No free lunches in economic reform

A recently released report from the Grattan Institute in Australia surveys ‘game-changing’ ways to increase GDP. Its conclusions on the priorities for economic reform are summarised in a diagram:

Notably, two of the three most urgent changes that they identify relate to lifting workforce participation. That’s a tricky topic because, while more labour might increase GDP, it also decreases leisure time. As John Quiggin has recently blogged:

…it’s not the amount you produce, but the amount you produce per unit of effort. If you are putting in more hours, or increasing your pace along with your hours, to produce that last unit of output, your productivity is declining, not increasing.

The ideal is to work just long and hard enough that the extra money you could make by working more would not compensate you for any additional effort.

Genuine productivity growth, on the textbook view, doesn’t come from working harder or faster. Rather, the main sources of productivity growth are technological progress and the improved education needed to take advantage of that progress.

John Daley, author of the Grattan Institute’s report, is mindful of these concerns and suggests that the problem is not really the lack of participation itself, but the barriers to participation erected by the government. In particular he points to goverment income transfers that reduce the incentive to work. Most of those transfers are intended to redistribute income based on judgments about fairness in society, so changing them to increase workforce participation will sacrifice some societal equity to gain efficiency and wealth. That doesn’t mean it’s wrong but just skimming the headline points from the Grattan Institute’s report reinforces the economist’s maxim that there are no free lunches. Even when there are unambiguously inefficient policies that reduce GDP, there’s usually a reason that they exist.