Revitalising the Australian economy: Navigating the headwinds

The role of small business

Small business continues to be the engine room of economic growth. The latest government statistics indicate that of the 2.24 million businesses in Australia, there were 2.18 million (97.3 per cent) micro and small businesses (those with less than 20 employees). Of these, there were 1.4 million (64.2 per cent) micro businesses that did not employ any staff. Small business contributes 30 per cent of GDP, employs 44 per cent of all workers and generates 40 per cent of new jobs. The annual turnover for 60 per cent of these small businesses is less than AUD$200,000.

However, if small business is to prosper, some things need to change. Innovation processes are less common in small businesses, with 60 per cent engaged in innovative activity compared to 67 per cent for medium sized businesses and 80 per cent for large businesses. Small businesses also report slower rates of productivity improvements compared to large firms (28 per cent compared to 36 per cent). Whilst small businesses represent 44 per cent of all businesses that export goods, they only account for 0.5 per cent of exports by value. Despite increases in the number of small businesses that are ‘born global’, significant scope exists for them to become more dynamic, innovative and efficient.

Recent research by the OECD and others indicates that small business can play an important role in lifting national productivity growth and, more importantly, national living standards through a variety of ways, including improved diffusion of knowledge, products, processes and technologies across businesses.

However, significant challenges have emerged.

The global environment

The global environment has been impacted with the election of Donald Trump as US President, Brexit, rising protectionism, the rise of China as a super power, a ‘trade war’, ongoing technological advances with the advent of the Fourth Industrial Revolution, continuing demographic shifts, transnational cybercrime, the impacts of climate change and continuing refugee crises. At the same time, our world has continued to become increasingly interconnected and interdependent with scientific and technological advances in one country driving economic growth globally.

Other global challenges abound, including increasing urbanisation, environmental degradation and the rising demand for sustainable food sources, water and energy. It is not inconceivable that these could become political, economic and security disruptors over the longer term.

For Australia, and for any of our trading partners, these issues have the potential to undermine regional stability, contribute to conflict and affect economic interests. For instance, the OECD estimates that 60 per cent more food will be needed by 2050 with growing demand by middle classes for more resource intensive food like meat (which has spawned a new non-meat industry led by Bill Gates and others). The United Nations estimates that, if no changes are made to the way water is used, demand will outstrip supply by over 40 per cent by 2030. In addition, the United Nations estimates that the world needs to create around 40 million new jobs every year, just to keep pace with the growth of the global working age population.

While Asian economies are largely growing, we note that, in the developed world, the headwinds are gathering as productivity gains associated with past technological advances have largely been exhausted, while the benefits for productivity from current and future technological advances have not yet been realised. Real wage growth is not expected to improve in developed economies unless productivity increases. Other constraints on global growth include ageing populations especially in Japan, China and the European Union; high public debt and low official interest rates; and China’s slowing economy as it matures (which the OECD estimates will peak at 27 per cent in the 2030s and then slowly decline).

These events and trends have all combined to create an environment of further uncertainty and change. What we need to consider is the impact of these factors on the Australian economy and the need to develop appropriate domestic policy responses for the benefit of small business, SMEs and more broadly.

Being a small, open economy, Australia is particularly susceptible to the rise in global protectionism. This could damage future economic growth and undermine the global rules that underpin our trade and investment. At a time when productivity remains stagnant, this could have serious consequences for the Australian economy and our future living standards. These economic ‘headwinds’ continue to strengthen and present potential challenges for the Australian economy going forward.

Successfully navigating these headwinds will be essential to maintain, if not boost, Australian productivity growth, improve national income and raise living standards. The challenges for Australian policymakers are increasing, making the need for action immediate.

Productivity – headwinds are gathering

The long-term trend in Australian labour productivity growth has been declining over the last half century, with annual productivity growth being flat for over a decade. This trend is more clearly indicated by the downward revisions to the 30 year average growth rate made by the Commonwealth Treasury in its successive Intergenerational Reports, falling from 1.75 per cent to 1.5 per cent in its last report.

However, sluggish productivity growth in the Australian economy is not unprecedented, nor is weak national income growth. The recent strong growth in Australia’s terms of trade boosted growth in Australian national income to the envy of most other developed countries and gave rise to the mining boom. Unfortunately, the mining investment boom is now behind us. Looking ahead, it is growth in the non-mining sector that will largely determine the prospects for Australian incomes and living standards.

These declines in productivity growth partially reflect the effects of longer-term structural change in the Australian economy that has seen a decrease in the relative importance of many traditional goods producing industries such as manufacturing and agriculture, and an increase in many service sector industries.

More recently, multi-factor productivity (MFP) has underpinned labour productivity growth in most industries, with 9 of the 16 industries for which MFP is reliably measured, experiencing positive average MFP over the current productivity cycle. However, productivity headwinds are strengthening and have the potential to make it harder for Australia to maintain, let alone improve, living standards into the future.

Governments have an essential role to play in addressing these headwinds. 

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