The Productivity Puzzle
As the latest indicators show our economy struggling to escape recession, it is widely accepted that the key to improving our economic performance is to raise our productivity levels; and this is very much the focus of the government’s efforts to close the gap with Australia. But there is a mystery at the heart of our productivity performance. If we could solve that mystery, we might see our productivity performance lift very quickly.
One of the reasons that high levels of productivity are important is that, by improving our competitiveness in the internationally traded goods sector, our exports are stimulated – and buoyant exports, by removing a balance of trade constraint on growth, allow us to grow faster both at home and in overseas markets. That faster growth in turn promotes productivity improvements and – hey presto – we are in a virtuous circle of export success and productivity growth.
And this is indeed the experience of successful exporting economies. Their export industries exploit the larger markets and higher margins offered by the internationally traded goods sector, with the result that those industries grow quickly and lead the rest of the economy into productivity growth, rather as a locomotive leads a train. There is then a strong market imperative to move the economy’s best resources – of capital and skill – to those growth points in the economy.
Those factors can become so powerful that a country like Japan in the 1960s and 1970s will develop virtually two economies; statistics from that era show that the Japanese domestic economy was very similar to other economies, with normal inflation, growth and productivity levels, whereas the export economy showed rapid growth, low inflation and high and fast-growing productivity. That experience has been shared, perhaps not quite so dramatically, by other successful exporting economies ever since.
Some research* conducted two or three years ago on the New Zealand economy, however, suggests that we have not, for some reason, been able to tap into that successful experience. The research showed that – as expected – our exporting firms exhibited significantly higher levels of productivity than the generality of New Zealand firms. This is not surprising, since in general terms, only the more productive and therefore competitive enterprises can foot it in international markets.
But, unexpectedly, the research showed that – for the period covered by the research, from 2000 through 2005 – productivity in our exporting firms grew no faster than in firms in the rest of the economy. The boost to growth and productivity as a consequence of exporting seems simply not to have materialised. Our exporters, despite being our best performers, were not able to gain the benefits from exporting that exporters elsewhere had found so valuable. This begs the obvious question – why?
The question surely suggests that there are factors at work in our economy that inhibit our exporters but that are not evident in other more successful economies. Those factors, whatever they are, seem to mean that even our best firms, ready and primed to take advantage of export opportunities, cannot make them count.
There is of course always a small number of firms that will make a breakthrough in terms of a new technology or a new product and will be able to sell successfully in overseas markets without worrying too much about price competitiveness. It is then tempting (and the temptation is often yielded to) to be diverted into concluding that such firms show the way to successful exporting, productivity and growth, and that that is the course the rest of the economy should follow.
But most international markets are extremely price sensitive, and success in those markets depends crucially on the price competitiveness of the individual exporter, and even more of the export sector as a whole. Only if exporters are competitive in price terms can they grow market share and boost profits through healthy margins. Otherwise, they must choose between maintaining prices and losing market share, or dropping prices and taking lower margins.
That is, indeed, what seems to be happening to New Zealand exporters. They get to the export starting line, but something then stops them from running a successful race. Their failure, or inability, to kick on means that they do not derive the expected advantage from faster growth, better returns, and higher productivity. The virtuous circle eludes them.
We do not need to look far to identify the culprit. We have run, and have done for many years, a policy of perennially high interest rates and consequently over-valued exchange rates that has meant that our exporters are always fighting a head wind. They struggle to the starting line but are then weighed down, in price competition terms, by a dollar rate that cuts their margins and shrinks their markets.
Our narrowly focused macro policy may, in other words, be more than an obstacle to individual exporters, but the major factor in our productivity disappointments. The key to our economic salvation may be a willingness to think again. Mystery solved?
Bryan Gould
6 July 2010
*Some Rise by Sin, and Some by Virtue Fall: Firm Dynamics, Market Structure and Performance, by Richard Fabling (Reserve Bank of New Zealand), Arthur Grimes (Motu Economic & Public Policy Research), Lynda Sanderson (Ministry of Economic Development), Philip Stevens (Ministry of Economic Development)
This article was published in the NZ Herald on 12 July.
Standing Up for Ourselves
Prime Minister John Key was seen at his best in Nelspruit, South Africa, when the All Whites achieved their famous result against Italy. He was there supporting our team, celebrating their success, blowing a vuvuzela and praising the team’s “courage and pride.”
Back home, however, “courage and pride” were less in evidence. A New Zealand MP, within the precincts of our own Parliament, had been roughed up by Chinese security officers. This was seen as requiring an apology to the Chinese on behalf of the New Zealand people for the embarrassment caused to the Chinese Vice-President.
Let us be clear. This was a straight conflict of political cultures. On the one hand, the Chinese intolerance of free speech, let alone protest, and on the other, our proud history of human rights, freedom of expression and tolerance of political dissent.
In this area, and quite apart from the intrinsic value of the human rights that we take so much for granted that we seem to think that they are scarcely worth defending, we do indeed have a proud record. We regularly top international assessments for the effectiveness of our democracy. We are recognised as pioneers who have been the standard-bearers for a whole range of social and political advances. When we speak on issues of free speech, we are listened to with respect.
We rightly celebrate our sporting success but our record on human rights is truly a matter for national pride. We demand in the way we conduct our public affairs a range of democratic freedoms that are not only stamped on in China but where even an attempt to exercise them would lead to prison or even execution. A peaceful protest against government policy in China would not only be suppressed immediately; it would not even be reported.
It was necessary to apologise to the Chinese, so we are told, because we owed the Chinese Vice-President, as an invited guest to this country, a duty not to embarrass him. But this is to allow the Chinese to import their political culture into our Parliament. Protest is, by definition, embarrassing and even offensive to those whose interests are challenged. Freedom of speech isn’t worth much if it is only acceptable when it suits the interests of those in power. If that were the case, we should stop posturing and pretending and concede that our human rights are worthless when it comes to the crunch.
We have instead entered an Alice-in Wonderland world where government ministers feel able to say with a straight face that a scuffle in which a flag was seized from a peacefully protesting New Zealand MP by Chinese security guards at the entrance to Parliament and that was clearly seen by reporters on the spot and shown on television news programmes was in fact an assault by that MP on Chinese officials for which an apology was required.
It must surely have required a very powerful motivation to prompt people who expect to be taken seriously to come up with such a laughable distortion of what happened. We are assured that our new dependence on trade with China was not a factor, but it is hard to see what else could explain such a craven response.
The irony is that it is precisely our relationship with China that is likely to suffer in the long term. Even if we do not apparently have enough self-respect to stand up for what we say we believe in, it is the respect of others – not least the Chinese – that is truly at stake.
The relationship with China is, we hope, one for the long term. But if, at the outset, we demonstrate that we are pushovers, that we are prepared to ditch our supposedly most fundamental values for the sake of staying in Chinese good books, what chance is there of the relationship developing in any way other than that of a client state entitled to no respect or consideration? Surely we trade with the Chinese because we have products they want and for which they are prepared to pay a fair price, not because we will give up our principles at the sight of a five-dollar note?
And it is not only the Chinese who will draw the conclusion that we are full of wind and no substance. When we speak up for the rule of law and freedom of expression on behalf of those who are repressed, in countries like – for example – Fiji, do we now expect them to take us seriously? We do not even allow Fiji’s political leaders to come here, let alone be protected from protest when they get here; is that because it is easier to pick on the little guys?
For once, John Key’s touch may have deserted him. Many of those who have no sympathy with Russell Norman’s protest will come to see that they would be aghast if their own right to protest at something they felt strongly about were to be trampled on. When minds have cleared and the immediate party political loyalties have subsided, New Zealanders who are rightly proud of what we have achieved in this free country will view this episode as a source, not of pride, but of shame.
Bryan Gould
23 June 2010
This article was published in the New Zealand Herald on 29 June.
Wealthy Individuals Do Not Hold the Key to a Stronger Economy
As the smoke clears, and the mirrors are packed away for another year, we can now make a more considered judgment of the 2010 budget. It should straightaway be acknowledged that the budget was a well-balanced and intelligent exercise, with something in it apparently for everyone. There may be a raised eyebrow as to why a Paul Reynolds of Telecom deserves an extra $3500 per week from the tax cuts, while the average family has to get out a calculator to check whether they will be better or worse off by a few dollars, but – on the whole – people see income tax cuts more clearly and place a greater value on them than they do on GST increases of the same monetary value. Politically, the budget will play well.
A similarly positive assessment can be made of the budget’s underlying fiscal stance. The deficit, about which there was so much alarmist talk a year ago, will keep on rising with a consequent boost to economic recovery, and yet is still projected to rise less and come down sooner than was earlier forecast. Indeed, the positive noises about the government’s finances lead one to wonder why we allowed last year’s budget to be so totally circumscribed by Standard and Poor’s narrow view of what was required. A more confident budget last year could have seen a stronger recovery today.
But what of the most important of the government’s stated budget objectives – the promotion of growth and a better economic performance? Here, the report card is much less favourable.
The budget seems to be driven by a view of how the economy works that is intuitive rather than reasoned or supported by evidence. The government believes, apparently, that if the wealthy can earn more and keep more of their wealth, they will work harder and invest more, and we will all benefit as a result.
There are many things wrong with this view. First, it is not supported by the evidence, and is contradicted by the experience of those countries which have tried it. It rests on the discredited “trickle down” theory, which flies directly in the face of the correlation, in countries like the US and the UK, between greater inequality and greater proportionate rewards for the wealthy on one hand, and on the other hand, a poorer economic performance, including more irresponsible behaviour and a greater propensity to financial meltdown.
The evidence suggests that if the spending power of the wealthy is increased, it does not “trickle down” to the rest of us through greater investment and a keener eye for new opportunities, but manifests itself instead in more ostentatious and unproductive consumption. If it is invested at all, it is directed into riskier and less worthwhile get-rich-even-quicker schemes, rather than into the substantial strengthening of our productive capacity through solid investment in the whole economy – investment that, to its credit, the government is trying to make in research, and needs to make in our economic infrastructure and in the education, skills and health of our workforce.
But the main concern about the budget approach is that it reveals a limited and out-dated understanding of how a modern economy works, though one that obviously commends itself to those like the wealthy whose interests it serves. The pages of Adam Smith might suggest that an economy comprises an agglomeration of unrelated individuals, each pursuing their own private interests to the general advantage, but that is not how a successful modern economy works. Economies are huge and complex mechanisms that respond to broad policy settings that determine major issues like competitiveness, profitability, investment and productivity. They are not driven by individual motivations but by responses across the board to broad economic realities.
There is little point in offering tax hand-outs to wealthy individuals, if macro-economic policy settings ensure that investment in productive capacity will not produce a worthwhile return, however it is taxed. The government shows no sign that, as we come out of recession, it will abandon overall policy settings that will once again knock the top off any recovery by burdening the whole economy with high interest rates and an overvalued exchange rate.
Why should we expect that offering additional discretionary purchasing power to a few wealthy people will do the trick, when the price competitiveness and profitability of everything we do is undermined because every domestic cost is raised in international terms to uncompetitive levels, with knock-on and adverse consequences for investment and employment, and in the end living standards as well?
That would be as sensible as expecting to win the Rugby World Cup off the back of a couple of brilliant individuals, while overlooking the fact that the rest of the team cannot pass, catch the high ball or throw the ball into the lineout straight. Missing out on the Rugby World Cup would be one thing, but we might also fail in our attempt to move up the OECD league tables if we can’t get the basic skills right and the whole team playing well.
Bryan Gould
24 May 2010.
This article was published in the NZ Herald on 26 May.
They Might As Well Be In Zhejiang Province
The Chinese interest in buying up a significant chunk of New Zealand’s dairying real estate has hit the headlines over recent weeks. Hard-pressed dairy farmers, perhaps including the Crafars or their receivers and creditors, might understandably be grateful that at least somebody is ready to pay a good price for dairy farms, especially when the Australian banks seem unwilling to lend for such a purpose.
Should we welcome the willingness of overseas buyers to invest in our productive industries? Or should we be concerned that a significant part of New Zealand and its productive capacity is passing into foreign control?
Those, after all, are the questions that now have to be answered by the Overseas Investment Office. The issue gives rise to allegations of xenophobia on the one hand, and a concern for New Zealand’s viability as an independent country on the other. And it arises at a time when it has emerged that Chinese investors have spent billions in acquiring important interests in a range of leading Kiwi companies such as Mainzeal and Fisher and Paykel Appliances.
It also has to be assessed in the light of New Zealand’s unenviable record of having already sold off a higher proportion of our national assets than any other advanced country. We had sold to overseas owners by 2006 $82.7 billion’s worth of our national assets, a 700% increase since 1989. The repatriation overseas of the profits made from these assets imposes a further burden on our endemically unbalanced current account, and the need to borrow more overseas as a consequence means that our problems are considerably exacerbated.
We should, in trying to assess these considerations, immediately rebut any suggestion that the nationality of the prospective purchasers is a relevant factor. Whether Chinese or Americans, British or Japanese, the issues are the same. Should we be happy to see our productive capacity pass in to hands other than our own?
It is at this point that the particular features of the proposed purchase become relevant. It is one thing to wave through the foreign acquisition of a New Zealand manufacturing company. New manufacturing capability, we hope, will always emerge. A company that passes into foreign ownership may see its profits go overseas and may even move its operations out of New Zealand, but there can always be the hope that the next one will come along before too long.
Even if the foreign purchase is of some asset of national infrastructure – a rail network or an airport – experience suggests that once the foreign owners have sucked out all the profit they can, they might well sell the asset back into New Zealand ownership. Whatever downside is suffered is not necessarily forever.
It is here, however, that the current Chinese bids have to be regarded as both different and more worrying. First, the asset that is being chased is an important piece of real estate, an asset of which there is a finite amount. We cannot in this instance sell it off and then look to recreate some more.
Our most important productive industry – dairying – is entirely dependent after all on the availability of suitable agricultural land. If that land is no longer available to us, then we suffer a permanent diminution in our productive capacity and therefore in our national wealth.
So it becomes very important to understand the nature of the Chinese interest in our dairy farms. We know that, in one major case at least, the proposal is not just to buy a large number of South Island dairy farms. It is also to build a factory or factories in which the milk from those farms will be processed and from which the product will then shipped to consumers in China. This is, in other words, a process which will be entirely controlled from cow to consumer by Chinese money in the Chinese interest. The farms will be to all intents and purposes part of China and will entirely serve the interests of the Chinese economy. They might as well be located in Zhejiang province.
The scale and purpose of this intervention strongly suggests that it is not intended to be a fly-by-night investment that will be quickly sold on. This is clearly intended to be a permanent transfer of productive capacity from New Zealand to China. It feels as though it reflects not just the Chinese commercial interest but the national interest as well.
Let us be clear. New Zealand workers may be allowed to keep their (relatively low-paid) jobs for the time being (though under the free trade agreement with China even that cannot be guaranteed), but the profits of the productive capacity and the capital value of the asset will have passed out of our control and will have become a Chinese asset rather than ours.
Given the huge sums that Chinese investors have available, is there any limit to the proportion of our productive industry we would be prepared to see sold off? If there is, should we not be clear what it is? And would this not suggest that this is not your average foreign purchase, but one to which the Overseas Investment Office should pay special attention?
Bryan Gould
24 April 2010
This article was published in the NZ Herald on 28 April.
Equality Matters
In the opening months of the year, the political issues are coming at us thick and fast. Standards in schools, what to do about crime, tax reform, improving our economic performance, meeting Maori interests, have all crowded their way on to the political agenda.
The government has addressed each of these, one by one. National standards in primary schools will, we are told, improve the life chances of those who are currently being left behind. “Three strikes and you’re out” will reduce violent crime. A shift from direct to indirect taxation will transfer resources from consumption to investment. A renewed emphasis on economic growth will close the gap with Australia. And the Maori Party’s agreement with the government will help to advance specifically Maori interests.
There may be merit in each of these responses. But what if they all miss the real point? What if there is an underlying factor that unites all of these issues? And what if overlooking that factor means that the specifically targeted responses to each individual issue are less likely to be effective?
It can be argued that there is such an underlying and unifying factor – one that does not necessarily explain every dimension of these pressing issues or offer a comprehensive solution to the problems but that – if ignored – will make an effective response unnecessarily difficult. That issue is the growing inequality that has disfigured our society in recent decades.
Each of the specific issues is, after all, a consequence or an expression of that inequality. Both the 20% of students who are said to be let down by our education system and those misfits who are filling up our overcrowded jails come overwhelmingly from the economically disadvantaged in our society – and the former group are all too likely to migrate eventually into the second group.
The tax concessions for the better off are linked to the drive for economic growth, and both are linked to the “trickle-down” theory that the poor will eventually benefit if the rich get significantly richer – a theory whose implementation has done so much to widen the gap between rich and poor in our country. And the Maori struggle for a fairer share of national wealth is – at least in some senses – a crusade by and for the dispossessed and disadvantaged in our society.
To make these links between inequality and the problems confronting New Zealand today is more than mere speculation. In a ground-breaking piece of research, the authors of a study called The Spirit Level* have established that in countries where inequality has increased most sharply – countries like the US and the UK – there is also the most damaging rise in social problems like crime, drugs, early pregnancy, and gambling, and – even more significantly – the most significant impairment of the physical and mental health of the population. It is of course very obvious that these are also the same countries whose failing financial systems precipitated the global recession.
In countries where equality is much more evident – countries like Japan and the Scandinavian countries – the record on social ills is much better. The researchers are able to show that the statistical correlation between inequality and social dysfunction is too sustained, over time and place, to be accidental.
Where does New Zealand stand in such an assessment? From having been one of the most equal societies in the developed world, over the last 25 years New Zealand has progressed (if that is the right word) towards inequality faster than almost any other country. So, if the research is to be believed, we should not be surprised if we now exhibit the same difficulties as afflict other unequal societies.
The research shows that the steeper the income inequality ladder, the harder it is to climb, and the slower and more difficult social mobility becomes. At the same time, greater equality improves the quality of life for everyone and not just the poor. Even the wealthy will enjoy life more in an integrated and whole society. People across the board will live longer and will be less likely to suffer violence or have a problem with obesity; their children will have a better chance of doing well at school and will be less likely to use drugs or become teenage parents.
Our best chance, in other words, of giving children – Maori and pakeha -a better chance at school, or of keeping them out of jail, is to reduce income inequality. Our best chance of improving national economic performance is to focus on improving the education and health of the whole population so that everyone can make a full contribution.
Conversely, to allow or encourage the income gap to widen is seriously to prejudice the chances of dealing successfully with current problems, and to risk making future problems worse. As we look to the current range of responses, from national standards in education to re-balancing the tax system, we must hope that our political masters understand this simple truth. It would be a tragedy if the measures directed at specific issues make the underlying problem worse.
*The Spirit Level: Why More Equal Societies Almost Always Do Better, by Richard Wilkinson and Kate Pickett, 2009
Bryan Gould
12 February 2010