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Enterprise and Productivity: Harnessing Competitive Forces - TPRP 08/04

Entrepreneurs’ access to resources…

The four drivers of productivity: capital, skills, innovation and natural resources, matter for the fifth, enterprise. Enterprise is not possible without access to these inputs. They provide the resources which entrepreneurs need to make their ideas a success, no matter at what point in the production chain or what size their firm. They create the business environment that attracts firms to locate in New Zealand. However, without the entrepreneur to identify new investments and solutions and bring these resources together and combine them, there would be no new ventures that drive the productive churn in the economy.

To the extent that government policies affect the other four drivers of productivity, they will affect the level of entrepreneurial activity in the economy. Given New Zealand’s small domestic market size, international as well as domestic sources of finance, people and ideas are important in creating an attractive business environment. Consideration to international flows of these resources should be a central part of a broad range of policy settings.

Shallow capital markets may inhibit access to capital for some firms

Firms in New Zealand use less capital per employee than other OECD countries. This is partly due to a higher than average cost of capital, but even given high interest rates, some potentially profitable opportunities may not be undertaken. Possible reasons for this include uncertainty in the macroeconomic or regulatory environment, the incentives and disincentives provided by the tax system, access to finance or an aversion to high levels of risk.

New Zealand has open capital markets, but the financial system has some unusual features compared to other countries. New Zealand has a small and immature venture capital market, which often acts as a source of capital for small, high growth potential firms, and the stock market and domestic corporate bond market are relatively small and illiquid. The result is that financing is largely intermediated by banks. This structure means that firms are unlikely to be able to access a comprehensive menu of financial services through all stages of development, and to the extent that banks cannot assess the value of a potential investment, even if profitable, firms may not be able to access finance at all.

While access to finance is generally not an issue for an established firm with a proven credit history and valuable assets for use as collateral, younger firms with limited cash flow, firms that have intellectual property rather than physical assets and highly geared companies may find limited access to capital prevents investment.

Overall, a lack of development in certain parts of New Zealand’s financial system could be imposing a moderate constraint on the growth and performance of New Zealand firms. The promotion of domestic saving and measures to increase the level of venture capital are important for granting a greater level of access to capital for many firms. For a more in-depth discussion see the paper, Investment, Productivity and the Cost of Capital: Understanding New Zealand’s “capital shallowness”.

Increases in the flow of skilled workers will boost productivity in the long run

A broad skill base, including both basic and advanced skills, is important for creating a business environment conducive to investment and growth. The individual entrepreneur starting out on a new enterprise and the large multi-national corporation demand skilled employees of all varieties.

Whilst New Zealand performs well on a number of metrics of educational achievement, there are a number of issues that may be limiting access to skills for firms. Approximately 40% of students leave school without gaining a Level 2 qualification or better (OECD, 2007b). In addition, of the many people who do achieve a higher level of skills, emigration to foreign markets becomes an attractive proposition leading to further reductions in the available skills base for firms.

Shortages of skilled labour are apparent from discussions with business. Respondents to the World Economic Forum’s Competitiveness Survey ranked an inadequately educated labour force as the fifth most problematic factor in doing business in New Zealand. The Treasury November 2007 Monthly Economic Indicators Report states that the labour market continues to be very tight with considerable wage pressure for experienced and skilled staff and that there is extreme difficulty in finding new staff.

Improvements over the long term will come from improving the quality of early education, and from targeting support to disadvantaged and at-risk children. This needs to be followed up by ongoing engagement in quality education and training both in school and after young people enter the workforce. New Zealand also has an opportunity to access pools of international talent, and a challenge in order to retain domestically educated individuals. A range of factors are likely to be important including access to housing, cultural factors and wages in attracting the best internationally educated individuals. For a greater discussion of the mechanisms through which New Zealand’s skills base can be improved see Working Smarter: the Contribution of Skills to Productivity Growth.

Access to domestic and international sources of innovations will spur the adoption of new ideas

New ideas are the driving force behind enterprise. An innovative environment, within firms and public institutions, is important for both creating new ideas and adopting ideas that create the basis for new investments. Firms need to be able to access new ideas, from scientific and applied research in the research institutions to new ideas already being applied in other firms. Access to a large pool of ideas may be inhibited by the small size of the domestic economy.

As New Zealand is responsible for only 0.16 per cent of OECD research and innovation (OECD, 2005a), it is important that firms have the capabilities to access international innovations that can be adapted and exploited in New Zealand. A firm’s capability in this area is often a product of how engaged in research that firm is itself. Firms engaged in research and development are often more aware of new ideas that are generated elsewhere and have the capabilities and understanding to utilise those ideas in their own areas of work. Managerial capability in networking to access overseas sources of ideas is important to make sure that New Zealand firms move towards the technology frontier.

It’s also important that firms are given the opportunity to leverage off the public sector; research funded by government or higher education institutes is roughly 57 per cent of total research in New Zealand (MoRST, 2006). For firms to maximise the benefit, these new ideas need to be business facing, so that they can be brought to commercialisation. For a greater discussion of the manner in which firms can interact with the innovation system, both domestic and international, see Innovation and productivity: using bright ideas to work smarter.

Capital, skills and ideas build agglomerations

Access to skills, ideas and capital determine where businesses locate. Evidence on economic geography suggests that businesses choose to locate close to the input markets they use, in particular skilled labour, specialist suppliers and similar firms that can provide tacit knowledge transfer. Even successful clusters such as Silicon Valley, containing a number of firms that have access to the latest communication technologies and could conduct their business activities from anywhere in the world, choose to locate within close vicinity to each other. This is to benefit from input markets, most notably labour supply and knowledge transfer, that help to reinforce the location decision, making it even less likely the firm will relocate and more likely that other firms will start up there. Successful agglomerations create spin-offs, as new ideas create new firms, and attract complementary activities: Silicon Valley is notable for its concentration of venture capitalists, helping to provide financing for new start-ups.

To create economies of agglomeration, the market needs to be of sufficient size. It is possible that no market in New Zealand is large enough to create large agglomeration benefits. Auckland is the most likely location to attract international business due to its access to labour and suppliers. Successful agglomerations are built on the five drivers of productivity. A large pool of skilled labour, transport infrastructure, universities and ideas, sources of capital and a range of factors that attract labour such as access to housing and cultural and environmental amenities are important in creating agglomeration benefits. For Auckland especially, it may be important to focus on the five drivers of productivity if this helps to create an agglomeration that attracts business to set up and locate there.

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