How do business cost reductions benefit the economy?

Each year, the Office of the Chief Economist in the Department of Industry, Innovation and Science releases the Australian Industry Report. This Report is a broad-ranging, comprehensive analysis of the economic conditions affecting Australian industry. Contained in the report is a range of innovative and insightful data analysis and research aimed at shedding light on the opportunities and challenges facing Australian industry.

Cadence Economics was pleased to assist the Department by undertaking economic modelling for Chapter 3 of the Report, looking at the impacts of business cost reductions. We were commissioned to model the economic impact of six particular cost reductions using our in-house, computable general equilibrium (CGE) model. Using this model, we were able to assess the direct effects of business cost reductions, as well as indirect, second-order effects, including changes to capital supply and labour responses.

A key insight from the modelling was the complexity of business cost reductions on the economy when interactions between industries, which is some cases are rivalrous, are considered.

A good summary of the broad impacts of cost reductions is replicated from the publication below (Figure 3.1 on page 46). The modelling shows that all forms of cost reduction lead to higher economic growth as measured by gross domestic product (GDP) and that the ultimate outcomes of cost reductions vary depending on which cost is reduced.

For example, lower rent and facility costs provide strong support for employment and investment, although the benefits are concentrated among capital-intensive services and construction. Lower interest rates support investment, but not as much for employment, with the benefits being concentrated in construction and high-tech services.

The analysis undertaken is an example of how our modelling is used to demonstrate the mechanisms underpinning potential economic reforms.

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