Time for A Step Change
Europe’s leaders are being taught lessons that they refuse to learn. The Greek economy was always too weak to join the euro zone; now that it is – as a consequence – flat on its back and weighed down by debt, the “remedy” imposed on them by their European partners is an enforced dose of yet more austerity that will make it quite impossible for them ever to pay off their increased debts.
The consequences for the European – and ultimately the world – economy will be dire. Greece is only the beginning; a recession-infected Europe now looks inevitable. Already, even in remote New Zealand, we are being warned that the euro zone’s difficulties will mean a worse economic outlook for us in future years.
But before we put the entire blame for our woes on the Europeans, let us recognise that the bizarre European determination to treat austerity as the remedy for recession is shared by our own leaders. We seem to be locked into the same ideological deep-freeze.
We are, after all, now entering our fifth year of either negative or minimal growth. We, too, have insisted that the key to securing a recovery that seems constantly to disappear further over the horizon is to close part of our economy down.
Our principal goal, it seems, is not to reduce unemployment and get the economy moving, but to cut the level of government economic activity. The result? The economy continues to stultify and the government deficit proves increasingly stubborn and difficult to manage.
But our economic problems are not defined by the recession alone; they are more deep-seated than that. The simple truth is that, despite the great advantages of buoyant export markets and record commodity prices, we continue to live well beyond our means.
We make up the gap between what we earn and what we spend by borrowing from overseas and by selling off our assets to foreign owners. We have been doing this for decades, but the price we pay for this indulgence is getting increasingly steep. We have to pay an interest rate premium to foreign lenders, if they are to continue to lend to us, and we also have to pay to foreign owners – across the exchanges – the profits on the assets we no longer own, with the result that our perennial trade imbalance gets even harder to manage.
More and more of our national wealth goes overseas. We have less and less control over our own economy, as the proportion we actually own diminishes. High interest rates not only inhibit domestic investment but produce an overvalued dollar that prices our goods out of international markets, including our own, and reduces our return on those goods that we do sell.
We have been travelling down this no-exit road now for nearly thirty years. Yet our policy-makers still set their faces against any change of policy. We continue to assert that the only focus of macro-economic policy must be to control inflation, even though the measures we use to do so are poorly focused and slow-acting, and actually make our real problem much worse.
What is our real problem? It is certainly not inflation. It is that we are basically uncompetitive. We have steadfastly ignored the fact that the world has changed and that rapidly developing economies like China, India, Korea, Taiwan and Singapore are now super-competitive economic powers, determined to build on that huge advantage by holding down their exchange rates and becoming ever more competitive.
They have rapidly built the strength of their productive sectors and have earned huge trade surpluses which have allowed them to buy up the assets (including our own) that they will need for further development. Many of them already enjoy living standards better than ours and pay wages and salaries that are higher.
We, on the other hand, are arrogant (and stupid) enough to believe that competitiveness does not matter, and that we can – in defiance of economic rationality – continue to push up our exchange rate with impunity. By focusing on inflation, to the exclusion of other objectives, and using interest rates and an overvalued dollar in the attempt to control it, we make it inevitable that our lack of competitiveness gets worse.
The result is that we dare not grow – even in a recession – for fear of balance of trade constraints, and are reduced – for as long as we can find willing lenders and buyers – to financing our unsustainable consumption by overseas borrowing and selling off what little remains of our assets.
It is time that we realised that competitiveness produces improved productivity, and not the other way round. We cannot hope to innovate and develop if we are constantly fighting the headwind of being uncompetitive. We should no longer be tinkering at the margins, with largely ineffectual tax changes and constant but ineffectual exhortations to improve productivity; it is time to make a step change by making competitiveness the focus of policy.
But our leaders seem blithely unaware that their out-dated nostrums are destroying our economic future. The exchange rate, and issues of competitiveness, it seems, are no-go areas for discussion. They prefer their own simple certainties to the evidence before our eyes.
Bryan Gould
12 February 2012
This article was published in the NZ Herald on 14 February
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.
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