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Investment, Productivity and the Cost of Capital: Understanding New Zealand’s Capital Shallowness - TPRP 08/03

Does New Zealand Suffer from an Impediment to Capital Accumulation?

There are two ways to look into the question of whether New Zealand suffers from an impediment to capital accumulation as described in the previous section. First, we can ask whether New Zealand appears to suffer from a high cost of capital relative to other countries. The second way is to explore what forms an impediment might take and ask whether any of these appear to exist in the New Zealand context.

Does New Zealand Have a High Cost of Capital?

Unfortunately, existing evidence about New Zealand’s cost of capital from a macroeconomic or economy-wide point of view is scarce and much of what is available provides information that is now at least five years old. There are basically two types of available evidence: estimates of the return to the entire capital stock from national accounts data and estimates of real interest rates on comparable assets (similar maturity government bonds).

One way to estimate the cost of capital is to look at data from the national accounts.  This approach estimates the average cost of the entire capital stock

Information from National Accounts Data 

Hall and Scobie (2005) take the national accounts approach. The idea is to estimate the average cost of capital for the entire capital stock by tallying up the total annual income that flows to capital and then divide it by the value of the stock of capital (which is estimated by aggregating historical investment flows). That is, in any given year:

cost of capital = total payments to capital / value of capital stock.

From the national accounts, it is straightforward to get a figure on how much of a country's annual income (that is, GDP) flows to labour inputs. It is very common in macroeconomic research to treat whatever GDP is left over after labour income is subtracted as capital's income; this is what Hall and Scobie do to calculate the numerator in the ratio above.[10] Figure 7 shows Hall and Scobie's estimates of the cost of capital for OECD countries. Their results show New Zealand's cost of capital as fairly high, with a rising trend. New Zealand equals or exceeds the "OECD Average" for 1976-2002 (the entire period for which they are able to make a New Zealand estimate).

Figure 7: Hall and Scobie’s Estimates of the Cost of Capital, 1976-2002
Figure 7: Hall and Scobie’s Estimates of the Cost of Capital, 1976-2002.
Source: Hall and Scobie’s (2005) calculations, based on OECD national accounts data.

Note: The y-axis label “OS” refers to “operating surplus” which is the national accounts concept that corresponds to income after labour costs. The authors adjust this for the income of sole proprietors.

Returns paid to land and natural resources should ideally be separated from returns paid to machinery and other "reproducible" physical capital.  This is particularly important when considering countries that have relatively large stocks of natural capital, like New Zealand

Caselli and Feyrer (2006) make this same calculation for a sample of countries, including New Zealand, and then refine it further. They make an important criticism about calculating the cost of capital as described in the equation above: the measure of capital income used to calculate the return to capital includes not just payments to what they call "reproducible" physical capital (that is, the kind of capital we are interested in for the purposes of this paper: machinery, information and communications technology, buildings, etc.), but also payments to natural physical capital (land and natural resources) as well. Dividing the income that flows to all capital by the reproducible capital stock (as is the case in Hall and Scobie and many studies regarding other countries) will lead to an overestimate of the cost of capital – particularly in countries where the value of land and natural resources are relatively substantial.[11] Caselli and Feyrer use estimates on natural capital stocks from the World Bank (2006) to come up with a narrower estimate of income flows to reproducible physical capital. That is, they attempt to correct the problem by excluding income flows to land and natural resources.[12] Their results are shown in Figure 8. Unfortunately, their latest year of estimate is no more recent than 1996.

Figure 8: Caselli and Feyrer’s Estimates of the Cost of Capital, 1996
Figure 8: Caselli and Feyrer’s Estimates of the Cost of Capital, 1996.

Caselli and Feyrer’s base calculation of cost of capital for New Zealand and Australia is broadly in line with Hall and Scobie’s for the same year: Caselli and Feyrer estimate 13% for both countries; Hall and Scobie put Australia at 13% but New Zealand closer to 14%. However, they disagree sharply regarding the US: Caselli and Feyrer make a base estimate of 12%, compared to Hall and Scobie’s 16%. It is unclear what causes this discrepancy.

An estimate that attempts to correct for natural capital shows New Zealand’s cost of capital as low compared to the OECD

Figure 8 also reports Caselli and Feyrer’s revised cost of capital estimates, after adjustment for land and natural resources. New Zealand’s adjusted cost of capital is significantly lower than Australia, the US and the OECD average. In fact, New Zealand ties with Sweden and Greece for the lowest adjusted cost of capital in Caselli and Feyrer’s OECD sample. Caselli and Feyrer go on to make an additional adjustment for the relative price of capital equipment across countries.[13] This makes New Zealand’s cost of capital appear yet lower than the comparator countries, but the effect is small, enlarging their estimate of the gap between New Zealand's cost of capital and that of the OECD average by an additional half a percentage point. (In other words, New Zealand faces only a slightly elevated cost of imported capital goods such as machinery and computer equipment.)

Caselli and Feyrer’s natural resources adjustment should be taken cautiously – valuing a country’s stock of natural capital is subject to even greater difficulties than valuing the stock of reproducible capital. The World Bank data is based on necessarily crude estimates of the value of subsoil resources and various types of land, including protected land. The World Bank estimates the per-capita U.S. dollar value (for year 2000) of New Zealand's natural capital (including urban land) at 42% higher than that of Australia (despite Australia's more valuable subsoil resources) and 66% percent higher than the US. An inspection of the World Bank’s data suggests that a substantial part of the dramatic discrepancy between New Zealand’s “base” and “adjusted” cost of capital in Figure 8 is due to the high value accorded by the World Bank to New Zealand's protected land.[14] However, even if protected land is excluded, New Zealand's natural capital stock is still 13% larger than Australia's and 35% larger than that of the US.


  • [10]According to national accounting principles, national income (GDP) must equal the payments made to factors of production (labour, capital and any other factors).
  • [11]Hall and Scobie compare (for Australia and New Zealand, p. 3-5) preliminary estimates of a combined stock of land plus reproducible capital. However, because they worry about data quality, they do not use this broader stock as the denominator when estimating the cost of capital.
  • [12]Arguably Caselli and Feyrer’s criticism could be taken further: their adjusted measure of reproducible physical capital income may still include income flows to other items that could be labelled as factors of production such as research and development.
  • [13]This is the price of machinery, etc. (which is typically imported by small countries) as distinct from our use of the term “cost of capital” which refers to financial cost.
  • [14]There is some argument that perhaps Caselli and Feyrer should have excluded protected land from their measure of the natural capital stock.
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