Brian Fallow: Time for business to get out and invest

With so many potential workers already employed, NZ needs other ways to lift output. Picture / NZME

One of the more cheerful findings in the NZ Institute of Economic Research's quarterly survey of business opinion this week is a rise in firms' intentions to invest in plant and machinery.

A net 18 per cent of firms say they expect to lift investment over the next 12 months, up from a net 16 per cent three months ago and a high level by historical standards.

It is consistent with other findings in the survey, which suggest businesses are bumping up against capacity constraints: 17 per cent cited capacity (as opposed to demand, labour or finance) as the main factor limiting their ability to increase turnover, historically a high level for that indicator. In addition, reported capacity utilisation is high, especially for builders but also for manufacturers.

Investment intentions in ANZ's monthly business outlook surveys have also been at robust levels.

These indicators are symptomatic of a business cycle getting increasingly long in the tooth.

After eight years of a negative output gap - indicating slack in the economy - the Reserve Bank reckons it has now turned positive.

Labour force participation - the proportion of the working age population either employed or actively seeking work - is at a record high.

All hands to the pump, in short, has just about done its dash as a strategy.

We need to invest in a more efficient pump, both to maintain the economy's momentum and to lift productivity to justify the higher wages an increasingly tight labour market portends.

So is that happening? Are firms putting their money where their confident mouths are and increasing capital expenditure?

The evidence is a bit mixed.

Imports of capital machinery and plant in the 12 months ended February this year were down 1.5 per cent on the year before. But that could be explained by a stronger New Zealand dollar making imports cheaper.

Meanwhile, growth in business borrowing has been slowing, January recording the weakest annual growth for two years. That is despite a substantial fall in interest rates for business loans over that period.

The gross domestic product data for 2016 is a bit more encouraging.

Business investment in plant, machinery and equipment over the course of 2016 was just 1.8 per cent higher in real terms than in 2015.

But when intangible fixed assets (software) and transport equipment are added, the rise in investment was 3.6 per cent. That is more like it, but still falls short of the rise in overall spending in the economy last year, which was 3.9 per cent on an annual average basis.

Deepening the capital-to-labour ratio - the capital invested per worker - is essential if New Zealand is to lift its frankly lousy productivity performance.

In the year to March 2016, the latest period for which official productivity statistics are available, labour productivity (output per hour worked) actually fell, by 0.7 per cent, Statistics NZ reports.

Over the current (incomplete) economic cycle, labour productivity growth has averaged just 0.7 per cent a year, which is less than half its long-run average. It is also less than half the rate the Treasury likes to assume in its long-run projections for future economic growth.

More timely indicators are not encouraging, either. In the December 2016 quarter, hours worked according to the household labour force survey rose 1.3 per cent, while paid hours according to the quarterly employment survey (of businesses) rose 1.2 per cent.

But economic output grew just 0.4 per cent in the same period, implying falling labour productivity.

Are firms putting their money where their confident mouths are and increasing capital expenditure?

Turning this around will require firms to do one (or both) of two things: get a lot smarter than they have been at using the resources of capital and labour already at their disposal, or increase capital expenditure.

Why wouldn't they lift capex?

The confidence recorded in business sentiment surveys is understandable, after all.

The consensus among economic forecasters is for New Zealand's GDP growth to remain north of 3 per cent a year for the next couple of years anyway.

The construction sector is humming.

Population growth is still going strong. That might dilute the per capita metrics, but for sectors like retailing it is helpful.

Tourist arrivals are at capacity-challenging levels.

The cost of capital is hardly an impediment. We may have seen the bottom of the interest rate cycle, but rates are expected to rise fairly gradually from what is a very low base.

The terms of trade (export prices relative to import prices), while off their highs of a couple of years ago, remain quite favourable by historical standards.

And after five years in which the Government's fiscal policy has been contractionary, the Treasury expects a "small positive impulse" from that source in the year ahead.

As part of the preparation for next month's Budget, Treasury officials have recently undertaken a round of meetings with businesses.

They report that after a couple of seasons with a dairy payout at levels below break-even for most of them, farmers are expected to remain cautious about large-scale investment.

In other sectors, however, a number of large-scale investment projects have either recently been completed, are under way or are due to start this year.

"Investment intentions were evenly spread between IT and building physical capacity," they said.

"However, in Auckland some firms noted that the benefits of expanding physical capacity were being eroded by the state of transport infrastructure, which is impairing the mobility of both customers and suppliers and making it difficult to service the city as a whole."

Untangling that particular hobble on growth remains crucial.