Beyond the boom: Australia's productivity imperative

By Charlie Taylor, Chris Bradley, Richard Dobbs, Fraser Thompson and Daniel Clifton

An outsized boom in the natural-resources sector has produced strong income growth for Australia, but its fundamentals have been weakening. Building a more balanced and resilient economy that can withstand a potential slowdown depends on getting back to the basics of productivity growth.

Australia has been riding the wave of Asia’s economic growth, supplying coal, iron ore, and minerals to meet unprecedented demand in China and other emerging markets. As commodity prices spiked in recent years, the country has attracted a flood of investment into its mines, processing plants, pipelines, and ports. More money has been invested in Australian resource projects in the past 5 years than in the previous 20.

Asia’s economic and demographic trends point to sustained demand in the decades ahead, but growth fuelled by demand for natural resources carries risk. The McKinsey Global Institute (MGI) report Beyond the boom: Australia’s productivity imperative finds that “one-off” factors—including favorable terms of trade and an investment surge—have driven half of the country’s recent growth, obscuring the truth about its overall economic health.

The magnitude of Australia’s resource boom belies some weakening fundamentals. Since 2005, the country has enjoyed 4.1 percent annual gains in income. But growth in labor productivity has fallen to just 0.3 percent. Capital productivity is now the biggest drag on income growth.

MGI outlines four potential scenarios for the future and finds that growth is likely to slow down, even in the best possible outcome. But in the worst-case scenario—if terms of trade move back toward their long-term average, some capital projects stall, and productivity growth remains low—income growth could stagnate at just 0.5 percent a year until 2017.

Australia can’t control commodity prices and global demand for resources, but by reversing its slide in productivity, it can take steps to create a softer landing when the boom eventually subsides. The report identifies four sectors—defined by their proximity to the resource boom and their exposure to trade competition—and pinpoints the major challenges for each of them. Successfully addressing these areas could raise national income by up to AU $90 billion (about US $95 billion) a year by 2017.

  • Resource sectors: Getting capital productivity right. Australia is less than halfway through the capital boom, with AU $443 billion in investment still to come in the resource sector. Major capital projects are prone to inefficiencies and overruns, but the country has an opportunity to boost its capital productivity by up to 30 percent if firms emphasize a top-level focus on value, adopt a best-practice “tool kit,” and assemble project teams with superior execution skills.
  • Resource-rider sectors: Improving efficiency. Transport, utilities, professional services, and other resource-related sectors have grown dramatically because of their links with the mining and energy boom. Yet at the same time, their labor productivity has fallen dramatically as well. Stakeholders must find ways to develop new infrastructure more cost effectively. Additionally, a more integrated cross-sector approach to resource productivity can reduce the need for some expensive new projects.
  • Local services: Implementing microeconomic reform. Sectors such as retail trade and telecommunications have been largely unaffected by the resource boom. They have posted solid productivity gains but tend to lag behind international benchmarks. Australia can close the gap through a renewed focus on microeconomic reforms that streamline regulations, encourage innovation, and promote competitive markets.
  • Manufacturing: Creating a foundation for long-term competitiveness. Like other developed economies, Australia has seen its manufacturing base erode. Improvement will depend on cost efficiencies, particularly the neglected area of management quality; higher labor mobility; and a shift to innovative manufacturing, which offers the best long-term potential for competitiveness.
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