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3  Current New Zealand Situation

While productivity is a consequence of business decisions, government can assist business to improve productivity by:

  • maintaining a stable economic environment that supports economic adjustment
  • providing a business environment that supports productivity growth
  • ensuring value for money and sustainability of public services.

Government policy settings will impact on business productivity

This section discusses New Zealand's current settings in these three areas and outlines where more can be done to assist productivity.

Stable economic environment

A stable macroeconomic environment gives investors confidence in the New Zealand economy as a place to invest. It gives New Zealand businesses a degree of certainty for making business decisions. Successive governments have done a good job of getting the New Zealand economy in a position where it can respond well to economic shocks. Low levels of public debt allow freedom to look through short-term cyclical fluctuations and there is room to adjust monetary policy to support demand. However, the recent sharp revisions to the economic outlook have resulted in projections of an extended period of fiscal deficits. This worsening in the medium term fiscal outlook takes place in an environment where the international financial crisis has highlighted the vulnerability associated with New Zealand's very high level of external debt, the government has taken on significant contingent liabilities, and risk aversion has increased funding costs.

The current situation puts a premium on maintaining economic stability

Ensuring financial sector stability is critical to supporting the medium-term challenge of lifting productivity, given its influence on the availability of capital and security of payments systems. It will be important that the temporary arrangements to guarantee financial system liabilities are unwound in a way that continues to support confidence, liquidity and the effective intermediation of funds to households and businesses.

It may also require changes to fiscal policy and financial sector regulation in the medium term

There are significant economic imbalances in New Zealand that will need to adjust over time. Retaining flexible economic settings should help ensure this adjustment is orderly. Adjustment and rebalancing of economic activity will likely see faster growth in the tradeable sector, increases in household savings and a reduction in household debt in response to lower asset prices. A stronger national savings position over the longer term would help New Zealand to better manage external vulnerability and volatility.

Business environment for productivity growth

Raising productivity is the key driver for achieving higher incomes. Economic growth is a dynamic process of creation and destruction; the creation of new firms, new investments and new methods of production drive growth and replace the old, less productive firms and methods of the past. In the long term, entrepreneurship, innovation and technological change create productivity growth. While there is no single recipe for lifting productivity, a range of factors is consistently emphasised in economic evidence and shapes our choice of priorities. Some of these factors are more important because of New Zealand's characteristics and the nature of the trends identified above.

The policy directions outlined to improve productivity build on international evidence and New Zealand- specific factors

New Zealand needs to become more connected with the world economy

Small economies that have high productivity rely heavily on international economic connections. New Zealand is currently only moderately well connected to the world economy based on measures such as the intensity with which we trade and invest offshore and the integration of our firms into international production chains. Evidence from the OECD suggests that distance plays a significant role in explaining New Zealand's lower productivity.

Small economies that are productive have strong links to the rest of the world that stimulate competition and specialisation, and introduce new ideas and provide access to resources

Recent turbulence in global financial markets has highlighted some of the risks associated with globalisation. A consequence could be that less rather than more integration is seen as desirable in the future. In our view that would be a mistake. There are clearly lessons to be learnt for how countries manage global financial and macroeconomic issues. But as a country with much to gain from greater international connections, New Zealand would be significantly worse off from moves to halt or reverse the trend toward greater globalisation.

Deepening New Zealand's international links will be critical to lifting our productivity growth. We need to attract and retain the ideas, firms, individuals and capital that drive productivity. In the absence of a large market in close proximity, international connections allow New Zealand to:

  • access resources that will facilitate higher productivity: skilled people, foreign capital to overcome the domestic savings constraint and international goods and services
  • specialise in areas of comparative advantage and benefit from economies of scale
  • absorb and apply international knowledge to New Zealand’s resources
  • stimulate competition that spurs innovation and moves resources to areas of comparative advantage.

A business environment that increases investment and productivity growth

The environment government creates for business investment and innovation is critical to productivity growth. A competitive business environment requires institutions and policies that reward innovation and risk-taking, support long-term investment in the factors that drive productivity and recognise the wider international business environment in which New Zealand competes for resources and markets its products.

A competitive business environment rewards business investment and innovation

There is increasing recognition that policies that may compare well with OECD averages are unlikely to be sufficient to overcome some of the constraints to productivity growth for a small distant economy. Evidence suggests that New Zealand currently has a low level of capital per worker, and moderate business investment implies that this gap is not narrowing. Addressing low levels of capital requires policies that raise the returns to investment and overcome those factors that may unnecessarily raise the costs of accessing capital.

Overall, our assessment is that medium-term policy changes are required in taxation, regulation and the public institutions that support business investment. Another factor is New Zealand's private savings rate, which appears to have been low for some time. Higher domestic saving is likely over time to reduce the cost of capital, aid development of deep capital markets and increase business investment.

Skills and participation: an opportunity to improve long-run productivity

A highly skilled labour force is critical for economic growth. Skills increase the productivity of individuals, and those they work with. They can also raise the returns to investment in capital and technology, and enable firms to innovate and move to higher value-added production. The link from skills to productivity depends on how the supply of skills is matched to changing demand, on firms' ability to effectively utilise workforce skills and on how well individuals are able to use their skills.

Acquiring skills is also one of the most effective ways in which to make best use of the personal abilities that exist across society. Opportunity, economic growth and productivity are interrelated. For example, if those from poor families face barriers which make it difficult for them to acquire and use their skills, their economic potential is wasted, social cohesion is undermined and social expenditure comes under pressure.

Higher skills lift productivity and are key to people participating fully

Demand and competition for skills is increasing world-wide. Population ageing will require that we make better use of our human capital. Demographic changes also mean that our workforce will be increasingly diverse, and we will need to address the long-standing disparities in educational achievement across socio-economic and ethnic groups to maintain and improve our skill base.

Current skills settings provide a mixed picture. Average levels of participation in education and performance compare well with other countries. This may not be sufficient to meet future needs however, and there are concerns about the amount of variation in performance. Wide disparities in achievement are evident at all ages and stages of education, with scope for increased participation in early childhood education by disadvantaged children and in secondary schooling of those aged 15 to 17.Increased participation in tertiary education has been dominated by sub-degree qualifications. To at least keep pace, we will need improvements across the skills system.

Natural resources and climate change: better management of natural resources

New Zealand relies heavily on our natural resources to generate income. Natural resource limits and international measures to reduce climate change emissions increasingly influence economic growth as these inputs to production become more scarce and costly. The way in which these pressures are managed is important to maintaining and improving New Zealand's productivity.

New Zealand needs to put in place policies that ensure the more productive use of natural resources

Protecting our natural resource base will involve establishing limits on resource usage where these do not currently exist. More intense land use is putting more pressure on water availability and quality. We need to embed policies and mechanisms to encourage innovation to manage within these limits, and ensure that resources are applied to their highest value use. Such a process will require trade-offs across differing priorities, but could offer significant economic opportunities and is essential to increasing New Zealand's national welfare over time.

In the case of climate change, it will be important to negotiate outcomes that reflect New Zealand's circumstances and the speed and ambition of other countries' commitments. New Zealand has a low carbon-intensive energy sector and substantial emissions from agriculture, making New Zealand's future emission reduction commitments expensive.

Improving the value for money and sustainability of public services

More effective and efficient public sector

If the public sector performs well, it has the potential to lift New Zealanders' living standards, strengthen social capital and increase New Zealand's productivity. The public sector plays a crucial role in the provision of infrastructure, development of skills and support for innovation that are important intermediate influences on productivity. It also determines the quality of regulation and manages other institutions that directly influence the investment environment. In delivering a range of services, the public sector also uses a significant proportion of New Zealand's resources. This means these resources are not available to increase production in the private sector and potentially raises the cost of inputs to business. This puts a premium on ensuring the effectiveness and efficiency of its activities.

Tighter fiscal conditions increase the urgency of improving the quality of existing spending

There are opportunities to improve the effectiveness and efficiency of public sector spending. There is little information available to assess whether public expenditure is delivering on its objectives. The system lacks strong emphasis on performance and incentives to manage fiscal pressures. Addressing the challenging fiscal conditions ahead and creating fiscal headroom to pursue tax and spending priorities will require greater value for money in public expenditure. Expenditure growth needs to slow from the pace of the past several years if it is to remain sustainable. The options we identify later in this briefing are aimed at strengthening the public management system’s critical levers: focusing resources on priorities and strengthening accountability. This can be supported by adapting approaches used overseas to review areas that require particular attention.

Sustainable fiscal position

A range of adjustments to current policy settings will be required to ensure the longer-term sustainability of public sector activity in the face of expenditure pressures arising mainly from the transition to an older population. In the face of uncertainty these decisions raise a range of difficult trade-offs across generations. The tendency is to delay these decisions and face these choices closer to the time. However, earlier adjustment in some areas will be smaller and less disruptive in the long term. Over the next several years, more concerted attention will need to be given to how policies will adjust over time and what compensatory changes must be made.

A permanent shift to an older population will be less disruptive if we adjust policies earlier

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