GDP per capita and labour utilisation in Australia

Emily Pye

Department of Industry, Innovation, Science, Research and Tertiary Education

Working Paper 03-12

December 2012

Economic Conditions SectionIndustry Policy and Economic BranchIndustry Innovation DivisionDepartment of Industry, Innovation, Science, Research and Tertiary EducationCanberra

The author thanks the Economics Conditions Section and Richard Snabel for their comments and support. The views expressed in this paper are the author’s and do not necessarily reflect those of DIISRTE or the Australian Government.

Abstract Gross domestic product (GDP) per capita is often used as a measure of wealth and

wellbeing in a country. Comparable to the combined growth of labour utilisation and

of labour productivity, the growth rate of GDP per capita can be used to compare

economic performance across countries and has been examined by many studies.

These measures vary between countries to indicate varying standards of living,

varying levels of technology, varying access to capital and cultural differences.

This paper attempts to establish how growth in labour utilisation and labour

productivity can affect growth in GDP per capita. This paper focuses on Australian

data for the period 1980 to 2011 and uses a number of labour market and

productivity indicators to establish a relationship between labour utilisation, labour

productivity and GDP per capita at the aggregate level and by industry.

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ContentsGDP per capita and labour utilisation in Australia............................................................................................................ i

Abstract........................................................................................................................................................................ ii

Contents...................................................................................................................................................................... iii

GDP per capita and labour utilisation in Australia...........................................................................................................1

Introduction.................................................................................................................................................................. 1

Australian GDP per capita........................................................................................................................................1

What is driving growth in GDP per capita?..............................................................................................................2

Labour utilisation.......................................................................................................................................................... 5

Australian labour utilisation......................................................................................................................................5

Trends in full time and part time work......................................................................................................................7

Unemployment and underemployment....................................................................................................................8

Participation rate and ratio of persons of working age.............................................................................................9

Labour utilisation across industries........................................................................................................................10

Labour utilisation and an aging population.............................................................................................................11

Labour productivity.................................................................................................................................................... 12

Australian labour productivity.................................................................................................................................12

Labour productivity growth.....................................................................................................................................12

Labour productivity by industry..............................................................................................................................15

Conclusion................................................................................................................................................................... 1

References.................................................................................................................................................................. 2

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GDP per capita and labour utilisation in Australia

Emily Pye

Introduction

Gross domestic product (GDP) per capita is frequently used as a measure of wealth and wellbeing in a country. Often described as a combination of growth in labour utilisation and labour productivity, growth in GDP per capita can be used to compare economic performance across countries and has been examined by many studies. These measures vary between countries to indicate varying standards of living, varying levels of technology, varying access to capital and cultural differences.

This paper attempts to examine how labour utilisation and labour productivity have grown in Australia over the past three decades and establish how these factors have affected Australia’s GDP per capita.

GDP per capitaGDP per capita is a measure of the total market value of goods and services produced by an economy, on a per person basis. It is the traditional measure of wellbeing and is used as a proxy measure of living standards. It is not a perfect measure, however, as wellbeing includes more than material living standards.

The Australian Bureau of statistics defines GDP per capita as the ratio of the chain volume estimate of GDP to an estimate of the resident Australian population1.

GDP per capita is only one measure of economic prosperity in a country. There are many other measures, both at the aggregate level and at more focused levels. Some examples of indices created to explain the disparities between countries include gross national income, the unemployment rate, social expenditure, and for international comparison, the United Nations Human Development Index and the World Economic Forum Global Gender Gap Index.

An OECD working paper suggests ‘low levels of output per head may indicate opportunities for catch up, and the breakdown into proximate causes may give hints as to the underlying factors behind below-average performance’2.

Australian GDP per capita

The Treasury projects Australian real GDP per capita growth for the next 40 years to 2050 to slow to 1.5 per cent per annum, from 1.9 per cent per annum over the previous 40 years to 20103. An aging population is cited as the major driving factor causing this decline. An aging population will reduce the proportion of the population of working age, thus reducing the labour force participation rate.

The World Bank Global Economic Prospects publication expects GDP per capita in Australia to grow by 2.6 per cent and 3.2 per cent in 2011 and 2012 respectively. These rates are above the aggregate growth rate expected for the world and the expected growth rate of high income countries, yet are not as high as the growth rates expected for developing countries.

Chart 1 illustrates the growth of Australian GDP per capita over the past 40 years.

1 ABS Cat No. 5206.0.

2 Scarpetta et al, 2000.

3 Treasury, 2010.

Chart 1: Australian GDP per capita

Source: ABS Cat. No. 5206.0 Australian National Accounts.

The chart shows volatile growth in GDP per capita during the 1980s with growth averaging slightly less than 2 per cent. There was then a significant fall in growth in the early 1990s, which is consistent with the global downturn and stock market crashes. Growth recovered for the rest of the decade, averaging over 2 per cent, and for much of the 2000s was consistently around 1.6 per cent. Another fall in growth can be seen in the late 2000s, coinciding with the global downturn following on from the global financial crisis.

What is driving growth in GDP per capita?

Growth in GDP per capita is often used as the measure of economic progress of a country, indicating the rate at which living standards are changing. Growth of GDP per capita can be described as a combination of the growth of labour utilisation and the growth of labour productivity. This explanation suggests that economic growth is the result of increasing hours worked by increasing employment and/or individuals working more hours and that these hours are more productive.

Labour productivity also reflects the impact of increased capital investment as well as the impacts of skills, technology and management practices and the firm level and the impacts of transport and infrastructure at the aggregate level. Labour productivity is a residual measure with captures other productivity drivers in addition to actual labour productivity. The impact of these factors also shows the effect of innovation on growth. Innovation can be defined as the implementation of a significantly improved product or process within a firm to generate economic value. The Productivity Commission and the OECD both note that innovation is key to enhanced productivity growth.

In the 2010 Intergenerational Report, economic growth is described as the combination of three factors, population, participation and productivity. The following diagram shows more detail behind the three factors.

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Figure 1: Growing the economy from Treasury’s Intergenerational Report 2010

Source: Australian Treasury’s Intergenerational Report 2010.

The OECD paper Economic Growth in the OECD Area: Recent Trends at the Aggregate and Sectoral Level4 explains that growth in GDP per capita is driven by 5 factors:

- Changes in the ratio working age persons to the total population

- Changes in the labour force participation rate

- Changes in the employment rate

- Changes in the number of hours worked per person employed

- Changes in labour productivity, measured as GDP per hour worked.

Van Ark and McGuckin (1999) also use the same decomposition of GDP per capita growth in their paper International comparisons of labour productivity and per capita income to explain the differences in per capita income between countries.

Kacker and Ianchovichina (2005) note that ‘there are some notable differences across developing countries and regions’. The neoclassical model used in this World Bank paper asserts that a country’s initial level of per capita income, or GDP per capita, is not correlated to its growth rate. That is, based on this model, developing countries will not necessarily have higher growth rates compared to developed nations. Furthermore, countries have different growth rates as they move towards their own long run equilibrium that is constructed from their specific rates of capital, population and technology.

The World Bank’s Global Economic Prospects 2012 includes forecasts of real GDP growth for 2012, 2013 and 2014. These forecasts show the difference GDP per capita growth expectations in developing countries than developed or high income countries.

4 Scarpetta et al, 2000.

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Table 1: World Bank forecasts of real GDP growth (2005 PPP weights, percentage growth)

Area 2011 2012 2013 2014World 2.7 2.5 3.0 3.3High income 1.6 1.4 1.9 2.3

Australia+ 2.9 3.5 4.0 n/aDeveloping countries 6.1 5.3 5.9 3.0

+Australian data is from the June 2011 release.

Source: Global Economic Prospects: Managing growth in a volatile world, The World Bank,

June 2012.

The forecasted GDP per capita growth for Australia shows it to be slightly higher than the weighted average of the high income countries and the world average but not nearly as high as the expected growth rates for developing countries.

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Labour utilisation Growth in labour utilisation can indicate a move towards more labour intensive work practices, or growth in a sector that is particularly labour intensive. Labour utilisation can also be affected by trends developing towards part-time and casual work as firms become more flexible towards working arrangements. Work/life balance is often citied as reason for lower labour utilisation in developed countries where leisure time is highly valued. The ABS notes ‘Rising living standards depend not only on productivity growth but also on the average hours worked by each member of society’5. Labour utilisation in an economy can be estimated by the number of hours worked at the per capita or aggregate level.

The ABS provides a number of measures of labour utilisation in the Australian economy, including aggregate monthly hours worked by employment status and sex, and by state. In addition, the ABS quarterly detailed labour force publication reports the number of actual hours worked with breakdowns including, industry, occupation, status in employment and sex. This paper uses aggregate monthly hours worked to construct aggregate hours worked per year and subsequently the annual percentage growth in labour utilisation.

Australian labour utilisation

The early industrial history of Australia and comparatively low working hours of the time illustrated Australia as a ‘workers paradise’6. This is cited as the result of a ‘highly unusual system of labour regulation’ compared to other developed economies. The combination of an influential labour movement with social and industrial regulation led to higher wages and limitations on long hours of work. Campbell (2005) notes that ‘in contrast to the past, the working-time profile in Australia today is noteworthy for relatively long working hours’. This observation is based primarily on official labour force data and sees growth in unpaid overtime as the main factor behind the increase in the proportion of full-time employees working longer hours.

In addition, Chesters (2010) asserts that there was little if any change in usual hours worked in Australia during the global financial crisis in her paper The Global Financial Crisis in Australia. Those who were self employed in the period 2006 to 2008 did record a slight decrease in usual hours worked while employees reported working more hours during this period than previously.

The ABS publishes data on usual hours worked in its Labour Force Survey7 which can be used to approximate the working hours of Australians. Chart 2 indicates the average monthly and yearly hours worked by an employed person.

5 OECD 2004.

6 Campbell, 2005.

7 ABS Cat No.s 6202.0, 6291.0.55.001 and 6291.0.55.003.

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Chart 2: Monthly and yearly hours worked per employed person

Source: Based on ABS Cat. No. 6202.0 Labour Force.

The chart shows that in 1979, at the start of the series, employed persons worked around 153 hours per month. In 2010, this number has fallen to 141 hours per month for all employed persons. The overall trend visible in both the monthly and yearly series is that of a general decline in working hours.

This data includes both full time and part time employed persons, the effect of part time workers on labour utilisation is discussed further in this paper.

The following chart indicates the year-on-year percentage change of annual hours worked by employed persons. It shows that there are several periods of sharp decline in labour utilisation.

Chart 3: Year on year growth of annual hours worked per employed person

Source: Based on ABS Cat. No. 6202.0 Labour Force.

The early 1980s, early 1990s and early 2000s all show marked declines in labour utilisation. These periods align with periods of downturn in the Australian and world economies. They also align with periods of slower growth in GDP per capita. This

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may be the result of employers offering full time workers fewer hours rather than making them redundant in times of economic downturn.

The IMF8 notes that Australia’s strong performance in the 1990s was ‘attributable to both faster growth in hours worked and to a pickup in labour productivity, capital productivity and total factor productivity growth’. Further analysis by the IMF also found that structural reforms at this time did have a significant positive effect on productivity growth in the long run.

Trends in full time and part time work

Australia is seeing an increase in the proportion of part time workers in the labour force. Jefferson and Preston 2010 acknowledge that continued shift to part time employment has remained as a long term trend through the short term fluctuations in Australia’s economic performance.

Chart 4: Australian employment—total, full time, part time

Source: ABS Cat. No. 6202.0 Labour Force.

There could be many explanations for the marked increase in the proportion of employed persons who work part time. It could be the result of more women entering the workforce and wishing to work part time to manage their family duties, or the availability of more part time jobs in the labour market, changes to workplace laws or an overall change of preference of workers. The reason behind the trend is not of as much interest to this paper as the effect on labour utilisation across the economy and by extension, the effect on growth of GDP per capita.

8 IMF 1999.

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Chart 5: Proportion of full time and part time persons in Australian employment

Source: ABS Cat. No. 6202.0 Labour Force.

When considering labour utilisation, an increase in part time workers who were previously unemployed will increase the overall number of hours worked at the aggregate level and thus increase output. This must be taken into account when looking at hours worked per employed person, as the part time hours will appear to drag down labour utilisation. In addition, workers who were previously employed on a full time basis moving to part time work will cause labour utilisation to decrease.

Unemployment and underemployment

The ABS defines underemployment as ‘part-time workers who want, and are available for more hours of work than they currently have, and full-time workers who worked part-time hours, during the reference week for economic reasons (such as being stood down or insufficient work being available)’ 9. The ABS notes that underemployed workers in an economy are an important component of underutilised labour resources.

Over three quarters of a million part time workers were underemployed in September 2011, according to the ABS. An underemployment rate of 7 per cent was reported in September 2011, indicating that 7 per cent of the labour force was working fewer hours per week than they would like to.

There is the potential to increase the aggregate hours worked in the economy if there was work for these underemployed workers. An increase in aggregate hours worked in the economy could in turn increase GDP per capita, if productivity remains constant.

9 ABS Cat No. 6265.0.

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Chart 6: Unemployment and underemployment rates

Source: ABS Cat. No. 6202.0 Labour Force.

It is evident from Chart 6 that the unemployment rate has been trending downwards while the underemployment rate has been trending upwards. This shows that more people are employed but that an increasing number of employed persons are working fewer hours than they would like. This could be due to a change in the type of jobs available in the economy, changes in workplace laws or a change in the preferences of workers.

Chart 6 also reveals an interesting change in the behaviour of the unemployment rate and the underemployment rate around 2000. Prior to 2000, the unemployment rate has been greater than the underemployment rate. However, post 2000, the unemployment rate is lower, reflecting structural change in the labour market, in particular the shift from full time to part time work.

Jefferson and Preston (2010) observe that after the global financial crisis there were ongoing “relatively high rates of labour utilisation” . They identify uneven development or ongoing structural change in the labour market towards less secure forms of employment as contributing factors to high rates of labour utilisation and the shift towards part time employment.

Participation rate and ratio of persons of working age

The aforementioned OECD paper10 also notes the effect of the participation rate on growth of GDP per capita, including it as one of the five components listed earlier in this paper that contribute to GDP per capita growth.

The Australian participation rate indicates that there is a high proportion of the population engaged in the labour force, whether they are currently fully employed or not. The participation rate has shown slow, and sometimes mixed growth over the past three decades as seen in Chart 7. The 2010 Intergenerational Report notes that the labour force participation rate for people aged 15 and over is projected to fall over the next 40 years to 2050.

10 Scaroetti et al, 2000.

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Chart 7: Participation rates in Australia by age group

Source: Based on ABS Cat. No. 3101.0 Australian Demographic Statistics and 6202.0 Labour

Force.

Labour utilisation across industries

A comparison of hours worked per employed person and value added by industry shows that labour utilisation varies across industries. As seen in Chart 8, some industries have much lower labour utilisation, such as accommodation and food services, and retail trade, compared to other industries which have much higher labour utilisation, such as mining and agriculture. This could be explained by the different capital and labour ratios between industries. Labour utilisation typically has an inverse relationship with capital intensity—the proportion of capital used in production.

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Chart 8: Labour utilisation and industry value added by industry in 2011

Source: ABS Cat. No.s 5206.0 National Accounts and 6202.0 Labour Force.

These discrepancies could be caused by higher numbers of part time workers in some industries. The mining industry has work schedules that are very different to a 9 to 5 office work environment more common to subsectors of the services industry.

Labour utilisation and an aging population

It is widely recognised that Australia, like most developed nations, is facing the problem of an aging population. The 2010 Intergenerational Report notes that ‘steps to improve Australia’s participation rate will minimise the impact of an ageing population’ and that ‘a growing population assists in managing the pressures of an ageing population and provides the skills needed for continued economic growth’.

Forecasts from the Productivity Commission’s Economic Implications of an Ageing Australia indicate that both participation rates and average weekly hours worked per employed are set to decline. The report shows that aggregate participation rates in Australia are expected be approximately 56 per cent by 2044–45, around 7 percentage points lower that current levels. The decline in average weekly hours worked per employee is cited as due to the ‘rising incidence of part-time workers generally and the increasing labour market share of older workers, who have a greater tendency to work part-time than others’. Although there are positive effects on the unemployment rate with an ageing population, the Productivity Commission believes that these will be far outweighed by the negative effects on participation and average hours worked.

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Labour productivity Labour productivity is the most commonly used measure of productivity, showing the relationship between changes in output and changes in labour inputs. Growth in labour productivity can indicate a shift towards greater use of capital intensive methods and/or a decrease in the employment of low-productivity workers. Pilat (1996) asserts in his paper on labour productivity in OECD countries that ‘labour productivity is the most important determinant of a country’s income level’11.

Economic growth theory suggests that in the long term, productivity is what determines living standards. As previously discussed, growth in GDP per hour worked, or labour productivity growth, in conjunction with labour utilisation growth, drive growth in GDP per capita.

Australian labour productivity

Labour productivity in Australia has experienced strong growth since the 1980s. The 2010 Intergenerational Report notes that labour productivity over the past four decades has accounted for most of the growth in real GDP per capita.

As shown in Chart 9, there is a notable decline in growth in the mid 1980s and flatter growth for most of the 2000s. Productivity also appears to be tapering off in recent years.

Chart 9: Australian labour productivity 1980–2011

Source: Based on ABS Cat. No.s 5206.0 National Accounts and 6202.0 Labour Force.

Labour productivity growth

Rahman et al (2009) note in their paper on trends in Australian productivity that ‘trend productivity grew markedly during the 1990s — particularly, it was much stronger during the late 1990s than was the case earlier. Further, trend productivity growth appears to have weakened since the beginning of this decade’. Based on cyclical fluctuations and productivity growth cycles, in this paper 1.75 per cent is considered a benchmark for the growth rate of productivity. The trend of labour productivity growth around this benchmark can be seen in Chart 10.

11 Pilat, 1996.

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Chart 10: Growth in labour productivity

Source: ABS Cat. No.s 5206.0 National Accounts; 6202.0 Labour Force; and Rahman, Stephan

and Tunny (2009).

There are periods of lower productivity growth than the benchmark and also lower than the surrounding years. In particular, the mid 1980s and the 2000s show lower, and sometimes negative, productivity growth compared to other years.

Equally, there are periods that show particularly high productivity growth, such as the early 1980s and late 1990s to early 2000s. These surges could be the result of recovery from economic downturns. Rahman et al (2009) note ‘a number of conjectures have been made about Australia’s recent productivity experiences,’ and lists opening to international trade, adoptions of information and communication technologies and increased research and development activity in the 1990s, as the drivers of productivity during that time.

Equally, there are differences in the average annual growth rates for the past five productivity cycles, as shown in Chart 11. The productivity cycles used in this paper reflect those used by the ABS and the Productivity Commission. Productivity data is inherently volatile and cyclical and so the ABS has calculated productivity cycles to reflect the peaks and troughs in productivity growth. It can be expected that calculating annual average growth rates across productivity cycles would smooth any volatility experienced during the cycle but also risks removing some of the activity during the period. Also, the paper assumes that the periods of the productivity cycles are consistent across industries which may not be the case.

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Chart 11: Average annual growth rates of labour productivity, by productivity cycle

Source: ABS Cat. No.s 5206.0 National Accounts; 6202.0 Labour Force; and author

calculations.

Average annual growth rates do show that there was an elevated productivity growth in the productivity cycles 1989–94, 1994–99 and 1999–2004.The most recent three productivity cycles shown in the chart suggest slowly falling productivity, measured as GDP per hour worked. Although the growth rate seen in the 2004–08 productivity cycle is lower than that of the three previous, it is higher than the average growth rate of the 1985–89 productivity cycle.

Ewing et al (2007) note that while long term productivity drivers can be challenging, ‘understanding short term changes is particularly difficult’. Ewing et al also note that ‘after growing rapidly during the 1990s, trend productivity growth slowed in the current decade’. Their analysis goes on to separate the market and non-market sectors to examine the growth in labour productivity in separate parts of the economy. It is found that these different sectors have experienced varying labour productivity growth. The different contributions of sectors is replicated and discussed further in the labour productivity by industry section of this paper.

Valadkhani conducted a study in 2003 to examine the sources of aggregate labour productivity growth in the period 1970 to 2001. Based on empirical estimates, this study found that policies aimed at promoting investment, trade openness, international competitiveness and wage negotiations will improve labour productivity in the long term. In the short term, most of these factors were also found to make contributions to labour productivity, with the exception of labour reforms which were found to require more time to have an impact. Valadkhani (2003) also goes further to suggest that for productivity growth to remain strong in the future ‘the economy should invest more in human capital, physical and information and telecommunications technology’.

In a speech to the Committee for Economic Development of Australia in 2001, David Gruen makes note of the much suggested explanation for productivity growth—that improved performance of productivity growth is the result of microeconomic reforms implemented since the 1970s. He goes on to dispute this explanation, noting that productivity numbers are volatile and that microeconomic reform should enhance productivity growth yet we do not know for how long. Also, Gruen mentions a number of factors that could also have enhanced productivity growth over this period, namely, a fall of barriers to international trade and growth in the technology sector.

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This view is echoed by Quiggin (2001) who takes a sceptical view on the effects of structural reforms on labour productivity growth. Quiggin examines empirical evidence behind reforms such as labour market reform, financial sector reform and trade reform, and finds that there is no empirical evidence to support the claim that microeconomic reform was responsible for improvements in productivity.

In the 2010 Intergenerational Report, productivity growth is expected to be consistent with the average annual growth rate of the previous 30 years, that is 1.6 per cent per annum. It is noted that it is particularly difficult to estimate productivity growth over the long term due to historical variation and difficulties in measuring productivity itself.

It is a widely discussed assertion that with an aging population in Australia and consequently falling participation rates, productivity growth will be the key to driving future growth in the Australian economy.

Labour productivity by industry

As would be expected, different industries have different levels of labour productivity. Ewing et al (2007) observe that there are different rates of productivity growth for the market and non-market sectors of the economy. In particular, they note ‘much of the slowdown in productivity in recent years is due to low productivity growth overall in 2004–05, and low productivity growth in the non-market sector…in 2005–06’.

As illustrated in Chart 11, the different sectors of the economy have experienced different rates of growth in labour productivity over the past 25 years. there are measurement problems associated with productivity in the services industry. It is difficult to measure the output of non-market subsectors of services industry that do not have tangible output, such as education and health. It follows then, that labour productivity in these subsectors is very difficult to estimate given it is based on output per hour worked. This will result in underestimating labour productivity growth in these subsectors.

Chart 12: Average decade growth rates of labour productivity by industry

Source: ABS Cat. No.s 5206.0 National Accounts; 6202.0 Labour Force; and author

calculations.

Disaggregating the sectors of the economy further, in Chart 13, there are two sectors in particular that can be described as outliers. Mining and financial and insurance services, both with high levels of industry value added, show much higher levels of labour productivity than any other sector. This result highlights a problem with measures of labour productivity. Typically, labour productivity does not take into consideration the level of capital intensity, that is the relative weight of labour and capital inputs. It is likely that the mining and financial and insurance services sectors’

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high capital intensity is the explanation for the higher levels of labour productivity shown in chart 12.

Chart 13: IVA and labour productivity by industry in 2011

Source: ABS Cat. No.s 5206.0 National Accounts and 6202.0 Labour Force.

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ConclusionIt is widely recognised that growth in GDP per capita is driven by growth in labour utilisation and growth in labour productivity. It follows that to increase the growth in GDP per capita, a commonly used measure of wellbeing, growth in either labour utilisation or labour productivity is required. This approach could have unintended policy implications, such as lowering productivity as less productive workers are employed, or increasing wage costs leading to capital substitution. This paper serves as a starting point for further research into the drivers of GDP per capita growth, the implications of changes in these drivers, and the suitability of this type of analysis for various industry sectors.

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