Yes, Australian businesses have become less dynamic. But there are bigger reasons for our sliding productivity growth

Since 2005, annual labour productivity growth (growth in output per hour worked) has been the best part of one percentage point below its long-term average in Australia and other developed countries.

The Productivity Inquiry that I helped conduct for the Productivity Commission found this will lead to much-slower improvements in Australians’ living standards than in the past.

In the search for a culprit, economists including Australia’s Competition Minister Andrew Leigh have pointed to reduced business competition resulting in decreasing dynamism, by which they mean:

• less entry and exit of firms
• less job-switching
• a significant reduction in business investment
• mergers leading to increased business concentration
• an increase in the markups businesses can sustain
• only few highly-productive firms, with the rest increasingly less so

A study that I have just published in Australian Economic Papers, reviews the evidence and finds that while most of these things have happened (and while many are undesirable) they aren’t sufficient to explain what’s happened to productivity.

The findings suggest that even if we did make our economy more competitive and businesses more dynamic (and we probably should) improving productivity growth depends on a much bigger set of policy reforms.

Here’s what we find.

Firm entry and exit has been slowing

In Australia, the rates of firm entry and exit (meaning companies either joining or dropping out of an industry) declined between 2005–06 and 2012–13.

While there’s been an increase in firm entry more recently, it’s been mainly among non-employing business – sole traders and independent contractors – rather than bigger businesses.

In the US (we don’t have an equivalent Australian study) red tape may be strangling dynamism. Investment in new profitable businesses has slowed at the same time as there has been a significant increase in regulation of those businesses.

In Australia, improvements in business survival rates at least partly seem to reflect improved conditions for both survivors and new entrants, rather than barriers that protect unproductive survivors at the expense of more-productive entrants.

Job-switching has slowed

Australian job mobility has declined dramatically over the past 30  years, in part because the population is ageing, and older workers are less likely to switch jobs than younger workers.

Another explanation might be that Australian businesses face a less volatile environment, suggesting job turnover does not have value in its own right.

While job churn tends to fall if barriers to job mobility rise, it also falls when businesses face fewer shocks, making any link between declining job turnover and diminished competition ambiguous.

Business investment has slowed

Non-mining business investment in Australia has stagnated over recent decades, as it has in a number of other advanced economies.

Among the suggested explanations are risk aversion and uncertainty, pessimism about the future and lower productivity growth. The role, played by competition – if any – is far from clear.

Business concentration has climbed

The average concentration of Australian businesses (the extent to which industries are dominated by a few big firms) appears to have been falling until the early 2000s, and climbing since then.

Most of the increased concentration appears to have been in already-concentrated industries, with technological advances and exposure to imports explaining a lot of it.

As an example, concentration has increased in “warehousing and storage”, but the industry has taken advantage of technological advances including parcel tracking and smart warehouses, meaning both concentration and competition have increased as firms have scaled up to install new technologies.

Businesses profit margins have climbed

Markups (profit margins) appear to have climbed by around 57% in Australia between 1980 to 2016, which is less than in the US, Canada and much of the European Union, but greater than in New Zealand and most Asian countries except for South Korea.

But markups at the level of the firm are difficult to measure because they depend on assumptions about the way the firm makes its products. Different assumptions can produce very different estimates.

There are only a few highly-productive firms

Globally and in Australia the most-productive firms seem to be three to four times more productive than the less productive, but, at least in Australia, there is little evidence to suggest the gap is widening.

What evidence there is suggests the gap between the most-productive Australian firms and the most-productive global firms is widening, suggesting all Australian firms are slower to adopt leading technologies than they were.

Put bluntly, Australian businesses as a whole appear to have become slow to adopt world best practice; which is a problem, but not necessarily a problem of highly-productive firms versus the rest.

There are a range of policies that can help to reverse the decline, but it is far from clear that competition plays much of a role.

We’re at risk of chasing the wrong target

The broader reasons for Australia’s declining productivity growth include changing demographics, changing international trade patterns and the changing nature of industries as Australia continues to moves towards a more service-based economy.