ADDRESS TO THE

CANBERRA BRANCH OF THE ECONOMICS SOCIETY OF AUSTRALIA

POLICY REFORMS TO STRENGTHEN THE ‘NEW ECONOMY’

2000 CHRIS HIGGINS MEMORIAL LECTURE

14 NOVEMBER 2000

Paula Higgins, ladies and gentleman, it is an honour for me

to be invited to present the Chris Higgins Memorial Lecture for 2000. May I also

acknowledge Chris’ two sons, David and Tim, both of whom, I’m pleased to say,

are currently with the Commonwealth Treasury.

When I first entered Parliament in March

1990, Chris had been the Secretary to the Treasury for around six months. His untimely

death in December 1990, meant that I did not have the chance to develop a personal

association.

But his written legacy as a key contributor to Australian macroeconomic analysis,

econometric modelling, and economic policy advice is clearly visible. He was enormously

energetic and prolific, both as an academic and through his roles in the Bureau of

Statistics from the mid-1960s and in Treasury from 1970.

Through parts of the sixties and seventies, Chris researched and published broadly as a

PhD student and then as a Fullbright scholar in America, and as an Associate Professor at

the University of British Columbia.

He continued to learn from the best of international policy practice in the early

1980s, in the most senior economist’s position an Australian has ever filled in the

OECD’s Economics Department.

In his work at the OECD Secretariat in the early 1980s, Chris initiated the

Organisation’s switch away from mainly short-term analysis of macroeconomic cycles

and policies towards more emphasis on structural reforms and on a medium-term, sustainable

macro framework. He continued to advance that line in the mid and late 1980s as Treasury

Deputy Secretary and Australian representative on the OECD’s Economic Policy

Committee.

Chris demonstrated a commitment to public service.

A decade ago, the Commonwealth Treasury had far fewer challengers in economic

forecasting and the giving of economic policy advice. It held pre-eminent place because

its resources – in terms of personnel, research and access to information – were

vastly superior to private sector analysts.

But increased transparency and more easily disseminated information, opened the door to

many voices forecasting and advising the Government. Hardly a day seems to go by without

some company or other observing that the economy is set for a boom, or possibly sliding

into recession, or the budget is at a record surplus, or alternatively back in deficit. Of

course, the more dramatic the pronouncement, the more likely it is to get on the news and

– I am sure the public relations advisers have made this point – the more likely

the company, its logo and its spokesmen will get exposure.

And whilst training at the Treasury or Reserve Bank is still the best training for

economists, the private sector, able to pay much higher salaries than the Public Service,

is able to recruit those economists after their training and build a capacity in

forecasting and macroeconomics.

We can hardly complain about this recruiting activity. Young economists have families

and children and naturally want to provide for them. And we who, by and large, support

open markets cannot complain about those who are willing to pay market rates for highly

sought after skills and services.

But I would like to say a word for public service. And as someone who has spent about

half his working life in the private sector and half in Parliament, I do want to reiterate

the importance of public service. For people with sought after skills, the remuneration

may be less. But the quality of our government and the quality of our national life is

quite directly influenced by our Public Service. And will be the better, for better people

in it. People who are prepared to devote themselves to the national interest in advising

government, in administering it and in carrying out decision–making, are people who

should be recognised and admired, not constantly denigrated. There are some that do not do

as well as they should, but there are an awful lot of decent and devoted people who feel

very deeply about their country and where it can go.

And Chris was one of those. And a strong, professional Treasury is important to good

policy. It will not keep its influence by reason of a monopoly any longer – it is now

challenged by multitudes of advisers – but only by reason of its professionalism

The New Economy

Tonight I want to direct some comments to the issue of ‘The New Economy’.

In the late 1990s there was a step up in growth in the United States, that according to

previous experience would have brought a step up in inflation. But it did not.

Policy-makers who would normally have taken a pre-emptive strike with monetary policy

began considering whether this was just a glitch in the data, a lag in inflation, or

whether something structural had occurred –whether we were experiencing some kind of

new economy.

A new growth in productivity seemed to have occurred. A great deal of academic work was

commenced to identify which countries had experienced this productivity growth and what

the common factors were that could explain it. The OECD began an investigation of these

issues in the latter part of 1999

A new chapter in the productivity story

As I suspect many of you would have heard me say already, the OECD’s Growth

Project identified in its initial report to the June 2000 OECD Ministerial Council Meeting

that the US, Australia, the Netherlands, Denmark, Norway and Ireland had achieved a

significant lift in trend GDP per capita growth in the 1990s. This lift in performance was

relative to both their own earlier history, and the OECD average.

Moreover, this achievement was associated with high labour productivity growth, high

total factor productivity growth, and good employment outcomes.¹

Work published just last month by the US Federal Reserve Board also singled Australia

out as one of the few economies to have lifted productivity growth in the second half of

the 1990s, even outperforming the US in productivity growth.²

The origin of the New Economy concept was the step up in productivity. But what

produced the productivity growth? Why was it the US in particular that had experienced

this development rather than continental Europe or Japan?

One of the measures on which the United States consistently outstripped Europe and

Japan, indeed the world, was the application of information and communication technology

(ICT). And by this route the description ‘New Economy’ became increasingly

applied to economies that have large ICT industries or apply ICT widely throughout their

economies

Productivity and growth performance: an historical analogy

Let us go back 30 years. From the early 1970s there was a marked productivity slowdown

in the US economy. Robert Solow’s observed the paradox that “we can see the

computer age everywhere except in the productivity statistics”.

In 1997, Robert Gordon (still today a sceptic as to the real productivity contribution

of computers) said, “for more than a decade American corporations have been

shovelling billions of dollars in computers down a black hole, with no response at all

from the sluggish growth rate of American productivity.”³

Yet in late 1989, the Stanford economic historian Paul David warned against the pitfall

of “unrealistic impatience” in analysing and predicting the information age.

In a powerful analogy, he pointed to the slow diffusion of the electric motor through

the industrial structure. It took from 1900 to 1920 before electric power had become the

dominant industrial energy source over steam, even though central generating stations had

been established in New York and London as early as 1881.

David’s research suggests that the full advantages of the electric motor were not

reaped until the entire factory system had been re-conceived and re-built.

David’s key insight was that today’s information and communications

technologies, like the electric motor before them, are ‘general purpose

technologies’. In both cases, the full extent of what could productively be done with

them was not initially obvious. It required huge investments, much trial-and-error, and

the forced diffusion by competitive pressures of the successful new business models and

workplace skills.

If we learn from this ‘electric age’ analogy, we should beware of

“unrealistic impatience” in expecting the full payoffs from ICT: there is a very

large economic restructuring required to achieve its full benefits. The early prizes will

go to those who, under competitive pressure, are the quickest and most flexible to adapt.

And we should also guard against blind faith in assuming the ultimate benefits. Getting

the most out of ICT requires that the entire suite of macroeconomic policies and

structural policies should simultaneously be working well. In particular, it requires

competitive pressures in a well-managed, flexible economy to deploy the new technologies

productively.

As the OECD continues its Growth Project work, it seems likely to clarify that there is

no one single explanation in all six of the highly performing economies for their

productivity surges. All have drawn on ICT advances, but in their own ways in the context

of their other relative strengths.

That should not surprise us, as wealth is created from trade (both domestic and

international) based on comparative advantage: from harnessing differences for

mutual benefit. It does not come from seeking to conform to an OECD statistical average,

nor from seeking to emulate one leading economy in every detail

ICT production and ICT use

Much as Paul David’s historical analogy had predicted, Solow’s computer

productivity paradox has begun to be solved. For the US, productivity jumped in the second

half of the 1990s, and it is now clear that ICT was the main factor in the US case.

The question of how much of the US ‘new economy’ productivity surge arises

from that economy’s production of ICT, and how much arises from the use

of ICT throughout the economy has been the subject of detailed studies this year.

The most influential study (around which most other researchers’ results cluster) is by

Stephen Oliner and Daniel Sichel of the Federal Reserve Board.⁴

They find that of the US increase of about 1 percentage point in labour productivity

growth in the second half of the 1990s, around one-third arose from productivity gains

within the semiconductor and computer producing sectors themselves, while over forty

percent arose from capital deepening from the accelerated investment in ICT elsewhere in

the economy.⁵

Almost thirty percent of the productivity gain remained unexplained by changes in the

volumes and qualities of labour and capital. This unexplained amount remains as the

residual measure of total factor productivity growth in non-farm businesses outside the

semiconductor and computer producing sectors. At least part of this gain is also likely to

be ICT-driven efficiency gains.

It is irresistible to seek Australian comparisons to these US findings, as has been

done recently by both the Federal Reserve Board and Goldman Sachs (Table 1).⁶

It is notable from these comparisons that first, the Australian productivity began to

lift in the early 1990s before the US but experienced a quantum jump in the later part of

the 1990s. It has been even stronger than US productivity growth, and by an increasing

margin over time.

Most analysts attribute the earlier start to Australian productivity growth and its

stronger performance to include some element of ‘catch up’ on the US.

Second, since Australia has no semiconductor or computer production, productivity gains

in those US sectors is absent from our performance. The strength of our performance is

therefore all the more remarkable.

Third, Australian investment in ICT is very high and has accelerated through the late

1990s. The growth of investment in software continued at even higher rates than in the US,

and growth of investment in hardware also showed a very large jump from an already high

base in the second half of the 1990s, but not to US levels. Nor does the share of ICT

investments in the total capital stock seem to have built up to US proportions yet.

The sense that Australian ICT investment is still building up to US levels contributes

to the Goldman Sachs’ judgement that Australia is ripe for a second wave of

productivity improvements that would take over where the first wave of reform-based

benefits left off.⁷

Fourth, Australia, like the US, is unlikely to have begun to see the productivity gains

from E-commerce yet, as efficiencies from B2B, B2C and ‘Government on line’ or

E-government were only burgeoning in the late 1990s.

Fifth, Australian E-commerce readiness is among the highest in the world and little

behind the US’s, whether it is measured by PCs per household, installed computers per

thousand inhabitants, secure servers per thousand inhabitants, or internet connections and

use. (Figure 2 illustrates two of these measures.)

In fairness to critics of the lack of Australian semiconductor and computer production,

let me underscore again: the US did obtain about one-third of its late-1990s

productivity gain from the extraordinary technical advances in its production of

semiconductors and computers.

But without that production of semiconductors and computers, Australia’s

productivity performance over the 1990s still outstripped the US’s. With the right

policies to maximise our gains from the new technologies, I see no reason why that could

not continue

The ‘new economy vs old economy’ fallacy

The information and communication technologies (and their applications in E-commerce)

are general purpose technologies that will redesign Australian industry. Their effects

will be all-pervasive, because they lower information costs and transactions costs.

Australian business is in the process of redesigning itself to use the new ICT and

E-commerce technologies.

The ‘new economy’ is mostly the productive use of ICT in the ‘old

economy’. This is the sense in which Alan Greenspan recently noted that

“… in a meaningful sense, there is, with few exceptions, little of a truly

old economy left. Virtually every part of our economic structure is, to a greater or

lesser extent, affected by the newer innovations. No old-economy textile plant could exist

in today’s environment without technologies that Edmund Cartwright could never have

imagined.”⁸

I believe this will become even clearer in the next phase of the ICT revolution, when

E-commerce becomes more prominent.

Success at E-commerce will require (amongst other things) that we have:

• A stable environment of low inflation and low interest rates, so that firms can finance

  necessary investments;

• An open global trade and investment environment and an open national economy, so that

  we can make full use of others’ markets, improvements and ideas;

• A trustworthy electronic signature and legal framework, to enforce electronic

  commitments;

• A competitive telecommunications sector, to keep down the cost of electronic

  transactions;

• A competitive transport sector, to deliver electronic orders either to consumers, or to

  firms under ‘just in time’ inventory management in new B2B exchanges;

• A developed equites market, to help provide venture capital;
• A solid financial sector – with competitive credit card charges, to mention a topical

  example particularly relevant to E-commerce;

• A flexible business sector, to experiment with competing models of E-commerce, with

  their widely different implications for the redesign of modern corporations;

• An effective competition authority to monitor the generally pro-competitive impact of

  the new technologies, and prevent the occasional anti-competitive exceptions;

• An effective consumer protection process to give citizens the confidence to try the new

  modes of commerce;

• An education system that prepares people for the scientific future in which facts

  count, rather than destroying interest in science through postmodernist and

  deconstructionist relativism;

• An R&D system in which government contributes towards the tasks with largest

  external benefits, and business identifies and finances the tasks with most immediate

  market application;

• Cultural values that applaud success, forgive failure, and encourage all to ‘have

  a go’;

• An income tax system that does not act as a disincentive for mobile people with high

  skills.

• Good corporate governance and insolvency law, to minimise the costs of the inevitable

  but unpredictable failed experiments; and last but far from least,

• Flexible labour markets.

The path forward

This is a very long list. Achieving it requires the substance of coherent,

pro-competitive policy reform across a broad front, not the simplistic and wrong-headed

response of higher government taxing and spending.

No country fully delivers all these requirements – yet.

But perform a thought experiment.

How much does this shopping list sound like the United States? How much does it sound

like the Euro zone? How much does it sound like Australia?

Let me conclude with a few comments on labour market flexibility.

Alan Greenspan recently offered some provocative observations in attempting to explain

the lower level of high-tech investment (not production) in continental Europe and Japan,

relative to that in the United States. I quote him at length to convey the full flavour of

his analysis:

“…..Arguably, this outcome has resulted to an important degree from the

particular legal structures and customs that govern labor relations in much of Europe and

Asia. By choice over the decades, Europe, for example, has endeavored to protect its

workers from some of the presumed harsher aspects of free-market competition. To

discourage layoffs, discharging employees was made a difficult and costly process in

comparison with that in the United States. By law and by custom, American employers have

faced many fewer impediments in recent years to releasing employees.

This difference is important in our new high-tech world because much, if not most, of

the rate of return from the newer technologies results from cost reduction, which on a

consolidated basis largely means the reduction of labor costs. Consequently, legal

restraints on the ability of firms to readily implement such cost reductions lower the

prospective rates of return on the newer technologies and, thus, the incentives to apply

them. As a result, even though these technologies are available to all, the intensity of

their application and the accompanying elevation in the growth of productivity are more

clearly evident in the United States and other countries with fewer impediments to

implementation.”

I emphasise that last phrase, “other countries with fewer impediments to

implementation”, because I put Australia in that category. Dr Greenspan continued:

“Parenthetically and counter-intuitively, … reducing the risks of hiring by

American employers, has contributed to a higher rate of employment in the United States

compared with the vast majority of our major trading partners.

A particular irony in all this is that Europeans have been finding investments in the

United States increasingly attractive and have accounted for an increasing share of the

expanding total of foreign investment in U.S. direct and portfolio assets.” ⁹

Labour market reform is important for creating more jobs and securing employment.

I think we now realise that it was the lack of competition and flexibility in

Australian markets that caused our gradual relative economic decline, and it is by

heightening competition and flexibility that we are reversing it.

An open competitive economy is the economy that is going to capture and utilise new

improvements, new capacities, new productivity developments.

Thank you.

Figure 1: US Business Sector Productivity Growth
Average annual per cent change

Table 1: Contributions to Australian and US productivity growth in the 1990s

Source: Wilson, D., “Australian Productivity: Catching a ‘New

Economy’ Wave”, Goldman Sachs Global Economics Paper No. 50, July 2000,

Table 4.

Note: Wilson uses unpublished ABS data to replicate for Australia the format of the

Oliner and Sichel analysis of US productivity. He uses the Oliner and Sichel data for the

US. However his presentation is not identical to Oliner and Sichel’s, as Australian

data does not permit the same treatment of the communication equipment sector as in the

US.

Figure 2: Australia: One of Six OECD members with above average diffusion

of both

Internet Hosts and Secure Servers

Click to enlarge Figure 2

Source: OECD: Internet and Electronic Commerce Update, Chart 3; http://www.oecd.org/dsti/sti/it/cm/stats/newindicators.htm#chart3.

Notes: Internet hosts are computers with Internet Protocol addresses (ie,

connectable to the Internet). They are an underestimate of Internet access, as they do not

identify computers behind a corporate firewall, able to access the Internet through a

single corporate server with an IP address.

Secure servers provide a useful measure of readiness for E-commerce, as they are

able to handle encrypted credit card transactions.

---

1. Is There a New Economy:

First Report of the OECD Growth Project, OECD, Paris, pp 4 – 12

2. Christopher Gust and Jaime Marquez, Productivity

Developments Abroad, Federal Reserve Bulletin, October 2000, pp 665 – 681

3. Robert Gordon (1997), “Comment on Daniel

Sichel, The Computer Revolution” cited in J. Bradford DeLong, “What Went

Right in the 1990s? Sources of American and Prospects for World Economic Growth” in

Reserve Bank of Australia, The Australian Economy in the 1990s, edited by David

Gruen and Sona Shrestha, July 2000

4. Oliner, S.D. and D.E. Sichel, The Resurgence of

Growth in the Late 1990s: Is Information Technology the Story?, May 2000, US Federal

Reserve Board Staff Working Paper, available at http://www.bog.frb.fed.us/pubs/feds/2000/200020/200020pap.pdf

5. One conflicting estimate on this point is in

Robert Gordon’s argument, in Does the ‘New Economy’ Measure Up to the

Great Inventions of the Past, NBER, 2000. He attributes three-quarters of the post

1995 acceleration in US productivity growth to cyclical factors, and can then

‘explain’ the remaining quarter by the gain in productivity in producing computers. However it is not credible that much (if any) of the recent US productivity

improvement is cyclical: see Figure 1, which shows that at comparably late points in

earlier upswings, productivity had long ceased its cyclical increase, and was instead

falling

6. Christopher Gust and Jaime Marquez, Productivity

Developments Abroad, op. cit.; and Wilson, D., Australian Productivity:

Catching a ‘New Economy’ Wave, Goldman Sachs Global Economics Paper No. 50,

July 2000

7. Wilson, D., Australian Productivity: Catching a

‘New Economy’ Wave, ibid.

8. Alan Greenspan, Challenges for Monetary Policymakers,

address to the 18th Annual Monetary Conference: Monetary Policy in the New Economy, Cato

Institute, Washington, D.C., October 19, 2000. Available at http://www.federalreserve.gov/BoardDocs/Speeches/2000/200010192.htm.

Edmund Cartwright was the inventor in the 18^th century of the power loom and

the wool-combing machine. He built a weaving mill in 1787.

9. Alan Greenspan, Global Economic Integration: Opportunities

and Challenges, address to a symposium sponsored by the Federal Reserve Bank of Kansas

City, Jackson Hole, Wyoming August 25, 2000. Available at http://www.bog.frb.fed.us/boarddocs/speeches/2000/20000825.htm.