• The Productivity “Puzzle”

    The Prime Minister was surely right last week to identify low productivity as being at the heart of our economic problems. Low productivity has been a constant feature of our economic performance for at least the two decades leading up to the current recession, and it will remain our biggest headache as we face a post-recession future.

    The bad news is that the Prime Minister’s statement is not a brilliant new insight. If talking and worrying about low productivity was a cure, we would have solved it long ago. The difficulty has never been in identifying the problem – it has been in knowing what to do about it.

    There have of course always been those in denial. I remember being challenged in 1994 by Roger Kerr of the Business Roundtable to substantiate my assertion that New Zealand productivity was lagging badly. I think he assumed that the “reforms” of the preceding 10 years must have dealt with the issue. When I produced the figures (which have continued to be depressing ever since), I heard no more from him.

    It is not as if we haven’t tried the usually touted solutions. Privatisations, tax reforms, removing “labour market rigidities”, strict adherence to monetary policies, have all been tried – and none have worked. Nor is it that we are lazy; so bad has been our productivity performance that we have continued to lag in the OECD tables, despite working longer hours. As a result, the average New Zealand family is now up to $80,000 a year worse off than its Australian counterpart – no wonder the grass on the other side of the ditch looks greener.

    The Prime Minister’s statement has been given added weight, of course, by the credit rating downgrade applied to us last week by Fitch. The credit rating agency rightly pointed, not to the government’s deficit which they said was par for the course (prompting doubts about the priority given to it in framing the Budget), but to the indebtedness of the country as a whole. Our need to borrow at such high levels – one of the highest per capita levels in the world – is surely a function of our overall economic failure of which low productivity is both a symptom and a cause.

    If we really want to address the problem of low productivity, we need to do more than wring our hands and repeat the failed nostrums of the past. That is not to say that the Prime Minister’s list of initiatives is not a good one. As a former university Vice-Chancellor and current Chair of the Foundation for Research Science and Technology, I am the last person to cavil, for example, at the emphasis on increased investment in higher education and research, but these are necessary rather than sufficient pre-conditions for better productivity.

    If we really want to solve our problems, we need to take a broader view. A broad economic failure is likely to have an equally broad economic cause. But that is the one possibility that our policy-makers have resolutely refused to contemplate. If low productivity is both a consequence and a cause of poor economic performance, should we not at least be asking whether our economic policy settings over recent decades have been correct?

    Productivity is a function of many factors, almost all of which cost money. To improve productivity, New Zealand firms need to spend on new skills training, new technology, new product development, new equipment, new market development, new research and development. The truth is that the New Zealand productive economy has not been competitive or profitable enough to invest in international standards of productivity growth.

    Has this happened for reasons beyond our control? No, we have done it to ourselves. Our insistence on exclusively targeting inflation and on using interest rates and the exchange rate to restrain economic activity has meant a built-in and continuing bias – over decades – against growth, profitability and investment. Number 8 wire has its uses, but as an alternative to a macro-economic policy that focuses on good and sustained profits that are re-invested in new productive capacity, it falls somewhat short.

    Some recent research about New Zealand productivity is most instructive. It shows that, as expected, our export firms are our most productive – typically, it is only the most competitive enterprises that will venture into export markets.

    Less expectedly, however, it also shows that our export firms did not increase their productivity any faster than others. They did not, in other words, “kick on”, to take advantage of bigger and more profitable markets overseas. One can only conclude that there was something in the domestic environment that inhibited them – that the burdens of high interest rates and therefore expensive borrowing to finance expansion, and of an over-valued dollar that reduced price competitiveness and cut profit margins, had meant that New Zealand exporters had simply been unable to invest in the productivity growth that was needed to maintain and improve competitiveness against overseas rivals. They were, at best, hanging on by their fingernails. Some, like Fisher and Paykel, gave up, and moved their operations overseas.

    Isn’t it time that we removed our ideological blinkers and applied some common sense?

    Bryan Gould

    18 July 2009