The real factor holding back productivity (hint: it’s not labour)
Last week was bank profit bonanza season, during which very senior bankers took their moment in the sun to declare that Australia needed to press forward with a reform agenda aimed at boosting national productivity. Ian Narev of the Commonwealth Bank, Mike Smith of ANZ and Brian Hartzer of Westpac all, in their own way, declared that as a nation we should get out of the way of markets and let creative destruction shift capital to its most productive uses.
It is an admirable sentiment that makes perfect sense in theory. Productivity growth is the key to national prosperity, never more so than in Australia right now as we struggle with failing competitiveness after the mining boom.
But Australia’s senior bankers should perhaps pause for a moment to reflect upon how productivity works. Capital efficiency is a key input into the equation and has been dragging the chain far more than labour for the past decade. Some of that is the result of a capital-intensive mining boom, yet to see its big returns, but another unexamined factor is also strongly at work. The price of land is a key input cost for most businesses. So when costs are inflated, it reduces the competitiveness of industry, making it harder for Australia to compete abroad. The associated higher housing cost also places upward pressure on wages.
For decades, the resource allocation governed by the banks has been channeled away from the tradable sector and infrastructure investment towards the financial sector, as home buyers have taken on ever-bigger mortgages and chased house prices higher. It should be no surprise that the finance and insurance industries — which are dominated by mortgage lending — have grown at more than twice the pace of the rest of the economy since financial markets were deregulated in the mid-1980s, due in part to the housing quango operated by the various levels of government (see below charts) …
Australia’s housing obsession has also starved productive sectors of the economy of credit. In the early 1990s, Australia’s banks lent nearly two-thirds to businesses, with the balance split between housing and personal lending. However, after the mid-1990s explosion of housing values, these ratios have reversed, with housing lending dominating at the expense of businesses …
To add insult to injury, much of the boom in mortgage lending has been funded by heavy offshore borrowing by Australia’s banks, in turn driving up Australia’s net foreign debt.
At the heart of the problem are Australia’s unique mix of tax concessions, such as negative gearing, a constipated supply system, and major banks that use internal risk models that make mortgage lending their most profitable business. The end result is too much of the nation’s capital is tied-up in housing, which has choked-off productive areas of the economy.
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