Two improbable outposts

Monday afternoon’s post was prompted by news of the New Zealand Initiative’s business leaders’ study tour to Switzerland.  Switzerland is materially better off than New Zealand, but as I illustrated over the last 45 years it is the only advanced country to have managed lower productivity growth than New Zealand.

The news of the Swiss trip reminded me of a story I’d seen a while ago, and had meant to write about, about another business study tour (involving at least some of the same people), to another laggard OECD economy, Israel.  Even the Prime Minister’s chief science adviser went along.  That trip was promoted by the Trans-Tasman Business Circle.   You can read about it here in a story written by a journalist who was invited along on the trip (or there is an Israeli perspective here).

Most people have heard of Israel’s high-tech sector, which was the focus of this New Zealand mission.   Somehow, there is an impression around in many circles –  I recall first encountering it at The Treasury –  that Israel is an economic success story.   Here are a couple of snippets from the Herald story

The mission will visit leading Israeli companies and institutions.

This includes Start-Up Nation Central, which connects companies and countries to the people and technologies in Israel that can solve their most pressing challenges.

Start-Up Nation Central was inspired by the 2009 best-selling book Start-Up Nation: The Story of Israel’s Economic Miracle, which explores the roots of Israeli innovation. The book continues to generate enormous demand from around the world for access to the people and technologies of Israel’s innovation ecosystem.

and

Why Israel? Moutter reckons while there are obvious differences, New Zealand shares many things with Israel. “We are both relatively young countries, with a culture and heritage of innovation, as well as some similarities in terms of market scale – from our perspective Israel is a more comparable point of reference for New Zealand than larger innovation ecosystems such as Silicon Valley or Shanghai. How has this small nation, less than 70 years old, with less natural resources than New Zealand, in one of the most volatile regions in the world, become widely known as the Start-Up Nation? I believe it will be invaluable for New Zealand to have greater insight into this journey.”

Sounds good. It is a shame about the hard data.

In the modern sense, both Israel and New Zealand are young countries.   And they are both somewhat improbable outposts.    New Zealand was the last major land mass settled by humans, and was so remote that until the 19th century all economic activity had to occur within these islands. Foreign trade wasn’t possible, or economic.   Technology changed that and for a time –  after the land was taken more or less by force and the indigenous culture displaced – an economy grew here that supported some of the highest material living standards in the world, for a pretty small number of people.  We remain physically remote, and that still seems to matter rather a lot.

As for Israel, the land itself has been close to where major civilisations grew and prospered long ago. Ancient Israel itself was, for a time, a rich kingdom.   But in the 19th century there wasn’t much high value economic activity there.   Through some mix of ideology, religious convictions, the horrors of Nazi Germany, and other later push and pull factors, a mass relocation of Jewish people has occurred.  In a land taken more or less by force, in the process something fairly remarkable has been built –  a relatively rich democratic society, in a region with little or no tradition of democracy and where modern prosperity has otherwise been achieved only in some of the countries with oil windfalls.  Physical distance isn’t such an issue for Israel.  It is surrounded by countries with hundreds of millions of people.    Unfortunately for Israel, many of the regimes of those countries (or popular movements those regimes suppress) would like nothing more than the destruction of the state of Israel.   Sixteen countries, apparently, ban altogether people on Israeli passports, and most of those countries are quite physically close.  So, mostly, economic and social ties aren’t close.  In an age when distance seems to matter rather a lot.

As I did with my Swiss post the other day, I’m going to start my comparisons from around 1970 where possible.  For us, it was just before Britain entered the EU and before the dislocations of the collapse in the terms of trade in the 1970s.  For Israel, it was 20 years after independence, when the country had achieved reasonable size (the population then was very similar to New Zealand’s, at just under three million), and it was few years after Israel’s greatest military success.

Unfortunately, not all of the Israeli data goes back that far (especially in the OECD databases).  As I showed the other day, in 1970 New Zealand’s labour productivity (real GDP per hour worked) was just a touch below that of the median OECD country (in company with the larger European countries).     I couldn’t find good comparable data for Israel for 1970 (whether for GDP per hour worked or real GDP per capita) but it looks as though Israel had outcomes pretty similar to New Zealand, perhaps just a little below.   On the earliest OECD data I could find, Israel’s real GDP per capita was around 5 per cent less than New Zealand’s in 1977, and the few years leading up to 1977 were bad ones for New Zealand.

The OECD has real GDP per hour worked data for Israel from 1981.   This chart shows how New Zealand and Israel have done relative to the median of the OECD countries for which there was 1970 data (ie mostly those who were really prosperous and democratic back then).

israel real gdp phw

Israel’s outcomes, at least on this score, look a lot like New Zealand’s.      New Zealand’s have been pretty poor.    The median real GDP per hour worked for that group of country (mostly the rich countries in 1970) is 42 per cent above New Zealand’s 2015 number.

From 1981 to 2015. the median OECD country achieved growth in real GDP per hour worked of 72.7 per cent.  That was around the sort of increase the US and the UK experienced.    But here are bottom five growth rate countries over that period

Growth (%) in real GDP phw 1981-2015 Level in 2015 (USD, converted at 2010 PPPs)
New Zealand 56.5 37.5
Netherlands 54.0 61.5
Israel 52.3 35.1
Italy 39.9 47.7
Switzerland  37.5 56.5

New Zealand wasn’t the worst, and neither was Israel.    But both New Zealand and Israel started out materially less productive than the Netherlands, Italy and Switzerland, and we still languish well down the field.   For all its problems, even Italy manages much higher average labour productivity than either Israel or New Zealand.

The picture doesn’t change much if, say, one starts the comparison from 1990 (after many of our reforms had been done).    We and Israel still managed labour productivity growth in the bottom quartile of OECD countries.

What about foreign trade?  It is now better realised that New Zealand’s export (and import) share of GDP has been going nowhere for quite some time.  By contrast, world trade as a share of GDP has been trending strongly upwards over the decades.  And while exports aren’t some panacea –  governments can always subsidise them and get more of them –  in successful highly productive economies, an increasing share of foreign trade (again imports as well as exports) is usually part of the mix.  In fact, I’m not aware of any country that has successfully closed the economic gaps to the leading economies, without export success playing a material part.

So here is a chart of exports as a share of GDP, for Israel, New Zealand and for the OECD as a whole, since 1971.

israel exports

Being small countries, you would expect both Israel and New Zealand to do more foreign trade than larger countries.  As the chart shows, both countries used to export a lot more (share of GDP) than did the OECD countries as a whole (in which, of course, the US is a large share).   That is no longer so, despite (in Israel’s case) that vaunted high-tech sector.  Firms in both countries  –  remote in their own ways –  find it more difficult to be a part of global value chains than, say, contiguous European countries (in something approaching a single market) do.  But whatever the full set of reasons, it isn’t an encouraging picture.

One factor, so I hypothesise, might be relatively rapid population growth.  As I noted, in 1970 Israel and New Zealand had similar populations.  Now Israel is getting on for double New Zealand’s population.

Using the United Nations population data, here is a chart of population growth since 1990.

israel popn

High-income countries in total have had population growth or around 16.5 per cent over that period.  New Zealand’s population has increased much faster than that (at around 35 per cent), and Israel’s population has increased much more rapidly still, up by around 79 per cent.

If there are lots of great new opportunities in a country, population growth needn’t impede productivity growth. In some cases, it might even help it.  Australia, for example, has also had rapid population growth, but seems to have had enough new opportunities (all those minerals) that its overall productivity and per capita income performance hasn’t been bad (although far from top tier).

What of New Zealand and Israel?  There don’t seem to have been many new high value opportunities in New Zealand –  in fact, in the article on the mission to Israel one thing that struck me was how many of the listed participants were from domestic-focused firms.   For Israel, one might have supposed it was different (all those high tech firms).

I’ve argued for some years, that rapid population growth can crowd out other business activities.  The basic logic is pretty simple.   New people –  whether born or migrant –  need new capital stock.  A modern economy requires rather a lot of (physical) capital per person (houses, roads, offices, schools, shops, machines etc) and real resources that have to be devoted to meeting the needs and demand of the new people, can’t be used for other purposes.  It is often those “other purposes” that seem to get squeezed out –  in particular, investment in the tradables sector.  People have to live somewhere, so that demand is often more inelastic (insensitive to changes in price) than is potential investment in support of new business opportunities

It needn’t happen.  A country with a fast-growing population could also have a higher than usual savings rate.   That would free up resources to meet both potential needs.  Over time, one might expect that.  And a country with a fast-growing population might also meet some of its needs by running a current account deficit (drawing on resources from the rest of the world).  But while you import a car, you can’t import non-tradables.  So current account deficits can help, but they don’t relieve all the pressure.

What do the summary data suggest? The IMF publishes data on the savings and investment rates for each advanced country back to 1980.  Over that period, both Israel (in particular) and New Zealand have had materially faster population growth than the median advanced country.   All else equal, that should have been reflected in a higher share of GDP having to be devoted to investment in both New Zealand and Israel than in the typical advanced economy.

But here are the data

israel I There is plenty of cyclical variation, but in both countries on average over this period, the share of investment spending in GDP has been a bit lower than advanced country median.     Given all the resources that needed to go to meeting the needs of the fast-growing populations (simply maintaining capital per person), there will have been materially less “left over” for capital deepening, or for new businesses and ideas.  It isn’t a mechanical rationing process, but just a response to the opportunities and the relative prices.

And here is the same comparison for national savings rates.

Israel savings

Again, despite the much more rapid population growth rates, both countries have had lower national savings rates than the median advanced country over this period.

I don’t know enough detail about Israel to be highly confident about quite what mix of factors is important in explaining its sustained underperformance (relative to other advanced, and key emerging, economies).  But the underperformance is pretty clear.  Israel’s productivity, like New Zealand’s, languishes towards the lower end of the OECD (and certainly of those OECD countries that were market economies a few decades ago).  Perhaps there are some specifics in the Israeli high-tech sector from which visitors can learn.   But if, to some extent, Israel’s sheer survival (so far) might be loosely termed a “miracle”, it isn’t clear that its economic performance is anything of the sort.   Very rapid population growth looks like it might have been part of the story (whatever it has done in terms of boosting the number of future IDF soldiers).

24 thoughts on “Two improbable outposts

  1. When comparing the productivity of Israel shouldn’t also discuss the effects of large annual multi-billion USA government subsidies, plus USA military subsidies, plus USA government preferential privileges, plus the global system of synagogue donations channelling multi-billion funds into Israel annually – where it all goes I know not – but by way of comparison New Zealand does not share in the same munificence

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      • Yes, I agree those are all relevant factors. As is the imperative of the defence industry – survival in part depends on constant innovation etc. Then again, defence costs are big burden on living standards.

        Windfalls – whether natural resources or cash transfers – are undoubtedly a short-term gain, but it isn’t so clear that they are helpful long-term. They can lead to an overvalued real exchange rate, and take pressure off the need for local innovation. I’m not close enough to Israel to know quite how it applies there, but it is an issue with remittance flows to plenty of less developed countries.

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  2. It’s very hard to create widespread prosperity with high tech alone.

    To give them some credit, I see Israel has been improving their savings rate. I wonder if that is from the retained earnings of some of the successful high tech firms.

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    • Fiscal policy looks to have been a bit less deficit-prone that it once was.

      I’m sure there are lots of micro policy improvements Israel could do – I recall a visit a few years ago from someone from their Finance Ministry who was telling me how messed up their land use/housing policies are.

      But overall, I’m not inclined to be that critical of their economic performance – given the location and the demographic imperatives (that make immigration more about defence and Jewish identity than about productivity) perhaps they doing are about as well as you could reasonably expect given the constraints (given that no one has perfect micro policies).

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      • I would agree its pretty messed up. More like compulsory seizure of disputed palestinian lands for free, build the houses for new settlers and charge new settlers full price for land and building and making a massive profit on the sale.

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  3. Somewhat on the ‘saving-investment’ comments, do you think future NZ governments should target further reductions in net debt or invest in roads, schools, etc? I guess we all need a cushion for ‘shocks’ to come but on a relative basis, NZ seems to have wiggle room…?

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  4. If the population is going to keep on growing at anything like 2% pa we clearly lots more physical capital. That said, a lot of the roads the get built (perhaps esp outside Akld) have such poor cost-benefit returns, that I’m sure we could do better just be reallocating spending already being done. Transmission Gully is a prime example.

    I’m very sceptical of the “interest rates are low so we shld borrow more” line. Interest rates are low for a reason, and after 8 years it clearly isn’t just cyclical. And, of course, low as global rates are, we still have the highest real rates anywhere in the developed world, so should be particularly cautious.

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      • that is what comes of having a modest savings rate, which runs head on into the investment needs of a population rising materially faster than in most other advanced economies…….. What gets squeezed out is the most interest and exchange rate sensitive spending – typically, the discretionary business investment.

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      • Its an interesting point; how do the Israeli real interest rates compare with ours over time? I did a quick look around and they look quite a bit lower than ours.

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      • Yes, Israeli rates are a lot lower than ours. Their policy rate has been effectively zero for several years.

        I want to dig into the Israel story a bit more deeply, but the increased national savings rate over the last few years (see chart in the post) may be part of the story in Israel.

        Thus, some people who accept my general analytical framework will respond that “so we should take steps to raise national savings rates in NZ”. With the govt already having a balanced budget, I’m sceptical of the merits of that approach.

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      • NZ households have $160 billion in cash deposits plus $60 in KiwiSaver and listed shares with $1.2trillion in net wealth including house value of which 33% is fully paid up and only $160 billion in debt. Not exactly modest.

        NZ Interest rates look more like a monopoly driven bonanza for our Australian owned banks with $5billion sucked out of NZ to Australian Shareholders. HSBC is offering 4.09% for 18 months fixed but our Australian owned banks continue to raise interest rates now at 4.85% for 2 year fixed. Part of that is due to collusion with the RBNZ with its recent rushed 40% equity rule that makes many customers captive to their banks. The lack of competition is very apparent.

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      • Australian tax authorities are now levying a additional tax 0n Australian banks which is a clear recognition that exorbitant profits are being made by our Australian monopoly banks. NZ must move with more speed to prevent further erosion of kiwi wealth from excessive bank profits.

        “Australian Federal budget 2017: Banks face new tax, bigger penalties for misconduct. However, given Australia’s relatively concentrated banking sector, dominated by the big four, it is also likely to see an increase in mortgage and/or other lending interest rates to maintain profitability.

        In an effort to combat this, the Government said the Australian Competition and Consumer Commission (ACCC) would undertake a residential mortgage pricing inquiry for the next year.”

        http://www.abc.net.au/news/story-streams/federal-budget-2017/2017-05-09/federal-budget-2017-big-banks-bear-the-brunt/8511364

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  5. I’m skeptical about ‘high tech innovation’ especially in a small country. If the idea is unique and great then it is too easy for the big (USA) country to lean on the little country – for example any new computer concepts from the UK from WW2 to about 1980 when the UK computer manufacturers collapsed. Once the US defence force says we will only buy from an American business the technology moves to America.
    The rare big success stories in small countries such as Nokia in Finland show how a big success can lead to a big failure and I’m guessing the rest of the Finish tech companies couldn’t absorb all the talent laid off by Nokia.
    The problem with real technical innovation is someone can come along with either a replacement innovation or much the same but with better marketing: Lotus -> Excel; Betamax -> VHS -> DVD -> Internet cloud; Netscape -> IE -> Firefox -> etc. Brilliant ideas are very easy; it is the implementation that matters, don’t the Japanese have a term for it about continual tiny improvements.
    Apparently the common feature for big manufacturing success is an endless collection of small businesses or that is what I was told about Birmingham in its heyday and also about Toyota’s suppliers and I’m guessing much of China’s current success – plenty of small flexible businesses is the secret. In NZ we call them farms?
    Meanwhile I have a some innovations; would someone would like to take them off my hands for a modest tithe: the childproof lock on a fridge, axe handles made of black palm, bilum handbags?

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    • I have some sympathy with that perspective (altho I’m not disputing the success of Israel’s high tech sector, just noting that it doesn’t seem to be enough). My prediction remains that if, say, Xero is a success – which is perhaps looking more likely – its ownership and management won’t be based in NZ for long.

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      • I was thinking of Xero too.
        For really cheap pure programming then India is the place but most IT jobs require social interactions as well as computing expertise – New Zealanders had that balance and so did Aussies and Poms. I had the impression in PNG that New Zealanders were slightly preferred for computing and accounting jobs because they were cheaper.

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      • Kiwi software company Xero is offering to help some of its American staff move to New Zealand in the wake of the US election. He said the company would help staff make the move to New Zealand – “just because we like to hang out with y’all”.

        Wellington-based business incubator Creative HQ is also encouraging Americans to head down under.

        “Disappointed by the election results? Build the future from New Zealand,” the company says on its homepage.

        http://www.nzherald.co.nz/business/news/article.cfm?c_id=3&objectid=11745744

        Looks like NZ IT companies would prefer to stay in NZ.

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      • Time will tell. In many cases of successful NZ-founded companies (and it isn’t just true of NZ, but of other peripheral places), some overseas bidder eventually recognises the value of what has been created, reckons even more value could be created if located nearer global markets/resources etc and offers a price that shareholders can’t responsibly refuse. In fact, it is almost everyone’s interests for them to accept. there are exceptions of course – especially if a founder maintains effective control, and puts a high premium on his/her home location.

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  6. There’s got to be something tenuous if you are looking for linkages between the Israeli high tech sector and local productivity. The destination for their start-up IPOs is usually not the Tel Aviv stock exchange but London or NY. To wit, the listing of this nano satellite company in Perth (of all places) which is now about to deliver dirt cheap telecommunication services for the entire African continent using technology born in IDF labs. To some of those 90000 odd negatively geared NZ house loving investors who happen to read this blog, the market cap of that company has multiplied by a tad near 10 times in the past year while it’s on its way to deliver badly needed services to a billion souls.

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    • Yes, but which stock market a company might be listed on isn’t really the key issue, if one is looking at national accounts issue. These firms were developed in Israel, many still operate from Israel, they use a lot of Israeli IP and human capital. And yet – for all those successes (and I’m not trying to cast doubt on the reality of them) it hasn’t been enough to lift Israel’s productivity from the tail end of the OECD group. I suspect very rapid population growth is likely to be part – tho only part – of the answer. No one would have thought that proposition very surprising even 50 years ago (indeed, there was an empirical paper showing exactly such results in the premier economics journal about 30 years ago, across the pool of advanced countries).

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  7. Productivity growth from my point of view is a proxy for manufacturing. Manufacturing is scalable and especially now with automation.
    Those example you site, are a proxy for manufacturing. This is my hypothesis.
    Netherland, has a large manufacturing base, helped in part have a large ‘domestic (EU)’ market.
    Australia’s productivity growth is predominately due to mining. Which is particulary scalable. From my experience, the service sector in Australia and many other countries are not particularly that more productive than NZ (less so ). Israel is not suitable for a large scale manufacturing base, nor is NZ.
    Low volume, high value exports like tech, medicines, IT services are definitely feasible in these type of countries.
    NZ’s main manufacturing output is agricultural. Unfortunately, the NZ mindset is not export related for non-agricultural products where we have a natural advantage. NZers are not as hungry for success and there is not that drive for success and survival that you have in other countries.
    Those countries with high productive growth amongst developed nations are those situated in precarious environments; lack of agricultural/mineral wealth. They need to export/manufacture to survive. e.g South Korea, Japan, Taiwan, Singapore, Netherland, Germany.

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  8. In 2011, hundreds of thousands of Israelis took to the streets protesting, among other things, the cost of living. For some reason, that economy is still put out there by the mainstream media as worthy of our attention. (I think Fran O’Sullivan did one such piece) .

    Perhaps the Jewish diaspora repatriate earnings? Like the Pacific Island MIRAB model (Migration, Remittance, Aid and Bureaucracy), they’re somewhat nobbled.

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