Dynamic efficiency - the key to lifting Australia's productivity performance?

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Dynamic efficiency - the key to lifting Australia's productivity performance?

Posted 27/03/2014 by Robert Dolamore

The need for Australia to lift its productivity performance is well recognised (see for example the International Monetary Fund’s (IMF’s) latest assessment of the Australian economy). With its terms of trade declining Australia can no longer rely on the willingness of the rest of the world to pay more for our exports to fund improved living standards. Part of the challenge is improving the efficiency of Australian firms and other organisations that produce the goods and services we consume as a community and export to the rest of the world.

In broad terms productivity is a measure of how efficiently an economy uses resources to produce economic output. Productivity can be raised by increasing the efficiency of firms, public sector bodies and not‑for‑profit organisations. Economists usually distinguish between three types of efficiency: allocative efficiency; productive efficiency; and dynamic efficiency. The first two of these are static concepts being concerned with how much can be produced from a given stock of resources at a certain point in time. The third is a dynamic concept and concerned with pushing out the production possibility frontier and giving the community access to more and better goods and services over time.

  • Allocative efficiency – is about ensuring resources are allocated between alternative uses in a way that maximises community wellbeing.
  • Productive efficiency – describes the situation in which output is being produced at is lowest possible average cost. This occurs when an organisation, industry or the economy as a whole is operating on its production possibility frontier (i.e. producing the maximum output from a given set of inputs).
  • Dynamic efficiency – involves improving allocative and productive efficiency over time. This can mean developing new or better products and finding better ways of producing goods and services. Learning, investment and innovation are key elements of dynamic efficiency and central to the ability of an organisation, industry or economy to adjust to changing circumstances.

The Productivity Commission has produced a very useful summary of how it defines these and related concepts, which provides a more detailed discussion than is possible here.

In its assessment the IMF observed that ‘Since Australia has already benefited from sizeable productivity improvements following substantial structural reforms in the 1990s, finding further scope for improvement will not be easy’. This is not to suggest Australia has exhausted opportunities for structural reform but rather a future reform agenda is likely to look somewhat different to what it did in the 1980s and 1990s. In this context reforms focusing more squarely on improving dynamic efficiency appear particularly fertile ground.

In the context of an aging population and the opportunities presented by the economic rise of Asia the potential payoffs from improved dynamic efficiency are likely to be relatively large. Faced with these developments the question is not ‘What do we produce well today?’ but ‘How can we add value tomorrow by improving the quality of a good or service and/or produce it more efficiently?’ and ‘What new things might we develop the capacity to produce efficiently?’

Governments can potentially play a wide ranging role in fostering improved dynamic efficiency including by: ensuring the macroeconomic and social environments are conducive to learning, investment and innovation; investing in research and development; investing in education and training; removing regulatory and other barriers that may impede firms undertaking worthwhile investment; supporting collaboration between universities and businesses; and ensuring appropriate industry, foreign investment, intellectual property and competition policy settings are in place.

In a recent contribution Joseph Stiglitz and Bruce Greenwald have emphasised the importance of knowledge to economic growth and development and the role of government in creating a ‘learning society’ arguing:

‘All of this highlights that one of the objectives of economic policy should be to create economic policies and structures that enhance both learning and learning spillovers: creating a learning society is more likely to increase standards of living than the small, one-time improvements in economic efficiency or those that derive from the sacrifices of consumption today to deepen capital.’[1]

A focus on dynamic efficiency invariably draws attention to organisations themselves and in particular the quality of their management practices. In a market economy much depends on the decisions firms themselves take in relation to their organisational culture, work practices, risk management, investment and innovation. In a 2012 paper, David Gruen and Ben Dolman cited findings from an international study of 9000 medium and large manufacturing firms in 20 countries that suggests management practices in Australia are mid-range and well below top performers like the United States, Germany, Sweden, Japan and Canada. Moreover, Australia was found to have a somewhat longer tail of firms with relatively poor management performance than the United States. The authors found that lifting management practices in Australian manufacturing firms to the average level in the United States would raise the level of productivity in Australian manufacturing by around 8 per cent.

Securing the payoff from reforms targeting improved dynamic efficiency will almost certainly require a concerted effort by Australian managers to embrace a culture of learning and innovation.

[1] Bruce Greenwald and Joseph Stiglitz, ‘Industrial policies, the creation of a learning society, and economic development’, in Joseph E Stiglitz and Justin Yifu Lin (eds), The Industrial policy revolution I: The role of government beyond ideology, International Economics Association, Conference vol. no. 151-I, 2013,  p. 45.

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