Sunday, April 10, 2011

Roger Kerr: Productivity Growth Still New Zealand's Big Challenge

In its two reports to date the 2025 Taskforce has provided estimates of the income gap between New Zealand and Australia.

Its base measure of the gap is real GDP per capita in purchasing power parity terms.

In its first report the Taskforce put the income gap at 35% for 2008. OECD projections in a table in its second report last November suggested that the gap would be 38 percent in 2010.

Official figures now available support this projection. They show a 2.8 percent fall in real GDP per capita for New Zealand and a 0.3 percent rise for Australia since 2008.

This deterioration should not come as a surprise. As a New Zealand Treasury officer noted at an Australian conference last month, “Before the global recession hit in late 2008, New Zealand’s economy was already in poor shape. Our average annual growth was less than 1% in the years
leading up to the 2008 global financial crisis and we went into recession several months earlier, before just about every other developed economy.”

It is too early to criticise the government for not closing the gap. Not only did it inherit a weak and unbalanced economy but it has had to contend with the GFC and now the Christchurch earthquake. Meanwhile, the Australian economy has been robust and is growing strongly.

Nevertheless, the fact that no turnaround in sight is ominous. With each passing year the task of closing the gap by 2025 becomes harder and the implications dire. As the Taskforce noted, “Based on current projections of the income gap and its impact on emigration, a net 412,000 New Zealanders could leave New Zealand over the next 15 years”.

There are two main strategies for closing the gap: increasing workforce participation and increasing productivity.

Workforce participation can be increased. The Taskforce noted that raising the age of eligibility for New Zealand Superannuation could make a material contribution. It also advocated reducing labour market barriers to employment and reform of the welfare system to reduce the numbers on benefits.

However, productivity improvements must do most of the heavy lifting.

Last month, Statistics New Zealand updated its productivity series on the so-called ‘measured’ sector which now accounts for around 80% of the economy, excluding mainly government administration, defence, health and education.

For the year to March 2010, labour productivity grew by 3.7%, but this was due to the fall in labour input (hours worked) being greater than the fall in output (GDP). For similar reasons, multifactor productivity – a measure of the efficiency of producing goods and services in the economy – grew by 1.5%.

But what matters much more is not the outcome for a single year but the result over an economic cycle or at least several years.

The release highlighted the fact that despite the strong increase in 2010, the growth rate for labour productivity over the 2006-10 period (not a complete cycle) is lower than for any of the completed cycles going back to 1978. The same is true of multifactor productivity.

Essentially the story is that productivity growth improved dramatically in the economic reform period (labour productivity was in the 2.5-3% range in the three cycles during 1985-2000) but slumped thereafter.

Moreover, the gains were greatest in the industries where reforms were most comprehensive, in particular agriculture, transport and communications.

The picture was much the same in Australia, which implemented similar reforms, although New Zealand outperformed Australia in these industries and did better overall in the measured sector for a period. However, as the Taskforce noted, “New Zealand’s outperformance was essentially all over by 1995”, even though Australia’s productivity growth has also fallen back in the past decade.

The conclusion on these issues reached by the Taskforce is worth quoting in full.

“A vast body of theoretical and empirical evidence supports the proposition that productivity is a fundamental source of economic growth, and that economic policy has a very important impact on it. In particular, reforms which improve the quality of regulation, reduce government ownership and protection from imports, and increase competition, have consistently resulted in increases in the wealth of the societies implementing them …

[P]roductivity and economic growth in New Zealand were increased as a result of the economic reforms instituted by New Zealand from the mid-1980s, both absolutely and by comparison with Australia. However, public policy in New Zealand in the past 15 years has often been inconsistent with achieving increased levels of productivity, whereas Australia continued to introduce a range of productivity-enhancing reforms over that same period.”

These are not academic issues: they go to the heart of the prospects for improving New Zealanders’ living standards. Disbanding the 2025 Taskforce, as has been mooted, and perhaps the ambitious goal of catching Australia, is a worrying sign that the government may be thinking
of throwing in the towel.

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