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Summary and Introduction

New Zealand faces a big challenge to overcome its long-standing productivity shortfall

One of the biggest challenges facing New Zealand is its productivity shortfall relative to other OECD countries; New Zealand is currently ranked 22nd out of the 30 OECD countries in the productivity league table and an hour of work in New Zealand typically generates 30 per cent less output than an hour worked in Australia. Low productivity is not a new phenomenon; productivity has been an issue in New Zealand since at least the 1970s.

A focus on productivity is desirable not solely so that New Zealand becomes more internationally competitive, but also because in the long run, growth in incomes is fundamentally linked to output per worker. Growth in GDP per person rests on either encouraging a greater proportion of the population into work, or by improving the productivity with which each worker produces output. New Zealand has performed well in encouraging increased numbers of people into the labour market, but there is a limit to how much increased participation in the workforce can drive growth. Productivity growth must be at the heart of any future economic growth.

This is one of a series of Treasury papers on productivity performance

This paper is part of the Productivity Performance and Policy series of papers that discuss New Zealand’s long-term productivity performance and the factors that may be inhibiting New Zealand from reaching its potential. Putting Productivity First is the overview paper which sets out the productivity challenge facing New Zealand and highlights key issues across five drivers of productivity: enterprise, skills, innovation, investment, and natural resources. The next two papers, New Zealand’s Productivity Performance and Does Quality Matter in Labour Input? The Changing Pattern of Labour Composition in New Zealand, discuss past and more recent productivity performance and the impact that improving labour quality has had on labour productivity respectively. The final four papers address the enterprise, innovation, investment and skills drivers in turn, building on the analysis in the preceding papers by reviewing and interpreting available evidence to draw conclusions for the underlying factors affecting productivity.

This paper focuses on investment. The small size of New Zealand’s capital stock has attracted much concern in the search for answers around New Zealand’s productivity performance.

The main concern here is the physical capital stock – the total value of machinery, computing equipment, buildings, etc. – which is the result of annual investment. (Investment is the annual flow that adds to the stock and makes up for depreciation.)

The main points are:

  • Compared to most OECD countries (including the US and Australia), New Zealand has low levels of labour productivity, capital intensity and multifactor productivity (MFP, a measure of how efficiently the economy makes use of capital and labour). Thinking in terms of a basic economic model allows for the insight that low capital intensity can be thought of as, at least partly, a by-product of low MFP.
  • New Zealand firms face a somewhat elevated cost of capital compared to other OECD countries, resulting in lower capital intensity than would otherwise be justified by the economy’s level of MFP.
  • This paper discusses several factors – including low domestic saving, financial market development, exchange rate volatility, tax and high external indebtedness – that may be responsible for upward pressure on the cost of capital.
  • More complicated models point to the importance of the terms of trade in understanding New Zealand’s capital intensity and productivity experience. They also suggest that it may be useful to think of New Zealand as a region of a broader Australia-New Zealand economy.
  • The quality of investment matters for productivity. Well-functioning markets are critical to guiding private investment to the highest returning investment opportunities. High quality public investment is more likely if based on sound principles of cost benefit analysis.
  • Focusing on the factors that raise MFP will be an important part of the response to raising investment and labour productivity. Innovation, skills and building an environment that supports enterprise development are critical areas of focus. Addressing the potential factors that inflate New Zealand’s cost of capital relative to other countries will also be important.
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