Our days of productivity improvement may be gone for good

The Productivity Commission’s five-yearly report on our productivity performance seems to have sunk like a stone but, before it disappears without trace, it has one important thing to tell us: the obvious reason productivity improvement has slowed, and why, ceteris paribus, it will probably stay slow.

Economists like trying to impress people with Latin phrases. Many conclusions in economics depend on the assumption of ceteris paribus – all other things remaining unchanged. Economists are always holding all other variables constant while they see what effect a change in variable A has on variable B.

Trouble is, in the real world, all else almost never stays unchanged. In which case, the relationship between A and B that you thought you could rely on has been stuffed up by some other variable or variables between C and Z.

Back to the point. Everyone thinks they know what productivity means, but they often don’t. The commission’s report says productivity improvement is “the process by which people get more from less: more and better products to meet human needs, produced with fewer hours of work and fewer resources”.

“In many cases this growth occurs with lighter environmental impact” – a truth many scientists just can’t seem to get their heads around.

The report says that over the past 20 years, the rate of improvement in productivity has slowed in all the rich countries, but with Australia slowing more than most.

Why? Many reasons, no doubt, but one big one that ought to have been obvious, since the American economist William Baumol noticed it in the 1960s.

The fact is that most improvements in the productivity of labour come from advances in technology. You give workers better, “labour-saving” machines to work with, which allow them to produce more in a typical hour of work.

(The other big one is giving workers more education and training, which allows them to work more complicated machines – including computers and software – design more complicated machines and programs, and service complex machines.)

Trouble is, it’s easier to improve productivity in some industries than others. In particular, industries that produce goods – on farms, in mines and in factories – can, and have, hugely increase their productivity by mechanising and computerising. Same in utilities, transport and communications.

In the production of services, however, it’s much harder. Although some services can be delivered digitally – streaming video, say – with little involvement by workers, most services are delivered by people, from less-skilled services delivered by waiters, cleaners, bedmakers and shop assistants, to highly skilled teachers, nurses, doctors, lawyers and prime ministers.

You can give these workers a car or a mobile or a screen, or give a hairdresser a better pair of clippers, but there’s not a lot you can do to speed them up. As Baumol famously remarked, it takes an orchestra just as long to play a symphony today as it did in 1960 – or 1860.

After two centuries of playing this game, we’ve ended up with goods industries that are highly “capital-intensive” – lots of expensive equipment; not many workers – and service industries that are highly “labour-intensive”: many workers; not much equipment.

Which means the productivity of labour is sky-high in the goods sector, but not great in the services sector.

But here’s the trick. You might expect that wages will be much higher in the high-productivity goods sector and much lower in the low-productivity services sector. But no. Wage rates do vary according to the degree of skill a worker possesses, and on the demand for that particular skill.

But a cleaner in a factory gets paid pretty much the same as a cleaner in a lawyers’ office. And a doctor gets much the same working in a big factory’s clinic as in a hospital.

Why’s that? Because, if an economy is working properly (which ours isn’t at present), it’s the economy-wide improvement in productivity that tends to increase all real wages by about the same percentage.

This is brought about by market forces. Despite their low productivity, employers in the services sector have to pay higher wages to stop their workers moving to higher-paying jobs in the goods sector.

Remember too, that over time, mass production lowers the prices of manufactured goods. That’s particularly true if you judge it by how many hours of labour it costs to buy, say, a car or a restaurant meal.

What we’re saying is that, in rich, high-productivity economies such as ours, labour is the more expensive resource, and capital the less expensive resource.

It’s also true that there’s a limit to how much you can eat, how many cars you can drive and how many TV sets you can watch, but no yet-discovered limit to how many services you can pay other people to perform for you.

Put all that together and the goods sector’s share of the economy keeps getting smaller, while the services sector’s grows – to 80 per cent of the economy (gross domestic product) and 90 per cent of total employment.

But it also means that the sector which has little ability to improve the productivity of its labour also has to keep paying more for its labour as the goods sector increases the productivity of its labour.

Gosh, that’s not nice. No, which is why Baumol said that the services sector suffers from “cost disease”. And the services sector’s huge and growing share of the economy explains why productivity in the economy overall is improving more slowly than it used to.

But it could become even worse. If, as it seems, the goods sector has finally exploited almost all its potential to become more productive, and there’s not a lot of obvious scope to improve the services sector’s productiveness, it’s hard to see how we’ll get much more productivity-driven growth in the economy.

What a dismal prospect. Talk about the problems of affluence. You know, I don’t think the world’s poor have any idea how hard life will become for us.

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The knowledge economy is behind the soaring price of land

Over the two centuries and more that people have made a serious study of how the economy works, economists have fallen in and out of love with land. At first, they thought it was at the centre of everything, then they decided it wasn’t terribly important. But the wheel may be turning again. In a major speech last month, the Grattan Institute’s Brendan Coates criticised his profession for its “longstanding intellectual neglect of the economics of land”.

You don’t have to think about housing affordability for long to realise it is not actually the high cost of building a house that’s the problem, it’s the high cost of the land it’s built on.

But why is the cost of land rising much faster than the economy is growing? And why don’t economists take more interest in why this is happening and what we could do about it?

Coates began the annual Henry George Lecture by summarising the history of economists’ waxing and waning interest in land as a resource used to produce goods and services.

The first economists – the Physiocrats – thought of almost nothing other than land, he says. Land was fundamental: agricultural labourers were the source of economic growth, while landlords simply commandeered what the workers produced and flowed it through to the rest of the economy.

The next generation of economists, the “classical” economists of the 18th century, broadened their focus to studying the complex interaction of three “factors of production”: land, labour and (physical) capital.

Adam Smith, a Scotsman known as the father of economics, argued that the “division of labour” – workers specialising in different occupations – and technological innovation were what drove economic growth. But land was still central.

David Ricardo, an English member of parliament, argued that landlords were simply the lucky beneficiaries of land’s natural scarcity (any country has only a fixed amount of it) and its productive capacity, to produce food and fibre and even valuable energy and minerals, Coates says.

And Henry George, the last great classical economist, argued that the rental income enjoyed by landlords must be socialised by taxing the unimproved value of all privately owned land.

Do that, and you wouldn’t need any other taxes. George campaigned hard, but never persuaded any government to follow his advice.

Coates says we “would have done well – possibly much better than we have done – if we’d heeded the lessons of Henry George and paid more attention to the economics of land”.

But in the 19th century the classical economists were replaced by the neo-classical economists, who were a lot less interested in land. And in 1956, the great American economist Robert Solow developed a theory of economic growth, which held that it was improvements in the efficiency with which labour and physical capital (machines and buildings) were combined that drove our standard of living.

The role of land in production - and in inequality - disappeared from the theories economists devised to explain the world, Coates says. Instead, land was treated as just another form of physical capital.

Coates says that “the shifting focus on land in the history of economic thought reflects the changing nature of the economies that economists were trying to explain”.

The Physiocrats observed a world dominated by agriculture. It was obvious that the ownership and use of land determined what got produced, in what quantities. And who got what.

The classical economists watched this world transition through the Industrial Revolution, and the neo-classical economists developed theories for a world that had made that transition.

Economic power started to gravitate towards those who owned capital (whether physical or financial) and away from those who owned land. Agricultural production made way for industrial production.

For most of the 20th century, the neglect of land was of little consequence. More important was the amount of capital invested (to make labour more productive) and the pace of innovation (ditto).

“But as the advanced economies of the world have transitioned again – from manufacturing to services – land is back,” Coates says. Economies powered by intangible capital – how much you know; how much information you can gather – strive or stagnate on the ability of individuals to come together and combine their knowledge and skills.

As any real estate agent will tell you, it’s about “location, location, location”. In Australia, it’s the Grattan Institute that’s done most to help us see that, these days, it’s big cities that drive the economy.

Eighty per cent of the value of all goods and services produced in Australia is generated on just 0.2 per cent of our land. Economic activity is concentrated in CBDs, with the Sydney and Melbourne CBDs accounting for 10 per cent of all economic activity in Australia – more than three times the contribution of agriculture.

This concentration reflects the rise in knowledge-intensive services, clustered together at the hearts of our major cities. The willingness of businesses to pay high rents to locate in the CBDs of our big cities shows the value they gain from access to high-skilled workers and proximity to suppliers, customers and partners.

Similarly, the willingness of workers to pay much higher prices for homes located close to those employment centres shows they, too, see value in being crammed in. Our experience of working from home during the pandemic has changed this a bit – three days in the office rather than five – but not a lot.

All this helps explain why house prices have risen about five times faster than average full-time earnings over the past 25 years. And it means the price of land is a much bigger factor in the economy than it used to be.

It’s leaving existing home owners seemingly much better off, but aspiring home owners much worse off. It’s the product of a clash between the rise of the knowledge economy and our longstanding attitudes towards the taxing and regulation of land.

It should not be beyond the wit of economists to come up with a better approach.

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I foresee a world where workers gain the upper hand

Former NSW premier Neville Wran was the first politician – but far from the last – to say the election would be about “jobs, jobs, jobs”. That line captured perfectly one of the great economic certainties of our age: you can never, ever have enough jobs to go around.

That’s what most of us think, and the reason we think it is that it’s been true for the past 50 years. That’s how long it’s been since we had a rate of unemployment so low no one worried much about it.

But, as my colleague Jessica Irvine reminded us only yesterday, at 3.5 per cent, unemployment is at its lowest in almost 50 years.

To put it more positively, at more than 64 per cent, the proportion of the working-age population with a job is higher than it’s ever been. If you don’t find that gratifying news, there’s something wrong with you.

At present, we have a record number of unfilled job vacancies, about as many as we have unemployed workers. (Of course, not all the jobless have the right training – or live in the right part of the country – to fill those vacancies.)

Now, you can argue this happy outcome is just a temporary consequence of the pandemic. For two years, the official interest rate was almost zero, and governments – federal and state – were spending like wounded bulls.

So we had a huge increase in the demand for labour, but at a time when there was a two-year ban on imported workers. Little wonder employment grew strongly, vacancies shot up and employers complain incessantly about skill shortages.

You can also argue that, now our borders have reopened, our normal high inflow of foreign students, backpackers and skilled workers on temporary visas will resume, and the jobs market won’t stay nearly so tight.

Then you can argue that it only needs Reserve Bank governor Dr Philip Lowe to step too hard on the interest-rate brakes and we – as with many other developed economies – will be plunged into recession and rising unemployment.

You can argue all that. But I think these short-term factors are hiding deeper, longer-term trends that have brought us to a turning point. We’re going from never having enough jobs available for people to fill, to never having enough people available to fill all the jobs.

And here’s the bonus: if I’m right, we’ll be going from insecure jobs and stagnant wages to much higher wages and bosses falling over themselves to attract and retain the workers they need.

Business people are nothing if not opportunistic. When workers are plentiful, they pick and choose and make demands. But when workers are hard to find, they become wonderful people whose only concern is their workers’ welfare.

The first factor that’s working to turn the tables is the ageing of the population: more oldies leaving the workforce than youngsters joining it. Fertility has fallen below the replacement rate of 2.1 kids per woman.

For many years we’ve sought to slow population ageing by maintaining one of the advanced economies’ highest rates of immigration, with an emphasis on young, skilled workers.

Skilled immigration is also used to keep downward pressure on wage rates. With the pandemic receding, big business is desperate for high immigration to resume ASAP. And the Albanese government is likely to oblige.

But setting high immigration targets is one thing; attaining them is another. These days, migrants come mainly from developing countries. But all the other rich countries have an ageing problem, so we’ll be competing against them for takers.

China’s population is also ageing rapidly. Our intake of foreign students – some of whom are allowed to stay on – has been reduced by our falling out with China, but has always been a temporary play while Asia’s emerging economies get their universities going.

The final factor that will keep the demand for workers growing faster than the supply is the way the rich economies are becoming service economies, much of which represents the growth of the “care economy”.

Australia has already reached the point where 80 per cent of our production and 90 per cent of our employment is from the services sector. The thing about services is that they’re mainly delivered by people. As the Productivity Commission has noted, it’s much easier to use machines to replace people in farming, mining and manufacturing than it is in the services sector.

As people become old, they need more services – from doctors, nurses, paramedics and age care workers. All these people require education and training – by more services-sector workers.

Have you noticed all the stories lately about shortages of teachers, GPs, hospital workers and, before that, aged care and childcare workers? We’re going to get them all from overseas? I doubt it.

I noticed a tweet from an economics professor: “‘skill shortage’ = wages too low to attract workers”.

Get it? If we want all these people, we’ll have to pay them a lot more than we do now – and treat them a lot better.

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If higher productivity comes from new ideas, it's time we had some

Economists and business people talk unceasingly about the crying need to improve the economy’s productivity, but most of what they say is self-serving and much of it’s just silly. Fortunately, this week’s five-yearly report on the subject from the Productivity Commission, The Key to Prosperity, is far from silly, and might just stand a chance of getting us somewhere.

It’s the first of several reports and, unlike the tosh we usually get, it’s not selling any magic answers. Business people mention productivity only when they’re “rent-seeking” – asking the government for changes that will make it easier to increase their profits without them trying any harder.

Their favourite magic answer is to say that if only the government would cut the tax paid by companies and senior executives, this would do wonders for productivity.

As for the econocrats, too often they see it as a chance to advertise the product they’re selling: “microeconomic reform” – by which they usually mean reducing government intervention in markets.

A lot of people think wanting higher “productivity” is just a flash way of saying you want production to increase. Wrong. The report makes it clear that improving productivity means producing more outputs, but with the same or fewer inputs.

It sounds like some sort of miracle, and it is pretty amazing to think about, but it happens all the time.

Another mistake is to think that wanting to increase productivity is the bosses’ way of saying they’re going to make us work harder. No, no, no. As the report repeats, productivity comes from working smarter, not harder or longer.

In response to the scientist-types who keep repeating that unending economic growth is physically impossible, and then wondering what bit of this the economist-types don’t get, the report says that “while economic growth based solely on [increased] physical inputs cannot go on forever, human ingenuity is inexhaustible”.

Get it? Economic growth doesn’t come primarily from cutting down trees and digging stuff out of the ground – and the scientists are right in telling us we must do less despoiling of the environment, our “natural capital” – it comes overwhelmingly from using human ingenuity to think of ways to produce more with less.

That’s why the report says improved productivity is “the key to prosperity” and is based on “the spread of new, useful ideas”.

To be more concrete, productivity is improved by people thinking of ways to improve the goods and services we produce, ways to make the production process less wasteful – more efficient – and thinking up goods and services that are entirely new.

This gives us a mixture of novel products, improved quality and reduced cost.

Over the past 200 years, since the start of the Industrial Revolution, the productivity of all the developed economies has improved by a few per cent almost every year. In our case, over the past 120 years the economic output of the average Australian is up seven-fold, while hours worked has consistently fallen.

Trouble is, the miracle of productivity improvement has been a lot less miraculous in recent times. Over the past 60 years, our productivity improved at an average rate of 1.7 per cent a year. Over the decade to 2020, it “slowed significantly” to 1.1 per cent a year.

The report is quick to point out that much the same has been happening in all the rich countries. (It does note, however, that the level of our productivity is now lower than it was compared with the levels the other rich countries have achieved.)

This is significant. It suggests that whatever factors have caused our productivity performance to fall off are probably the same as those in the other rich economies. But as yet, none of them has put their finger on the main causes of the problem.

If they’re still working on the answers, so are we. So the report focuses on thinking about what may be causing the problem and where we should be looking for answers. Remember, this is just first of several reports.

So, unlike the rent-seekers and econocrats, it’s offering no magic answers. But it does come up with a good explanation for at least part of the productivity slowdown: for most of the past two centuries, one of the main ways we’ve produced more with less is by using newly invented “labour-saving equipment” to replace workers with machines in farming, mining and then manufacturing.

The quantity of goods we produce in those industries has never been greater, but the number of people employed to produce it all is a fraction of what it once was. And this accounts for a huge proportion of the productivity improvement we’ve achieved since Federation.

Because producing more with less makes us richer, not poorer – increases our real income – total employment has gone up rather than down as we’ve spent that extra income employing more people to perform all manner of services – from menial to hugely skilled.

So successful have we (and all the rich economies) been at shifting workers from making goods to delivering services that the service industries now account for about 80 per cent of all we produce and about 90 per cent of all employment.

See the problem? In the main, services are delivered by people. So the economy’s now almost completely composed of industries where it’s much harder to improve productivity simply by using machines to replace workers. It’s far from impossible, but it’s much harder than on a farm, mine site or factory.

That’s the more so when you remember that two of the biggest service industries are health and social assistance, and education and training.

It’s pretty clear that, if we’re going to get back to higher rates of productivity improvement, we’ll have come up with some new ideas on how to make the service industries more productive, without diminishing quality. That’s what comes next in the Productivity Commission’s series of reports.

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Sorry, the economy's bum does look big. We've put on a lot of weight

If you’re like many readers, you think economists and business people are obsessed with gross domestic product and dollars, dollars, dollars. So, as a never-to-be-repeated offer, today I’m going to write not about what Australia’s production of goods and services is worth, but what it weighs.

Believe it or not, Dr Andrew Leigh, a federal Labor politician and former economics professor, is just publishing the paper Putting the Australian Economy on the Scales in the Australian Economic Review.

Using a lot of ancient statistics and making various assumptions – so that his figures are, on his own admission, “rough” but still indicative – Leigh estimates that the physical weight of the nation’s annual output of goods and services has gone from 55,000 tonnes in 1831, to 6 million tonnes in 1900, 62 million tonnes in 1960, 355 million tonnes in 2000, and 811 million tonnes in 2018.

Of course, our population has grown hugely in that time, but the weight of output per person is also way up. It was less than a tonne in 1831, six tonnes in 1960 and 32 tonnes per person in 2018. That’s a 47-fold increase.

Well, that’s nice to know. But who in their right mind would bother working out all that? What does it prove? More than you may think – especially if you worry about the impact all our economic activity is having on the natural environment.

You’ve heard, I’m sure, about our big and growing “material footprint” caused by our production and consumption of raw materials. It, too, is measured by weight. The United Nations Environment Program International Resource Panel publishes estimates of the footprints of 150 countries, with the Australian figures coming from the CSIRO and industrial ecologists at the universities of Sydney and NSW.

In measuring a country’s footprint, they take account of four kinds of raw materials: biomass (from grass to timber), metals, construction materials and fossil fuels. It turns out, for instance, that the footprint of a kilo of beef is 46 kilos.

The UN takes a great interest in countries’ material footprint because one of its sustainable development goals is to decouple economic growth from environmental degradation. Ecologists worry that, particularly as poor countries lift their living standards up towards those the rich countries have long enjoyed, the pressure on the globe's natural environment will be . . . well, unsustainable.

But whereas the ecologists’ figures show all countries’ material footprints getting bigger, a lot of economists argue that as economic growth and advances in technology continue, the economy is “dematerialising” – getting lighter.

This is because most of the growth in GDP has come from more provision of services rather than more production of goods through farming, mining and manufacturing. Human labour has no weight, even though it may involve more use of electricity and fuel.

But also because the physical weight of many goods is falling. Leigh reminds us that houses and vehicles are built from lighter materials. Domestic appliances are more compact. Transport networks are more energy-efficient. Software makes it possible to upgrade devices – from games to cars – that might previously have required new physical parts or total replacement.

These shifts led Alan Greenspan, former chairman of the US Federal Reserve, to claim in 2014 that “the considerable increase in the economic wellbeing of most advanced nations in recent decades has come about without much change in the bulk or weight of their gross domestic product”. Without question, he argued, the economy “has gotten lighter”.

So the point of Leigh’s calculations is to check who’s right: those economists claiming the economy is dematerialising, or the ecologists calculating that our material footprint is getting heavier.

Clearly, he comes down on the side of the ecologists. Although his method gives an estimate of the economy’s weight that’s about a fifth lower than the ecologists’, he confirms the general trajectory of their continuing increase. He estimates that a 10 per cent increase in real GDP is associated with a 12 per cent increase in its weight.

Now, you could argue that Australia’s huge “natural endowment” of minerals and energy makes us quite unrepresentative of the advanced economies. Our mining industry has been booming, on and off, since the late 1960s. All you need to know is that our production of (heavy) iron ore – most of it for export – has risen ninefold since 1990.

But Leigh believes all the rich economies have expanding material footprints. The goods they consume may have been getting lighter per piece, but they’ve gone on consuming a lot more of them. Planes may be more fuel-efficient, but far more people are flying far more often (when we’re allowed). Clothes may be lighter, but we buy more of them. Food packaging may be thinner – I can remember when fruit and veg arrived at the greengrocers in wooden boxes - but we’re eating more takeaway meals.

Leigh concludes that, like the paperless office, the weightless economy remains surprisingly elusive. Which doesn’t change the need for us to put the economy on an ecological diet.

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Services are taking over the economy – despite the politicians

One test of whether our political leaders are looking to the economy’s future or clinging to its past is whether they show an understanding that most of our future lies in the services economy.

Whether they hanker for an economy where most people earn their living by growing things, digging things out of the ground or making things.

Probably only the dearly departed Malcolm Turnbull passes this test, with his early enthusiasm for innovation and agility. Kevin Rudd said he didn’t want to be the leader of a country that didn’t make things. Scott Morrison took a lump of coal into the Parliament to show where his allegiances lay.

But as the Organisation for Economic Co-operation and Development reminds us in its latest report, the shift from producing goods to performing services is fundamental to the process of economic development.

Every country’s economy starts on the economic development journey with most people working on the land, and others in mines. That’s where we were in the 19th century. About a hundred years ago, the great migration from the country began, with more and more people moving to the city to work in factories.

By 1971, employment in manufacturing had reached 1.4 million workers. Manufacturing’s share of total employment in Australia reached 25.5 per cent a little earlier in 1966.

But from that period on, employment in manufacturing began to decline, both in absolute numbers and as a share of the total.

It – and employment in the other goods industries: agriculture and mining – declined as a share of the total simply because employment in the services sector grew much faster.

So, for at least for the past 50 years, it’s services that have been going up while goods industries have been going down. That’s true whether you look at shares of total employment or shares of total production (gross domestic product).

When you turn to the absolute numbers of workers, they’ve been declining in agriculture for more than a century. Today, just 325,000 people work on the land.

In manufacturing, they’ve been falling since 1971, to be down to 980,000 today.

Mining employment got a fillip from the resources boom, but even its job numbers have resumed their decline since 2013, and are now down to 245,000 – or just 2 per cent of our total employment of 12.6 million.

There’s nothing peculiarly Australian about this move from farming to manufacturing to services. You can see just the same progression in other rich economies and in “emerging” (that is, rapidly developing) economies.

It’s been unfolding before our eyes in China since it began opening its economy to the world in the late 1970s. It was all the people leaving its farms to work in city factories that, a few years ago, took the proportion of the world’s population living in urban areas to more than half.

Returning to Oz, don’t get me wrong. Some of us will always be working in the goods part of the economy. That’s particularly true of Australia because, though we’ve never been great shakes at manufacturing, we have had, and will continue to have, a comparative advantage in agriculture and mining, relative to other countries.

Note this: though the number of people working in the three parts of the goods sector has been falling, that doesn’t mean we’re growing less food or digging fewer minerals. Our annual production of food and minerals and energy is greater than ever. Even in manufacturing, our annual production has been falling only since 2008.

How can production go up while employment goes down? Easy. Increased productivity of labour caused by automation – technological advance. The use of more and better machines has made farming, mining and manufacturing more “capital-intensive” and so less “labour-intensive”.

That’s the thing about the goods side of the economy: it’s relatively easy to use machines to replace men (and women). And this isn’t bad, it’s good – for two reasons. First, it’s helped make goods cheaper, thus making us more prosperous.

Second, it’s much harder to use machines to replace workers delivering services. Robots will change this to an extent, but by not nearly as much as the alarmists claim.

And it’s not hard to think of more services we’d like other people to do for us. That’s why total employment is higher than it’s ever been. And why further growth in services’ share of total employment and production is inevitable and inexorable.

Where will the new jobs be coming from? That's where.

The OECD report tells us that, in 2014, the goods sector’s share of production was down to 17 per cent (agriculture 3 per cent, mining 6 per cent, manufacturing 8 per cent), with the services sector’s share up to 83 per cent – about average for the OECD.

Within services, the biggest industries are: business services, 14 per cent of GDP; wholesale and retail trade, 10 per cent; financial services, 9 per cent; construction, 8 per cent; health and aged care, 7 per cent; education 5 per cent and defence and public administration, 5 per cent.

A favourite argument the goods industries use to exaggerate their importance to the economy is to point to their higher share of exports (a widget sold to a foreigner is more virtuous than one sold to a local, they claim).

A third of all our agricultural production is exported. For manufacturing it’s more than a quarter (bet you didn’t know that) and for mining it’s more than 90 per cent. For services it’s a mere 11 per cent.

This means that, as usually measured, agriculture contributes 8 per cent of total exports; mining, 40 per cent, manufacturing 26 per cent, and services, 26 per cent.

Education of overseas students is now our third biggest export, after iron ore and coal. Tourism is the other big one.

But the OECD points out that the goods we export have inputs of services embedded within them. Allow for this and agriculture’s share of total export “value-added” drops to 5 per cent, mining’s to 30 per cent and manufacturing’s to 13 per cent, while services’ share rises to an amazing 52 per cent.

Services are taking over the economy. Live with it.

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Jobs in the services sector have smartened up

So much for our ailing economy. Did you see that 264,000 additional jobs have been created in the first eight months of this year, with 88 per cent of them full-time?

That's a remarkable increase of 2.2 per cent in total employment, according to trend figures issued by the Australian Bureau of Statistics this week.

Where did all those jobs come from? We won't know for certain for a week or two, but I can tell you now: not from agriculture, the production of goods (mining, manufacturing, utilities and construction) or the distribution of goods (transport, postal and warehousing; wholesale and retail trade), but from household and business services.

How can I be sure all the net increase in jobs will have come from the services sector? Because that's been the case for about the past 40 years.

This isn't all that surprising. As the Reserve Bank's head of economic analysis, Dr Alexandra Heath, observed in a speech last week, one of the most pronounced changes in the structure of our economy [and all advanced economies] has been its move away from a goods-producing economy towards a more services-oriented economy.

This isn't because we're producing fewer goods – we aren't – but because the growth in our production of services has been much faster.

"Australians are producing more services, consuming more services and trading more services with other economies than ever before," Heath says.

One reason for the shift to a services-based economy is that Australian households have experienced remarkable growth in their real incomes, she says.

We've had uninterrupted growth for more than 25 years, and real income per household has more than doubled since the early 1960s.

"As incomes rise," she says, "households typically spend more of their income on household services – such as health, education and restaurant meals – than on goods."

But demand for business services – that is, businesses providing services to other businesses - has seen its share of gross value-added grow from less than 20 per cent in the early 1990s to more than 25 per cent today.

The category includes professional and technical services; information, media and telecoms; rental, hiring and real estate; and financial and insurance services.

Part of this growth is just the reclassification of existing activity from goods to services as businesses that produce and distribute goods have increasingly outsourced non-core activities to specialist providers in the services sector.

The trend to outsourcing has been encouraged by technological advance that's lowered the cost of communication and logistics (moving things around) and meant that the scope and complexity of what can be outsourced have increased over time.

(Though, in my humble opinion, firms that outsource their telephone answering to overseas call centres where people you can't understand repeat scripted lines regardless of the context, and have little power to fix your problem because the firm back in Oz doesn't really trust them, will one day reap the customer revenge they so richly deserve.)

It should involve cost savings to outsourcing firms because specialist providers are able to achieve greater economies of scale and pass some of the benefits on to their customers.

So outsourcing is an example of one of the key building blocks of our modern prosperity: ever-greater specialisation and exchange, leading to ever-greater productivity. (This ought to be true when profit-driven businesses do it; it's not always true when governments do it badly or with ulterior motives.)

But outsourcing doesn't explain all the growth in business services. Some of those services are totally new.

And Heath says there's evidence that the nature of the work being done in the business services sector is generally changing faster than in other sectors. "This all suggest that business services are at the centre of how technological change is transforming the Australian economy," she says.

Traditional business services, such as accounting and legal, have been joined by management consulting, internet providers and computer system design.

The growth in outsourcing of business services, and the increasing integration of business services with other sectors of the economy, fit with evidence that "supply chains" are getting longer. That is, there's an increasing number of stages through which goods and services pass.

Not surprisingly, the goods production sector is the most fragmented – has the longest supply chain – because it uses the most "intermediate" inputs to produce its final products.

Research suggests that the reorganisation of production associated with the lengthening of supply chains has led to a shift towards more high-skilled labour, Heath says.

There's growing evidence that advances in computer technology have helped drive a shift from routine to non-routine jobs, creating new jobs as well as making others obsolete.

The share of people employed in the business services sector has almost doubled over the past 50 years, to be about 20 per cent of the workforce. Most of this growth has been in "non-routine cognitive" jobs, as you'd expect when computerisation is an important driver.

(Similar forces are working in the household services sector – all those extra doctors, teachers and academics – although it has also seen a significant increase in demand for non-routine manual jobs.)

If you look more directly at the types of skills and abilities required in the business services sector you see that, since the mid-1990s, there's been a shift towards occupations requiring higher-level cognitive skills such as systems analysis, persuasion, originality, written expression, complex problem solving and critical thinking.

Heath concludes that the business services sector "has played a key role in the way the economy has responded to technological progress.

"In the process, business services have become more important, more specialised and more integrated with other sectors. There is some evidence that this has been associated with higher productivity growth."

Figures from the labour market "also support the idea that business services industries are at the heart of how technological change is transforming the structure of the economy".

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We're not doing too badly on productivity

Rummaging through the media's rubbish bins this week, I happened upon some good news. According to the Productivity Commission's annual update, the productivity of labour improved by 1.4 per cent in 2013-14.

And get this: in the 12-industry "market sector" of the economy, it improved by 2.5 per cent in that year and by 3.7 per cent the year before.

To give you an idea, the 40-year average rate of market-sector productivity improvement is 2.3 per cent. So, despite all the worrying we've been doing in recent years about our poor productivity performance, it seems we're now doing quite well.

In which case, how come no one wanted to tell us? I can think of three reasons. First is the media's assumption that good news is of little interest to their customers.

Second is that the Productivity Commission's preference is for brushing aside the labour productivity figures and getting us to focus on the figures for "multi-factor productivity", which show an improvement of just 0.4 per cent in 2013-14 and 0.4 per cent the year before. This compares with the 40-year average of 0.8 per cent a year.

Third is that the nation's economists are engaged in a campaign to persuade us we need a lot more micro-economic reform so as to raise our rate of productivity improvement and, hence, the rate at which our material standard of living is rising.

They'd make the same argument whether our productivity performance was good, bad or indifferent, but it helps the selling job if they leave us with the impression our recent performance is poor.

Anyway, let's take a closer look at the commission's new figures. Productivity, which compares the growth in the output of goods and services with the growth in inputs of labour and capital, is a measure of the efficiency of our production. When outputs grow faster than inputs, the economy – the economic machine, so to speak – has become more efficient.

The simplest (and probably least inaccurate) way of measuring productivity is to take the increase in the quantity of goods and services produced during the year and divide it by the increase in the total number of hours worked to produce the stuff.

The main way to increase the productivity of workers is to give them more machines to work with. But the commission believes a more revealing measure is multi-factor productivity. You calculate this by dividing the increase in output by the increase in labour inputs plus the increase in capital inputs (use of machines and other equipment).

The main thing causing an increase in multi-factor productivity is technological advance – the invention of better machines plus improved ways of running businesses. But also improvements in "human capital" – the rising education and skill of the workforce.

That's all fine in theory, but it gets pretty ropey in practice. For a start, we have no way of measuring the productivity of the public sector (healthcare, education and public administration) because, for the most part, it doesn't sell its output in the market.

The market sector covers the financial services, mining, construction, manufacturing, transport, retail trade, wholesale trade, information media and telecommunications, electricity gas and water, agriculture, accommodation and food services, arts and recreation services, rental hiring and real estate services, professional scientific services, administrative support services, and "other" services industries.

That's 16 industries – though, for reasons it doesn't explain, the commission's 12-industry measure of market sector productivity doesn't include the last four industries on that list. Even so, the 12 industries account for 65 per cent of gross domestic product.

A much more serious problem is that the measurement of multi-factor productivity is quite dodgy. It's measured as a residual, meaning that any error in measuring the three other items in the sum will (and does) make the measurement of multi-factor productivity wrong.

More particularly, economists have no way of accurately measuring capital inputs. Just one of their problems is that they can't distinguish between more machines and better machines, meaning their so-called measure of multi-factor productivity excludes much of the technological advance it purports to measure.

The besetting sin of economists is the way they confidently quote their figures to a trusting public, without breathing a word about the data deficiencies and dubious assumptions that lie behind their calculations. When they fail to issue a product warning, it's the duty of the conscientious economic journalist to call them out.

In such circumstances, the commission's results need to be treated with scepticism – particular when, as was true in the noughties, they were so unprecedentedly low as to be implausible.

But let's look at the commission's breakdown of the latest year's supposedly weak result of 0.4 per cent. Half of the 12 industries – all of them in the services sector – achieved remarkably strong improvements, ranging between 1.1 per cent and 5.4 per cent.

Three industries – mining, construction, agriculture – had growing production but marginally declining multi-factor productivity. We know the problems in mining and construction are temporary. Agriculture's poor performance came mainly from drought.

The last three industries – utilities, manufacturing and transport – suffered declining production but lesser declines in inputs, meaning their multi-factor productivity deteriorated quite significantly.

We know the utilities, particularly electricity and gas, are coping with major structural changes, not helped by the earlier misregulation of poles and wires. We know manufacturing is still recovering from the high exchange rate caused by the resources boom. Whatever transport's problem is – we're not told – it will get over it.

That's the trouble with the supposedly worrying figures for multi-factor productivity. Apart from the ropiness of their calculation, when you investigate the stories for the particular industries involved you can't find anything major to worry about.

I'd say that, despite all the barrow-pushers wanting to use poor productivity figures to bolster whatever cause they're promoting, we're not doing too badly on productivity.

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Lower dollar boosts services exports

Did you know that when the value of our dollar falls, imports become dearer? When the Business Bible learnt this last week, it got so excited it led the paper with the news.

Every smarty knows that the economic turmoil in Greece and China must spell bad news for us, so when the turmoil caused the Aussie dollar to fall below US75¢, this was obviously the start of the badness.

Apparently, it means the "global purchasing power" of Australian households has fallen. Who knew?

Immediately, our ever-vigilant media sprang into action to determine which purchases were likely to be more expensive. Don't you love the way the media can find the downside in any piece of economic news?

The fact that for months the nation's macro-economists and many of our business people have had their tongues hanging out, thirsting after a lower exchange rate, was something no one considered worth mentioning.

Nor that Reserve Bank governor Glenn Stevens' wish to see the dollar fall to US75¢ had finally come true.

It's true that if you view the position solely from the perspective of consumers, a higher dollar is good news and a lower dollar is bad.

However, from the perspective of Australia's trade-exposed industries and their employees, it's the other way around.

A high dollar means you get fewer Aussie dollars for anything you export, whereas the imports you compete against in the local market are now cheaper than they were.

So a higher dollar means Australian tradeable industries suffer a loss of international price competitiveness, which almost always leads to them reducing their production and their job opportunities.

In other words, a higher dollar has a contractionary effect on economic activity (which at least has the advantage of reducing inflation pressure). And that's been our story since the mining boom caused the Aussie to appreciate so strongly.

However, with mineral commodity prices having been falling since mid-2011 and mining construction projects winding up since the end of 2012, the dollar finally began falling back; though, thanks to the advanced economies' resort to "quantitative easing" (creating money), not by as much as the fall in commodity prices implied should happen.

It follows that a lower dollar has an expansionary effect on economic activity. Since our exporters now get more Aussie cents for each US dollar they earn, they're able to export more. And, since imports are now more expensive to their domestic customers, they're able to recapture a larger share of the local market.

The consequence is that our tradeable industries increase their production and the job opportunities they provide.

In our attempts to explain why relatively strong growth in employment – particularly since the start of this year – has caused the official unemployment rate to stay steady at 6 per cent, you'd have to give the lower dollar a fair bit of the credit.

That's particularly evident in the strong growth in employment in the services sector and in exports of services. Historically, services were regarded as non-tradeable, but globalisation and advances in transportation, telecommunications and digitisation are making that less true every year.

The tradeable services sector's improved price competitiveness comes at a time when Asia's middle-class is growing in size and income, with its consumption preferences shifting towards Western goods, services and destinations.

No service industry better demonstrates the lower dollar's beneficial effect on production and jobs than tourism: an industry where import replacement is just as important as exporting. The lower dollar not only attracts more foreigner visitors, it encourages Australians to holiday at home rather than abroad.

Estimates from Paul Bloxham, of HSBC bank, show spending on tourism accounts for about 3 per cent of gross domestic product, with about a third of this coming from foreign tourists.
The industry employs more than 500,000 people.

Overall, the value of tourism exports reached $14 billion in 2014, up 8 per cent. Tourist arrivals from China over the year to May were up 21 per cent on the previous year, Bloxham says. Chinese visits to Oz have increased to 920,000 over the past year, up from 370,000 five years ago.

Turning to education exports, Bloxham says international student enrolments reached a new high of almost 147,000 at the start of this year. Last year, the value of education exports reached $17 billion, surpassing the previous record in 2009.

And Joe Hockey has reminded us that the value of all services exports over the year to March was up 8 per cent, their fastest growth since 2007.

So if the fallout from the present international turmoil involves further falls in the Aussie, don't let anyone tell you it's a bad thing.

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Slower immigration keeps unemployment steady

While we're busy scaring ourselves silly imagining all the terrible consequences that may or may not flow from the turbulence in the eurozone and China, forgive me for intruding with some good news closer to home: unemployment has stopped rising.

The employment figures we got from the Bureau of Statistics this week confirm – and so make a lot more believable – the amazing figures we got a month ago saying the official rate of unemployment had stabilised at 6 per cent.

Barring some unexpected disaster, it's now looking less likely the Reserve Bank's forecast that unemployment will rise to 6.5 per cent by June next year will be realised.

Let's cut through the month-to-month volatility that so many in the markets and media love by sticking to the smoothed seasonally adjusted estimates known as the "trend" figures.

They show that total employment grew by 215,000 over the year to June, an increase of 1.9 per cent. More than half these extra jobs were full-time.

Since the labour force – all those people either in a job or actively seeking one – grew at about the same rate as employment, this was sufficient to get the rate of unemployment back down to where it was in June last year – 6 per cent.

And this happened despite the rate of participation in the labour force – the proportion of the population aged 15 or over who were either employed or unemployed – rising from 64.7 per cent to 64.8 per cent during the year. Not bad considering the retirement of the baby-boomer bulge is working to lower the participation rate.

As I say, this is the same story the figures were telling us a month ago. So where have the extra jobs come from? Well, Kieran Davies, of Barclays bank, has used somewhat different figures – they say we had employment growth of 240,000 over the year to May – to tell us.

He follows the Reserve Bank's practice of splitting the economy into five broad sectors: household services (including accommodation and food services, education, health, recreation and other services), business services (information technology, media and communication, finance, real estate services, professional services and administrative services), goods (farming, mining, manufacturing, utilities and construction), distribution (retail and wholesale trade and transport and storage), and public administration.

Davies found very strong jobs growth in household services of, in round figures, 180,000, with strength in healthcare (90,000), accommodation and food services (50,000), and recreation and arts (40,000).

He makes the point that household services account for a third of total employment, and have driven total jobs growth since the global financial crisis.

Business services, which account for almost a fifth of total employment, have been the next most important sector, with growth of about 80,000. This was driven by professional services, up 90,000, offset by falls in employment in other categories, such as real estate services (20,000) and finance (10,000), but small gains in other categories.

Modest contributions to total jobs growth came from goods distribution (20,000) and public administration (10,000).

Against this, however, there were job losses in mining (30,000), farming (30,000), manufacturing (5000) and utilities (5000), which more than offset jobs gains of 20,000 in construction.

As you see, as well as this quite strong growth in employment overall, there's been a change in the composition of employment, with relatively small contractions in various goods industries more than offset by big increases in service industries.

If this news of strong overall employment growth comes as a shock to you, that's hardly surprising. The economy's been growing at below its "trend" (medium-term potential) growth rate of 3 per cent for a number of years.

And it's often repeated that the economy has to grow at its trend or potential rate of 3 per cent a year just to stop unemployment rising.  (This 3 per cent rate of growth in the economy's potential capacity to produce goods and services comes from labour force growth of 1.7 or 1.8 per cent a year, plus growth in the productivity of labour of 1.3 or 1.2 per cent a year).

So, with real gross domestic product growing by just 2.3 per cent over the year to March (and needing to achieve an unlikely 0.8 per cent growth in the June quarter to achieved the Abbott government's budget-time forecast of average growth of 2.5 per cent in 2014-15), how on earth is it possible for employment to be growing fast enough to hold unemployment steady?

Well, one possibility is that the economy's actually growing a lot faster than the national accounts say it is, but this doesn't seem likely.

A more likely explanation is that the economy's potential rate of growth is no longer as high as 3 per cent a year. It's more likely to have fallen to 2.75 per cent – or even 2.5 per cent, as some are suggesting.

Why? Because slower growth in the population than we've had in recent years –  slower than the econocrats were expecting – is causing slower growth in the labour force.

Population growth is slower because fewer Kiwis are coming to Oz and more are going back home where, for the moment anyway, the economy's prospects are brighter. As well, the end of the mining construction boom means fewer workers and their families are coming in under temporary 457 visas.

If the economy's potential growth rate is lower, that means we can stabilise unemployment at a lower rate of actual growth. In our present circumstances, employment growth is probably being encouraged by the lower dollar and the exceptionally slow growth in wage rates.

Note that when the economy grows more slowly because the population is growing more slowly, we're not left worse off in terms of growth in income per person. But lower immigration does make it easier to get on top of unemployment – something economists prefer not to mention.

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Subsidies no way to fix high dollar problem

Emeritus Professor Max Corden, of Johns Hopkins University, formerly of Oxford University and now back at the University of Melbourne, is probably Australia's most distinguished living economist. So when he writes on what we could do about "Dutch disease" we ought to take note.

What follows is my account of his paper for the Melbourne Institute, The Dutch Disease in Australia: Policy Options for a Three-Speed Economy. As is often my custom, it will consist largely of direct quotes, indirect quotes and paraphrases of his paper. This practice is known as "reporting". If I misreport his views, feel free to criticise; but don't be silly and accuse me of stealing them.

Corden is an expert on Dutch disease - the economists' term for a situation where a boom in one export industry leads to an appreciation in the exchange rate, which reduces the profitability and the output of other export and import-competing industries.

He starts by dividing the economy into not two, but three sectors according to how they're affected by the boom. First is the "booming sector" (mining and related industries, in our case), then there's the "lagging sector", consisting of the other trade-exposed industries hard hit by the high dollar (part of manufacturing, agriculture and tradeable services such as tourism and some education).

But then there's the "non-tradeable sector" consisting mainly of those service industries whose prices are determined only by domestic supply and demand. This third sector is important because it's the largest part of the economy and "there are almost certainly net gains" from the boom.

The gains arise because the boom causes increased domestic spending on non-tradeables and because of the reduced prices of imported items.

Corden argues there are three broad options for the government to choose from in responding to the difficulties Dutch disease causes for the lagging sector.

Option 1 is "do nothing". "The real exchange rate appreciation is an inevitable consequence of the terms of trade boom and the capital inflow, both of which have benefits," Corden says.

"Some industries rise and some decline, and some declines, in any case, may be temporary. The government can help in the adjustment process, but should not try and stop or slow up adjustment," he says.

"This is one point of view, though it may not be politically attractive," he says. But "doing nothing" doesn't prevent the government from fostering the flexibility of the economy, improving the skills of the labour force, removing obstacles to people moving, temporarily assisting losers, providing information or improving infrastructure.

Option 2 is "piecemeal protectionism". "Of the various groups of industries adversely affected by Dutch disease it is manufacturing - or perhaps particular manufacturing industries, or even firms - that are usually selected for deserving special assistance, whether in the form of subsidies or import tariffs," Corden says.

But this option is "highly undesirable" and "based on questionable economic thinking". (Note that when Corden uses the term "protection" he's including subsidies as well as import tariffs.)

What's wrong with piecemeal protection? Apart from all the usual arguments against protection, there's one that applies particularly to Dutch disease, but is usually overlooked. Corden calls it the "general equilibrium effect".

"Suppose extra protection is provided for the motor car industry," he says (writing well before last week's announcement of extra assistance to General Motors). This reduces imports of cars, as is the intention of the policy, but will lead to extra appreciation of the exchange rate.

If all manufacturing industries were significantly protected there would be a substantial appreciation, which would actually worsen the Dutch disease effects on other industries in the lagging sector - agriculture, tourism and education exports.

Similarly, protection for selected manufacturing industries would have adverse effects on other industries in the lagging sector, including those parts of manufacturing that didn't receive the extra assistance.

"These losers would thus suffer not only from the effects of the mining boom but also from the political success of their industry colleagues in extracting protectionist measures from the government," he says.

It's been suggested that the miners should be required to source various supplies domestically rather than import them. A similar requirement could be imposed on government spending and on private suppliers to the government.

Such requirements would also lead to greater exchange-rate appreciation than otherwise. They would thus benefit some industries and workers but, through their aggravation of the Dutch disease effect, would damage other industries and workers.

The third option the government could choose in responding to Dutch disease is "fiscal surplus combined with lower interest rate". The government cuts spending or increases taxes to achieve or increase a budget surplus.

This would have a contractionary effect on demand in the economy, but its reduction of inflation pressure would allow the Reserve Bank to ease its monetary policy and lower the official interest rate. This, in turn, would lead to some depreciation of the exchange rate because our lower interest rates relative to those in other countries would reduce the net inflow of capital to Australia.

So the Dutch disease effect would be moderated, but at the cost of politically difficult changes in taxation and spending.

The advantage of this option is that it benefits all lagging-sector industries evenly. But, Corden argues, it's just one way of providing "exchange-rate protection". So it, too, creates winners and losers.

All tradeable industries benefit from the lower exchange rate (including the miners), but the much larger, non-tradeable sector loses from it by having to pay more for imports. The lower dollar also reduces the incentive to invest in Australian development.

I conclude from Corden's analysis there's no easy, costless way to ameliorate the downside that comes with the blessing of the mining boom. There are just options that carry more disadvantages than others.

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Why the economy isn't splitting in two

The news from last week's national accounts seemed very clear and very worrying: the economy was splitting in two, with the mining-boom states of Queensland and Western Australia roaring off into the future, leaving the rest of Australia going nowhere fast.

Over the year to December, state final demand grew by more than 11 per cent in WA and by 10 per cent in Queensland, but by about 1.5 per cent in the rest of Australia.

Fortunately, the true position isn't nearly as bad as that, as Kathryn Davis, Kevin Lane and David Orsmond explain in an article in the March quarter Reserve Bank Bulletin, issued this week.

The trick was that label "state final demand". When we talk about "growth" in the context of the national accounts we're talking about growth in (real) gross domestic product - the value of all the goods and services produced by the market during a period.

We focus on production because it's production that creates jobs and generates income. The equivalent of GDP at state level is gross state product.

So if you want to compare how the states are travelling you compare the growth in their GSP.

Trouble is, the Bureau of Statistics doesn't publish GSP quarterly, only annually. What it does publish quarterly is state final demand, the national equivalent of which is "domestic final demand".

Because these are the only figures available, the media (and some economists who should know better) have fallen into the habit of assuming state final demand and GSP are much the same thing.

Wrong. State final demand differs from GSP in one minor respect and one major respect: it takes no account of exports and imports. And that's not just overseas exports and imports, it's also exports and imports between the states.

In other words, when you make state final demand a substitute for GSP you're implicitly assuming each state has no trade with either the rest of the world or even the other states. Or that its trade is always in balance.

Guess what? Make such unrealistic assumptions and you get misleading results.

The authors point out that growth in spending on home building and non-mining investment over the year to December didn't vary much between the states. There were two main differences. One was that whereas consumer spending grew by about 3.5 per cent in NSW, Victoria and Queensland, it grew by 6 per cent in WA.

The other difference was the huge growth in mining investment spending in WA and Queensland. This was what did most to explain why their growth in final demand was in double figures whereas NSW and Victoria's demand growth was so modest.

But here's the point: the Reserve estimates that roughly half the spending on mining investment goes on imported equipment. Take this into account and the gap between the mining and non-mining states gets a lot smaller.

Another factor narrowing the gap is that part of the miners' spending on investment (and their ordinary operations) goes on goods and services, such as accounting and consulting services, produced in other states. And some of the workers who fly-in/fly-out take their income home to other states.

To give you an idea of how the shift from state final demand to GSP narrows the gap between the states, let's look at the most recent figures, for 2010-11 as a whole. The final demand figures show spending growth ranging from 1.4 per cent in SA to 6.5 per cent in WA - a spread of 5.1 percentage points.

But the GSP figures show production growth ranging from 0.2 per cent in Queensland (get that) to 3.5 per cent in WA - a spread of 3.3 percentage points. After WA came Victoria on 2.5 per cent, SA on 2.4 per cent, NSW on 2.2 per cent and Tasmania on 0.8 per cent.

In other words, state final demand provided a quite misleading guide to the states' ranking. Queensland does so well on spending but so badly on production because, though it gains from having a fair bit of mining, it loses from being so dependent on tourism (hard-hit by the high dollar).

In the absence of more up-to-date figures for GSP, the trick is to examine independently estimated direct and indirect measures of state activity. If the mining states really were growing five or six times faster than the other states, you'd expect that to mean they had much lower rates of unemployment and much higher rates of inflation than the others.

It's true WA's trend unemployment rate was a very low 4.1 per cent in February, but the other mainland states were all tightly bunched around the national average rate of 5.2 per cent. As for inflation, over the year to December the mining states had the lowest rates rather than the highest.

If the gap between the mining states and the rest turns out to be narrower than you expected it's because you've been misled by all the talk of a two-speed economy: mining in the fast lane, manufacturing in the slow.

In truth, and as the distinguished economist Max Corden, of the University of Melbourne, reminded us this week, it's actually a three-speed economy, with mining in the fast lane and manufacturing (plus other export and import-competing industries) in the slow lane, but with almost all other industries - the non-tradable sector - in the middle lane.

This matters because the non-tradable sector benefits from the mining boom and the high dollar in two ways: from the increase in national income brought about by the high commodity prices, and from the lower prices of imports brought about by the high dollar.

Guess what? This non-tradable sector accounts for the great majority of production and employment in all states bar WA (where mining accounts for an amazing 33 per cent of GSP).

The people of Victoria see their state as weak on mining (true) and heavily dependent on manufacturing. Not true: manufacturing accounts for 8 or 9 per cent of GSP in all states bar WA (5 per cent). Where Victoria and NSW stick out is in their dependence on the business services sector (particularly financial and insurance services), which accounts for 28 per cent and 30 per cent of GSP, respectively, compared with about 17 per cent in the other states.

It's because business services are mainly in the not-hard-hit non-tradable sector that Victoria and NSW aren't travelling too badly compared with the mining states.

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