Robertson on productivity: not much basis for confidence

I’m not going to write much about the Productivity Hub (Productivity Commission, MBIE, Treasury, and Statistics New Zealand) conference yesterday on “Technological Change and Productivity”.   Not all of it was even about productivity, not all of it was even relevant to New Zealand (there was a genuinely fascinating presentation from a US academic on the economics of wind and solar power, which must matter a lot if half your power is generated from fossil fuels, but rather less so in a country where 90 per cent of power is hydro-generated).   And there was lots of focus on micro data on firm (or agency) level productivity, even though no work in that area has yet been shown to shed much light on the large gap between economywide average productivity in New Zealand and that in most other advanced OECD countries.   But the “Reddell hypothesis” did get a (positive) mention from the platform, when the Productivity Commission’s Director of Economics and Research, Paul Conway, reprised some of the thoughts from his 2016 “narrative”, highlighting the likely importance of the macroeconomic symptoms: persistently high real interest rates (relative to other countries) and a high real exchange rate.   Conway suggested that we should focus much more on bringing in highly-skilled migrants, and that if that led to a reduction in total numbers that might well be a good thing.     With 47 MBIE people among the 200 or so (mostly public service) registrations, I don’t suppose that proposition commanded universal assent, but there wasn’t any further open discussion.

I couldn’t stay for the final session, but fortunately that speech has been made widely available.  The Minister of Finance gave an address on “The Future of Work: Adaptability, Resilience, and Inclusion”.   At one level, I was pleasantly surprised: there was more about the productivity challenges New Zealand faces (our overall underperformance) than I’d expected.  And if I’m sceptical about the Treasury Living Standards Framework, and attempts to build policy around “well-being”, I couldn’t really disagree with the thrust of this line from early in the speech

Improving productivity is key to improving wellbeing. By producing more from every hour worked, businesses become more profitable, incomes rise, and workers’ wellbeing rises as time is freed up and purchasing power rises.

And it was good to have the new Minister of Finance remind us that productivity growth (lack of it) has been a longstanding problem in New Zealand.  Although even then he seemed inclined to underplay the problem: for example, basically no productivity growth at all for the last five years.   And he noted that GDP per hour worked is now around “20 per cent below the OECD average”.   But since the average includes places like Turkey and Mexico, and a group of countries (ex eastern bloc) which weren’t market economies at all 30 years ago, it might be better to highlight the point I made in yesterday’s post:   for New Zealand to catch up with the G7 economies as a whole, we’d require a 50 per cent lift from current levels (assuming those countries had no growth at all), and to match that group of highly productive northern European economies (France, Belgium, Netherlands, Germany, Switzerland and Denmark), we’d need more like a two-thirds increase.   Even to catch Australia –   which lags some way behind the OECD leaders –  would take a 40 per cent increase in economywide productivity.   That lost quarter-century won’t be regained easily.

But it is one thing to recite these numbers (early in one’s term as Minister of Finance).  As even Robertson put it

I am most certainly not the first New Zealand politician to both highlight the challenge of low productivity, nor to say that we will address it.  So the proof will be in what we actually do. 

And what is on that “to do” list?   And that is where it gets a bit disconcerting.

There are a couple of the reviews underway

Our Tax Working Group and the reforms we are making to the Reserve Bank Act are an important part of setting the path to a more productive economy.  That focus on improving productivity is at the heart of the terms of reference for both these reviews.

No serious observer believes that the sorts of changes foreshadowed for the Reserve Bank Act –  desirable as the general thrust might be –  will make any difference whatever to the trend level of productivity in New Zealand.  Monetary policy just isn’t that potent.  As for the Tax Working Group, a (limited) capital gains tax might, or might not, be a good idea but I’d be surprised if anyone believed it would make a very material difference to overall economic performance (and, after all, much of the TWG documentation has a prime focus on fairness).    For all the talk about “too much investment in housing” recall –  as the Minister doesn’t in his speech –  that a key element of government policy is building lots more houses.  Resources used for one thing can’t be used for other things.

What else is the government planning?

The government has committed itself to the goal of a net zero carbon economy by 2050.  This is an essential shift for New Zealand away from an economy that hastens climate change to one that is more sustainable and develops New Zealand’s strategic advantages.

We will need to ensure this is a just transition where affected industries and communities are given the support to find new sustainable growth opportunities.

Again, you might or might not think this is a worthwhile goal, but it isn’t going to lift economywide productivity relative to what would have happened without the net zero goal.   Even the Minister is here focused on smoothing transitions, minimising disruption.

Then there is skills.

The Future of Work was the catalyst for our three years’ free training and education policy. One of this Government’s key policies is to provide one year of free post-secondary education or training, gradually progressing to 3 years by 2025.

So in a country where the OECD data suggest that the skill levels of New Zealand workers are already among the very highest in the OECD, the government is going to spend rather a lot of money (all funded by taxes, with their deadweight costs), in the expectation that a marginal cohort of people who would not otherwise have invested in formal training/education will now do so.  Most of the immediate gains will go to people who would in any case have gone to university (or done other comparable training)  –  I’m expecting my kids to be in that category –  and most of the people who take up formal training who otherwise would not have done so, are likely to well below the leading edge in terms of productivity potential.    If there are gains at all economywide –  which seems unlikely, but I’m open to persausion –  they will almost certainly be pretty small.  It is mostly a middle class welfare policy, not a productivity policy.

Then there is regional development policy

A major example of this is the Provincial Growth Fund developed as part of our coalition agreement with New Zealand First.  This will see significant investments in the regions of New Zealand to grow sustainable and productive job opportunities.

The details of the Fund are to be released shortly and will provide some of the most significant development of our regions in decades.  These will be driven from the ground up, with the Government as an active partner.

If it ends up less bad than a boondoggle we should probably be grateful.  It isn’t the sort of policy that has a great track record, and it is hard to be optimistic that one new minister –  with a vote base to maintain –  is going to transform the sort of flabby thinking around regional development presented at Treasury late last year.   At very very best, it is all rather small beer.  Recall that we need a two-thirds lift in economywide average productivity to catch those northern Europeans.

It goes on

It is my strong belief that the most critical element to New Zealand succeeding in the Future of Work is a renewed social partnership between businesses, workers and the government. 

If we look at Germany as an example, union members often sit on company boards as part of the decision-making process, ensuring that employee wellbeing is considered alongside high-level corporate profit and financial targets.

One of my goals as Minister of Finance is to develop this new partnership at a system-wide level to promote a combined work stream on how we can apply these lessons to other industries and sectors. 

Maybe the Minister doesn’t see this sort of stuff mostly affecting productivity performance.  But if not, what will?

Perhaps R&D.

In the Coalition Agreement with New Zealand First we have set a target of hitting an R&D spend of 2% of GDP in ten years. That’s more than a 50% increase in R&D investment relative to GDP over that time and will make a significant contribution to improving our productivity.

Officials say that this is an ambitious goal. We believe this can be done, with the Government incentivising such vital work by the private sector.

Minister for Research, Science and Innovation, Megan Woods, has already begun work on overhauling New Zealand’s R&D regime, with Ministers set to discuss officials’ initial findings later this month. We are committed in the first instance to restoring R&D tax credits to give firms some certainty about their investments.

But, as with earlier comments the Minister made in his speech about relatively low rates of business investment, there is no suggestion that the government has thought about what it is in the economic environment that leaves private businesses –  pursuing profit opportunities where they find them –  unwilling to spend more, whether on R&D or investment.

It was interesting that the Minister of Finance chose to highlight comparisons with Germany in his speech.  As I’ve pointed out in an earlier post,  Germany doesn’t have an R&D tax credit (actually of those successful northern European countries I highlighted earlier, neither does Switzerland) –  although the senior OECD official whose seminar I attended the other day, who didn’t seem wildly enthused about the merits of such tax credits, did note that the German government is under business pressure to introduce such a scheme because, eg, France and the Netherlands have them.

There are stories galore about what gets claimed for under R&D tax credits, and one person at the seminar the other day indicated that the Australian government is currently looking to wind back its R&D tax credit, having realised that a significant amount of money is being rorted.  If free tertiary education is (largely) welfare for middle class parents and their children, R&D tax credits look like welfare for the owners (often foreign) of businesses.    The R&D spending already happening would, presumably, have taken place anyway, so if there is to be a tax credit in respect of that spending it is pure gift (on top of the advantage of being able to immediately expense anyway).   There will be significant incentives to reclassify some activities as R&D that weren’t previously (because there was no advantage to doing so).  Some of that will bring to light genuine R&D spending that wasn’t previously visible – slightly tongue in cheek, the OECD official noted this was one advantage of R&D credits.   Other spending won’t really be R&D at all, and IRD will be engaged in a constant battle to hold the line.  And perhaps there will be some additional R&D work undertaken that wouldn’t otherwise have occurred.  But surely –  a bit like the increased teritary participation that will flow from fee-free study –  most of that will be, almost by definition, the least valuable, most marginal, activities; the stuff not worth doing without a subsidy?

It is, frankly, a bit hard to believe that even the best R&D tax credit –  and I gather MBIE officials are working hard to limit any abuses and wasteful transfers in the forthcoming tax credit –  will be a transformative part of the story.

Let’s go back to those northern European countries, with a slide from the OECD official’s presentation:

pilat

France –  third bar from the left –  has some of most generous government support for business R&D of any country in the OECD database, including a generous tax credit.   That support has materially increased in the last decade, but it was still fourth highest in 2006 (the white diamond).   Germany (DEU) has low overall government support, and no R&D tax credit at all.     These are both advanced industrial economies, situated right next to each other, with lots of trade between them.   And here is OECD data on the respective levels of real GDP per hour worked.

fr and ger

Identical at the start, identical at the end, and never –  through the whole period (Mitterrand, absorbing East Germany or whatever) – any very material deviation between the two lines.  It is the sort of relationship –  univariate and all –  that makes it more than a little hard to take seriously suggestions that introducing an R&D tax credit here will make any material difference to our relative productivity performance.

And here is the OECD data (for 2015) on R&D spending in each of those six highly productive northern European countries, and New Zealand.  “BERD” is business expenditure on research and development.

R&D spend n europe.png

Remember that Germany and Switzerland are the two of the northern European group that don’t have R&D tax credits, and provide little direct government support to business R&D.   I’m not suggesting any sort of perverse relationship  –  a lot probably depends on the specific sectors businesses in particular countries concentrate on – but it should at least be a little sobering to reflect that the two countries in that grouping with no R&D tax credits have higher rates of business spending on R&D than any of the other countries in the group (even with all the incentives that such credits create to classify spending as “R&D”).  One might wonder if the big French incentives –  increased in the last decade –  might not have been sold on the basis on “we are lagging behind Germany in R&D spend” and need to “do something” to catch up.

Mostly, a reasonable hypothesis still looks to be that firms will invest (including spending on R&D) when it appears to be profitable for them to do so.  If so, it might be better to spend some more time understanding what holds firms back –  addressing issues at source if possible –  rather than just throwing more government money at a symptom.  There isn’t much sign the government has done anything more than highlight a few trendy symptoms, rather than really engaging in an integrated narrative of New Zealand’s economic performance.  The Minister of Finance concluded his speech yesterday

I want us to re-write our productivity story, so that New Zealand becomes a leading example of a sustainable and productive economy in which everyone gets a share of economic success.

It is a worthy aspiration –  shared, no doubt, by a long line of predecessors stretching back decades –  but there is little sign of the sort of serious thinking –  or even engagement with the full range of symptoms (eg weak export share, high real interest rates, high real exchange rate, physical remoteness and yet rapid population growth) – that would provide much reason for confidence that they might yet devise an effective strategy to respond to the specifics of New Zealand’s situation.

And since a common response whenever I write along these lines is “but what would you do differently?” here are links to a version of my story given to a business audience , a version given to the Fabian Society, a more recent version to a general audience.   In the margins of the conference yesterday, one person commented that he thought one problem was that few officials had read my original paper, prepared a few years ago for a Reserve Bank/Treasury-hosted conference, which puts the basics of the argument in a standard two-sector (tradables and non-tradables) analytical framework, here is the link to that paper too.