• The Productivity Puzzle

    As the latest indicators show our economy struggling to escape recession, it is widely accepted that the key to improving our economic performance is to raise our productivity levels; and this is very much the focus of the government’s efforts to close the gap with Australia. But there is a mystery at the heart of our productivity performance. If we could solve that mystery, we might see our productivity performance lift very quickly.

    One of the reasons that high levels of productivity are important is that, by improving our competitiveness in the internationally traded goods sector, our exports are stimulated – and buoyant exports, by removing a balance of trade constraint on growth, allow us to grow faster both at home and in overseas markets. That faster growth in turn promotes productivity improvements and – hey presto – we are in a virtuous circle of export success and productivity growth.

    And this is indeed the experience of successful exporting economies. Their export industries exploit the larger markets and higher margins offered by the internationally traded goods sector, with the result that those industries grow quickly and lead the rest of the economy into productivity growth, rather as a locomotive leads a train. There is then a strong market imperative to move the economy’s best resources – of capital and skill – to those growth points in the economy.

    Those factors can become so powerful that a country like Japan in the 1960s and 1970s will develop virtually two economies; statistics from that era show that the Japanese domestic economy was very similar to other economies, with normal inflation, growth and productivity levels, whereas the export economy showed rapid growth, low inflation and high and fast-growing productivity. That experience has been shared, perhaps not quite so dramatically, by other successful exporting economies ever since.

    Some research* conducted two or three years ago on the New Zealand economy, however, suggests that we have not, for some reason, been able to tap into that successful experience. The research showed that – as expected – our exporting firms exhibited significantly higher levels of productivity than the generality of New Zealand firms. This is not surprising, since in general terms, only the more productive and therefore competitive enterprises can foot it in international markets.

    But, unexpectedly, the research showed that – for the period covered by the research, from 2000 through 2005 – productivity in our exporting firms grew no faster than in firms in the rest of the economy. The boost to growth and productivity as a consequence of exporting seems simply not to have materialised. Our exporters, despite being our best performers, were not able to gain the benefits from exporting that exporters elsewhere had found so valuable. This begs the obvious question – why?

    The question surely suggests that there are factors at work in our economy that inhibit our exporters but that are not evident in other more successful economies. Those factors, whatever they are, seem to mean that even our best firms, ready and primed to take advantage of export opportunities, cannot make them count.

    There is of course always a small number of firms that will make a breakthrough in terms of a new technology or a new product and will be able to sell successfully in overseas markets without worrying too much about price competitiveness. It is then tempting (and the temptation is often yielded to) to be diverted into concluding that such firms show the way to successful exporting, productivity and growth, and that that is the course the rest of the economy should follow.

    But most international markets are extremely price sensitive, and success in those markets depends crucially on the price competitiveness of the individual exporter, and even more of the export sector as a whole. Only if exporters are competitive in price terms can they grow market share and boost profits through healthy margins. Otherwise, they must choose between maintaining prices and losing market share, or dropping prices and taking lower margins.

    That is, indeed, what seems to be happening to New Zealand exporters. They get to the export starting line, but something then stops them from running a successful race. Their failure, or inability, to kick on means that they do not derive the expected advantage from faster growth, better returns, and higher productivity. The virtuous circle eludes them.

    We do not need to look far to identify the culprit. We have run, and have done for many years, a policy of perennially high interest rates and consequently over-valued exchange rates that has meant that our exporters are always fighting a head wind. They struggle to the starting line but are then weighed down, in price competition terms, by a dollar rate that cuts their margins and shrinks their markets.

    Our narrowly focused macro policy may, in other words, be more than an obstacle to individual exporters, but the major factor in our productivity disappointments. The key to our economic salvation may be a willingness to think again. Mystery solved?

    Bryan Gould

    6 July 2010

    *Some Rise by Sin, and Some by Virtue Fall: Firm Dynamics, Market Structure and Performance, by Richard Fabling (Reserve Bank of New Zealand), Arthur Grimes (Motu Economic & Public Policy Research), Lynda Sanderson (Ministry of Economic Development), Philip Stevens (Ministry of Economic Development)

    This article was published in the NZ Herald on 12 July.