The Productivity “Puzzle”
The Prime Minister was surely right last week to identify low productivity as being at the heart of our economic problems. Low productivity has been a constant feature of our economic performance for at least the two decades leading up to the current recession, and it will remain our biggest headache as we face a post-recession future.
The bad news is that the Prime Minister’s statement is not a brilliant new insight. If talking and worrying about low productivity was a cure, we would have solved it long ago. The difficulty has never been in identifying the problem – it has been in knowing what to do about it.
There have of course always been those in denial. I remember being challenged in 1994 by Roger Kerr of the Business Roundtable to substantiate my assertion that New Zealand productivity was lagging badly. I think he assumed that the “reforms” of the preceding 10 years must have dealt with the issue. When I produced the figures (which have continued to be depressing ever since), I heard no more from him.
It is not as if we haven’t tried the usually touted solutions. Privatisations, tax reforms, removing “labour market rigidities”, strict adherence to monetary policies, have all been tried – and none have worked. Nor is it that we are lazy; so bad has been our productivity performance that we have continued to lag in the OECD tables, despite working longer hours. As a result, the average New Zealand family is now up to $80,000 a year worse off than its Australian counterpart – no wonder the grass on the other side of the ditch looks greener.
The Prime Minister’s statement has been given added weight, of course, by the credit rating downgrade applied to us last week by Fitch. The credit rating agency rightly pointed, not to the government’s deficit which they said was par for the course (prompting doubts about the priority given to it in framing the Budget), but to the indebtedness of the country as a whole. Our need to borrow at such high levels – one of the highest per capita levels in the world – is surely a function of our overall economic failure of which low productivity is both a symptom and a cause.
If we really want to address the problem of low productivity, we need to do more than wring our hands and repeat the failed nostrums of the past. That is not to say that the Prime Minister’s list of initiatives is not a good one. As a former university Vice-Chancellor and current Chair of the Foundation for Research Science and Technology, I am the last person to cavil, for example, at the emphasis on increased investment in higher education and research, but these are necessary rather than sufficient pre-conditions for better productivity.
If we really want to solve our problems, we need to take a broader view. A broad economic failure is likely to have an equally broad economic cause. But that is the one possibility that our policy-makers have resolutely refused to contemplate. If low productivity is both a consequence and a cause of poor economic performance, should we not at least be asking whether our economic policy settings over recent decades have been correct?
Productivity is a function of many factors, almost all of which cost money. To improve productivity, New Zealand firms need to spend on new skills training, new technology, new product development, new equipment, new market development, new research and development. The truth is that the New Zealand productive economy has not been competitive or profitable enough to invest in international standards of productivity growth.
Has this happened for reasons beyond our control? No, we have done it to ourselves. Our insistence on exclusively targeting inflation and on using interest rates and the exchange rate to restrain economic activity has meant a built-in and continuing bias – over decades – against growth, profitability and investment. Number 8 wire has its uses, but as an alternative to a macro-economic policy that focuses on good and sustained profits that are re-invested in new productive capacity, it falls somewhat short.
Some recent research about New Zealand productivity is most instructive. It shows that, as expected, our export firms are our most productive – typically, it is only the most competitive enterprises that will venture into export markets.
Less expectedly, however, it also shows that our export firms did not increase their productivity any faster than others. They did not, in other words, “kick on”, to take advantage of bigger and more profitable markets overseas. One can only conclude that there was something in the domestic environment that inhibited them – that the burdens of high interest rates and therefore expensive borrowing to finance expansion, and of an over-valued dollar that reduced price competitiveness and cut profit margins, had meant that New Zealand exporters had simply been unable to invest in the productivity growth that was needed to maintain and improve competitiveness against overseas rivals. They were, at best, hanging on by their fingernails. Some, like Fisher and Paykel, gave up, and moved their operations overseas.
Isn’t it time that we removed our ideological blinkers and applied some common sense?
Bryan Gould
18 July 2009
Too Late for Complacency
Reality is beginning to catch up with complacency. We have consistently underestimated the severity of the recession; our forecasts have constantly had to be adjusted to take account of the ever-worsening outlook, but they still lag behind the true dimensions of the downturn.
A sign of the times is the fall in GDP for the first quarter of the year. What this figure tells us is, that despite the optimism expressed by the Treasury and others in the months before Christmas, the recession is well into its second year and is still building momentum. No one now believes that the second quarter of 2009 will show any reversal of the trend, and that means that we are now about to enter our seventh quarter of recession, with little or no relief in sight.
Why have our forecasts so consistently understated what has been happening, with the result that our policy response has been dangerously inadequate? The answer is a complex one.
The first part of the answer lies in the fact that we are experiencing a different recession from the one that has afflicted most of the rest of the world. Our recession has come in three phases; the first began at the end of 2007 with our own home-grown recession, when our domestic economic policies hit the buffers and the constant use of ever-higher interest rates and an over-valued exchange rate in a failing attempt to control inflation had done enormous damage to our wealth-creating sector.
Long before the rest of the world, we had already become accustomed to living with recession. We were therefore less panicked by the onset of the second – global – phase of recession, in the third quarter of 2008, when the world’s financial institutions were in free fall. We felt that we were already grappling with the problems, and we were in any case less affected – in the short term at least – by financial failures than most other countries. There was a sense of “phoney war”; people began to believe that the recession was not so bad after all.
But what they had not reckoned with was the third and most dangerous phase of recession – the price paid by our small, vulnerable, open economy when the financial crisis impacted the real (and not just the financial) economy around the world. What we are now discovering is that as growth turns negative, unemployment rises, credit becomes more difficult and expensive, and investment plummets on a global scale, there are very nasty consequences for our export markets and for the prices we are paid for our goods – and that is to say nothing of the increased cost of the international credit on which, in our indebted state, we are so greatly dependent.
The worst of our recession, in other words, is yet to come; as I warned in these pages in December “we are still looking to the early end of a recession that has barely begun.” We are likely to be first in to the recession, but last out. Our share of the pain from the global downturn will follow – at the end of the causal chain – as a consequence of the pain felt by others, but we are still behaving as though the measures thought adequate to deal with the first (home-grown) phase of recession will carry us through. Part of the reason for this, sadly, seems to be a continuing predilection for relying on monetary policy, and an ideological reluctance to accept the value of government intervention.
Our so-called “stimulus” package has been piecemeal and small-scale – scoped to deal with recession in early 2008 but inadequate to respond to what is now in store. And, it has been less effective than it might have been because it has been misdirected, taking the form of tax cuts for the well-off (who may or may not spend them) rather than direct investment in economic activity and in lifting demand.
We still seem to pay inordinate attention to the OCR, but that bolt has largely been shot. Monetary policy, once interest rates have been cut to low figures, is largely ineffectual to stimulate the economy. The Governor of the Reserve Bank’s insistence on keeping further minor cuts up his sleeve does have one consequence however; it is read by the foreign exchange markets as an invitation to pile in to the New Zealand dollar, so that a once again over-valued currency will ensure that any nascent recovery will be still-born. And, when we eventually do turn the corner, the odds are that we will be back on the same debt-fuelled treadmill that ran us into the buffers in the first place.
There will be some developments to help us – net migration figures and a stabilising housing market perhaps – but the most important factor depressing our immediate economic future is rising unemployment. We have only now started to see the full potential of job losses. The actuality and the fear of unemployment is only just getting under way. If we don’t want to see the recession deepen into 2010, we should be acting now.
Bryan Gould
28 June 2009
The Country Not The Government Should Be The Budget Priority
Even as they prepare their annual budgets, governments don’t always enjoy the freedom of action they would like. The intervention of outside agencies like the IMF is all too familiar to many governments whose economies have run into the buffers, and even at the best of times New Zealand governments have been content to hand over major decisions about the economy to an “independent” (for which read “unaccountable”) bank.
In terms of democratic accountability, however, we seem to be plumbing new depths in this country with the tacit acknowledgment that the government’s budget strategy is being shaped by the view taken of us by a mid-level desk officer in an overseas credit rating agency. How did we, as a sovereign country, become so powerless to decide our own destiny? Why, at a time when the economic crisis has called into question so much of what was the prevailing orthodoxy, are we still so dependent on the opinions of bean-counters who are focused on only one small part of our economic landscape?
We don’t have to look far for the answers. After decades of poor economic performance and – as a consequence – of living beyond our means, we are now one of the world’s most indebted countries. On some measures, only Iceland had a greater overseas debt in proportionate terms than we have – and we know what has happened to Iceland.
The size of our debt means that we are dangerously dependent on the willingness of others to lend to us. In times of plentiful and relatively cheap credit, borrowing was not a problem, though even then the high interest rates we had to offer crippled our productive economy. But the global crisis has changed all that. Credit is now in short supply and countries like New Zealand, with huge debt to finance, will have to pay an interest rate premium to borrow – if they are able to borrow at all.
The level of interest will depend crucially on our credit rating – and because our debt is proportionately so big, the cost of even a small hike in interest rates as a consequence of a credit rate downgrade will be damagingly high. That is why the government is so concerned about the view taken of us by Standard and Poor’s, and why this month’s budget will be framed to please them.
This, then, is the long-term outcome of the economic policy we have pursued for twenty-five years – that our government feels that it must dance to the tune of a credit rating agency rather than address the worst recession in living memory with the policies that stand the best chance of bringing it to an early end.
There is, however, a mystery at the heart of the government’s acceptance that it must toe the credit rating line. The focal point of economic strategy appears to be the over-riding priority given to the size of the government’s debt. The scope for stimulating the economy through, for example, investing in much-needed infrastructure (which most commentators agree is the best way to deal with a recession) is said to be greatly constrained by a government debt that threatens to shoot into the stratosphere within a few years if public spending limits are relaxed.
But is this really the case? Let us leave to one side the argument I have advanced on other occasions – that stimulus now through public spending is the best way of reducing government debt in the medium to longer term. Let us instead register that even pessimistic projections of how far and fast the deficit might grow would still leave government debt at levels that in both our own historic terms and in terms of international comparisons would be comparatively low.
It is not government debt that is the problem. Careful management over the past decade has left the government’s finances in pretty good shape. We can afford, more than most countries, to allow the government deficit to grow a bit, if that is the price to pay for prudent investment in our economic future and for getting on top of the recession quickly.
Our real problem is not the government and the role that it might play in putting in place a counter-recessionary stimulus package. The underlying problem is the country’s indebtedness – what banks, businesses, individuals as well as the government need to borrow to fund our failure to pay our way. That problem is a function of the long-term failure of economic policy and performance – and it will only get worse if we fail to use the power of government to rescue us from recession.
This is a time for keeping our eyes firmly on the ball. There is a bigger game in town, in other words, than the government’s debt and the risk of a credit rating downgrade. The budget strategy should focus on the country’s accounts, not just the government’s. The best way of looking after the latter is to get the former right.
Bryan Gould
15 May 2009
Spend Now, Prosper Later
The global recession dominates the thinking and writing of the world’s best economists – and not surprisingly, they exhibit a wide range of views as to what is really happening. There is not even a consensus about how deep and how long the recession will be, let alone what should be done about it.
In New Zealand, we are now reaching a more sober assessment of how we will be affected. After an early period that was somewhat akin to a “phoney war”, we are now beginning to realise that the worst may be yet to come.
We must of course be careful to avoid undue pessimism. Deflation feeds on itself, as people prepare for hard times by battening down the hatches and thereby make the times even harder. But we must also be alert to the policy measures that could help – and there is at least an emerging consensus that the earlier such measures are put in place, the more effective they will be.
We also know now that the “jobs summit” – however well-intentioned – may have succeeded in creating a sense of pulling together but has not managed to produce much by way of measures to stop the slide into further recession. If we are to be effective, we need to decide now on what needs to be done.
The time may be right, in other words, to rehearse the arguments for government intervention. Virtually all of the world’s economists agree that the central feature of recession, and of threatened depression, is a deficiency of demand or purchasing power. In New Zealand, we are being hit by a double whammy in this regard; our export markets are contracting at the same time as unemployment and a deflated housing market mean that consumers at home are also spending less.
Left to itself, an economy will take a long and damaging time to correct this deficiency. But, it will be asked, what can governments do about this, when their own finances are being hard hit by recessionary factors? And if the government spends money it doesn’t have, isn’t this just building up problems for the future?
Our own Treasury is not immune from this kind of thinking. Its projections show – even without further interventions – a sharp rise in the government deficit in the next year or so, and they then extrapolate that rise so that the deficit appears to soar into the stratosphere over the next decade. This, they say, means we should be cautious about boosting government spending further.
This is not, however, an accurate way of looking at the issues. There is a good deal of evidence, supported by a growing number of economists, that the key is timing. A dollar spent now to boost the economy could save several dollars in government deficit later on.
The argument runs as follows. The government deficit rises and falls in line with the fortunes of the economy as a whole. A buoyant economy will generate a large tax revenue so that -as has happened over recent years – the deficit can actually be reduced by paying off debt. A flat or shrinking economy, on the other hand, will increase the deficit, as the government struggles to maintain essential services with falling tax revenues; and if the government does respond by trying to cut the deficit by spending less, this will make matters worse by dragging the economy even lower and making the deficit bigger in the long term.
If, on the other hand, the government has the courage to intervene now with carefully judged spending so that economic activity is boosted, the recession will end sooner and government finances will improve quicker. What might look like a frightening short-term deficit may well be the best protection against a bigger deficit in the long term. The priority is to spend the government dollar now, when it is most needed and will be most effective in correcting what would otherwise be a growing deficiency of demand.
Government spending now would of course depend for its efficacy on exactly what it was spent on. If increased government spending went mainly on consumption, little would have been achieved; that is why many believe that tax cuts are not necessarily the most effective means of boosting the economy and countering the recession.
If, on the other hand, the government spends now on investment projects that will strengthen our economy in the long term, we not only counter the current recession effectively, but will be better equipped to prosper in the future. Investment for this purpose need not be limited to physical facilities in areas like transport, communications and energy, but could also include programmes for improving our research effort and the skills of our people.
The ideologues and the faint-hearted will quail at the sight of a rising government deficit at this particular juncture. But common sense is our best guide. We are all familiar, in our personal lives and in our businesses, with borrowing now to invest in a more prosperous future. Let’s do it for our country too.
Bryan Gould
23 March 2009
This article was published in the NZ Herald on 26 March.
When The Facts Change
“When the facts change, I change my mind. What do you do, sir?” Such was John Maynard Keynes’ famous riposte to a critic who accused him of changing his mind about monetary policy during the Great Depression.
A similar response might be made today to those, like Don Brash, who maintain that they have been right all along, when the facts say otherwise. And there must be a suspicion that the Treasury are similarly afflicted – more concerned to maintain ideological purity than to do what the situation requires.
If we were feeling generous, we might feel a twinge of sympathy for our policy-makers. After trying and failing to use monetary policy to grapple with our own home-grown recession throughout 2008, they now have to meet the new challenge of a world that has changed and to do so with a monetary policy instrument that now seems even less relevant.
What, after all, is now the goal of monetary policy? For decades, we have been told that inflation is all that matters and monetary policy all that is needed to deal with it. Now that inflation is the least of our worries, and the limitations of monetary policy are evident, a significant change in mindset and a new range of policy instruments are surely needed.
Any sympathy we might feel should in any case be tempered by the thought that it is those same policy-makers who created many of our problems in the first place. Our 2008 recession – well-entrenched by the beginning of the year – was the end result of decades of ideologically-driven policy mistakes which had eventually run us into the buffers. Those mistakes had seen the average New Zealand family end up $80,000 a year worse off than their Australian counterparts, and even that disastrous performance was achieved at the expense of massive overseas borrowings, a huge trade deficit, and the fire sale of many of our national assets.
It is from this calamitous starting-point that we now face the threat of world recession. The measures put in place just to deal with our own recession were hardly adequate for the task, but they certainly need reinforcing now if we are to ward off the worst effects of the global downturn as well.
That is not to say that those measures are not welcome, as far as they go. The cuts in interest rates may be far too late but are better late than never. Tax cuts will also help but fall far short of what is needed and, according to most observers, are less effective than public spending in stimulating economic activity. The promise of a rolling programme of public investment in infrastructure is certainly welcome, though it seems to be proceeding on a somewhat leisurely timetable and needs to be decided and implemented soon if it is not to be too late.
On the other hand, some Ministers seem more worried about allowing the government deficit to grow than with the increased fiscal stimulus the economy now needs. But this is to put ideology ahead of practicality. The whole point of the last decade of reducing government debt was surely to equip us to use public spending to stimulate the economy when it proved necessary. In that respect, the prudence of past governments has meant that we are better placed than most to use government spending to help counteract recession – and that, rather than the size of the government’s deficit, is surely our top current priority. As Keynes insisted, deficits should in any case be measured and evaluated over a period, not in the short term.
We are of course constantly assured by Treasury that there is no need to worry because the size of the fiscal stimulus already delivered to the economy is very large by international standards. But that assertion needs to be carefully examined. The stimulus so far provided (including tax cuts and spending yet to materialise) is estimated to equate to 2.8% of GDP. This may have seemed adequate when planned last year as a response to our own recession, but as a counteraction to the global crisis it provides only half the stimulus delivered in the US and the UK (where huge sums have also been spent on bailing out the banks), and of course falls well short of the package announced by the Rudd government in Australia. These countries have, in other words, done much more than we have, from a starting-point that was much less difficult than ours; they were not already in recession, as we were, when the global downturn struck.
What we must recognise, in other words, is that – on top of our domestic woes – we now need to address a desperate international situation that is unprecedented in most people’s lifetimes. Much now depends on the “summit” arranged for 27 February. The Prime Minister seems at least to be aware that more needs to be done, and that spending on infrastructure is the way to go. We must hope that the summit – and his own advisers – agree with him.
Bryan Gould
6 February 2009