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New Zealand's Productivity Performance - TPRP 08/02

4.  Productivity performance in recent years

A number of factors may explain recent productivity performance.

Several factors might be contributing to the apparent slowing of observed growth in both economy-wide and measured sector productivity. The main factors considered in this section relate to changes in employment, labour quality, and industry and sector developments. Given the available information, it is difficult to isolate and weight the relative importance of the factors because of uncertainty around unobservable variables (eg, the business cycle) and data limitations.

Other studies have previously examined slowing productivity growth in New Zealand, Australia and Canada.

Studies examining productivity developments in New Zealand (Drew, 2007), Australia (Ewing, Fenner, Kennedy and Rahman, 2007) and Canada (Rao, Sharpe and Smith, 2005) have tended to find suggestive, as opposed to clear-cut, explanations. The latter two studies have considered the potential contribution of significant and sustained commodity price booms to the slowing of productivity growth in Australia and Canada noted in Section 3 above. A decline in observed productivity from higher commodity prices is not necessarily detrimental to national income.[9] However, because the terms of trade are volatile, increases in productivity tend to matter more over the longer term.

Changes in employment and labour quality

Recent output growth in New Zealand was strong because of high employment growth.

Ongoing labour input growth and lower-than-expected observed labour productivity growth have been features of New Zealand’s economic performance in recent years. For a number of years, the Treasury’s economic forecasts have incorporated the view that this pattern would change, with labour input growth slowing and labour productivity growth rising. This has not been borne out so far because of a story about labour force participation and employment, which have risen to rates beyond what was being forecast a decade ago. This has meant that, although GDP growth has been in the 3% per annum range, its composition (in a labour input and labour productivity sense) has been different from forecast.

High employment growth can dampen observed productivity growth.

During times of high employment growth, new workers tend to dampen observed productivity growth. For example, a rise in the employment rate might see a temporary reduction in observed productivity growth as new workers, even if they have high levels of formal qualifications, are generally less productive than existing workers, at least until they gain job-relevant skills. This is a short-term effect as once these workers gain job-relevant skills productivity growth should return to its original rate.

The IMF (2005) has assessed the impact of rapid employment growth on New Zealand labour productivity growth. They use results from a cross-country study on the determinants of labour productivity growth (Belorgey, Lecat and Maury, 2004), which found that the short-run elasticity of labour productivity growth in relation to increases in the employment rate is around -0.5. Given the employment rate rose by about 1% per annum from 1992 to 2004, the IMF note that labour productivity growth could have been dampened by as much as ½% per annum over this period. They suggest that annual growth in labour productivity should increase in the future in the absence of further increases in the employment rate.

Drew, Dupuy, Downing and Karagedikli (2005) decompose the 18% rise in employment from 1998 to 2005 into five different components to estimate the potential impact of changes in labour quality. They assume people entering work from short-term unemployment and net immigration are experienced workers, while those from outside the labour force, long-term unemployment and natural population increase are inexperienced. With inexperienced workers accounting for about two thirds of net employment growth from 1998 to 2005, the authors suggest the -0.5 estimate of the dampening effect on labour productivity from Belorgey, Lecat and Maury (2004) is plausible.

Hyslop and Maré (2008) examine compositional changes among workers from 1999 to 2007 using Linked Employer-Employee Data (LEED). They note that average annual earnings for a full-time equivalent worker rose by about 9% in this period, but this rise would have been about 15% without compositional changes in employment. The economic upturn from 1999 to 2007 brought many lower-skilled people into the workforce and dampened average wage growth (and, by proxy, average worker productivity).

Changes in labour quality currently get picked up as changes in labour productivity.

Szeto and McLoughlin (2008) examine labour quality using a similar methodology to work done overseas (including Australia) and outlined in McNaughton (2006). This methodology will also be used by SNZ in the near future. In this methodology, hours worked by high-skilled workers are given more weight than workers of low skill when calculating aggregate labour input. Weights of different skill groups are determined using wage rates, which assumes that wages are a good proxy for productivity and that individual characteristics reflect differences in productivity. Skill level is estimated by the level of formal education (proxied by highest qualification) and work experience and on-the-job training (proxied by age).

Estimates from Szeto and McLoughlin (2008) show an average rise in labour quality of 0.6% per annum from 1988 to 2005 as a result of increasing qualification levels, particularly at university degree level. With age as a proxy for work experience, an ageing of the workforce also contributed to rising labour quality. Although labour quality rose in every year of the sample period, the rise was not constant over time. The increase from 1988 to 1999 was 0.8% per annum on average and the increase from 1999 to 2005 was 0.2% per annum on average (Figure 9).

New estimates suggest labour quality has risen strongly since 1988, but modestly since 1999.
Figure 9: Decomposition of economy-wide output growth into growth in hours worked, labour quality and quality-adjusted labour productivity
Figure 9: Decomposition of economy-wide output growth into growth in hours worked, labour quality and quality-adjusted labour productivity.
Source: The Treasury
Underlying growth in labour productivity (ie, excluding labour quality) was higher from 1999-2005 than from 1988-1999.

The implication of rising average labour quality is that some of the rise in observed economy-wide labour productivity can be attributed to changes in the quality of labour input. In a growth accounting sense this means labour quality is identified separately. With labour quality rising by an average of 0.6% per annum, almost half of observed economy-wide labour productivity growth of 1.4% per annum between 1988 and 2005 can be attributed to the rise in labour quality. Put another way, labour productivity measured as output per quality-adjusted working hour rose by 0.8% per annum on average from 1988 to 2005, with annual growth of 0.5% in the 1988-1999 period and 1.3% from 1999. By comparison, unadjusted (ie, observed) economy-wide labour productivity growth averaged 1.3% to 1.6% over the whole sample period and in both of these sub-periods.

The stage and length of the business cycle is likely to have an impact on labour quality. The only times the labour quality index grows by at least 1% per annum are in economic downturns (ie, 1989, 1991, 1992, and 1998) as low-skilled workers are generally the first to be laid off in a downturn. The relatively long economic upturn since 1999 has led to a large rise in the number of workers and, as discussed above, this rise had a relatively high proportion of the lower-skilled. The rise in labour quality was much smaller in the latter part of the sample period, possibly due to a large increase in the employment of lower-skilled workers in the recent upturn.

Notes

  • [9]Observed productivity may decline as firms allocate extra inputs to marginal activities, where those activities are nonetheless still profitable given international prices. The time taken to put in place additional capital may also contribute to lower labour productivity growth. Real Gross National Disposable Income (RGNDI) adjusts real GDP for income flows with the rest of the world and changes in a country’s terms of trade (eg, a terms of trade improvement makes it possible to purchase more goods and services from overseas from the incomes generated by a given level of domestic production).
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