Poor returns to tertiary education

Tertiary education was quite a theme in the recent election campaign. In my household – with three kids likely to go to university in the next decade – promises to reduce the direct costs of tertiary education were tempting.  But resisting temptation remains a virtue.

A few days ago I noticed (thanks to Jim Rose) this chart

lifetime benefit of a degree

It isn’t a new result. These OECD data have shown for some time that the economic returns in New Zealand to getting a degree are pretty low relative to those in other advanced countries.   Such results even prompted Treasury to commission some external research on the gap in private returns.

In the chart – from a few years ago – whoever put it together has highlighted two groups of countries: the Nordic and Benelux countries on the one hand, where there are already lots of skilled people, and high income taxes, and former eastern-bloc countries which are now catching up to the rest of the advanced world, and where skills are in high demand, and able to command high returns. I’m, of course, more interested in the contrast between New Zealand and those central European countries.  As I’ve written recently, 25 years ago both we and they were looking to reverse decades of poor performance and catch-up with the other advanced countries. They’ve made progress in that direction. We haven’t.

Since the net benefits are shown in dollar terms (rather than, say, as a per cent of GDP per capita or of lifetime earnings), it is probably reasonable to expect that poorer countries will be bunched towards the left of the chart. And there one finds Turkey, Greece, New Zealand and Italy. But that clearly isn’t the bulk of the story. After all, even though they are now catching up, all six of the former eastern bloc countries shown still have levels of GDP per hour worked and/or GDP per capita similar to or (generally) below, those of New Zealand.

I had a look at a few background documents from the OECD. If anything, as we shall see, the New Zealand numbers may be even worse than what is shown in this chart.

It is important to recognise the distinction the OECD draws between private and public costs and benefits. Some of these things can be easily measured (eg upfront private fees, or direct public grants to institutions or individuals). Others are more approximate. (The other aspect, which I’m not sure any of these particular indicators attempts to account for is the selection bias, in which the typical person who undertakes tertiary study has other traits – eg intelligence – that mean that they would probably earn more in the labour force than the average person who does not undertake tertiary study.)

This chart is from a few years ago, and tries to break down the costs of tertiary education (in this case for a man). In New Zealand, as in most countries, the largest private cost by a considerable margin, is the foregone earnings of the student themselves.

tertiary costs

These OECD indicators assume that students do not work while studying.  In the latest OECD Education at a Glance they show estimates for 15 countries as to how much difference it would make to include reasonable estimates of actual student earnings. For New Zealand, doing so would lift the estimated returns to tertiary education by around 15 per cent, more than for most of the other countries shown. However, as you can see from the first chart above, a 15 per cent lift in returns to tertiary study in New Zealand would not alter our relative position on the chart.

The other aspect of the calculations which often doesn’t get much attention is the appropriate discount rate to use in making these calculations. It matters a lot – the costs are mostly incurred between, say, ages 18 and 22, and the economic benefits accrue over decades. A decision by an individual is a very long-lasting investment project, with significant irreversibilities (the years spent on education can’t be reclaimed).

The OECD at present adopts a very low discount rate.

The NPV results presented in the tables and figures of this indicator are calculated using a discount rate of 2%, based on the average real interest on government bonds across OECD countries. However, it can be argued that education is not a risk-free investment, and that therefore a higher discount rate should be used.

I’d say there was no ‘it can be argued” about it. No sensible government would do a cost-benefit analysis of building more schools or universities using a discount rate of 2 per cent. The New Zealand Treasury, for example, uses a default discount rate of 6 per cent real. And as an economic proposition, an individual’s tertiary education is a pretty risky proposition, with few effective diversification options for most people.

As it happens, in the latest Education at a Glance the OECD presents a table illustrating, to some extent, what difference it makes to use a higher discount rate.

discount rates.png

Using a discount rate of 5 per cent (real) reduces the estimated benefits by around 60 per cent (relative to the 2 per cent baseline) – and these numbers are for a man, and in most countries the net benefits to tertiary education for a woman are (on average) lower than for a man.

This issue matters particularly for New Zealand which has a higher risk-free interest rate on average than any of the other countries in the table. The gap is large. On Friday, the real interest rate on the New Zealand government’s longest (23 year) inflation-indexed bond was 2.39 per cent, while that for the US government’s 20 year indexed bond was 0.77 per cent (and US yields are far from the lowest in the world). A margin of 1.5 percentage points above “world” rates hasn’t been a bad guide for New Zealand interest rates over recent decades.

Even a 5 per cent real discount rate appears too low to evaluate a personal decision to invest in a tertiary education in New Zealand. But if one takes the results for New Zealand in the table above when evaluated at a 5 per cent discount rate, and then compares them against the results evaluated at 3.5 per cent for other countries (to capture that persistent difference in real interest rates), only Latvia would offer lower returns to tertiary education than New Zealand does.

And bump up the discount rate a little more and the estimated net returns to tertiary study will soon be approaching zero or going negative.  And, remember, those estimates are for a man. The average female returns are even lower.

People will have a range of reactions to these sorts of numbers. Some will take them as supporting proposals to reduce tertiary fees or increase student allowances. Such changes might increase the net private returns to tertiary education, but they won’t (of course) change the all-up net returns (someone still has to pay).  Others seem to see tertiary education as some sort of “merit good” that people should have the opportunity to undertake, at moderate expense, whether there is an economic return – to them, or the public more generally – or not.  And, of course, for some people and some courses, a tertiary education is more akin to consumption than investment (which is not intended as a criticism).

For me, I see them as yet another marker of the failure of the economic strategy pursued by successive governments over recent decades.  Our remoteness means it is very difficult to generate consistently high returns to anything much in New Zealand for very many people. The determination of our governments to quite rapidly increase the population here, despite those apparently limited opportunities, just compounds the problem. It does so directly – the limited natural resources (our one distinctive advantage) are spread over ever more people – and indirectly, through a persistently overvalued real exchange rate and high real interest rates.

Returns to tertiary education in New Zealand are probably quite reasonable for those New Zealanders who get an education here, and then leave (but that is probably a poor investment for the taxpayer). For many of those who stay, it looks like a distinctly marginal proposition. Attempting to bring in lots more skilled people from abroad – most of whom aren’t that skilled anyway – just compounds the economic problem, even if the New Zealand taxpayer doesn’t have to pay anything for their tertiary education. There just aren’t the good economic opportunities here for a rapidly growing population, and increasing subsidies to tertiary education would seem likely to further exaggerate the evident imbalances.

In an economy that was making progress towards reversing decades of relative economic decline, there is good reason to expect that returns to investment in tertiary education (like other prospective investment returns) should be consistently high relative to those in other countries. Sadly, those returns appear to be consistently low in New Zealand – especially when evaluated at an appropriate discount rate. And, of course, we are making no progress at all in closing those productivity gaps.

A problem awaiting the new government

Whichever party, or group of parties, gets to form the next government will face the same facts about our disappointing economic performance.  As I noted a few weeks ago, based on the recent PREFU projections, not even Treasury seemed to rate very highly the chances of meeting the National-led government’s export objective.

Here is the share of exports in GDP, showing actuals for the last decade or so, and Treasury’s projections for the next few years.

x to gdp

By the end of that forecast period, there will only be four more years until the goal of a much-increased export share of GDP was to be met.  On these numbers, exports as a share of GDP would by then be at their lowest since 1989, 32 years earlier.  So much for a more open globalising economy.

One of the indicators I like to use is a rather rough and ready decomposition of real GDP into its tradable and non-tradable components, first developed by an IMF staffer looking at New Zealand a decade or so ago.    It assigns the primary sector and the manufacturing sector components of real production GDP, and the exports of services component of expenditure GDP, to the tradables sector –  the bits where New Zealand firms are competing with the rest of the world.  The rest of GDP is classed as non-tradable.    It isn’t a precise delineation by any means: some local manufacturing isn’t really tradable (due to high weight and low value, and thus transport costs) and, for example, the electricity generated for Comalco is, in effect, tradable.   But, broadly speaking, it seems to capture something meaningful about the New Zealand economy.  In the early days of the National government, then Minister of Finance Bill English was quite keen on it.

All economies need firms in both tradables and non-tradables sectors.  So one sector isn’t inherently better or worse than the other.  But countries that are catching up with the world-leading economies tend to be ones in which the tradables sector (exports and import-competers) lead the way.  In such economies, firms are finding more and better, more lucrative, ways to tap the much larger global market.  Of course, we also gain when the non-tradables sector is becoming more productive –  both directly as consumers, and as a reduction in the input costs of tradables sector firms.    But there is a limit to how many cafe meals we can serve each other.  There isn’t really a technical limit on, say, how many smart ideas, translated into appealing products, that firms in a small country could sell to the rest of the big world.

As well as dividing real GDP into tradables and non-tradables components, I’ve also expressed both components in per capita terms.    Over long periods of time, most real economic series trend upwards, and actually it is something like per capita production or value-added that matters most in looking at gains in material well-being.   Here is the latest version of my chart, updated for last week’s GDP release.

t and nt components to jun 17

The series do bob around a bit.  The tradables sector, for example, had a very good June quarter on the back of a couple of tourism one-offs (the World Masters’ Games and the Lions tour) but then it had had a poor year last year.   But what I try to draw attention to is that (a) the peak in the tradables series was as long ago as 2004, and (b) real per capita tradables sector output is now no higher than it was at the end of 2000, almost 17 years ago.  Across the whole terms of two governments, one National-led and one Labour-led, there has been almost no growth at all in the real per capita GDP of the tradables sector. None.

Some economists really don’t like the chart.  So lets look instead at each of the components that make up the tradables sector measure.

tradables components 2

Services exports, in real per capita terms, did very well in the 1990s, growing quite strongly until around 2002.  But, overall, almost no growth since.   The mining sector briefly did very well around 2007/08 when a new oil well came on stream.   And, in per capita terms, the agriculture, forestry and fishing component of production GDP, and the manufacturing component, have gone almost nowhere over 25 years, again in real per capita terms.

What changed 15 years ago?  Well, one of the things that has changed a great deal is the real exchange rate.  Here is a chart of the Reserve Bank’s index, showing an average for the last 15 years (as well as one for the previous few years).

rer to july 17

It is unlikely –  all but inconceivable in fact –  that if we keep on doing what we’ve been doing for the last 15 years or more, in terms of economic policy settings, that we’ll see any sustained per capita growth in our tradables sectors.  It is that old line about a definition of insanity being doing the same stuff over again and expecting a different result.

Even to sustain those sectors at the sort of flat levels –  no growth at all – we’ve had over the last 15 years or more has involved the significant subsidies of (a) unpriced pollution externalities especially around water, (b) significant direct subsidies (to, most notably, the film industry) and (c) significant effective subsidies to the export education industry (by offering a bundled product where students can pay for an education –  in some cases an “education” –  and get preferred access to work and residence visa entitlements too –  that benefit being provided free to the providers by the New Zealand government).

I’d be very happy for a new government, of whatever stripe, to deal directly to any or all of those distortions.  But they, and their advisers, need to bear in mind that exchange rate chart.   Unless the real exchange rate falls quite materially, it is difficult to envisage much growth in other tradables industries to replace the shrinkage in the subsidised industries.  (It was exactly the same issues policy advisers faced when we started liberalising, and stripping away earlier subsidies, in 1984.)   Real exchange rates can’t be managed directly, but they can be materially influenced by removing the sorts of other policy distortions that put intense pressure on domestic resources, and drive up the prices of non-tradables relative to tradables, skewing the economy away from the tradables sector.

I’m not optimistic about prospects, but the good thing about pessimism is that one can, just occasionally, be pleasantly surprised.

 

Productivity and employment

With 30 seconds thought it is pretty obvious that if the least productive 10 per cent of our workforce simply dropped out and stayed home, then across the whole economy average GDP per hour worked would increase, all else equal.   All else equal, the productivity of any particular individual still employed wouldn’t change –  in practice it might well, as someone would still have to do the filing or the cleaning –  but the average would.

So far, so uncontroversial.  No one thinks it would be a sensible policy approach to lifting productivity to, say, bar such low productivity people from working.  Doing so would not only be inhumane, but it would make us, on average, poorer (output is still output, even if productivity of the marginal worker is below average).    In practice, of course, high minimum wages (relative to the market median), as in New Zealand, have exactly that effect –  pricing some low-productivity people (who couldn’t, at present, command a wage in the market at least equal to the statutory minimum.

But every so often in the last 20 years, as people have tried to grapple with New Zealand’s continuing poor average levels of GDP per hour worked, and the failure to achieve any convergence to the (now) richer members of the OECD, someone pops up with line “ah, but we are more effective than most in drawing in the low productivity members of our community, which will bias our measured average productivity (and productivity growth) downwards.

The latest example was in the Sunday Star-Times business section yesterday.

New Zealand’s track record on labour productivity may look worse than it is because a growing number of Kiwis are in work, the Productivity Commission says.

In fact, this wasn’t reporting any new Productivity Commission work.  Rather, one of the Productivity Commission’s senior staff had pointed the journalist in the direction of some interesting work done by able researchers at Motu a couple of years ago.  And, despite the implication readers (like me) may have taken from the headlines and the lead sentence (above), the research work related to a period 2000 to 2012, not to the period of nil productivity growth over the last five years.

It suggested annual productivity growth would have been about 70 per cent higher, averaging 0.24 per cent, between 2001 and 2012, instead of 0.14 per cent, were it not for a decline in skills associated with higher employment.   Motu estimated last year that the skill level of the average Kiwi worker fell by 1.8 per cent over the period as more people joined the workforce.

Again, despite the hyped lead-in (“70 per cent higher”) do note that the difference in these two (multi-factor) productivity growth rates cumulates over 11 years to a total difference of around 1.1 per cent.  Welcome, but not exactly game-changing.

Motu provided a nice non-technical summary  (page 3f) on what they’d actually done, using detailed data from the Longitudinal Business Database (LBD).

Productivity estimates are typically based on the quantity of labour used by firms to produce output. However, the characteristics of a firm’s workers also have an important influence on productivity, with different types of labour impacting differently on the technologies that firms adopt and their performance more generally. Because data on individual workers are linked to the data on firms in the LBD, it is possible to construct a measure of the quality of a firm’s labour force and measure the impact of this on productivity.

The measure of worker quality – which is derived from earnings data – reflects the bundle of skills, qualifications and experience of individual workers. As such, it picks up a broader range of worker attributes beyond qualifications.

Based on this measure, the average quality of the New Zealand work force declined slightly by 1.8% from 2001-2012…..

This somewhat surprising decline in the average quality of New Zealand workers reflects the net result of two opposing forces. First, average skills increased due to ageing (ie, greater experience) and rising qualifications. For example, the share of tertiary qualified workers grew from 15% to 25% while the share of workers with no qualifications fell from 19% to 14% between 2001 and 2013. At the same time, full-time equivalent employment increased strongly by around 15% (Figure 1). The large number of new workers who came into the labour market had, on average, lower skills than existing workers. This lead to a dilution in worker quality that more than offset the improvement in qualifications and experience.

They look like nice results.

But since many of the concerns around productivity growth in New Zealand relate to cross-country comparisons –  how have we done relative to the rest of the advanced world, and relative to common underyling global trends –  it might be worth looking at what has happened in other countries.    It would take a pretty big study to replicate the Motu project across, say, the OECD.   But we do have readily accessible data on employment to population ratios across the OECD, and we have that data for a longer period of time than just 2001 to 2012.

Our HLFS goes back to 1986.  Here is how New Zealand’s employment to population ratio has behaved since 1986.

employment to popn 25 Sep

Over the entire 30 year period, our employment to population ratio increased by 2.4 percentage points, which isn’t a lot.  It seems quite plausible that the effect Motu identified was present in the data as the employment to population ratio increases, from the trough in 1992 through to 2007.  But most of that effect will have been reversing the opposite effects resulting from the really sharp fall in the employment to population ratio (disproportionately low productivity workers, almost by construction) from 1986 to 1992.

And what about the international comparison?  Here is the gap between New Zealand’s employment to population rate and that in the median of the 22 OECD countries for which there is data for the whole period (almost all the “old” advanced OECD countries, and not the former Soviet bloc countries).

employment 2

In all but one year, our employment to population ratio has been above that of the median OECD country.    That doesn’t automatically mean we have been employing more low productivity people –  some systems make labour force participation of both parents of small children easier than others, and some systems penalise older people staying in workforce less than others –  but lets grant that some part of the difference may be that we manage to employ more of the less productive groups.   At the margin, that might explain a small part of the levels difference between our average productivity and that of these, mostly richer, OECD countries.

But two things to note:

  • the gap is smaller now than it was thirty years ago.  In other words, even if this “employing the less productive classes” story is some part of the levels explanation, it is almost certainly less of an explanation than it was 30 years ago.  And yet the real puzzle people have been grappling with is why, after all the reforms, we haven’t made any progress in closing the gaps over the last 30 years.   These compositioneffects don’t look as though they can help over the post-1984 period as a whole (useful as they might be for interpreting data for some individual sub-periods).
  • there has been no material change in the gap at all over the last decade, suggesting that this compositional story doesn’t offer any explanation for why from 2008 to 2015 we did no better than middling relative to other OECD countries (not closing the gaps), and since 2012 we’ve been among the very worst productivity performers, with no labour productivity growth at all.

As I’ve pointed out in several posts recently, average real GDP per hour worked in Germany, Netherlands and France is now around 60 per cent higher than that in New Zealand (even though historically all were poorer and less productive than New Zealand).  In 2016, employment to population ratios in New Zealand and Germany were identical (while those in Netherlands and France were lower).  But here is the chart showing New Zealand’s employment to population ratio less the average of the ratios of each of those three countries.

employment 3.png

Over the period for which observers have been struggling for an explanation of our poor productivity growth, our employment to population ratios have been falling relative to those in several of the leading, and most productive, European economies.

Compositional effects (around the skill levels of the labour force) just don’t look like a credible part of an explanation for why the level of productivity here is now so much below that in the leading OECD economies, or why no progress has been made in closing the gap, over the last 30 years or the last five.

 

Investment data again highlight fundamental weaknesses

After an early morning with some boisterous visiting nieces and nephews, there is a certain calm retreat in getting back to some of the details of yesterday’s national accounts release.

I’ve written previously here about the investment numbers.  The state of investment spending is a useful, if never foolproof, indicator of the state of the economy.  Not so much in a mechanical adding-up sense –  a quarter of weak investment probably translates into a weaker quarter for GDP – as in the questions the data can pose about just what is going on more broadly, and the viable opportunities that businesses are finding, and taking up (or not), in New Zealand.

My typical starting point is a chart like this, breaking out investment spending into residential, government, and “business”.  (I put “business” in quote marks because, as the OECD does, it is calculated residually –  subtracting the other two components from total fixed capital formation.)

I shares of GDP june 17

Using quarterly data means living with a bit of “noise”, but not that much, and doing so enables us to see if there are any material changes emerging at the very end of the series.

I don’t want to say much about general government investment spending.   In recent years, that share has been averaging a bit higher than what we saw in, say, the five years before the last recession.  Then again, government (central and local) has faced significant post-earthquakes repair and rebuild expenditure, and the population growth on average over recent years has been a bit faster than that in the previous decade.  If anything, one might have expected the government investment share would have needed to be a bit higher still, at least given the range of functions governments currently take on,

What of residential?   In nominal terms, residential investment spending (new builds and renovations etc) as a share of GDP is now just below the highest levels seen in the history of this series (and actually in the annual series which goes all the way back to the year to March 1972, thus capturing the peak of the building boom in the early 1970s).    Given the rapid rate of population growth –  a little higher, but lasting longer, than the growth rates 15 years ago –  one would expect to see a pretty high share of GDP being devoted to housebuilding and associated activities.   But you will notice that the residential line has fallen a bit in recent quarters, and consistent with that the volume of residential investment spending undertaken in the June quarter this year was about 1.4 per cent lower than such spending in the June quarter of last year.

popn growth apc

In this post, my main interest is in the business investment component (the orange line in the chart).  Strip out the modest quarter-to-quarter fluctuations up and down, and there has been no real change in the share of (nominal) GDP devoted to business investment for almost six years now.   Over the six years, business investment as a share of GDP has been materially lower (around 2 percentage points of GDP) than the average for the 15 years or so prior to the 2008/09 recession.    That is a big change.    And doubly so because of the sustained acceleration in the population growth rate in the last few years (and with it growth in the number of jobs).  Workers typically need capital equipment, even if it is nothing more than a laptop (and associated software) and a place to work.

Ratios of nominal investment spending to nominal GDP aren’t the only sensible way to look at things. In particular, in New Zealand a lot of capital equipment is imported (eg vehicles and most machinery, but not buildings themselves).  A high exchange rate –  such as we’ve had in recent years, but also had to a lesser extent in the last few years of the 2000s boom –  tends to lower the price (in NZD terms) of capital equipment.  The volume of business investment might still be growing quite rapidly, even if the nominal investment spending share of GDP is pretty weak  (of course, for tradables sector firms the high exchange rate is no gain –  capital equipment might be cheap, but the expected returns to any investment are also dampened).

So here is a chart of the annual percentage change in real business investment.

bus i 2

The volume of business investment has been growing, but at a quite modest rate.  In the last five years of the previous previous boom, the annual growth rate was around 10 per cent per annum.  Over the last five years, the annual growth rate in the volume of busines investment has averaged only about 4 per cent (which also happens to have been the growth rate for the last year).

These pictures don’t really surprise me.  They are what one would have expected once one knew of (a) the magnitude of the damage caused by the earthquakes (from day one  at the Reserve Bank we knew this was a large non-tradables shock, which would skew activity away from business investment, especially in the tradables sector, for several years), and (b) the scale of the population increase.   Those pressures have helped hold our real exchange rate up so much and for so long, and reinforced the persistent large margin between our real interest rates and those abroad.  In that sort of environment, total business investment (share of GDP) is less than it otherwise would be, and –  although it isn’t able to be illustrated here –  what business investment does occur will be skewed away from tradables sectors.   Not even very high terms of trade levels were enough to counter-act the downward pressure on business investment growth, and monetary policy held tighter than it needed to be didn’t help either.

Looking back at that first chart, the weak and almost dead-flat business investment line was reminiscent of the productivity chart I showed yesterday.  It is also consistent with the weak export performance I wrote about last week.  The three indicators are causally related: business operating in, or which might have contemplated entering, the tradables sector, and thus taking on the world, simply haven’t been able to find sufficient attractive and remunerative opportunities.

The pressures associated with post-earthquake rebuild expenditure will wane, and probably already are.  But meanwhile, policy continues, year in and year out, to supercharge our rate of population growth, bringing in huge numbers of modestly skilled people, to a location where the successful opportunities for firms to take on the world with great products and services seem to be growing much more slowly than the number of people living here.  The flawed policy –  shared across both main parties and several of the minor ones –  just keeps making it harder than it needs to be for New Zealanders as a whole to get ahead.   Our immigration policy was crazy when lots of New Zealanders were leaving each year, but it is even more deeply problematic when the travails of Australia’s labour market mean that the outflow has (probably temporarily) largely ceased.

 

Productivity growth still missing in action

It was Paul Krugman, winner of the economics pseudo-Nobel Prize who famously captured one of the fairly basic insights of economics.  When it comes to material living standards in the medium to longer-term, if productivity isn’t everything, it is almost everything.   The terms of trade bob around, but probably won’t do much (harm or good) over the longer term, as they haven’t in New Zealand over 100 years.  But productivity growth –  managing to produce more per unit of inputs – is the basis for improved material living standards.   The best timely and accessible measure of productivity, widely used in international comparisons, is real GDP per hour worked.

Productivity growth in New Zealand has been pretty lousy in New Zealand for many decades, really since around the end of World War Two. We’ve had the odd decent run, but over the decades we’ve had one of the lowest rates of productivity growth of any advanced country.  We’ve slipped down the OECD league tables, and now part of the way we maintain reasonable living standards is by putting many more hours, over a lifetime, than the typical person in an advanced country.

Across the advanced world, productivity growth seems to have slowed from around 2005 (before the financial crisis).  We didn’t need to share in that slowdown, because productivity levels in New Zealand were so far below those of the OECD leaders.  Countries like the Netherlands, France, and Germany –  which historically we were richer and more productive than – now have labour productivity levels around 60 per cent higher than those of New Zealand.  We should have been able to close some of the gap in the last decade or so, utilising existing technologies, even if advances at the technological and managerial frontiers were slowing.  Various other poorer OECD countries –  notably the former Soviet bloc countries that are now part of the OECD – have done so.  We haven’t.

Several weeks ago the Prime Minister and the Minister of Finance were repeatedly claiming that New Zealand’s productivity performance in recent years had really been pretty good.  In fact, they suggested that under their watch we’d managed faster productivity growth than in other advanced economies and that the gaps were beginning to close.

I went to some lengths to unpick those claims.    New Zealand doesn’t have an official measure of real GDP per hour worked (unlike Australia, where the ABS routinely reports numbers as part of their national accounts release).  Instead, we have two measures of real GDP (expenditure and production), and two measures of hours (HLFS and QES).  Instead of just picking on one combination, I calculated all the possible methods, and looked at them individually and on average (nine in total).

For broad-ranging international comparisons, it often makes sense to use annual data, because not all countries have easily accessible quarterly data.  Unfortunately, the annual data are often only available with a lag, and the OECD doesn’t yet have annual data on real GDP per hour worked for all countries for calendar 2016.   But in the years from 2008 to 2015, on not one of the possible New Zealand productivity measures did New Zealand quite manage productivity growth as fast as that of the median OECD country.

This morning Statistics New Zealand released the latest quarterly national accounts, which enabled me to update the various quarterly productivity series.   In this chart I’ve shown the average of the various possible measures, and compared the performance of New Zealand relative to that of Australia (using the official Australian data).  I’ve started the chart in the last quarter of 2007, just before the 2008/09 recession began.

aus vs nz ral gdp phw 2

Over the first few years, through the recession period and in the year or two beyond, productivity growth in New Zealand and Australia was modest, but we more or less kept pace.   But what is striking is how increasingly large and persistent the deviation has been since around the start of 2012.  Over the five years, we’ve had no productivity growth at all, and Australia has managed quite reasonable growth.   And over the last five years, using the average measure for New Zealand doesn’t mask anything: from the second quarter of 2012 to the second quarter of 2017, the strongest of the nine series recorded productivity growth of 0.8 per cent (that is, in total over five years) and on the weakest, the level of productivity fell by 0.6 per cent (in total over five years).  Best guess: zero.

Recall that at the start of the period the average of level of productivity in Australia was already well above that in New Zealand.  That gap has widened still further.  In the early days of this government readers will recall that there was a goal to close those gaps to Australia by 2025, only eight years away now.

It has been a dismal performance.  Productivity isn’t mostly about how hard people work, but is much more about the ability of firms to find opportunities here that generate high incomes, and in particular high wages.  That is very difficult when the real exchange rate is as persistently high as it has been here.  Particularly over the last few years, very rapid population growth has underpinned the strength of the real exchange rate, driving up the prices of non-tradables relative to those of tradables.

And what of the comparison I mentioned earlier with the former Soviet-bloc central and eastern European countries (Slovenia and Slovakia, Poland and Hungary, the Czech Republic, and Latvia, Lithuania and Estonia)?  Thirty years ago, all of them were in a much worse state than New Zealand, but like New Zealand they had an aspiration to reverse decades of economic underperformance and catch-up with the richer countries in the OECD –   in their case, particularly those in western Europe.     But here is how we have done relative to them over the period since 2000, when there is consistent data available for all the countries (and by then all the other countries had got well through the nasty shakeouts immediately after the fall of communism).

eastern europe 3.png

It is a steady and substantial decline in our productivity levels relative to those of these central and east European countries.   The data are only annual, of course, but as you can see in earlier chart, we’ve had no productivity growth at all recently so not incorporating the last couple of quarters won’t help the picture.   Some of these countries –  communist-era basket cases 30 years ago –  now have levels of productivity very similar to New Zealand’s.  Most are on a path that may well take them past us in the next decade or so.  Most, as it happens, have little or no population growth.  They make the most of their opportunities –  which are considerable, being close to western Europe –  with their own people.

To sum up, New Zealand has lagged a bit behind the median advanced country since 2007/08, and has had no productivity growth at all for the last five years.  We continue to drift further behind our closest neighbour, Australia, and now face the likelihood that before too long we’ll be overtaken by countries that, throughout modern history, were never previously as productive as New Zealand was, and which 30 years ago we’d have looked on as pretty hopeless cases.   We could do much better, but there is absolutely nothing to suggest that we will manage to do so pursuing current economic policies.  Sadly, there isn’t much sign that any of the parties competing for your vote on Saturday are offering anything materially different, that might finally begin to reverse almost 70 years of continuing relative decline.   The apparent refusal of our leaders to face the reality, and make steps to change, won’t alter the fact of our continuing relative economic decline.

 

 

Employment growth: simply not that spectacular

There was another post on Kiwiblog this morning, attempting to cast New Zealand’s recent economic performance in a particularly good light.   Here was the bit that really caught my eye:

this is not just exceptional job growth locally, but internationally. Here’s the percentage increase in in major OECD countries in 2016:

  1. NZ 5.7%
  2. Germany 2.9%
  3. Ireland 2.9%
  4. US 1.8%
  5. OECD 1.6%
  6. Australia 1.6%
  7. Sweden 1.5%
  8. UK 1.4%
  9. Canada 0.7%
  10. France 0.6%
  11. Finland 0.5%

Now there are at least three problems with this comparison:

  • it makes no allowance for the much more rapid rate of population growth in New Zealand than in almost any other OECD country,
  • it cherry-picks the OECD countries it compares us with (I’m not sure when Ireland and Finland became “major” OECD countries), and
  • it ignores the break in the HLFS hours worked and employment series in 2016q2.  In fairness, the author might not have been aware of the break, but serious economic analysts (including the Treasury) are.

I illustrated the break in the series in a post several months ago.

What about the rate of job growth.  Fortunately, we have two measures: the (currently hard-to-read) HLFS household survey measure of numbers of people employed, and the QES (partial) survey of employers asking how many jobs are filled.   Unsurprisingly, the trend in the two series are usually pretty similar, even if there is a fair bit of quarter to quarter volatility.

employment

Since we know there are problems in the HLFS, and the QES doesn’t look to be doing something odd, perhaps we are safest in assuming that the number of jobs has been growing at an annual rate of around 2.5 to 3 per cent.   That isn’t bad at all. But SNZ also estimates that the working age population has been growing at around 2.7 per cent per annum.  No wonder the unemployment rate is only inching down.

Now that we have 2017q2 data, so a full year on the new HLFS questions, the annual percentage growth rates of the two employment series have indeed converged again.

hlfs and qes E

In other words, one can’t take as meaningful any annual percentage growth in the HLFS employment (or hours) numbers for calendar 2016.

A better way to deal with all three issues is to look at the percentage point change in the employment to population ratio for the whole OECD group.   The most recent period for which we have full data for all countries is 2017q1.  For New Zealand, using growth in employment over the year to 2017q1 would still be distorted by the break in the series, so for New Zealand only I’ve shown the change in the employment to population ratio from 2016q2 to 2017q2.

E to popn last year

And on this – much more useful – comparison, New Zealand ends up as a middling performer, the median country.   There is no stellar New Zealand “job creating machine”, just a huge increase in working age population.     Job growth isn’t to be gainsaid, but it is productivity growth (or the absence of it) that is the key determinant of gains in medium-term living standards.  And did I mention that there had been no productivity growth, at all, for the last five years now?

(To be clear, I would not put much –  if any –  weight on a single year comparison.  After all, all labour force surveys have some sampling error.  But if people want to make sense of employment growth, in international comparison, over just the most recent year, this is really the only sensible way to do it.  As it happens, over that year, our change in the employment to population ratio was the same as that for the OECD as a whole.  It was just a bit less than that for the EU as a whole and for the euro-area –  who, of course, generally had a deeper unemployment hole to climb out of.)

Eastern and central Europe, and us

Eastern and central Europe don’t get much coverage in the New Zealand media, or in New Zealand economic analysis.   But I’m intrigued by the region.    There are multiple levels to that –  religion, other dimensions of culture, battles in two world wars, decades of Soviet repression, and so on.   But what really plays on my mind is that these countries regained their freedom, and the hope that came with that, at much the same time that many senior and influential people here (and young economists like me) were convincing themselves that New Zealand had passed a turning point and our economic prospects really would be looking up.

Here there had been the famous jibe from David Lange, comparing New Zealand’s economy pre-1984 to a Polish shipyard.  At one level of course, it was a ridiculous claim, which trivialised the evils –  and rank inefficiency – of Communism.    But it had also captured something about the mood for change, partly in reaction to the plethora of controls the New Zealand economy had laboured under for decades.   Actually, New Zealand had been been liberalising for decades, but (generally) rather slowly and inconsistently.   And our living standards relative to those in other advanced countries had been dropping for several decades; the inefficiencies the heavy protectionism etc created were compounded by our worst terms of trade for a very long time.  Daft interventions like the Think Big energy projects just reinforced the sense of something having gone very wrong.

And so, over 10 years or so, there was a dramatic –  at times almost frenzied – period of far-reaching economic and institutional reform.  Much of it was admired –  even envied –  abroad, at least among the like-minded.   Outfits like the OECD and IMF praised the reforms, and typically had a few more to suggest, and there really was a belief that nothing much now stood in the way of reversing the decades of relative economic decline.  Productivity growth would, it was assumed, follow smart economic reforms much as night follows day.    There are some people from that era who will now dispute that anyone seriously expected that sort of improvement, but David Caygill was the (very capable) Minister of Finance, and here is how he illustrated the story.

caygill 1989 expectations

No sense there that the reforms –  which were extended further by his successors –  would simply slow our relative decline.

At the time, I was heavily involved in the Reserve Bank’s (small)  part in all this –  achieving and maintaining low and stable inflation.   Medium-term growth and productivity issues weren’t our focus, but a couple of colleagues –  including then deputy chief economist Arthur Grimes –  had been doing some work on exactly those issues.  Their findings were published in mid-1990.    Having established the nature of New Zealand’s relative decline, and identified some of the possible causes (including, in their view, past rapid population growth) they ended their article this way.

grimes smith text

And at around the same time, eastern and central Europe was regaining its freedom.  The Berlin Wall fell, democratic governments were elected in Poland and Czechoslovakia, the Baltic states regained independence, a place like Slovenia emerged peacefully from what was left of hitherto communist Yugoslavia and so on.    They were great days for the cause of human freedom.  But also of economic opportunity.   The former eastern bloc countries didn’t have identical economies, and it isn’t as if there hadn’t been economic progress even during the Communist years.  Some –  notably Hungary –  had started reform and economic liberalisation earlier than others.    But each of them had highly distorted economies, typically insecure property rights, and little in the way of a proper financial system.    Data from this period are pretty patchy – especially for the countries that had been part of other countries up until then – but these countries weren’t dirt-poor: the better of them probably had GDP per hour worked in 1990 similar to, say, that in Korea.    They were middle income countries.   Then again, as far as we can tell, in say the 80 years prior to World War Two none of them had ever been much better than middle income countries either.  Certainly, they’d nothing like the productivity, GDP per capita, or material living standards of New Zealand.

So if we go back 25 years or so, both in New Zealand and in eastern Europe those leading the economic reforms, and those running governments, had serious aspirations of catching up with the richer and more productive advanced countries.    Of course, the mess in eastern Europe was a whole lot bigger than the mess here.  In both countries, unwinding controls and protectionist structures involved short-term losses of output.  Those were moderate here, but savage in some of the eastern European countries.  But in both places there seemed to be great opportunities for catch-up and convergence.

I illustrated the other day how poor our productivity performance has been relative to the other advanced OECD countries over that period.  From a starting point in 1989, productivity levels have slipped another 12 per cent further behind the median advanced OECD country.  In other words, no convergence has happened at all.  That has been so even over the last decade or so when productivity growth in the the “frontier” countries has itself slowed, which might have been an opportunity for some catch-up when we were starting so far behind.

But how do we compare with the eastern European countries?  Seven of them –  the Czech Republic, Estonia, Hungary, Latvia, Poland, Slovakia, and Slovenia –  are now in the OECD, and thus in the OECD statistical databases.  One other –  Lithuania –  isn’t in the OECD but has apparently reached data standards that mean the OECD is reporting their productivity data.   There are other countries not covered –  from Belarus or Moldova at the bleak extreme, to EU countries such as Bulgaria, Romania (which I wrote about here), and Croatia at the other.    There is good data for some of them in other databases, but for today I just wanted to use the same OECD database Steven Joyce was using the other day in talking up New Zealand’s performance.

The OECD data on real GDP per hour worked for these countries starts in various years during the 1990s.  2000 is the first year for which there is data on all eight eastern European countries.  In a way, it is a shame not to be able to start from the late 1980s, as I did in comparing us with the more advanced OECD countries.  On the other hand, by 2000 the worst of the immediate post-communist disruption was well behind these countries (as the initial output losses in our own structural reforms were behind us).    Sixteen years since 2000 (annual data is available to 2016) is a reasonable run of time to see how we’ve done relative to them –  and neither the initial year nor the most recent year is muddied by recessions or financial crises.   Each country has had a recession during this period, and in some cases they were pretty wrenching adjustments, involving IMF support.

Here is the cumulative real productivity growth for each of those countries, and New Zealand, since 2000.

eastern europe 1

The country with the slowest growth – Slovenia –  managed twice the productivity growth of New Zealand over this period, and the OECD estimates suggest that the level of productivity in Slovenia –  30 years ago a province of a communist non-market country –  is now approximately equal to that in New Zealand.

And here is the time series: the level of productivity in each country is indexed to 100 in 2000 and then I’ve taken a median of the eight eastern European countries.

easetern europe 6

You can see that the downturn in 2008/09 was much more severe for many of these countries (especially the ones running semi-fixed or hard-fixed exchange rates).

And here is the ratio of those two series.

eastern europe 3.png

Our rate of decline, relative to the eastern European countries, might slowed a little in the last decade, but there is no sign of things levelling out.

And if defenders of New Zealand’s performance want to argue something along the lines of ‘well, they are still poorer and less productive than New Zealand, so they should be achieving faster productivity growth than we are’,   well we are a great deal less productive than the median advanced OECD country, and yet we’ve not managed to achieve faster productivity growth than them.

In fact, here is a chart showing OECD estimates of the 2015 level of real GDP per hour worked, converted at PPP exchange rates, for the eight eastern and central European countries,  for New Zealand, and for four of the big higher-productivity OECD countries.

eastern europe 4

These days, our productivity levels look a lot more like those of the eastern and central European countries than of the OECD leaders (and Norway and Luxembourg and –  questionably –  Ireland are well above even those countries’ numbers).

At about this point, people often start saying “well, of course…those eastern European countries are close to the industrial centres of western Europe, and have been able to be attract foreign investment in manufacturing and become extensively integrated into the value chains associated with modern manufacturing”.

To which my response is along the lines of “well, yes, that is my point about New Zealand”.  We are poorly located –  for anything other than not being overrun by German or Soviet armies – and not many firms seem to have been able to develop substantial (unsubsidised) businesses selling internationally competitive products and services from here, based on anything other than our (fixed) natural resources.

Which is why it has come to seem so odd that we, as a matter of public policy, are aggressively trying to grow our population –  issuing 45000 residence approvals a year, three times the per capita rate of the US.  In doing so, we simply make it harder for ourselves to prosper here.

In fact, here are the population growth rates of the eastern European countries and of New Zealand since 2000.

eastern europe 5

I don’t think I’d be too keen on living next door to revanchist Russia.  But the five non-Baltic states here are firmly ensconced in central Europe, and over the last 16 years they’ve had an average of zero population growth, while our population has grown by almost 23 per cent.

Countries like that don’t have to devote huge shares of available resources (capital and labour) simply to keeping with the infrastructure needs of a rapidly rising population.    That, in turn, keeps pressure off domestic costs, and keeps the real exchange rate lower than otherwise. Combined with more favourable locations, lower company tax rates (in most cases) and (the perhaps mixed blessing of) EU membership, they’ve been able to lift productivity and living standards for their people in a way that has had no parallel in recent decades in New Zealand.     On typical institutional metrics like ease of doing business and corruption perceptions we score well ahead of any of those countries.  We don’t need marches in the street to protect the independence of the judiciary (as in Poland).  And our people do well on international skills comparisons.  But it isn’t enough if one draws too many people into an unpropitious location.

Until we face up to the evident limitations of our location, and the absurdity of actively importing so many people from abroad into such a difficult location, it is difficult to believe that our underperformance, that has now stretched out over almost 70 years, will even begin to be reversed.    For most of modern New Zealand history, France and Germany and the Netherlands had lower labour productivity than New Zealand did.  Now they are far ahead. Slovakia is already passing us, and it seems reasonable to think that if we and they keep doing the same things we’ve been doing for the last 20 years,  Slovenia and the Czech Republic will also go past us in the next decade.    That’s good for them.  I don’t begrudge their success –  the fruits of freedom and decent policy, in the context of a good location – but what about us?

Here we have one main party that wants to pretend that productivity growth is just fine –  simply ignoring the data.   And another which recognises and is now highlighting the problem –  I was seriously encouraged to see Jacinda Ardern making the “flat-lining at best” point about productivity in last night’s debate –  but doesn’t seem to have seriously engaged with what might produce significantly better and different outcomes in the future.   The scary thing is that if their roles were reversed, Labour might well be pretending there wasn’t a problem, while National still wouldn’t be offering much of a serious solution.   And so, from the apparent refusal of either main party to really confront the presenting symptoms and attempt a serious diagnosis of what has been going on, we seem doomed to slip slowly ever further down the league tables.    There are always many useful reforms to be considered.  But, foremost, we need to markedly cut back that 45000 residence approvals target, and then back our own able people to make the most of the natural resources we have, in the face of the real and –  on curent technology ineradicable – severe disadvantages of our location.