Productivity Perspectives 2007

1. Productivity Perspectives 2007 Mining productivity: The case of the missing input? Vernon Topp, Harry Bloch*, Dean Parham Productivity Commission, Canberra *Curtin University of Technology, Perth

2. Background • Saw earlier: slower productivity growth in 2000s • market sector • mining • Yet signs of strong growth in prosperity • employment • investment • domestic demand • How do we reconcile? • Work in progress

3. Messages • There has been a decline in mining productivity • associated with the boom in commodity prices • There is a ‘short-run’ element • which has to do with capacity constraints • There is a long-run element • which has to do with depletion of reserves • In the context of higher commodity prices, the decline in productivity is not of such concern • Terms of trade gains have delivered strong improvements in prosperity

4. Outline • The big picture: Mining, productivity and prosperity • Commodity prices  productivity, terms of trade • Explaining the decline in mining productivity • Measurement and interpretation • unearthing the missing input • Implications

5. Links to presentations that follow • Erwin Diewert • productivity, terms of trade, welfare • measurement implications of terms of trade shocks • Ben Dolman • distributional consequences • productivity surge (1990s) • terms of trade shock (2000s)

6. Outline • The big picture: Mining, productivity and prosperity • Commodity prices  productivity, terms of trade • Explaining the decline in mining productivity • Measurement and interpretation • unearthing the missing input • Implications

7. There has been a sharp increase in mining commodity prices 40% increase in real prices from 00-01 to 05-06

8. There has been a sharp decline in mining productivity since 2000-01 8 industries 00-01 to 05-06 MFP -34 per cent LP -50 per cent 8 industries excluding services to mining ABS sector 00-01 to 06-07 MFP -24 per cent LP -35 per cent

9. Lower mining productivity has detracted from aggregate productivity growth Market sector multifactor productivity (MFP) From 00-01 to 05-06 Without mining 7.7% With mining 4.1%

10. But the associated terms of trade increase has brought income gains From 00-01 to 06-07: GDI pp 21.0 per cent GDP pp 12.6 per cent

11. Indirect effects • Supplying industries • construction, transport • Downstream industries • processing • Exchange rate effects • returns in other exporting industries • stronger import competition • productivity effects?

12. Outline • The big picture: Mining, productivity and prosperity • Commodity prices  productivity, terms of trade • Explaining the decline in mining productivity • Measurement and interpretation • unearthing the missing input • Implications

13. Lower mining productivity associated with strong growth in inputs but a decline in output 00-01 to 05-06 41 per cent 25 per cent -18 per cent

14. Measurement note • Output measured in volume terms, not value terms • effect of higher commodity prices ‘washed out’

15. Three main explanations for lower productivity put forward • Investment cycle view • stage of investment in new capacity • output response yet to come on stream • Bottlenecks holding back growth in output • transport infrastructure • people and skills • Depletion → more-marginal deposits • Lower yield or higher input requirements

16. Mining sector capital and exploration expenditure Low investment

17. Industries within the mining sector:growth 2000-01 to 2005-06

18. Key features • Prior to prices boom, little excess capacity • Mine production, transport infrastructure • Depletion, especially in oil & gas (and gold) • With prices boom, very strong growth in labour • only variable factor • Strong growth in intermediate input usage reduces value added (as opposed to gross output) • more mining services: exploration, operations? • more transport: eg fly-in fly-out? • Growth in capital inputs, especially in iron ore • additional capacity, not yet fully utilised

19. Assessment • With capacity constrained for the time being, more-costly methods being used to maintain/increase production • Made possible by very high rise in commodity prices • Evidence of more-marginal deposits • depletion in oil & gas and gold, while input usage increased • Some evidence consistent with bottlenecks • although difficult to separate out • Support for investment cycle • Capital inputs growing faster than output (iron ore) • However, even on the investment cycle view, more-marginal deposits mean output growth is unlikely to respond in the long run to the same degree

20. Outline • The big picture: Mining, productivity and prosperity • Commodity prices  productivity, terms of trade • Explaining the decline in mining productivity • Measurement and interpretation • unearthing the missing input • Implications

21. How do we interpret the decline in mining productivity? • Less efficient? Some element in ‘short’ run • capital bottleneck • lower labour, intermediates productivity • But a sense in which a (long-run) decline does not represent a decline in efficiency • no backward step in technology or production practices • move toward more (K, L) input-intensive production in extracting from more-marginal deposits

22. The missing input – or ‘lurking variable’ • ‘The ‘traditional’ production process  eg in manufacturing • use primary factors (K,L) and intermediates to transform intermediates into finished goods • all (tangible) inputs accounted for • The mining process • use primary factors and intermediates to extract ore fromin-grounddeposits • the input of ‘rock in the ground’ is not taken into account • an ‘environmental’ variable, which commonly are omitted • However, when the quality of the ore declines, more effort in terms of inputs of K,L and intermediates is required to produce a unit of output • measured MFP, which only takes account of traditional inputs, declines • Declining ore quality is a ‘lurking variable’

23. Mining extraction strategy • Baseline (Hotelling’s rule) • extract the highest quality (and most easily extracted and cheaply transported) deposits first. • extract at a rate at which resource rents (revenue less costs) from extraction equal the expected increase in resource rent from leaving deposits in the ground • Commodity price boom • Resource rents from current extraction rise • Little additional gain from leaving in the ground • particularly if price rises expected to be temporary • particularly if competition looming from alternative sources of supply • increase extraction at existing and readily-activated mines at much faster rate, and to a point, not previously envisaged

24. Evidence to support the more-marginal deposits theory • Decline in average ore grade • long term • since 1970s and 1980s • Also • coal deposits less accessible • oil depletion • impurities in iron ore • Correlation (-ve) between prices and MFP • Higher prices induce more-intensive input usage in extracting from more-marginal deposits

25. MFP inverted (RHS) Output price index - real MFP - actual Output price and MFP for the mining sector 200 0 150 50 100 100 50 150 Correlation coefficient = -0.78 0 200 1970-71 1975-76 1980-81 1985-86 1990-91 1995-96 2000-01 2005-06

26. Correlation coefficients  prices and MFP

27. Outline • The big picture: Mining, productivity and prosperity • Commodity prices  productivity, terms of trade • Explaining the decline in mining productivity • Measurement and interpretation • unearthing the missing input • Implications

28. Reconciling strong growth in prosperity with slow growth in productivity • Strong growth in mining • resource rents (prosperity) • employment • investment • not matched by growth in output (and productivity) • capacity constrained for some time • high intermediate usage dampens value added • investment cycle under way • more marginal deposits  even in the long-term • Also reflected in aggregates

29. Outlook • Although the investment cycle is in play • talk of a once-in-a-generation ‘super cycle’ • output growth is unlikely to respond to the same degree • unless substantial new discoveries • Mining productivity likely to turn around over the long term, but will ‘flatten out’ at a lower level than at the turn of the century • if higher prices sustained • Does NOT mean mining is less efficient

30. Derived demands • Probable distinction between input-related demands and output-related demands • Input related  strong • investment: exploration, mine development • employment: numbers, skills, sourcing • but growth in demand may slow • Output related  not so strong? • amount and location of processing • transport to market • spatial dimension of infrastructure needs

31. Implications for understanding productivity in mining • Importance of depletion and declining ore grades on measured MFP • Importance of output prices in MFP trends • commodity booms raise resource rents and induce faster depletion and reductions in average ore grades • High correlation between prices and MFP suggests that • over the very long term, discoveries and improvements in technology and production practices largely offset the effects of depletion • price booms and busts generate MFP ‘perturbations’ • Importance of intermediates efficiency at least in the ‘short’ term

32. Implications for measurement • Need more focus on intermediates • nature, extent and deflation • Do we do anything about the lurking variable? • take account of changing ore quality, etc? • For productivity (and national accounts in general), should we measure output in terms of value rather than volume?

33. Publication • Forthcoming working paper

34. Productivity work • Infrastructure and productivity • Migration and trade & investment flows • Mining productivity • Distribution of recent economic gains • Intangibles and productivity

35. Thank you Questions and comments?