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Productivity and Economic Growth

Delivered by Peter Mersi, Deputy Secretary Social Policy Branch, the Treasury, Wellington, on 9 December 2005.

Workplace Productivity Workshop

Good morning everyone.

This morning I would like to run through a framework that Treasury uses for thinking about where economic growth comes from, and touch on how workplace productivity fits into that thinking.

Slide 1: NZ and OECD per capita GDP
Slide 1: NZ and OECD per capita GDP

This chart shows our economic growth performance over the last couple of decades. We’ve made impressive gains since the early 1990s – and our growth rates have averaged higher than the OECD for much of the last 10 years or so. This means we have begun to ‘catch up’ with some of the countries that we like to compare ourselves with.

However, there is still a significant gap in the relative level of per capita GDP because for long periods in our history we lagged other OECD nations. This means we still have much to do. For example, we would need to exceed the United Kingdom’s per capita GDP growth by 1.9 percent per annum over the next 10 years to rise above the United Kingdom’s per capita GDP. To put that in context: New’s Zealand’s total per capita GDP average growth rate over the last 10 years has been only slightly higher than 2.0 percent.

Where has this more recent growth improvement come from?

Slide 2: Contributors to Growth
Slide 2: Contributors to Growth

This diagram shows some contributors to economic growth. Growth in GDP per capita is driven by increases in labour utilisation – that is, how many hours we work – or by increases in labour productivity – that is, how much we produce per hour worked.

Labour utilisation is determined by the proportion of the population who are working age, the participation rate of that population, the unemployment rate of those participating and the average hours worked by workers. Labour productivity is determined by the amount of capital available for each worker to use and what economists call “multi-factor productivity”.

There is a lot of debate about what multi-factor productivity is and what it measures, but broadly it can be thought of as the way in which labour and capital are combined and used.

Slide 3: Contributions to NZ growth
Slide 3: Contributions to NZ growth

This chart shows that in the first half of the 1990s, growth improvements mainly resulted from growth in labour utilisation (specifically, reductions in the unemployment rate and increases in labour participation) rather than from increases in average hours worked.

However, in the latter half of the 1990s labour productivity appeared to be providing greater impetus to our growth. This improvement continued until very recently, with productivity growth having eased again over the last year or so.

Most of this labour productivity improvement has been from multi-factor productivity – if you like, we’ve been working smarter. For easily measured sectors, New Zealand’s growth in multi-factor productivity has been comparable with Australia.

Although New Zealand is doing well on multi-factor productivity, lifting the rate of multi-factor productivity further will be critical to achieving the goal of returning New Zealand’s GDP per capita to the top half of the OECD.

As to the amount of capital per worker, this continues to show only a small improvement in performance – as reflected by a slower rate of capital investment.

There are a number of possible explanations for our low rates of capital investment.

Our industrial structure may be less capital intensive, or our domestic market may be too small to generate returns to scale. Our tax or regulatory settings may be impeding capital accumulation, or our financial market settings may constrain access to venture capital. These are all questions that require more thinking and research and, from a growth perspective, present one of the challenges facing the government.

Looking to the future, countries that perform well in terms of economic growth tend to be those that do well at increasing both employment and productivity. While there is still some scope to increase participation and employment rates for some groups, and there may be opportunities to increase the amount and type of capital per worker, our major challenge is to find ways to enhance multi-factor productivity. This challenge is at the heart of the Government’s workplace productivity agenda.

To summarise the situation, New Zealand has done well in terms of growth in the last decade.

But if we are to sustain growth, the economy will need to shift gears to focus on increasing labour productivity. We can’t just keep absorbing more people into the workforce – there simply aren’t enough people out there. And it’s not about getting people to work harder – most New Zealanders are working pretty hard already.

Increased labour productivity is about working smarter.

Looking to the Future

As Paul Krugman put it in his book, The Age of Diminished Expectations:

Productivity isn’t everything, but in the long run it is almost everything. A country’s ability to improve its standard of living over time depends almost entirely on its ability to raise its output per worker.

No single policy leads to productivity growth. Rather, it is a matter of getting a lot of interconnecting things right, and by ensuring incentives are aligned, creating an environment where firms can create and take advantage of opportunities. In my view, many of these policies exist and it is important that these be maintained and strengthened over time.

The Foundations for Growth

Growing the New Zealand economy is about growing the individual businesses that comprise the economy. For this to occur the institutional environment must be one that encourages enterprise and innovation, where firms seek out and develop profitable new opportunities, and where well-performing and more productive firms will prosper, while poorer performers exit.

In many respects the business environment in New Zealand is good. Aspects such as a predictable policy environment, clear property rights underpinned by a strong legal framework, and high levels of trust and transparency provide a sound basis for sustained growth.

Attention to creating open, flexible, and competitive markets over the past two decades has paid off in terms of creating a much more dynamic economy. This puts a premium on maintaining these broad frameworks and taking care not to erode their credibility.

Firm Level Productivity

Given the incentives and constraints created by the institutional environment, firms have a range of options about how they combine and organise inputs – and the way they do this will impact on their productivity.

Physical capital (machinery and equipment) is one of the two major inputs in the production process. As I mentioned earlier, the level of capital investment has a direct influence on labour productivity. One of the reasons that capital investment is also thought to boost multi-factor productivity is that it often embodies new technology, such as computers, enabling new and better ways of doing things.

The other major input is obviously labour and skills. Skills are important for employees and managers alike. Managerial capability is essential to provide the leadership and direction, and the organisational skills, to shape and lead a successful firm or organisation. Skilled employees not only improve production through such things as fewer mistakes and taking advantage of technological improvements; skills make employees and managers more flexible and adaptable over time. Importantly, responsibility for skills development is shared between individuals, families, firms, education providers and the government.

Innovation and technology are also crucial in improving productivity. They increase the output of each worker and they improve the quality of that output.

Finally, organisation of the firm is also essential – different structures and processes will often produce different results.

The last three of these factors – skills, innovation and technology, and organisation of the firm – were at the core of the Workplace Productivity Working Group’s recommendations, which form the basis of the Government’s Workplace Productivity Agenda.

Before I finish, I’d also like to touch on public sector productivity. So far I’ve focused on productivity in the private sector because it is by far the largest part of the economy and is the engine room for economic growth.

But the public sector is also important. Getting a more productive public sector is part of the overall growth and productivity story, and Ministers have recently asked to extend the Workplace Productivity Agenda to ensure the public sector is included.

The Public Sector

New Zealand ’s public sector is sound, but could still do better. Lifting performance in the public sector will assist in meeting fiscal goals and rising public expectations of services. Improved performance will assist growth in the economy by adding directly to productivity, and by freeing up resources and improving the quality of services to New Zealanders.

There needs to be a greater drive for performance (in terms of both effectiveness and efficiency) across all parts of the state sector. Our public management system has a number of recognised strengths, such as sound fiscal management and good public service ethics. New Zealand has a strong accountability focus, complementing freedom to manage for boards and chief executives. However, we could do better in providing for more focus and incentives to drive performance in a forward looking sense.

There is no one solution to these issues.

Responses need to focus more on changing incentives, and ultimately on the behaviours and culture in the public sector, using current tools and levers rather than introducing new ones, and shifting the focus so that public and ministerial expectations and needs drive public sector performance.

Thank you.

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