Former Economics Editor of the NZ Herald

Brian Fallow: The puzzle of puny productivity

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Income gains have largely come from working more, not from working better
Distance from markets is only part of the reason for poor productivity. Photo / John Borren
Distance from markets is only part of the reason for poor productivity. Photo / John Borren

Low productivity is a chronic weakness of the New Zealand economy.

There are times, and this is one of them, when its effects on incomes are disguised or offset by other things: strong population growth, high labour force participation and hours worked per capita, and favourable terms of trade.

But none of those is durable.

And not only is New Zealand to be found near the relegation end of the OECD league tables for productivity level, the trend is not our friend either. Average annual growth in labour productivity (output per hour worked) over the past 20 years is 1.4 per cent, but for the past 10 years it is 0.9 per cent.

Between 2009 and 2014, New Zealand enjoyed the fifth fastest growth in per capita gross domestic product among 25 OECD counties. But that reflected the third fastest growth in per capita hours worked; labour productivity growth was the fourth lowest.

Why? Well, for a start, being small and remote is an unhelpful combination.

Being small tends to retard competition, make it harder for firms to achieve economies of scale and lower the returns to innovation.

Being remote makes it harder to participate in the sprawling network of border-crossing global value chains which have come to dominate international commerce.

The question is, what can be done on the policy front to mitigate these handicaps and enable New Zealand to continue to earn a first world living in a rapidly changing global environment?

A richly informative paper released this week, by the Productivity Commission's director of economics and research, Paul Conway, reflects on these issues.

It is informed not only by the commission's inquiries into particular sectors but by the wealth of (anonymised) firm-level data now available from Statistics New Zealand, which provides a much more high-definition picture of the economy's workings.

It is an economy made up of relatively small domestic markets. That makes it easier for a handful of firms to dominate their market and to protect profit margins not through innovation and competition, but by extracting rents from suppliers and customers.

The single most useful thing policymakers could do to foster productivity gains would be to lift competition intensity in services markets, Conway says.

Let's be frank. The venture capital sector is embryonic, the sharemarket puny (relative to the size of the economy) and households and banks are preoccupied with housing.

The commission's inquiry into the services sector has left it critical of section 36 of the Commerce Act. It argues the test for anti-competitive behaviour should be whether a firm's conduct creates demonstrable harm to consumers, rather than the current test based on purpose and counterfactual speculation about whether the conduct in question would have occurred in the absence of market power.

The prevalence of small domestic markets can also mean that firms looking to grow need to go international earlier in their life cycles than they would in larger economies. That is easier said than done.

Clearly, distance matters, Conway says, but less than it used to.

Advances in information and communications technology mitigate the tyranny of distance (and in the case of the cloud, size).

Weightless exports, like software and digital services but also from the creative arts, make up a growing share of world trade.

But for firms to take advantage of those possibilities and carve out a niche in competitive global markets, they need access both to skills and to capital with the right risk appetite.

Dealing with a skills mismatch will require progress on three fronts, he argues.

The education and training system has to be responsive to the changing demands of business. But also to people who find their existing skills have become redundant.

If Auckland isn't working and isn't that well connected internationally, well, looking forward you kind of need it to be.

Second, the immigration system is not perhaps as well targeted as it might be.

And then there is the housing crisis. "To some extent cities are our most productive invention and if people are priced out from living in cities it is pernicious in lots of ways but lower productivity is one of them," Conway says.

"If Auckland isn't working and isn't that well connected internationally, well, looking forward you kind of need it to be," Conway says.

Another source of low productivity is capital shallowness. That is, low levels of capital invested per worker by international standards.

Longer-term real interest rates in New Zealand have long been significantly higher than in other comparable countries. That raises the cost of capital for firms and exerts upward pressure on the exchange rate.

"Our understanding of the economics behind that is not all that well developed," Conway says. "There are plenty of things we could do as a research community to get to the bottom of things like that." Part of the explanation, however, might lie in the fact that New Zealand's net national saving rate is low, requiring us to import a lot of foreigners' savings to fund the country's investment needs.

And the financial sector is not very good at allocating the savings we do scrape together to the most productive enterprises.

The commission notes that firms in the top quartile, ranked by productivity, account for a disproportionately low share of capital invested, and that is especially true of the services sector.

Underinvestment in business R&D and managerial capability negatively impacts on the ability of firms to commercialise new ideas and absorb new technology created elsewhere.

Let's be frank. The venture capital sector is embryonic, the sharemarket puny (relative to the size of the economy) and households and banks are preoccupied with housing.

There is a toxic interaction between the tax system and banking system, whose effect is to direct a torrent of money into real estate but leave only a meagre and exiguous trickle for productive enterprise.

But not all the blame can be laid at the door of craven politicians' reluctance to tackle the tax-privileged status of housing. Some belongs in the nation's boardrooms and executive suites.

"Underinvestment in business R&D and managerial capability negatively impacts on the ability of firms to commercialise new ideas and absorb new technology created elsewhere," the commission says.

Among firms, international connectivity and higher productivity are positively correlated. The causality probably works in both directions.

As well as directly traded services like travel and education, more and more of the value of goods traded consists of embedded services involved in producing them.

So the hard slog of negotiations to tackle behind-the-border barriers to trade and foster a more coherent international approach to regulatory practice remains important - the more so when there is a protectionist tide running.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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