New Zealand suffers from capital shallowness: the capital-labour ratio is low. Photo / Bloomberg
COMMENT:
Just how big and stubborn a productivity problem New Zealand has is starkly laid out in a new paper from the Productivity Commission.
Economic problems do not get more fundamental than this, if only for the obvious reason that income has to be earned before it can be spent, or taxed. And we are really not very good at doing that.
The commission starts by comparing New Zealand's gross domestic product per capita with the average of countries in the top half of the OECD ranked by income. It is a group which includes all the countries we like to compare ourselves with; the lower half of the OECD is dominated by former Soviet bloc countries.
New Zealand's per capita output is 30 per cent below the average of that peer group.
And that is despite the fact that hours worked per capita here is about 17 per cent higher – reflecting an exceptionally high proportion of the working age population employed, more than punishingly long hours per worker.
The combined effect is labour productivity, or output per hour worked, around 40 per cent lower than our international peers.
It is not improving either. The gap has widened from around 34 per cent in 1996.
It gets worse. When they look at all 36 OECD countries, almost all of those which have a lower productivity level than New Zealand at least have faster rates of productivity growth. So we get to wave at Slovenia and Slovakia as they overtake us.
The only OECD countries with both a lower productivity level and weaker productivity growth are Mexico and Greece. Maybe Portugal; it's a toss-up.
Under the growth accounting framework the two drivers of labour productivity are the capital-labour ratio (essentially the resources of hardware and software with which firms equip their workers) and multi-factor productivity, which is that part of output growth not explained by increased inputs of capital and labour.
New Zealand suffers from capital shallowness: the capital-labour ratio is low. The statisticians tell us that since the mid-1990s it has increased at only half the pace recorded across the Tasman, which explains a lot of why Australians are richer than us and so many Kiwis now live there.
So one of the most troubling revelations in the Productivity Commission's paper is that the capital-labour ratio in the "measured" or private sector has been flatlining since 2010.
Both capital and labour inputs have been growing since 2010 but at a similar pace, around 2.1 per cent a year. The two lines are heading north but are parallel, when what you want to see is a widening with capital growing faster, especially in a period when the cost of capital has been low by historical standards.
Since the global financial crisis labour productivity growth has been running at around 1 per cent a year, compared with a long-run average rate of 1.5 per cent. The latest read, for the year to March 2018, was 0.3 per cent.
The Treasury's economic forecasts in the Budget two weeks ago assume labour productivity growth will average 0.9 per cent a year over the five years to 2023, while multi-factor productivity growth averages 0.5 per cent. The gap between those two numbers has to be bridged by a decent pick-up in the capital-labour ratio -- something the statisticians have been unable to discern any sign of for years.
The forecasts assume, officials tell me, a "fairly solid" track for investment, "representing a combination of ongoing public sector investment and the response by businesses to a tight labour market with increased labour costs."
In other words they see the economy as having shifted from a period of relatively abundant labour supply in the wake of the recession and underpinned by strong net immigration to one where the net migration gain is slowing and unemployment has fallen to about its "natural" or non-inflationary rate.
Indicators like the PAYE tax take suggest that wage pressure is rising. So where there is choice between hiring and investing, the incentives increasingly favour the latter.
We can but hope that this confidence proves well-founded. Because if that capital deepening does not eventuate and the economy's stride is accordingly shorter, either tax revenue will fall short of expectations or it will meet them because of inflation rather than real growth. Neither is good.
ANZ chief economist Sharon Zollner has pointed to the difference between investment intentions and employment intentions in the ANZ Business Outlook surveys as an indicator of firms' preferences. It has been consistent with the broad downward trend in official labour productivity data.
"Over this business cycle firms have opted more heavily for labour [rather than investing in capital] than is typical, particularly in the past five years. This has absorbed the very large growth in the labour supply New Zealand has experienced via net immigration. However, it does have unfortunate implications for productivity growth, which is what drives real wage and wealth gains on a per capita basis over the medium to long term," she said.
So there may be a glimmer of hope in the May survey's rise in investment intentions while hiring intentions softened.
To be sure, there is a lot more to the weak productivity story than the capital-labour ratio: all the influences on multi-factor productivity.
There is a reason the commission has produced a metre-high stack of reports analysing the problems, and recommending remedies, for one sector after another.
For policymakers there are issues around investment in infrastructure, competition policy, fostering research and development and a healthy innovation eco-system, and an education system fit for purpose in the digital age. For starters.
Firms, meanwhile, face the challenge of how to learn from those at the frontier of their industry in technology and best management practice.
But the issue of capital shallowness is pervasive.
And the lesson for business owners seems clear: If you don't want to watch your grandchildren growing up via Skype and talking to you in a strange foreign accent, invest!
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