The Productivity Commission's paper 'Things you can’t drop on your feet: An overview of Australia’s services sector productivity' (PC Productivity Insights, April 2021) comments
Over the past 70 years the Australian economy has undergone a fundamental shift from agriculture and manufacturing to services. Services now account for about 80 per cent of production and 90 per cent of employment. Although the goods sector, including mining, will continue to be of economic importance, as Australia continues to become a more service-centric economy, long-run wages and national welfare will be increasingly linked to service sector productivity.
This said, services are not one monolithic industry; the service sector covers a wide range of jobs and outputs, from brick laying to neurosurgery. The Commission’s latest series, Productivity in the service sector, aims to better understand these industries, their different characteristics, factors affecting their productivity performance and potential implications for policy. The series will delve beyond national aggregates, using industry-sourced data and bespoke analytical approaches. This paper is the series launch — outlining the significance of and issues in service sector productivity, while future papers will be vignettes on subindustries.
Australia’s shift towards service production, and away from manufacturing in particular, has raised concerns. These include worries about services dragging on productivity performance and service sector jobs being lower paid or of lower quality. For the most part, these fears are unfounded. Many service sector industries provide jobs that pay as well as or better than manufacturing, with good job security. And the increased prevalence of casual work has been proportionally as large in the goods sector as in the service sector. Several service sector industries — including financial and insurance services and information, media and telecommunications — have also experienced productivity growth that outpaced the goods sector.
The service sector also faces challenges. COVID 19 has caused Australia’s first recession in nearly 30 years and parts of the service sector (especially hospitality, accommodation, recreation and retail) have been hit hard. Between 14 March and 11 April 2020, the food and accommodation industry laid off a third of its employees, and the recreation industry shed nearly 30 per cent of its workforce. Though employment has since improved, neither industry has fully recovered and concerns about COVID-19 continue.
While some services industries have performed consistently well over the long run, others have had persistently low productivity growth. For example, administrative support and arts and recreation have both had productivity growth below the market sector average since 1994 95. While this may partly reflect the challenges of measuring productivity in the service sector, it mainly reflects the intrinsic characteristics of many services, such as the need for face to face interaction, which limits market size and opportunities for trade, scale and capital deepening. Technological developments have and will continue to change some of the characteristics of the (historically) slow productivity growth services and increase their resource efficiency. For example, online learning increases access to, and competition within, education as well as increasing the scope for capital deepening and economies of scale. Likewise, digitisation of other services can lower search costs and asymmetries of information, further increasing competitive pressures and allowing greater diffusion of technology between firms. The Productivity in the service sector series aims to help identify such instances and where governments may have a role in facilitating this innovation.
Key points are
• The service sector constitutes the bulk of Australia’s economy, contributing 79 per cent of value added and 88 per cent of employment. This sector is diverse, encompassing all industries outside of mining, agriculture and manufacturing (the goods sector). This diversity (for example, from cleaning services to medicine) means that different service industries operate in very different ways.
• The rise of the service sector over the past 70 years, and the associated displacement of manufacturing as a share of economic activity, has raised fears of worsening labour market conditions, slower wage growth and slower productivity growth. Such fears are misplaced as:
• a large service sector is a feature of a mature and prosperous economy. As incomes increase we spend proportionately more on services relative to goods which stimulates output in the service sector, increasing its share of economic activity
• almost all advanced economies have had rapid growth in their service sector (and relative shrinking of their manufacturing sector). This is the case even for the ‘workshop of the world’, China, since 2005
• productivity growth in many service industries (including finance, ICT and transport) has outpaced the goods sector by a significant margin over the past few decades
• many service industries also have higher wages and total take-home pay than manufacturing, and the rise in casualised employment has been (proportionately) on par with the goods sector.
• However, some parts of the service sector (particularly labour-intensive and face-to-face services) have experienced persistently low growth in productivity and capital investment.
• Mostly this is due to their ‘intrinsic’ characteristics — they often need to be delivered in person (relative to goods); and in some instances, their quality is hard for consumers to reliably observe prior to consumption (and equally hard for statistical agencies to capture in data).
• In the ‘non-market’ sector, limited competition and a lack of market determined prices weaken incentives to innovate or contain cost growth.
• Numerous measurement issues that affect the service sector may explain some of the poor performance as there are possible quality changes (potentially positive or negative) not currently captured by productivity statistics.
• The issues affecting the service sector are as diverse as the sector itself. This paper is the first of several studies. Subsequent releases will examine particular service industries, highlighting the unique characteristics influencing their productivity in ways that are not possible using national accounts data alone. This paper marks the launch of a new series, Productivity in the service sector, looking at individual service industries. The series aims to explore the characteristics that differentiate service industries, how particular industries are performing, and factors playing a role in their productivity performance. There are several reasons the Commission has chosen to report on the factors that affect productivity improvement in the service sector, and to do so industry by industry.
First, the size and importance of the sector justifies attention. Like almost all developed nations, Australia is a service-intensive economy — services employ almost 90 per cent of Australian workers and account for around 80 per cent of GDP.
Second, the service sector displays great diversity in the nature of its output and methods of production. Services range from online retail platforms to dentists and accountants, and it does not always make sense to account for them as a group (box 1 and 2). For this reason, deeper analysis at an industry level can shed light on possible drivers of, barriers against and opportunties for service sector innovation. Morever, there are measurement issues that mean output estimates can sometimes be a misleading indicator of economic activity. These issues tend to be industry specific: the conflation of market risk premiums with genuine value add in finance, or the rapid obsolescence of old products and creation of new ones in information technology, for example.
Third, the COVID 19 pandemic has been especially difficult for the service sector. Behavioral changes in response to the pandemic along with mandatory closures have reduced face-to-face interactions, greatly increased the tendency to work from home and driven down or prohibited the use of some transport services. This has translated to signficantly lower demand for many services, particularly personal services (hospitality, accommodation, and recreation) and retail services. Between March and October 2020, the personal services sector collectively lost over 20 per cent of its workforce and, although it has recovered significantly since, employment remains 12 per cent below pre COVID levels (figure 1) (ABS 2020d, 2020f). Some of the pandemic induced changes, such as increased use of food delivery and online healthcare, may become permanent, with significant productivity implications.
Fourth, the differences in industry and regulation structure typically mean an economywide, ‘cookie cutter’ approach to policymaking is not necessarily appropriate for many service industries. Although some policy areas have economy wide implications (such as industrial relations and taxation), reform of many service sector industries demands a more bespoke approach, requiring detailed knowledge of the industry’s structure and regulatory environment.