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He Tirohanga Mokopuna: 2016 Statement on New Zealand's Long-term Fiscal Position

2 Economic growth (continued)

A more productive, adaptable, and resilient economy

The Treasury considers that improved economic growth would come from a more productive economy that is also adaptable and resilient against unexpected shocks and other changes. This Section outlines where the Treasury sees the challenges and opportunities for a more productive, adaptable, and resilient economy now and in the future. Many of these are also addressed by the Productivity Commission in its work and inform its narrative on productivity, and are captured in the Government's Business Growth Agenda.[10]

The Productivity Commission's narrative draws on existing work on New Zealand's productivity performance and brings two new sources of evidence to the table: insights from the Commission's inquiries, and new research using the Longitudinal Business Database (LBD). The Commission's narrative highlights the value of using detailed micro-data to understand productivity at the level of the firm, creating an opportunity to look beyond the performance of the "average firm". This is consistent with productivity analysis carried out by the OECD and the analytical gaps noted in Holding On and Letting Go. A more nuanced view of policy issues can come from understanding the distribution of performance at the firm level.

The Commission's analysis illustrates that in New Zealand, the processes of technical diffusion and the reallocation of resources from low to higher productivity firms are impaired. Labour productivity growth in New Zealand's leading firms has generally been much lower than in global frontier firms. There is also limited spread of technology and production techniques between New Zealand's frontier and non-frontier domestic firms. A long tail of low productivity firms indicates a lack of "up or out" dynamics.

As noted in Holding On and Letting Go, the productivity of the state sector is also important because it is a significant part of the non-tradable sector. For example, the state sector provides goods and services such as investment in infrastructure, and education. Non-tradable goods and services are often an input into exports, and so a more productive domestic economy (including the state sector) can enhance international competitiveness. The Productivity Commission is currently undertaking analysis on public sector productivity (e.g. in education).

Stronger international connections

International connections open up access to markets, people, capital, and ideas that a small domestic market cannot offer. The performance of New Zealand's international connections is mixed. New Zealand's trade intensity, and participation in Global Value Chains (GVCs) are relatively low, compared to the OECD averages (while its migration flows are above the average – see Section Three). Its level of outward direct investment (as a proportion of GDP) is also low, compared to the OECD average and for a small, advanced economy.[11] In some cases, such as for GVCs, New Zealand's performance is influenced by size, distance, and export profile.

The nature of global trade is changing rapidly and services are growing as a proportion of our trade, both in absolute terms and as inputs to our goods trade (e.g. transport and logistics). Improving our services trade performance could have a material impact on trade growth, offsetting many distance challenges. Although domestic and foreign barriers to trade are reducing via trade agreements, New Zealand firms continue to face scale and capability challenges to growing in offshore markets.

New Zealand has a large percentage of foreign-born population and a large proportion of New Zealand citizens offshore (compared with other OECD economies).[12] The opportunities this presents for the economy include encouraging the use of our foreign-born population as a source of ideas and market knowledge, to use our offshore diaspora to connect to new markets, and improving cultural literacy so we better understand and engage with growing Asian markets (see the discussion on immigration in Section Three).

Improved investment and innovation

In New Zealand, non-residential business investment (as a share of GDP), is close to the OECD median – although investment relative to employment growth is toward the lower end of OECD economies.[13] Factors that impact on investment decisions include access to the right productivity-enhancing capital, the cost of access, regulatory settings, macroeconomic aspects of the economy, and different incentives and obstacles faced by foreign and domestic investors. New Zealand's capital markets are highly integrated into international markets and capital flows from large emerging markets are likely to increase in coming years, providing further sources of capital for investment. Having a strong, resilient economy will make New Zealand a more desirable place to invest.

The pace at which innovation is spread throughout the economy is a key factor in lifting productivity. New Zealand has one of the lowest (public and private) research and development (R&D) intensities in the OECD and this could explain up to one-third of the productivity gap (investment in knowledge-based capital also appears to be low).[14] This may be a reflection of the nature of New Zealand's economy (e.g. the primary sector tends to use less R&D compared to manufacturing). Comparably lower investment in R&D may be another factor impacting on the diffusion of innovations from the 'frontier'.

The ability of firms to attract the quality of skilled workers required to cope with a rapid pace of innovation could also be a contributing factor to the slowdown in the pace of diffusion from the firms at the 'frontier' (see Section Three on the importance of labour quality for productivity).[15]

Exporting increases incentives to invest and innovate. New Zealand's 'small' domestic market and distance from foreign markets may lead to fewer incentives to invest in new technology (both in terms of physical capital and process improvements). New Zealand firms may need to enter international markets at an earlier stage than their counterparts overseas would otherwise.

Greater competitive intensity

Competition motivates firms to become more productive and shifts resources from less to more-productive firms. Pressure from competitors incentivises firms to innovate – by improving the quality of their products, reducing their costs, applying the latest technology from New Zealand and overseas, or introducing new business or management practices. More productive and profitable firms grow at the expense of their less competitive counterparts, and the economy's productivity grows with them.

Competition in New Zealand varies significantly across industries. The Productivity Commission and the Ministry of Business, Innovation and Employment (MBIE) find that service industries tend to face less intense competition than manufacturing industries, though MBIE suggests that competition intensity increased between 2000 and 2010.[16] The difference in competition between goods and services markets matches international experiences, although New Zealand's small size and distance to market further reduces the levels of competitive intensity. New Zealand's dispersed population also creates a series of small markets insulated against national or international competition.

The impact that cooperative structures have on innovation and productivity (positive or negative) is unclear. In New Zealand, cooperatives are most dominant in the primary sector, although they also exist in other industries (e.g. retail, insurance and finance). The cooperative structure helps to spread risk, however, corporate business owners may be more motivated than cooperative members to grow their businesses. This may affect innovation and the pace of investment in cooperatives.

Notes

  • [10] http://www.mbie.govt.nz/info-services/business/business-growth-agenda
  • [11] Outward direct investment (ODI) is direct investment flowing outside of New Zealand. New Zealand's stock of ODI is at 9 percent of GDP. Most of our flow is to Australia (55 percent) and from the manufacturing sector (41 percent). See the Business Growth Agenda report, International Investment for Growth, October 2015.
  • [12] See Section Three for a comparison of New Zealand to other OECD economies in terms of the percentage of the total population that is foreign-born. See also OECD (2015) Connecting with Emigrants: A Global Profile of Diasporas 2015, Table 4.2, p.179.
  • [13] Conway (2016), above note 9.
  • [14] Alain de Serres, Naomitsu Yashiro and Hervé Boulhol (2014) An International Perspective on the New Zealand Productivity Paradox, New Zealand Productivity Commission Working Paper 2014/1.
  • [15] OECD (2015), above note 8.
  • [16] Productivity Commission (2014) Boosting productivity in the services sector, Second Interim Report; MBIE (2016) Competition in New Zealand industries: Measurement and evidence, Occasional Paper 16/01.
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