The Treasury

Global Navigation

Personal tools

Treasury
Publication

Capital Shallowness: A Problem for New Zealand? - WP 05/05

4  Labour Productivity and Capital Intensity

This section analyses the level and growth of labour productivity and the role played by the amount of capital per hour worked. We refer to this latter concept as capital intensity.

4.1  Labour productivity

It has previously been shown that New Zealand has a lower level of labour productivity compared with Australia (see Ministry of Economic Development and Treasury 2005). Figure 5 indicates that this lower level of labour productivity has prevailed since at least 1978; furthermore the gap appears to have widened in the later years of the series.

Figure 5: Labour productivity levels in New Zealand and Australia: 1978-2002
Labour productivity levels in New Zealand and Australia: 1978-2002
Source: OECD.
Figure 6: Annual average growth rates of labour productivity in New Zealand and Australia: 1978-2002: 11 year moving averages
Annual average growth rates of labour productivity in New Zealand and Australia: 1978-2002: 11 year moving averages
Source: OECD.

4.2  Capital intensity

A critical determinant of the level of labour productivity is capital intensity or the amount of capital per hour worked. Consider the following identity:

(3)    

where Y/L is labour productivity or output per unit of labour, Y/K is capital productivity or output per unit of capital, and K/L is the capital-labour ratio or capital intensity. Thus labour productivity is made up of capital productivity, or how efficiently capital is being used within the economy, multiplied by the capital-labour ratio, or how much capital each worker has to work with.

As Table 2 shows, New Zealand’s low labour productivity level compared with Australia is not due to the fact that workers are using capital less efficiently than workers in Australia; the level of Y/K in New Zealand is virtually identical to that in Australia in all three periods shown. Rather, the difference in labour productivity with Australia arises from the lower capital-labour ratio in New Zealand; i.e., on average each worker has less physical capital to work with in New Zealand.

In contrast the lower labour productivity in New Zealand compared to the UK and the US is due to the combined effects of both lower capital productivity and a lower capital-labour ratio in New Zealand.

Table 2: Simple Decomposition of Labour Productivity
  1970-1979 1980-1989 1990-2002
  Y/L Y/K K/L Y/L Y/K K/L Y/L Y/K K/L
Australia   0.40   22 0.39 55 26 0.40 65
NZ   0.38   18 0.39 47 21 0.40 52
UK 16 0.40 41 21 0.44 47 26 0.46 56
US 24 0.60 41 27 0.55 50 33 0.52 63

New Zealand’s Labour data is obtained from the HLFS (backdated by Chappell-Mears).

New Zealand’s lower capital-labour ratio compared with Australia, the UK and the US is consistent with the fact that New Zealand’s capital stock has not been growing as fast as in these other OECD countries (see Table 1). At the same time New Zealand’s labour input (measured as total hours worked) has on average been growing faster over the 1990s than in Australia, the UK and the US, as shown in Figure 7.

Figure 7: Annual average growth rates of hours worked: 1980-2002: 11 year moving averages
Annual average growth rates of hours worked: 1980-2002: 11 year moving averages
Source: OECD and Statistics New Zealand.

Figure 8 shows the impact of the slower growth of capital and faster growth of labour in New Zealand on New Zealand’s capital intensity over time compared with selected other OECD countries. New Zealand has had a lower level of the capital-labour ratio than Australia, US and the UK since 1992. While in each of these other countries the capital intensity continued to grow throughout the 1990s, in the case of New Zealand the level of capital intensity in 2002 was no higher than that which it had been in 1991.

Figure 8: Capital Intensity (capital per hour worked): 1978 - 2002
Capital Intensity (capital per hour worked): 1978 - 2002
Source: OECD and Statistics New Zealand.

Figure 9 shows New Zealand’s capital-labour ratio as a proportion of Australia’s capital-labour ratio from 1978 to 2002. New Zealand’s capital intensity has been declining relative to that in Australia throughout the period. The only exception was during the years 1986-1990. This period corresponds to a time when Australia engineered a reduction in real wages through the Prices and Income Accords and the centralised bargaining process. It was also around the end of the 1980s that Australia’s labour markets started to become more flexible and decentralised.

Figure 9: Capital intensity in New Zealand relative to Australia: 1978 - 2002
Capital intensity in New Zealand relative to Australia: 1978 - 2002
Source: OECD and Statistics New Zealand.

One possibility which may explain part of the divergence in capital stocks between New Zealand and Australia is uncertainty. Macroeconomic instability weakens business confidence and can make long-term planning difficult. If investment is irreversible (that is, once a machine is put in place it has no alternative use), firms may be less likely to invest when output growth is unstable. Also, a highly volatile exchange rate may increase the risk to businesses of buying and selling in international markets. GDP growth and Real Effective Exchange Rate volatility for New Zealand and Australia are presented in Table 3. These indications show that the New Zealand economy continues to be more volatile than the Australian economy.

Table 3: GDP Growth and Exchange Rate Volatility in New Zealand and Australia
  Real Effective Exchange Rate
(standard deviations)
Real GDP Growth
(standard deviations)
  Australia New Zealand Australia New Zealand
1984-1994 100 74 100 150
1994-2003 52 78 63 100

Australia = 100 in 1984-1994.

Another source of uncertainty may arise from the regulatory environment. This includes legislation such as the Resource Management Act 1991 (RMA), which creates several unintended obstacles to private investment. Businesses are concerned with the current consents process, which is costly, lacks certainty and takes a long time to complete for large projects (Macquire Research 2004). However, based on an index of economic freedom (Miles, Feulner and O'Grady 2005) New Zealand’s ranking at 5th in 2004 compared with Australia’s 10th place ranking may well indicate that the overall business climate is not a major deterrent in New Zealand.

Page top