Brian Fallow on the economy

Brian Fallow is the Herald's Economics Editor

Brian Fallow: Productivity gap a real mystery

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Grim figures puzzle, among others, the OECD who reckon New Zealand's policy settings are relatively good.

Construction sector productivityhas been persistently sluggish. Photo / APN
Construction sector productivityhas been persistently sluggish. Photo / APN

Let's start by acknowledging that New Zealand struggles to earn a First World living.

Over the past 40 years we have seen our per capita gross domestic product decline from being above the OECD average to around 20 per cent below it.

It lurched lower in the late 1970s and again in the late 1980s and early 1990s and it has been more or less stable at around 20 per cent below the OECD average since then.

But even that relative stability masks a continuing decline compared to other developed countries in labour productivity, which is the foundation of incomes.

A paper by Productivity Commission economists Paul Conway and Lisa Meehan published this week shows that in the 1990s (1992 to 2000 to be precise) about half of the income growth derived from higher labour productivity or output per hour worked.

Almost as much came from increased hours worked as unemployment fell from the painfully high levels reached in the early 1990s recession and as more women joined or rejoined the workforce.

Since 2000, however, the contribution from employment changes has fallen sharply. Labour force participation rates are now high by international standards and as the population ages will eventually decline.

National income per capita has been boosted in recent years by high export prices, but while we may hope that trend will continue, it is out of our control and, as the Australians are learning, the terms of trade can turn against you.

So if we are not to slip ever closer to the relegation end of the league table of developed countries, lifting productivity is essential.

The problem is especially acute because we have, more or less, a common labour market with Australia which has continued to outperform the OECD average in productivity and, therefore, incomes.

The Productivity Commission report points to research which found that labour productivity in New Zealand is lower than in Australia in 10 of the 16 industries measured. It is less than half Australian levels not only in mining, but in construction and in the finance and insurance sector.

Some of New Zealand's manufacturing sub-industries have productivity levels that are less than half that in Australia.

All of this puzzles, among others, the good folks at the OECD who reckon that, all in all, New Zealand's policy settings are relatively good.

OECD economist Alain de Serres, speaking to a symposium on productivity in Wellington last month, said the OECD put a lot of time and effort into looking at how different policy settings in the areas of taxation, regulation, innovation and education affected GDP per capita.

Given its policy settings New Zealand's GDP per capita, as predicted by these relationships, should be about 20 per cent above the OECD average, not 20 per cent below it, he said.

How then to explain this gap, and set about narrowing it?

A lot of it can be laid at the door of those old conjoined twins, size and distance.

It is the combination of being small and remote that matters, Conway says. "If you are a small economy in the middle of Europe it doesn't matter so much."

One consequence of small domestic markets is that there is often a tension or trade-off between capturing the benefits of scale and the benefits of competition. "That's an awful dilemma for policymakers to face," he said.

De Serres pointed to evidence that poorly managed firms manage to survive more easily here than in the United States.

That is likely to reflect less competitive pressure and a lack of scrutiny and pressure from capital markets. With so many of New Zealand's largest companies either state-owned, farmer-owned or foreign-owned, the sharemarket intercepts relatively little of the country's economic life as is reflected in its low combined market capitalisation relative to GDP.

It may also help explain why New Zealand firms' rate of investment in information and communications technology is below the OECD average despite a vast body of evidence than ICT investment is a crucial driver of innovation in the services sector particularly.

And when the investment is made there is still the question of whether firms do enough by way of changing business practices or training staff to make the most of it, de Serres said.

Small size might also be a factor in New Zealand Inc's relatively low investment in research and development, as private sector R&D tends to be undertaken by large companies.

Meanwhile, distance from markets, suppliers and competitors explains a lot of the gap in GDP per capita between New Zealand and the OECD average, de Serres argues. When combined with the low R&D spend it could account for about half the productivity gap.

While there is not much New Zealand can do about its location, it can mitigate the negative effects of remoteness to some extent by fostering trade with closer parts of the world, not only Asia but Latin America, and not worry so much about northern Europe.

And we should ensure regulation does not unduly add to transport and telecommunications costs, he said.

When broken down by industry labour productivity growth since 1990 has been strongest in the information, media and telecommunications sector and in finance and insurance.

Agriculture recorded strong productivity gains in the 1990s but that has subsequently waned. It is a similar story for transport.

Productivity growth in manufacturing since 2000 has only been at two-thirds of the unimpressive pace managed by the wider economy.

Of particular concern in light of the twin challenges posed by Christchurch and Auckland, the construction sector has been a persistent productivity laggard.

However Statistics New Zealand is now able to provide researchers with much more fine-grained and detailed information, at the level of individual firms (don't worry, it's anonymised).

That allows them to look at the distribution of productivity performance within a particular industry or sector and not just at averages.

There is tentative evidence, Conway and Meehan say, that the spread within industries in New Zealand is unusually wide and it may be that our most productive firms are up there with the best of them internationally.

"If this is the case then New Zealand's poor productivity performance at the industry and aggregate levels would also relate to the extent to which new technologies and work practices diffuse from high to low productivity firms."

The possibility, no more, of some sort of future convergence towards best practice offers a shred of comfort in what is otherwise a pretty bleak picture.

- NZ Herald

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