I was recently very pleased to participate in GAP's National Economic Review: Australia's Annual Growth Summit 2010, and to return to Sydney, the fabulous city that I still call home.

However the organisers gave me a very challenging task; to describe how to improve Australia’s growth performance.

This is challenging because Australia has just clocked-up nearly two decades of consecutive growth, sailing through the Asian financial crisis and the bust of the IT bubble. And now it has even managed to navigate relatively unscathed through the deepest global financial and economic crisis in our lifetime.

However, Australia should not take for granted its enviable economic performance. Complacency ultimately leads to low ambition, and a failure to tackle the obstacles to maintaining solid economic growth.

Today I will speak about those obstacles. Or, to put it another way, I shall address the following two questions:

1. What are Australia’s future sources of growth?
2. How can they be harnessed?

But first to put this discussion into perspective and at the risk of over-simplifying, it is worth spending a moment on Australia’s past economic growth record and how it compares internationally.

The story is perhaps a familiar one to many of you. For several decades following the end of World War II, Australia’s growth was strong, but fell short of that in other advanced economies. Australia’s GDP per capita gradually slipped in international rankings. It was a slow, but perceptible decline that led to scary prophecies. Who could forget Paul Keating’s warning in 1986 that Australia would end up being a banana republic, if it did not reform its economy?

That statement certainly struck a chord, and I think brought public recognition of the need for further deep economic reforms, even if the full reform road map had not been worked out. The following decades witnessed a period where trade barriers were reduced, competition in product markets was strengthened, the financial sector was liberalised, of labour market reforms and the establishment of a stability-oriented macroeconomic framework.

The reforms were sometimes very painful, notably in the early 1990s, but the pay offs have been substantial. The reforms worked! Australia’s performance gap in terms of GDP per capita with the upper half of OECD countries narrowed. Today, Australian GDP per capita is about 7 per cent below that benchmark and is continuing to shrink.

Of course, Australia has also benefitted from the emergence of large economies, such as China and India. Their seemingly insatiable demand for raw materials and commodities has contributed to the improvement in Australia’s terms of trade.

In contrast, however, the gap in Australia’s level of productivity, measured as GDP per hour worked, is seemingly stubbornly stuck at about 15 per cent below the level in this benchmark group of countries for the past two decades. There have been spurts of very robust productivity gains, but they have not been sustained and events such as the drought have borne negatively on productivity in recent years.

All in all what these statistics tell us is that virtually all of the improvement in Australia’s per capita GDP towards the high achieving OECD economies in the past 20 years has come through an increase in labour utilisation. That is an accomplishment in itself, but it is ultimately an unsustainable way to ensure growth.

Unless Australia addresses its low productivity performance, it is likely, especially with the vitality of nearby markets to increasingly be limited by capacity constraints. As these constraints become binding they will hold back Australia’s future prosperity.

What, therefore, are these capacity constraints and what measures can be taken to enhance the economy’s supply side, especially actions that boost productivity?

A good place to start is with infrastructure.

Recent OECD work found that the benefits from efficient spending on infrastructure in energy, water, transport and communication sectors go well beyond their direct contribution to capital accumulation.

Good infrastructure facilitates trade, bolsters market integration and competition, fosters the dissemination of ideas and innovation and enhances access to resources and public services. These benefits are particularly important for Australia because of its size, geographical dispersion of the population and production centres and distance from other major markets.

Australia arguably faces an infrastructure shortage, which is impacting on the productivity performance of the whole economy. This can be attributed to low investment in infrastructure during the 1990s and from the pressure of population growth, environmental concerns and the strong demand generated by the mining boom.

Boosting the supply of infrastructure will require new investments in Australia’s infrastructure where the private and social rate of return is high. Measures that make better use of the existing infrastructure, and governance arrangements that improve the coordination between levels of government and between classes of infrastructure also have a role to play.

The upcoming OECD Economic Survey of Australia will examine in depth these issues, evaluate government policies in this area and provide recommendations on where further improvements could be achieved.

Innovation is a second important source of productivity and growth, and also an area where at first glance Australia is not at the cutting edge.  

Looking at various indicators of innovation performance, such as business R&D intensity, the share of scientists in business employment, and measures of patents, Australia ranks towards the lower end of OECD countries. On other proxies, however, such as higher education expenditure on R&D, Australia performs relatively well.

The importance of innovation has grown significantly, and the potential pay offs are large. We know from past OECD work that used private sector investment in R&D as a proxy for innovation that when R&D increases by 0.1 per cent of GDP, then output increases by 1.2 per cent.

This crude result suggests that if Australia were to achieve the same intensity of business R&D as on average in the OECD, GDP per capita could be some 7 per cent higher. While this calculation is of course too simplistic, it seems quite certain that a large potential exists in Australia to improve the capacity to innovate.

Since innovation matters for growth, what then matters for successful innovation? The OECD has just released its Innovation Strategy, which provides a comprehensive assessment on the drivers of innovation today, and the policies that can strengthen it.

The first thing we have learnt is that innovation depends not just on investment in R&D or supporting science and technology, but on a plurality of factors and an ability to bring them together through a supportive framework.

For example, to enable people to innovate, we need to develop wide-ranging skills that complement formal education and to adapt curricula and pedagogies to equip students with the capacity to learn and apply new skills throughout their lives.

Governments can also provide access to public data and ICT investments, such as broadband, that lower the barriers to innovation, network formation and collaboration.

Public policies to promote entrepreneurship and support the creativity of young innovative firms – the so called “gazelles” – have a role to play too. These firms tend to be the source of radically new “disruptive innovations” and they also tend to generate large productivity and employment gains.

But Australians should not go for the single quick fix. It is not useful to spend public money to boost this or that sector, or this or that champion in the hope it will result in higher productivity.

Rather, what is needed is a nation-wide “innovation effort” capable of aligning different Ministries, research institutes and businesses, and built around a coherent set of policies that work to deliver a stable macroeconomic environment and well functioning markets. In this respect, removing little-noticed impediments may do more to create a favourable innovation environment than promoting headline grabbing schemes.

Investment in human capital is a third source of future growth.

While Australia fares well in international comparisons important challenges remain in all education sectors. Skill and labour shortages were already evident prior to the global financial crisis and are likely to intensify going forward.

In early childhood education and care, tackling issues of under-supply and inequity in access are of major importance, not least because of the beneficial impact of early education on later outcomes.

In the secondary education sector government efforts to increase year 12 retention rates are welcome. At the OECD we believe this could be achieved by improving and promoting vocational education and training, which would at the same time help to address Australia’s skills gap.

Is there further scope to boost Australia’s labour utilisation?

Let me know say a few words about another source of growth: increased labour utilisation. I said earlier that Australia’s labour utilisation is comparable with other high performing OECD countries.  But this does not mean that labour supply cannot be boosted.

Australia’s tax and benefit system, for example, creates few incentives for part time workers to take up full time work because the payoff from working longer hours is small. The OECD calculates that for every additional dollar earned, an average worker moving from part time to full time employment will lose almost 55 cents in taxes or lost benefits. The disincentives are even greater for households with children where only one person works.

The OECD also recommends focussing on raising employment rates among disadvantaged groups, such as lone parents and people with disability capable of work.

Up to now I have focussed on various concepts of investment in Australia’s future growth capability. Now I would like to briefly say a few words about an “old” source of growth: trade.

It may be old, but trade remains as relevant today as it has been for centuries. In fact, trade was one of the few sources of growth during the crisis, thanks largely to the conscious efforts of governments to say no to protectionism.

Anti dumping, countervailing and safeguard measures, the traditional barometers of incipient protectionist pressures all remained within pre-crisis ranges.

Market opening measures, however, were few compared with the pre-crisis years. And since the world economy is becoming ever more interconnected it means in order to keep trade open, we have to keep on opening trade. That’s why it is important to complete the Doha round.

Even unilaterally there is scope to rationalise industry assistance. The Productivity Commission, for instance, estimates total assistance at the commonwealth level is equivalent to some $17 billion.

Up to now the implicit assumption of my remarks, indeed this conference is that growth in GDP is synonymous with progress in the well being of society. It turns out that GDP growth has been a reasonable short hand measure for the material progress of societies.

But economic resources, while important are not all that matters for the quality of people’s lives. Also important are people’s satisfaction, feelings and expectations, their health conditions, the quality of their daily work and commute, the conditions of their housing, their local environment and so on.

For a number of years there has been evidence of a growing gap between the image conveyed by official macro-economic statistics, such as GDP, and the perception of ordinary people about their own socio economic conditions. In Australia some measures of life satisfaction have declined in recent years, despite solid GDP growth.

This, of course, does not mean we should abandon metrics such as GDP. Rather, it underscores the importance of having a broad range of measures and indicators of people’s well-being alongside the more standard economic measures. Well being, after all, is our ultimate aim. Otherwise, what is the point of pursuing growth-oriented policies!

To sum up, the overarching long term challenge facing Australia is to raise its productive capacity faster. There is no miracle policy package that can guarantee this, but international experience does offer some useful insights.

I have highlighted the role of open markets in trade and the importance of long term investments in innovation, in infrastructure and in human capital to ensure Australia continues to grow and develop. In reality, they are all old sources of growth. What is new about them is their rising importance and their evolving nature in a globalised economy.

Jonathan Coppel is the Economic Counsellor to the OECD Secretary General. Previously he was head of the Office of the OECD Chief Economist. Since joining the OECD, he has held a range of positions, including Executive Manager of the NEPAD-OECD Africa Investment Initiative, Senior Economist and expert on foreign direct investment, Deputy Counsellor to the Chief Economist, Head of the EU and UK Desks and energy market analyst. Mr Coppel has also been a lecturer for the World Trade Institute’s Mile Masters Programme in International Law and Economics and at Sciences Po Institute in Paris. Mr Coppel has previously held senior management positions in the Reserve Bank of Australia and started his career at the Australian Commonwealth Treasury. Mr Coppel was educated at the Australian National University and Columbia University in New York.