Want greater productivity? Set wages to rise by 3.5 per cent a year

The Age

18-05-2025

Remember this next time you see the (Big) Business Council issuing yet another report urging the government to do something to improve productivity. What businesspeople say about productivity is usually thinly disguised rent-seeking.
'You want higher productivity? Simple – give me a tax cut. You want to increase business investment in capital equipment? Simple – introduce a new investment incentive. And remember, if only you'd give us greater freedom in the way we may treat our workers, the economy would be much better.'
Why do even economists go along with the idea that poor productivity must be the government's fault? Because of a bias built into the way economists are taught to think about the economy. Their 'neoclassical model' assumes that all consumers and all businesspeople react rationally to the incentives (prices) they face.
So if the private sector isn't working well, the only possible explanation is that the government has given them the wrong incentives and should fix them.
Third, businesspeople, politicians and even economists often imply that any improvement in the productivity of labour (output per hour worked) is automatically passed on to workers as higher real wages by the economy's 'invisible hand'.
Don't believe it. The Productivity Commission seems to support this by finding that, over the long term, improvement in labour productivity and the rise in real wages are pretty much equal.
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Trouble is, as they keep telling you at uni, 'correlation doesn't imply causation'. As Nobel Prize-winning economist Daron Acemoglu argues in his book Power and Progress, workers get their share of the benefits of technological advance only if governments make sure they do.
Fourth, economics 101 teaches that the main way firms increase the productivity of their workers is by giving them more and better machines to work with. This is called 'capital deepening', in contrast to the 'capital widening' that must be done just to ensure the amount of machinery per worker doesn't fall as high immigration increases the workforce.
It's remarkable how few sermonising economists think to make the obvious point that the weak rate of business investment in plant and equipment over the past decade or more makes the absence of improvement in the productivity of labour utterly unsurprising.
Fifth, remember Sims' Law. As Rod Sims, former boss of the competition commission, often reminded us, improving productivity is just one of the ways businesses may seek to increase their profits.
It seems clear that improving productivity has not been a popular way for the Business Council's members to improve profits in recent times. My guess is that they've been more inclined to do it by using loopholes in our industrial relations law to keep the cost of labour low: casualisation, use of labour hire companies and non-compete clauses in employment contracts, for instance.
Sixth, few economists make the obvious neoclassical point that the less the rise in the real cost of labour, the less the incentive for businesses to invest in labour-saving equipment.
So here's my proposal for encouraging greater labour productivity. Rather than continuing to tell workers their real wages can't rise until we get some more productivity, we should try reversing the process.
We should make the cost of labour grow in real terms – which would do wonders for consumer spending and economic growth – and see if this encourages firms to step up their investment in labour-saving technology, thereby improving productivity of workers.
Federal and state governments should seek to establish a wage 'norm' whereby everyone's wages rose by 3.5 per cent a year – come rain or shine. That would be 2.5 percentage points for inflation, plus 1 percentage point for productivity improvement yet to be induced. Think of how much less time that workers and bosses would spend arguing about pay rises.
Governments have no legal power to dictate the size of wage rises. But they could start to inculcate such a norm by increasing their own employees' wages by that percentage.
The feds could urge the Fair Work Commission to raise all award wage minimums by that proportion at its annual review. If wages of the bottom quarter of workers kept rising by that percentage, it would become very hard for employers to increase higher wage rates by less.
A frightening idea to some, maybe, but one that might really get our productivity improving.