Of Bread and Banking

That Australia’s economic productivity is not a good story is well known but some media reports of the latest productivity commission work at least provided a cause: artisan breads. You know, sourdoughs, batards, boules, casalinghi, Mongolian yak loaves.

This sounds feasible. My colleague Stephen Ries reminded me lines snake down the street outside Surry Hills’ infamous maison de cuisson, the Bourke St Bakery. People idling in a queue for 20 minutes to cough up $9 for a beer and rye sourdough are not gainfully contributing their labour to national output. 

But it’s worse. According to the reports, artisan bread requires grossly more inputs than your standard supermarket white sliced. More labour, more expensive and less utilised capital stock, more expensive premises (especially in Surry Hills). So you have two loaves of bread but one is much cheaper to produce.  

If that’s the case then we should also be worried about one of the good news stories in the PC’s latest Productivity Update which reported yet another decline in multi-factor productivity (the surplus after the cost of labour and capital are added, in effect a measure of efficiency) by 0.8 per cent. 

Labour productivity improved, by 2 per cent, but while labour inputs were up 0.2 per cent, capital inputs had risen 6.1 per cent. Those numbers over-whelmed a 2.2 per cent improvement in output. 

Banking and insurance though was a star performer. Total output for the sector was up 3.3 per cent, total inputs were down 0.3 per cent, including labour inputs 4.1 per cent. Capital inputs however rose 2.2 per cent, labour productivity rose 7.4 per cent and multi-factor productivity was up 3.2 per cent.

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Source: Australian Bureau of Statistics.

Yet if artisan bread is bad for productivity, what does that say about the financial services figures? Artisan bread would seem a model for what Australia is actually aiming to do in manufacturing, move up the value chain. Fewer commodified goods which can be mass produced in lower cost economies, more high value goods which capture the higher priced Australian inputs of labour, technology and process. 

Either the PC analysis is right and we should be sticking with the white bread or it’s not right and so maybe financial services productivity is not what it’s cracked up to be. 

The good news is artisan bread is good and the productivity story in banking and insurance is too. Probably. 

The boffins at the PC make the point they didn’t actually say artisan bread reflected poor productivity and certainly not that it was behind the poor data. They accept there is greater added value in sourdough and it’s a good thing. Their example was about how sometimes the data doesn’t capture the full value added so in fact it looks like inputs have gone up without commensurate added value

Those queues in Surry Hills and Fitzroy and North Adelaide and Teneriffe for expensive bread show the market is working. People are prepared to pay more for a more sophisticated good. (Which is not to say sophisticated is always better. Obviously the correct vehicle for the sausage sizzle sanger, fried onions and sauce is basic white slice.) 

The problem is sometimes the data doesn’t distinguish between loaves of bread. Or other manufactured goods. While the final value - $9 versus $1 for example – should capture this it is sometimes assumed the price has simply risen with no extra value. What used to take one hour of labour now takes five. What used to be mechanical is now (again) manual. Inflation has just put the price up. 

It shows is sometimes the data lag the actual but the boffins are not concerned the aggregate data is askew. Some elements are under captured, some over. But they warn against being too focussed on the detail of the productivity data. 

One area the PC does want to focus on more closely however is the very good result from financial services. 

The outlines of the story seem clear. The financial services sector has invested in technology, costs have been under intense scrutiny as revenue growth slows and labour inputs have been relatively stable. Hence the good numbers on labour productivity, capital inputs and total multi-factor productivity which have endured for a couple of decades. 

There was a dip in productivity improvement post the financial crisis which the PC and others attribute to a spike in funding costs – inputs – and the pricing of risk. 

The only sector with a higher rate of productivity growth is agriculture, which is around 30 per cent of the economic output of the financial services sector. 

Is there more to the story? There may be, the PC is working on that research. 

Yet we can look at some of the potential factors. 

The products in banking, essentially, have not changed much. While home loans come in different guises with bells and whistles, there is not a TipTop version and a wood-fired, gluten free Kale loaf version. 

So has the price of the product risen? In fact it has fallen if we use as a proxy for price the margins on home loans. This is the case more generally with banking products. 

According to the Reserve Bank’s Financial System Inquiry submission “greater competitive pressures contributed to a halving in the major banks’ net interest margins between the late 1980s and the mid 2000s. Australian banks’ net interest margins have remained around their historic lows, despite the many changes in the prices of loans and debt instruments since the crisis”. 

The RBA also makes the point that since 1997, “the profits of the major banks have grown at an average annual rate of around 10 per cent, the return on equity has averaged around 16 per cent and the return on assets has averaged around 0.9 per cent”. These returns are similar to other major companies in Australia, according to the RBA. 

So there is circumstantial evidence the positive story of financial sector productivity is robust with increased use of capital inputs and improved labour productivity leading to higher overall productivity and lower prices. 

However, there is a significant case to the negative, the cost of capital formation in Australia. This is fundamentally what the financial system is all about yet according to another FSI submission by Industry Super Australia, researched by The Boston Consulting Group, the cost of capital formation in Australia, the efficiency of the system, has blown out by 40 per cent in recent decades. 

Given the size of the financial sector in Australia, the sector’s efficiency is critical to Australian productivity. It looks like the sector is doing a good job but the extra work being undertaken by the PC will be very significant.

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.

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