What we know (and don t know) about economic growth in New Zealand. Strategic Policy Branch

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Lee Brown
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1 What we know (and don t know) about economic growth in New Zealand July 2016 Strategic Policy Branch

2 Document purpose What we know (and don t know) about economic growth in New Zealand : Brings together MBIE s collective knowledge about economic growth in one place Informs MBIE s medium-term policy, strategy and research goals Disclaimer The views, opinions, findings, and conclusions or recommendations expressed in this paper are strictly those of the author(s). They do not necessarily reflect the views of the Ministry of Business, Innovation & Employment or the New Zealand Government. The Ministry of Business, Innovation & Employment and the New Zealand Government take no responsibility for any errors or omissions in, or for the correctness of, the information contained here. The paper is presented not as policy, but with a view to inform and stimulate wider debate.

3 Key points Economic growth has been faster in New Zealand than in most other OECD countries in recent years New Zealand has high numbers of hours worked, high employment participation and favourable policy settings which predict that incomes should exceed the OECD average by 20 per cent New Zealand s income levels are more than 20 per cent below the OECD average. Low income levels largely reflect relatively low productivity growth in New Zealand Factors which are likely to boost New Zealand s productivity performance include our dynamic business environment (relatively high levels of firm and job entry and exit), and relatively high and rising levels of tertiary qualification attainment Factors which are likely to negatively affect New Zealand s productivity performance include the effects of size and distance, our relatively low levels of investment in R&D and industry structure Innovation, the diffusion of new technologies and knowledge, and the reallocation of resources to the most productive firms are seen as (increasingly) important for productivity growth in general For New Zealand, narrowing the productivity shortfall is likely to require some combination of higher productivity growth within industries, and a general shift in economic activity toward higher productivity industries. It will also require continued investment in R&D and skills

4 Chapter 2 The importance of growth and economic wellbeing Wellbeing is the goal Wellbeing is influenced by a broad range of material and non-material factors New Zealand punches above its weight in many nonmaterial measures of wellbeing As well as average wellbeing, the distribution of wellbeing is also important Income per capita as a measure of wellbeing has some strengths... Income per capita is a long-standing, internationally comparable and well-understood measure of economic growth It has an important indirect relationship with nonmaterial measures of wellbeing...and weaknesses, so that alternatives are sought Income is a flow rather than a stock, and so does not measure the physical capital stock, nor natural capital such as freshwater and biodiversity Other weaknesses include: that GDP includes income to foreign owned firms from production in New Zealand; that it does not reflect intangible benefits of ICT etc and only measures market activity A new measure developed by Grimes and Hyland (2015) uses consumption and wealth to supplement income in measures of material wellbeing This report is structured around the drivers of economic growth and wellbeing The framework below identifies some of the key determinants of economic growth and wellbeing It breaks down economic growth into two key components labour utilisation and labour productivity

5 Chapter 2 continued Determinants of economic growth and wellbeing New Zealanders well-being Economic Outcomes Social Outcomes Environmental Outcomes Labour productivity Labour utilisation The distribution of growth Insights from other small advanced economies The impact of New Zealand s unique combination of small size and distance Firm and employment dynamics, sector dynamics, and a regions view Innovation and science Investment, savings and financial market development International connectedness People, skills and talent Services from resources and infrastructure Regulation and regulatory institutions Business of government Macroeconomic conditions and tax

6 Chapter 3 Overview of growth New Zealand s economy has performed well in recent years, but productivity performance is below-average Economic growth has been faster in New Zealand than in most OECD countries in recent years Per capita income in New Zealand is around 20% below the OECD average, but is predicted to be 20% above the OECD average based on our favourable policy settings, high numbers of hours worked and high employment participation This largely reflects below-average productivity performance OECD modelling suggests that size and distance explain much of the productivity gap; size and distance limit economies of scale and make it more difficult to trade, invest and gain access to new technology. Low levels of investment in R&D and New Zealand s high integration of low skilled workers also contribute to the gap Productivity and innovation are highlighted in global trends Differences in productivity are the biggest source of differences in income growth across countries The OECD predicts that growth will increasingly depend on innovation and the dissemination of new discoveries at the productivity frontier Growth is distributed unevenly Sizable income gaps for Māori and Pasifika have not improved significantly since 1990 Inequality has been relatively stable in New Zealand in recent years, after a deterioration in the 1980s and 1990s. This trend is similar to other countries, although more pronounced in New Zealand

7 Chapter 4 Cross cutting perspectives New Zealand has a dynamic business environment New Zealand has relatively high rates of firm entry and exit, but surviving firms tend to stay small This may reflect low barriers to firm entry, a lack of competition in some parts of the economy and obstacles to firms reaching large size This emphasises policies to sharpen competition and reallocation of resources to the most productive firms Industry structure contributes to the productivity gap Around 30% of the gap between New Zealand s and Australia s labour productivity in 2009 was due to industry structure. 70% was due to within-industry productivity differences Sectors such as ICT, manufacturing and, more generally, those which are more trade- or competition-exposed, tend to exhibit higher productivity growth However, most of New Zealand s economic activity does not fall within these areas; services is the largest sector, and the primary sector is over-represented The Māori Economy has distinctive characteristics Māori assets are more highly concentrated within primary industries, tourism, manufacturing, construction and property services Regional economic development is important because of the relatively large proportion of Māori living outside the main centres Geographical proximity matters for growth Agglomeration benefits of concentrated economic activity are mainly seen in the growth of Auckland, but decreasing returns to agglomeration suggest raising density may have a bigger effect outside Auckland. The scale of Auckland might mean that even small increases in growth may have larger aggregate effects Growth differences across regions reflect differing industry and resource compositions, demographic changes and other differing rates of input growth, and knowledge spillovers and other dynamic effects

Innovation is an engine of growth The initial costs incurred in developing ideas do not get re-incurred by other firms which adopt ideas; this can result in increasing returns to scale and thus

8 Innovation is an engine of growth The initial costs incurred in developing ideas do not get re-incurred by other firms which adopt ideas; this can result in increasing returns to scale and thus growth Internationally, the private returns to R&D are high (c20-30%), and the social returns even higher Little New Zealand firm-level evidence available about the returns to R&D Science and innovation policy can make a difference Positive spillovers from R&D and innovation provide a rationale for intervention Good evidence that both direct subsidies and marketbased instruments can increase R&D spend and output New Zealand is a net importer of ideas; foreign knowledge explains much of New Zealand s agricultural productivity growth Chapter 5 Innovation and science New Zealand performs well in some areas New Zealand ranks highly in terms of broad institutions New Zealand s innovation rate is around the OECD average, and New Zealand performs well in trademarking however there is room for improvement New Zealand performs less well in terms of some innovation inputs (especially business expenditure on R&D) and outcomes (e.g. multi-factor productivity)

9 Chapter 6 Investment, savings and financial market development Financial markets and growth go hand in hand International evidence suggests the direction of causality between financial development and growth runs both ways Little New Zealand evidence available on this Capital markets are as expected and generally wellfunctioning New Zealand has small and under-developed capital markets, in line with our size and stage of development By and large, firms report they have access to the capital they need Recent regulatory (and other) changes are starting to improve the performance of capital markets Average long term interest rates in New Zealand are relatively high Saving rate is low New Zealand s investment is around the OECD average, but the saving rate is low Low saving is likely constraining domestic capital market depth and impacting on the exchange rate and the current account of the balance of payments

10 Chapter 7 International connectedness Migration has a small positive effect New Zealand has among the highest levels of immigration and emigration among developed countries Strong New Zealand evidence that migration boosts international trade, but the effects are small FDI is an important source of capital for New Zealand Proportion of foreign direct investment (FDI) to GDP in New Zealand sits above OECD average, outward direct investment (ODI) sits well below average Some wage benefits from FDI, but available evidence suggests limited spillovers from FDI New Zealand s trade intensity is low Trade is a powerful driver of productivity growth, as it encourages specialisation, increases competition and allows firms to expand their markets and achieve economies of scale New Zealand exporters are around 50% more productive than non-exporters, and are already more productive before they begin to export Exporting is associated with increased innovation and R&D New Zealand s share of external trade is well below that of similar countries. New Zealand ranks lowest in the OECD for participation in global value chains Spillovers from exporting are strongest for New Zealand firms in the same industry

11 Education and skill development has economic and other benefits The importance of labour quality to productivity growth has been found in both country-level and firmlevel studies New Zealand performs well in terms of quantity of labour, and in some aspects of quality Labour force participation rate in New Zealand is consistently higher than the OECD average It is estimated that half the rise in labour productivity in New Zealand from 1988 to 2005 is associated with rising educational levels New Zealand performs relatively well in terms of preschool education and tertiary qualifications, less well in terms of secondary qualifications and tertiary education wage premiums Immigration has modest positive economic impacts overall Chapter 8 People and skills Skill shortages affected by technology Firms reporting hiring difficulties tend to be better performers being exporters, foreign-owned, larger, overseas direct investors, and R&D performers Technical change appears to contribute to persistent skills shortages within specific occupational areas New Zealand has experienced skills upgrading i.e. an increasing demand for higher-paid and higher-educated jobs Management performance important for growth Limited but growing New Zealand and international evidence of the importance of management practices to growth New Zealand s performance on management practices is mixed Modelling suggests that productivity in New Zealand manufacturing sector could be boosted up to 10% if management quality improved

12 Chapter 9 Services from resources and infrastructure Good infrastructure especially important for New Zealand Large agricultural share of output and primary sector require efficient transport networks A dispersed population distance between main population centres and where electricity is generated requires a long and efficient transmission grid New Zealand performs well (and is improving) in rankings New Zealand s international infrastructure rankings have improved recently New Zealand has one of the fastest rates of change in high- and average-speed internet connections Ranking strengths include air transport infrastructure and ICT use. Weaknesses include mobile phone subscriptions and affordability of ICT New Zealand has abundant natural resources 2 nd of all OECD countries in natural capital per capita in 2011 Substantial freshwater resources but concerns over quality and availability Housing pressures in Auckland, and low productivity growth in construction New Zealand has a high rate of investment in housing compared to financial assets Relatively inelastic supply in Auckland, low interest rates, rising land prices and easy to access credit contribute to house price inflation Low productivity growth in construction is related to a large proportion of small firms and volatile demand. This leads to low rates of investment in skills, innovation and capital

13 Chapter 10 Regulation and regulatory institutions Regulation is essential for the proper functioning of economies and societies Regulation underpins markets, protects the rights and safety of citizens, and their property, and assists the efficient and equitable delivery of public goods and services. Regulation also imposes costs e.g. on businesses New Zealand performs well on international indices New Zealand has good broad policy settings and institutions and performs well on international indices, but this advantage is not as strong as it once was as other countries have been improving their institutions Broad international indices are of limited use for decision-making purposes. New (firm- and employee-level) studies on the impacts of individual regulations can help inform policy Labour market regulation promotes flexibility Current employment relations framework promotes flexibility and labour market dynamism; New Zealand had the least restrictive protection of permanent workers against collective and individual dismissals of 43 countries in 2013 New Zealand ranks well in terms of its product market regulatory regime, but the regime is criticised for being somewhat inconsistent in how it supports competition

14 Government is a major participant in and shaper of the New Zealand economy Across OECD countries, government spending on health, education and transport is found to raise longterm growth, while spending on housing held it back Little New Zealand evidence about the link between aggregate government activity and economic growth New Zealand s public sector performs well in international indices of effectiveness, but productivity growth has been slow New Zealand ranks highly in the World Bank s Government Effectiveness Index, a perceptions-based measure. Otherwise, there is less comparative evidence available about effectiveness New Zealand ranks around the OECD average in terms of public sector efficiency. New Zealand s public sector labour productivity growth has been slower than in the market sector in recent decades Chapter 11 Business of government Benefits from improving government performance Increased competition, especially competitive procurement, could improve public sector efficiency Government procurement in New Zealand totals around $39 billion per annum. The way procurement is undertaken can have significant economic benefits or costs Procurement may possibly play a role in fostering innovation

Key gaps/ Questions Areas of focus for MBIE s medium-term research include: business and employee innovation a key driver of productivity growth regulation where MBIE plays a key role, and there are

15 Key gaps/ Questions Areas of focus for MBIE s medium-term research include: business and employee innovation a key driver of productivity growth regulation where MBIE plays a key role, and there are important gaps in our knowledge competition which is linked to innovation, and there are important gaps in our knowledge overcoming size and distance integral to New Zealand s productivity performance story Want to know more? The latest version of the full report What we know (and don t know) about economic growth in New Zealand is available at The full report identifies some key knowledge gaps and questions

GROWING PROSPERITY THE AUCKLAND PROSPERITY INDEX: CHALLENGES AND OPPORTUNITIES AUCKLAND ECONOMIC INSIGHTS SERIES

MARCH 2018 5 AUCKLAND ECONOMIC INSIGHTS SERIES GROWING PROSPERITY THE AUCKLAND PROSPERITY INDEX: CHALLENGES AND OPPORTUNITIES aucklandnz.com/business Infometrics.co.nz a 2 Auckland Economic Insights Series