Measuring the Contributions of Productivity and the Terms of Trade to Australian Welfare

Conference presentation

Denis Lawrence (Meyrick and Associates) gave a presentation entitled, Measuring the Contributions of Productivity and the Terms of Trade to Australian Welfare, to the Productivity Perspectives 2006 conference. An accompanying paper by Denis Lawrence and Erwin Diewert, Measuring the Contributions of Productivity and the Terms of Trade to Australian Economic Welfare, has also been released.

Abstract

The recent resurgence in commodity prices has focussed attention on the potential impact of the terms of trade on Australia's welfare. The Productivity Commission engaged Meyrick and Associates to calculate the relative impact of productivity and terms of trade changes over recent decades. We adapt the index number methodology of Diewert and Morrison (1986) and undertake the analysis in both the gross product and net product frameworks. While the gross product framework has traditionally been used, it overstates the level of real income as it treats investment to cover depreciation as part of real output when only net investment increases sustainable final consumption possibilities.

The main conclusion is that, taken over long time periods of several decades, changes in the terms of trade have relatively little impact on Australian welfare. However, improvements in the terms of trade over the decade up to 2003-04 led to an increase in real income of 7.5 per cent. The total increase in real income over the same period was 47 per cent with higher productivity growth accounting for almost half this increase. The other major conclusion is that moving to a net domestic product framework from a gross domestic market sector framework leads to a reduction in the role of capital deepening as an explanatory factor for improving living standards and increases in the roles of technical progress (or TFP growth) and labour growth.