. For most of the past 15 years, firms have either been able to generate acceptable rates of return to their owners without having to find new and more efficient ways of doing things, or introducing new products and services – or, in the years following the financial crisis, have operated on the assumption that they didn’t need to – and hence, in all too many cases, they didn’t.

Ultimately, identifying and implementing the actions that will raise productivity is the responsibility of the managers of businesses (and government agencies). They need the co-operation of their employees, of course, and they can’t afford to alienate their customers in the process.

But, in the end, improving productivity is something that managers do, not governments. Governments can contribute to improving productivity growth by enhancing the incentives facing the managers of firms to want to look for ways of boosting productivity – in particular, by exposing them to more competition and by avoiding the temptation to protect or subsidise failing firms and industries. And governments can also help by making it easier for firms to implement productivity-enhancing changes within their own businesses, or industries, by reducing or eliminating the regulatory and other obstacles which governments often place in the path of such changes and by avoiding creating new ones. Governments also have a role in promoting and enhancing some of the capabilities that make it easier for managers to achieve higher levels of productivity when they are minded to strive for them – such as a more educated and skilled workforce, and appropriate (and appropriately priced infrastructure).

The benefits of getting this right are enormous. But so are the costs of failing to do so.

Saul Eslake is chief economist at Bank of America-Merrill Lynch Australia