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Putting Productivity First - TPRP 08/01

Summary

Productivity matters for New Zealanders’ living standards

“Productivity and the growth of productivity must be the first economic consideration at all times, not the last. That is the source of technological innovation, jobs, and wealth”.[1] A country’s ability to raise its standard of living depends on its ability to raise output per hour of work, the amount and value of goods and services each hour worked produces. This is not solely so that firms become increasingly internationally competitive; productivity is a fundamental driver of quality of life. Incomes are inevitably linked to workers’ productivity and a more productive labour force leads to higher wages.

A large proportion of New Zealand’s recent economic growth has been driven by increases in labour utilisation.[2] Whilst this has many economic and social advantages, it is not a sustainable source of long-run growth. New Zealand is nearing the limit to which economic growth can be driven by increased labour participation. Future growth will increasingly need to be derived from increases in productivity.

For several decades, long-term productivity growth has not lived up to aspirations and New Zealand has been low down the OECD league table that measures productivity performance. A number of interrelated factors are important for raising productivity, and there are no quick fixes or silver bullets. A broad range of steps impacting productivity on a number of fronts are required and it may take several years before any benefits are seen in measures of productivity.

And a focus on five drivers will help address the challenge to lift productivity performance

New Zealand’s productivity performance would benefit from a focus on five drivers of productivity, with consideration under each driver given to the role of international connections: Enterprise, Innovation, Skills, Investment and Natural resources.

This paper is the first in a series of papers that set out the key drivers that influence productivity performance and the ways in which it can be improved. It sets the scene for more detailed work on productivity performance and on each of the drivers outlined here. The paper aims to focus attention on the issues that economic theory and evidence suggest are of importance for New Zealand’s economy.

Summary messages: for overall productivity performance and for each driver

Productivity performance

  • New Zealand is currently 22nd out of the 30 OECD countries as measured by GDP per hour worked (a measure of productivity) and GDP per capita (a measure of material welfare). On average, an hour worked in New Zealand produces approximately 30 per cent less output than an hour worked in Australia.
  • This is not a new phenomenon; New Zealand has had a consistent productivity shortfall by international comparison since the 1970’s. A focus on those factors that drive productivity performance will help improve New Zealand productivity and raise standards of living over a longer time horizon.
Entrepreneurs are the driving force in the economy, identifying and taking advantage of a broad range of market opportunities

Enterprise

  • In international benchmarks, New Zealand scores well for its entrepreneurial framework, such as competition policy and the ease of doing business, and achieves a high degree of market entry and exit. Barriers to competition should be maintained at low levels and the promotion of competition should remain an important consideration when formulating policies that impact on the level of competition in product markets or for corporate control.
  • The tax system affects the quality of the business environment by altering incentives to engage in economic activity of many varieties; for firms to invest in physical capital and research and development and for individuals to acquire skills. Understanding the impact of the tax system on the drivers of productivity is important when formulating tax policy.
  • Good regulatory management requires that the regulatory environment improves over time and remains fit for purpose. This requires not only providing quality assurance on the flow of new regulation, but also systematically reviewing the existing stock of regulation.
Innovation includes a range of firm innovations including new processes, new business models and new technologies

Innovation

  • New Zealand has a reasonably strong academic research base but there remains a low level of commercialisation of innovations. While business research and development has been increasing, it is still low by international comparison.
  • In order to upgrade firms’ innovation performance it is fundamental that firms leverage off external sources of ideas, both internationally (New Zealand produces less than one per cent of all global research) and from the public research base. Policies that strengthen the interactions between firms and research institutions will help the adoption of new ideas.
Investment directly impacts on how much a firm can produce and on the productivity of labour by increasing the amount of capital and technology available to each worker

Investment

  • New Zealand has a relatively low capital stock per worker. While rates of investment have been increasing, they are only equal to the average rate within the OECD and lag countries such as Australia, Ireland and Spain.
  • Encouraging entrepreneurship, greater use of innovation and international linkages will improve the number of investment opportunities. Policies that promote savings and reduce the volatility of the exchange rate cycle can lower the cost of capital.
Better-skilled individuals are more productive, earn higher wages, increase a firm’s ability to adopt new technologies and increase the returns to investment in capital

Skills

  • The education level of New Zealand’s workforce is above the OECD median and improving, but there is a large group of children not achieving their potential and a large subset of the adult population with low literacy and foundation skills that limit their productivity.
  • Productivity gains over the long term will come from improving the quality of early years’ education, and from targeting support to disadvantaged and at-risk children. But this needs to be followed up by ongoing engagement in quality education and training both in school and after young people enter the workforce.
The management of natural resources in a sustainable way allows resources to flow to their most productive uses while achieving environmental goals

Natural Resources

  • New Zealand has an enviable environment, but pressures are starting to appear on multiple fronts: changes in social and cultural expectations, international consumer trends, climate change pressures and emerging capacity constraints for some resources, particularly freshwater.
  • An important focus is ensuring a comprehensive integrated framework which identifies crucial trade offs across goals, and facilitates a smooth economic adjustment in achieving these trade-offs. This would enable resource users to make informed, flexible and efficient decisions to ensure productive use of resources, while achieving environmental goals.
Size and distance matter and are important considerations across each of the five drivers

International Connections

  • International connections are important for all five drivers of productivity. New Zealand’s size and geographical location can explain up to 75 per cent of the gap in GDP per capita relative to other OECD countries. International flows of goods and services, finance, ideas and people can help New Zealand to access scarce skills, raw materials, intermediate goods and services, leading-edge technologies, new production techniques and other factors that influence the drivers of productivity.
  • Domestic policy-settings such as immigration policy and foreign ownership rules impact directly on the level of international connections. In addition, more indirect policy settings, such as social and environmental policy, tax and regulation also play an important role in attracting individuals and firms to locate in New Zealand.

Notes

  • [1]William E. Simon, former US Secretary of the Treasury.
  • [2]See Section 2.1, Economic Development Indicators 2007, Ministry of Economic Development.
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