Do big countries get richer (or more productive) faster?

The short answer appears to be “no”.

Much of the debate around the appropriate immigration policy for New Zealand seems to have as a sub-text (implicitly or otherwise) a sense that New Zealand population is just too small, and that if only we had more people we would be richer (per capita) and more productive.     Those who run, or rely, on this line rarely seem to engage with the estimates that New Zealand’s GDP per capita was at its peak, relative to incomes in other countries, at a time (around 100 years ago) when our population was about a quarter of what it is now.  (Of course, the population of other countries has also grown since then, but in most advanced countries the population growth rate has been much slower than in New Zealand –  the UK had about 45m people 100 years ago and about 65m now.)

In their recent report in support of New Zealand’s immigration policy, the New Zealand Initiative joined the group of those arguing that a larger population would be good for New Zealand’s per capita income and productivity.

I wrote about this point in a post back in 2015, in which I observed

I’ve long been fairly sceptical of that proposition. A casual glance around the world suggests no very obvious relationship. The United States and Iceland co-exist, and Japan and Singapore. At the other ends of the income spectrum, India and Bhutan, and Brazil and Costa Rica. There are all sorts of arguments advanced around the economics of agglomeration, and that analysis seems to work quite well in describing what happens within countries. But it does much less well in describing economic performance across countries. And as I’ve pointed out to people previously, if the real economic opportunities in big countries were so much superior to those in small countries, large countries would tend to have (more high-yielding projects and) higher real interest rates than small countries. But they don’t.

Over recent decades we’ve also seen many more smaller countries emerging, presumably because the people in those places concluded they wouldn’t pay too much of a price to be independent.

In the earlier post, I included some scatter plots suggesting that there was basically no relationship at all between the size of country and the subsequent growth in its real GDP per capita or productivity (real GDP per hour worked).    In this post I’m looking at much the same relationships, but this time just using the Conference Board’s Total Economy Database, which starts in 1950.

One of the challenges in any work in this area is that people tend to flow to rich and successful countries.  Indeed, plausibly in a successful fast-growing country, people might even be willing have more children on average.   The simplest way to correct for that is to take the population level at some historical point in time and then look at per capita growth subsequently.   Here is a chart for 33 relatively advanced (and relatively free) economies showing population in 1950 (in logs) and total percentage growth in real GDP per capita over the subsequent 65 years to 2015.

1950 popn and subseqeunt GDP pc

The simple regression line is still slightly downward sloping even if the very fastest growing countries (Singapore, Taiwan and South Korea) are excluded.  But note that I’m not arguing that higher populations are necessarily bad for subsequent growth, simply that there is little evidence (none in the simple bivariate relationships) that larger populations are good for growth.  Small and large countries seem able to successfully, and prosperously, co-exist.

What about more recent periods?  There has been a line of argument –  associated in the context of the New Zealand debate with Philip McCann –  that these issues have become much more important in recent decades as the nature of the global economy has changed (more reliance on ideas, trade in services etc).

Here is the same chart for the 25 years since 1990.

1990 population and real GDP pc

Take out the outlier (Singapore) and the bivariate regression line still slopes slightly downwards.

And for the same countries, here is the relationship between total hours worked in 1990 and subsequent growth in real GDP per hour worked.

1990 hours worked and subseqeunt productivity growth

And still no positive relationship.

My sample of countries in these charts excluded the countries of the former eastern bloc.  Most of them have relatively small populations, and most have –  not surprisingly –  done quite well in the last 25 years or so, once the shackles of communism were removed.   The quality of the data from 1990 might also be in some question.

But for completeness,  here are two charts from 1990 to 2015 with various of the eastern European countries added in (those now in the OECD and/or the EU).   This one for all the countries.

1990 hours etc - enlarged sample

And this one – as much for visibility as anything – just excluding Singapore, South Korea and Taiwan.

1990 hours etc - enlarged sample ex Sing, Taiwan, S Korea

There doesn’t seem to be any simple evidence that, across the relatively advanced world as a whole, a higher starting population has helped make for stronger subsequent growth in real GDP per capita or real labour productivity.

I concluded my earlier post this way

Charts of this sort are, of course, not conclusive. Lots of other things are going on in each country.  In an ideal world, one would want a much fuller and formal modelling of the determinants of growth. But equally, the absence of a positive relationship between the size of the country and its subsequent growth shouldn’t be surprising, and there have been previous formal research results suggesting a negative relationship.

Of course, perhaps New Zealand is an exception. Perhaps real per capita incomes would really be materially lifted if we had many more people here, even though there has been no such relationship across the wider range of advanced countries in history.  But in a sense we have been trying that strategy for 100 years and there is no sign that it has worked so far.   Very few relatively advanced countries have had weaker real per capita growth than New Zealand in the last 100 years (only places like Argentina and Rumania).

Perhaps the next 25 or 100 years would be different. But I think the onus is now on the advocates of policies to bring about a bigger and more populous New Zealand to demonstrate where and how the gains to New Zealanders from a much larger population are occurring?

At that stage, I was putting less emphasis than I now would on two (probably related) factors that make it even less likely that such a beneficial relationship would exist for New Zealand even if it did –  and these charts suggest it doesn’t –  for other advanced countries:

  • our extreme distance from other countries (markets, suppliers, value-chains, competitors etc) in an era when, if anything, personal contacts seem more important than ever, and
  • our continued very heavy reliance on natural resources –  and ability to apply new and better skills to those resources.   Those resources are in fixed supply, our heavy reliance on such natural resources is now quite unusual (it isn’t so for most OECD countries), and there is little sign of the economy successfully gravitating away to any significant extent from a reliance on natural resources.

Playing to our strengths, and maximising the prospects for New Zealanders, looks as if it would be much better-served by an approach that didn’t seem determined to drive up the population, regardless of the 100 years (or 70 or 25 or whatever period you like) in which there has been no evidence that a larger population is enhancing the economic well-being, or productivity, of New Zealanders.

And here is one last chart, for completeness, including all the relatively advanced countries –  eastern European and Asian alike –  and showing population in 1990, and subsequent growth in real GDP per capita.

1990 population and real GDP pc extended sample

Still no sign of that vaunted upward-sloping relationship.

What does the OECD really have to offer us?

The Organisation for Economic Cooperation and Development (OECD) is often loosely described as “the rich countries club”.  It isn’t an entirely accurate description –  there are several high income oil exporting countries who don’t belong (as well as places like Singapore and Taiwan), and some countries that are members (notably Mexico and Turkey) aren’t particularly high income.     But it is a grouping of mostly fairly advanced fairly open economies (New Zealand’s been a member since 1973).   And the organisation claims to be able to offer useful advice to countries as to how to improve their economic performance.  I’ve become increasingly sceptical of that proposition, especially as regards New Zealand.

On a biennial cycle the OECD’s Economic and Development Review Committee (EDRC) meets in Paris to review each member country’s overall economic performance, and offers some specific advice both on general economic management issues and on specific topics agreed in advance between the secretariat and the country concerned.  I wrote about the process, which draws on extensive staff work, on the day New Zealand was last reviewed in April 2015.

The next review is almost upon us.  The EDRC is scheduled to discuss New Zealand on 20 April, so the draft text is probably already in the hands of New Zealand government agencies.   The final text will presumably be released in late May or early June.  This year’s agreed special topics are “Increasing Productivity”, and “Labour Markets and Skills”.    The latter topic apparently includes the New Zealand immigration system, and when the OECD team came to Wellington last year I participated in a meeting with them, along with various government agency representatives, on some of the strengths and weaknesses of our system.   Historically, the OECD tends to be very strongly pro-immigration –  without much evidence for its benefits, especially in remote places like New Zealand –  and I expect their treatment this time will again reflect that presumption, probably with some suggested tweaks at the margins.   But, as often, the OECD might be able to present some cross-country data on the issues in interesting ways.

Quite what they’ll come up with to increase productivity could be more interesting.   In many ways, New Zealand is a test for whether the OECD has much useful to say.  For a member that was once among the richest and most productive OECD economies and now languishes a long way down the league table, New Zealand has been a bit of an embarrassment to the OECD.  After all, we did an awful lot of what they suggested 25 to 30 years ago.

I’m writing about the issue because a few days ago the OECD released one of their flagship cross-country publications, Going for GrowthThese documents often contain a lot of interesting cross-country comparative material –  data collection and presentation is one thing the OECD defintely does well.  But they also get specific, and have a couple of pages of economic policy priority recommendations for each country.  Since the OECD  must already have written their full substantive report on New Zealand for the forthcoming EDRC survey, one might have expected that the recommendations for New Zealand would be particularly incisive and well-focused, offering suggestions which, if adopted, would clearly help reverse our long-term underperformance.   As they note, labour productivity gaps between New Zealand and the other advanced economies have continued to widen over the last quarter century.   As the OECD’s own chart illustrates, real GDP per hour worked is now about 37 per cent below the average for the countries in the upper half of the OECD  (these are countries from Luxembourg and Norway at the top, to Italy and the UK at the bottom).

So what does the OECD propose for New Zealand?

  1. Reduce barriers to FDI and trade and to competition in network sectors.   Recommendations:  Ease FDI screening requirements, clarify criteria for meeting the net national benefit test and remove ministerial discretion in their application. Encourage more extensive use of advance rulings on imports and improve the publication and dissemination of trade information. Sell remaining government shareholdings in electricity generators and Air New Zealand. Remove legal exemptions from competition policy in international freight transport.
  2. Improve housing policies. Recommendations: Implement the Productivity Commission’s recommendations on improving urban planning, including: adopting different regulatory approaches for the natural and built environments; making clearer government’s priorities concerning land use regulation and infrastructure provision; making the planning system more responsive in providing key infrastructure; adopting a more restrained approach to land regulation; strengthening local and central government emphasis on rigorous analysis of policy options and planning proposals; implementing pricing to reduce urban road congestion; and diversifying urban infrastructure funding sources.
  3. Reduce educational underachievement among specific groups. Recommendations: Better target early childhood education on groups with low participation in such education. Improve standards, appraisal and accountability in the schooling system.To improve the school-to-work transition, enhance the quality of teaching, careers advice and pathways, especially for disadvantaged youth, and expand the Youth Guarantee. Facilitate participation of disadvantaged youth in training and apprenticeships. Students from Maori, Pasifika and lower socio-economic backgrounds have much less favourable education outcomes than others.
  4. Improve health sector efficiency and outcomes among specific groupsRecommendations: Increase District Health Boards’ incentives to enhance hospital efficiency, improve workforce utilisation, integrate primary and secondary care, and better managed chronic care. Continue to encourage the adoption of more healthy lifestyles.
  5. Raise effectiveness of R&D support. Recommendations: Further boost support for business R&D to help lift it to the longer term goal of 1% of GDP. Evaluate grant programmes. Co-ordinate immigration and education policies with business skills needs for innovation.

The general goals seem fine, in as far as they go.  And some of the specifics seem sensible enough too (others –  more R&D subsidies, government encouragement of “more healthy lifestyles”  –  seem distinctly questionable).    But could anyone with a reasonably in-depth understanding of the New Zealand economy and its performance over the last few decades, really think that that list, even if adopted in full, would really make a material difference in turning around New Zealand’s long-term productivity underperformance?   I’m all for fixing the housing policy disaster, but when the OECD talks of the agglomeration gains that might make possible, have they actually looked at the dismal Auckland productivity performance over a period when Auckland’s population has already grown very rapidly?

It is also quite surprising what they don’t mention.   Perhaps macro imbalances, such as our persistently high real exchange rate, or our (typically) highest real interest rates in the OECD, don’t easily fit in a structural policy document –  although they are significant symptoms that a list of possible structural policy remedies needs to notice.

But the OECD does publish as part of Going for Growth quite a range of cross-country comparative data on various structural policy indicators.  Even then there are puzzling omissions.  There is nothing at all, for example, on immigration policy.    And company tax is also missing.   Here is the data from the OECD website on statutory company tax rates for 2016.

company tax rates

New Zealand is in the upper third of OECD countries –  and with a company tax rate well above that group of countries (from the Czech Republic to Switzerland) at around 20 per cent.   I’m all in favour of reducing FDI barriers, for example, but for many firms who might consider establishing here, the likely tax bill is probaly a more significant consideration.  And I suspect it offers more payoff in improving productivity than the health system, whatever the merits of the specifics they propose there.

It was also interesting that the OECD does not mention our labour laws.    It is well-known that our minimum wage is quite high relative to median wages/labour costs. In fact, the OECD again illustrate it in their indicator pack. This is their chart, and I’ve simply highlighted New Zealand.

min wage OECD

It is a quite a stark picture, but doesn’t seem to be a priority issue for the OECD.  Actually, I doubt altering the minimum wage laws offers very much on the productivity front, but even if one is simply concerned about disadvantage (as they very much seem to be) we know that getting people into jobs is the best path towards longer-term economic security.   One needn’t go to the US end of this spectrum, but places like the Netherlands and Belgium aren’t exactly known as bastions of heartlessness, small government or whatever.

Overall, I think the list still suggests the OECD has very little idea what has gone wrong in New Zealand, and hence has little more than a generalised grab bag of ideas to offer in response –  many no doubt quite useful in their own way, but mostly likely to be tinkering at the margins.

Out of curiousity, I had a look at what they had to recommend for the previous country on the (alphabetical) list –  the Netherlands.  It is an interesting country too.  Productivity –  GDP per hour worked –  is above that for the group of countries in the upper half of the OECD.  Indeed for decades productivity levels in the Netherlands have been very similar to those in the United States.  Per capita income lags a bit behind, because Dutch people on average don’t work long hours each year (although the participation rate is high).    But it is, by most counts, a very successful economy.    Real GDP per hour worked is about 65 per cent higher than in New Zealand.

What does the OECD recommend for them?

  1. Lower marginal effective tax rates on labour income.
  2. Ease employment protection legislation for regular contracts and duality with the self-employed.
  3. Reform the unemployment benefit system and strengthen active labour market policies.
  4. Increase the scope of the unregulated part of the housing market
  5. Increase direct public support for R&D  [even New Zealand spends more on this than they do]

Setting aside the OECD’s taste for R&D subsidies, it mostly seems sensible, plausible, and well-targeted.  They  seem to have a better idea what to offer an already rich and successful country in the heart of Europe, than they have to offer a once-rich now-underperforming remote one.   For us, that is a real shame.

One can only hope that when the productivity chapter of the forthcoming New Zealand economic survey comes out, they can offer a more persuasive grounded set of recommendations as to what might make a real difference in reversing our decades of underperformance.

(For a more optimistic take on the OECD’s recommendations for New Zealand, see Donal Curtin’s assessment.)

 

 

Superior measures, but still no productivity growth

Statistics New Zealand this morning released their best estimates of New Zealand productivity growth.  They are annual only –  so the new data is for the year to March 2016 –  and cover only the “measured sector”, so excluding parts of the public sector in particular where productivity is just very hard to measure (there are few market prices for the services for a start).  They also make an adjustment for the changes in the composition of the labour force –  there is, in principle at least, a lot more human capital associated with an average worker now than decades ago when few people had a tertiary education.

Last week I ran this chart, showing an estimate of quarterly labour productivity growth (real GDP per hour worked)

real gdp phw dec 16 release

It isn’t an encouraging picture.  In fact, the last five years have been so bad, I’ve been hesitant about believing reality was quite that bad.

But here is new annual data, showing labour productivity and multi-factor productivity, both indexed to 1998 when the data in this format start.

measured sector productivity mar 2017

The summary?

  • No multi-factor productivity growth, in aggregate, for a decade –  the latest data point is very slightly  below that for the year to March 2006.
  • And no labour productivity growth for the last four years –  a picture very similar to the (differently measured, and more recent) real GDP per hour worked chart above.   In the last 10 years, there has been only around 4.5 per cent labour productivity growth in total.

Different models, and different measurement bases, will produce different results.  None of them suggest there has been much productivity growth in New Zealand for some considerable time.  And to repeat Paul Krugman’s succinct summary

“Productivity isn’t everything, but in the long run it is almost everything.”

Productivity growth: still missing in action

We get some annual multi-factor productivity data from Statistics New Zealand next week, but for more a more timely read on productivity what we have is data on real GDP per hour worked.   This chart compares New Zealand and Australian real GDP per hour worked since just prior to the recession of 2008/09.   As previously, for New Zealand, I’ve average the two GDP series, and used the HLFS hours worked series.  There is a break in the series in June last year, on account of changes in the HLFS methodology.  That lifted hours worked (as measured) by about 2 per cent, and in this chart I’ve silently adjusted for that (while still hankering for an offical SNZ series that corrected for the break).

real gdp phw dec 16 release

Still going nowhere – perhaps even backwards – after five years.     Diverging ever further below Australia over that five years.  And for the full nine years, less than 5 per cent productivity growth in total.

You’d like to think this sort of gross underperformance would be getting some attention in the run-up to the election.  But there isn’t much sign of that.

Perhaps we are just supposed to think of it as some sort of “quality problem”, or a “problem of success”?  Mark me down as unconvinced.

 

 

 

 

 

Not many good tidings….

…in the productivity numbers that is.

Statistics New Zealand yesterday released the September quarter GDP data, including the revisions to the quarterly data that stem from the annual national accounts for the year to March 2016 that were published a few weeks ago.    Headline writers focused on the quite high rates of growth for the September quarter, while more sober observers allowed for the 2.1 per cent population growth in the last year and noted that in per capita terms real GDP growth remains pretty subdued.

I dug out the data to see if there had been any productivity growth.   As I’ve noted on several occasions, the labour productivity trend in recent years has been so weak it almost seems too bad to be true.  I wondered if the picture might look better with the new data.

In Australia, the ABS reports an index of real GDP per hour worked as one of the standard suite of published series.  In New Zealand, no such luck.  So I average the two measures of real GDP (expenditure and production) and divide by hours worked from the HLFS.  Unfortunately, Statistics New Zealand upgraded the HLFS earlier this year, and in the process introduced a break in the hours worked series.  There is a step up in hours worked that is partly on account of simply measuring things differently (and probably better).  Improvements in statistics are, of course, welcome but it is a little frustrating that the agency has made no effort to produce an official break-adjusted series.   In the June quarter, hours worked rose by 2.6 per cent.  As real GDP rose by 0.7 per cent, and there has been little sign of productivity growth in recent years, I’m going to assume in the charts that follow that 2 percentage points of that increase in hours was just a result of the change in methodology.  It won’t be quite right, but it doesn’t look likely to be seriously inaccurate either, especially against the measurement challenges and revisions we always face in looking at GDP/productivity.

So here is the resulting measure of real GDP per hour worked

real-gdp-phw-dec-16

And, even with the data updates, there is still no sign of any material productivity growth.  It has been 4.5 years now since this productivity index got to around the current level.

There was plenty of gloomy commentary around the recent Australian quarterly GDP outcome, but in productivity terms  even after a poor quarter (in a series with some noise), Australia continues to pull away from New Zealand.  Here are the two GDP per hour worked series, starting from 2007q4, just prior to the New Zealand (and global) recession and the Australian downturn.

real-gdp-per-hw-aus-and-nz

Our dismal productivity performance really should be getting more attention, and raising more concern, than it seems to.  But today isn’t the day for a long post on the underlying problems and possible solutions.

I’ll be taking something of a break.  There might be a few posts in the next few weeks, but something like a normal flow won’t resume until the week starting 30 January when the kids start going back to school.

In the meantime, in honour of Sunday’s Feast of the Incarnation (aka Christmas) I’ll leave you with this from John Milton’s poem

On the Morning of Christ’s Nativity
Compos’d 1629

I

This is the Month, and this the happy morn
Wherein the Son of Heav’ns eternal King,
Of wedded Maid, and Virgin Mother born,
Our great redemption from above did bring;
For so the holy sages once did sing,
That he our deadly forfeit should release,
And with his Father work us a perpetual peace.

II

That glorious Form, that Light unsufferable,
And that far-beaming blaze of Majesty,
Wherwith he wont at Heav’ns high Councel-Table,
To sit the midst of Trinal Unity,
He laid aside; and here with us to be,
Forsook the Courts of everlasting Day,
And chose with us a darksom House of mortal Clay.

III

Say Heav’nly Muse, shall not thy sacred vein
Afford a present to the Infant God?
Hast thou no vers, no hymn, or solemn strein,
To welcom him to this his new abode,
Now while the Heav’n by the Suns team untrod,
Hath took no print of the approching light,
And all the spangled host keep watch in squadrons bright?

IV

See how from far upon the Eastern rode
The Star-led Wisards haste with odours sweet:
O run, prevent them with thy humble ode,
And lay it lowly at his blessed feet;
Have thou the honour first, thy Lord to greet,
And joyn thy voice unto the Angel Quire,
From out his secret Altar toucht with hallow’d fire.

The Productivity Commission’s story

Some months ago I ran a post about some of various attempts to explain New Zealand’s decades-long relative economic decline, and to propose remedies that might reverse this performance.  The first major piece along these lines that I’m aware of was by the Monetary and Economic Council in 1962.  Since that was the year I was born, and economic outcomes now, relative to those in other countries, are worse now than they were then, despite all the various policy reforms and all the ink spilt in trying to make sense of the situation, I find that all rather depressing.  A lifetime, and more, of relative economic decline.

In that earlier post I noted that the Productivity Commission, or more particularly its Director of Economics and Research, Paul Conway, had been at work for some time on a “narrative” of New Zealand’s economic underperformance, offering some combination of diagnosis and prescription.      Earlier versions have been presented at various conferences and seminars here and abroad, and this week the finished product was released.  (In the interests of full disclosure, I should note that the Commission paid me to provide some comments and suggestions on a relatively advanced draft of the paper, imposing no  restrictions on me writing about the finished product.)

The paper, Achieving New Zealand’s Productivity Potential, is issued under Paul Conway’s name.  There is no disclaimer, of the sort often seen on public sector agency research, that the paper represents only the views of the author and not necessarily those of the institution.  I asked Paul about the status of the paper, and he suggested that my description, that it was his paper but that the Commission was “not unhappy with the content”, sounded about right.

The paper is well worth reading, and should be read by anyone with a serious interest in these sorts of issues.    It should be reasonably accessible for most potential readers, and –  at least by Productivity Commission standards – at 80 pages it is quite short.    There are lots of interesting charts, and a variety of interesting issues/possibilities are dealt with (including some of the arguments I’ve been raising).  It is a balanced and fair-minded report, and a really useful contribution to the debate that needs to be had.   Even if the Prime Minister apparently no longer cares much about it – the recent statistics are just too bad for political comfort – productivity growth is the basis of any future long-term prosperity prospects.

The paper isn’t the last word on the issue by any means.  That isn’t just meant as an observation that I disagree with some of it.  As Conway notes, there are many issues where not enough research has been done, whether by academics, core policy agencies, or bodies such as the Commission.  Some of the paper is inevitably a bit speculative.  One goal of the paper might be to stimulate further debate, and prompt a demand for more serious research in a number of areas.

The Commission appears to be keen to be read by the government and its acolytes.  That is perhaps understandable –  only this week, the Prime Minister was dismissing out of hand theTreasury’s long-term fiscal projections, and much the same fate befell the 2025 Taskforce a few years ago.  But on my reading, the desire to not immediately lose all readers from the current government has led them to over-egg the pudding in a few places, in writing up the story of the last few years.  It isn’t central to the story, but the suggestion that New Zealand has materially closed the income gap to other advanced countries in recent years just isn’t supported by robust data, and praise for the Business Growth Agenda and regulatory reform both seem to go beyond the substance of what has been achieved.   There is at least an arguable case that the quality of regulation has deterioriated further in recent years.  Where it counts –  productivity –  at best New Zealand has not lost more ground relative to other OECD countries in the last decade or so. But the large gaps simply aren’t closing.

Even though he began his career at the Reserve Bank, these days Conway’s focus has tended to be on microeconomic issues, and often on firm-level research.  New Zealand is particularly well-positioned for such research, because of the creation by Statistics New Zealand of the Longitudinal Business Database, which enables (a small tightly controlled group of) researchers to conduct studies using anonymised detailed data on individual businesses.  Various researchers, at Treasury, Motu, the Commission etc, have produced a series of interesting papers looking at various aspects of firm behaviour in New Zealand.  Some more results in that vein are included in Conway’s narrative paper.  Indeed, this firm-level approach dominates the early part of the paper –  he argues that “this approach puts firms at the centre of the analysis”.

Interesting as the results of these papers often are, I’m less convinced that the firm level analysis is very helpful for understanding long-term trends in overall economic (and productivity performance).  Some of that may just be about short runs of available data.  Thus, the paper begins with some international evidence about the differential labour productivity performance of leading and laggard firms over the last 15 years or so.  There is a big difference.   The Commission produces some evidence suggesting something similar for multi-factor productivity in New Zealand.  But fascinating as that is, we have no way of knowing whether it is normal behaviour, or whether something unusual and new has been going on in the last 15 years.  And, at least on this score, we don’t even know whether New Zealand has been doing more or less well than other advanced countries, even over this relatively short period.  My concern has been that the availability of the data –  itself a wonderful thing –  is shaping the research agenda more than is really warranted.   Perhaps that is inevitable –  researchers will follow data, as water flows downhill –  but even if so, we need to recognise that the questions that data can help answer aren’t necessarily the ones policymakers should be most concerned with.

None of this is to suggest that firms aren’t important.  Most market economic activity takes place in firms.  But firms, and managers and workers within them, respond to incentives, and should typically be presumed to do so in a rational way, that best serves their own interests.    That includes choices to enter the market, to expand or cut back, or to leave it.  Or simply never to set up at all.    After the 50 or so years of our relative decline, it is likely that the structure of our economy, and the firms within it, look quite different than if a more successful path had been found.  And firm-level analysis simply can’t look at the firms that never came into being –  the exporting firms, for example, that might have developed if repeated aspirations to lift the export share of GDP (as in most other advanced countries) had been met.  So, it isn’t entirely clear to me what we learn, that sheds light on overall productivity performance, from an analysis of the firms that happen to be here now. The firm level data, for example, suggest that the labour productivity performance of our leading firms is perhaps 30 per cent below that of advanced country peers.  But that is, surely, just what we would expect.  GDP per capita is –  roughly –  30 per cent below that in many other advanced countries, and firms (and workers) will adjust so that, at the margin, resources earn their marginal product.  Production structures will, typically, look different in poorer countries than in richer ones.

And so one of my criticisms of the Conway/NZPC paper is that while it is strong on highlighting symptoms, it is much weaker on analysing and understanding incentives (eg the reasons why firms, and governments, behave as they do).  There is a tendency in the firm-level literature to treat firms as the cause of the problems –  firms don’t invest enough in R&D, aren’t very good at management or what ever –  without taking as a prior (perhaps to be tested) that individual firms and the people within them typically make decisions that appear rational, and indeed (on average) optimal for themselves.  There is sometimes a sense that if only firms were as smart as the researchers studying them, the problems would be solved.  The Conway paper largely avoids that tone, but it is still weak on the incentives/opportunities issue.    If, as one study suggests, New Zealand firms’ management capabilities really are weak –  on some measure –  why has that happened?  What makes it rational for firms to ‘under-invest” in such capability?  Is it, perhaps, that what counts as high level capability in these surveys is, in fact, more of a luxury consumption product, that tends to accompany –  rather than independently cause –  economic success?  I’ve previously posed similar questions about R&D.   My own story –  unproven – tends to be that firms would be likely to invest more in (genuine, not just classified for tax purposes) R&D, if the overall business environment (expected returns) were less unfavourable.  Similarly, business investment in New Zealand (especially that in the tradables sector) probably isn’t low because businesses are badly run, or because business people are failing in some duty to their country, but because the expected risk-adjusted returns to much higher levels of investment just haven’t been there.

Another concern about the paper is that, for all the interesting paragraphs (and charts), I still came away from it uncertain quite how the author (or the Commission) would summarise the story.  For example, as between the various firm-level “failures” and the big picture macro environment issues,  there is no overall summary that gives me a good sense of which issues they think were really important, and which are rather less so, in explaining how we got to the poor outcomes we have today.  The same is true of the way ahead: what initiatives have the potential to make a real and substantial difference and which, while perhaps nice to have, probably don’t matter that much.   I suspect there is still a tension in the author’s own mind.  His own micro-orientation comes through strongly in the final paragraph of the whole paper.

The broad policy considerations for lifting productivity offered in the paper highlight the importance of regulation that promotes knowledge diffusion into and throughout the economy and increased competition to improve resource allocation. Synergistic investment in skills, innovation and organisational know-how (including managerial capability) and other forms of KBC [knowledge-based capital] are also important. Flexibility, openness and receptiveness to new technology are also key and carry important implications across a range of policy areas.

This is a quite different tone than comes through at the start of the document (Foreword, Key Points, and Introduction).  But more importantly, it has a strong whiff of “more of the same”, even though Conway reproduces the OECD’s chart that suggests that on a standard OECD set of micro-structural policies, New Zealand should already be much richer and more productive than it is.     And it doesn’t really engage at all with the sense in the second half of the paper (which I think the author comes to perhaps rather late and a little grudgingly, or which he perhaps just struggles to fit with his firm-based focus) that macroeconomic conditions –  whatever has caused persistently high real interest rates in particular –  may, in fact, be a material part of the overall story of why the economy has systematically skewed away from growth in the tradables sector, and why it has managed such weak overall productivity growth for such a long time.

In fact, Conway comes a long way towards the view I have been espousing in recent years that the best explanation for persistently high real interest rates (relative to those abroad), which best fits other relevant stylised facts such as the persistently strong exchange rate, is a series of (insufficiently recognised/understood) demand shocks (see discussion on pages 39 and 40).  He also recognises the likely connection between these persistently, and unexpectedly, high real interest rates and the way in which the real exchange rate has stayed high, even though productivity differentials have suggested that we should have seen a material depreciation in the real exchange rate.   Nonetheless, when it comes to discussing the overall economic performance, and particularly the policy path forward, the real exchange rate tends to get only passing mention.  By contrast, I think it is likely to be central to the story.  It is a key part of the business environment that firms considering establishing or investing here have to take into account, and over which they have no control.

For my money, Conway also underemphasis the importance of New Zealand’s extreme geographic isolation.  He notes OECD research that suggests distance represents perhaps a 10 per cent penalty on New Zealand’s GDP per capita, and recognises that –  in some ways counterintuitively –  distance may, if anything, be more of problem/constraint now, especially in knowledge-based industries, than it was in decades gone by.  But I suspect he doesn’t take the issue sufficiently seriously.  On my reading of the paper, most of it would be almost exactly the same if New Zealand was conveniently located in the Bay of Biscay, rather than in a remote corner of the South Pacific, distant from markets, suppliers, key networks etc.  The continuing natural resource base of the overwhelming bulk of our exports doesn’t get a mention either, even though it might raise questions about whether New Zealand is a natural place to put ever more people –  ever more people exposed to the “tax” of distance –  if we hope to generate top tier first world living standards for New Zealanders.

Perhaps somewhat relatedly, there is a lot of discussion in various places of the potential challenges, including for individual firms, that being a small country –  a quite different point from being a distant one –  might involve.  Small domestic markets, and the inevitable limits on the amount of competition in, eg, domestic services markets are real factors facing people considering investing here.  And yet, it was puzzling that throughout the paper there were very few systematic comparisons across small advanced economies.  After all, evidence tends to suggests that small countries have not, in fact, achieved less productivity growth than large ones.  And it is a well-known stylised fact that small countries engage in much more international trade (exports and imports) than large ones do.  Thus, while a firm in a small country might face the “need” to move into exporting earlier than a peer in Japan or the USA might, and face hurdles in doing so, actually the evidence suggests that they do it, and do so in ways that, taken together, generate high incomes and high levels productivity for their home nations.  On my read, being a distant country is a problem –  and one we can do nothing to change –  but being a small country isn’t.  Keeping on trying to become a slightly bigger, still very distant, country doesn’t look like a path to success.  If, in fact, it is, the case isn’t made in the Conway/NZPC paper.

In fact, on that score, I was pleasantly surprised by where the author has got to on immigration policy.   My impression is that his bias, and that of the Commission, would naturally tend towards favouring non-citizen immigration –  it is, after all, fairly standard OECD orthodoxy.  But, as I have consistently argued, the issue has never been a high-level issues of first principles –  at some times and in some places, immigration may benefit all those involved, movers and natives – but one that requires a specific assessment in the New Zealand context.

But as Conway notes

It is difficult to conclusively assess the impacts of migration on the economy.

On the demand side

More broadly, and as discussed in Section 4, Reddell (2013) argues that demand-side pressures driven by strong migration inflows are part of the reason for high real interest and exchange rates in the economy, which supress investment and encourage resources into the low-productivity non-tradables part of the economy.

While

On the supply side, migration may generate small productivity increases via agglomeration.

Note the “may” and “small”

And

A supply of high-skilled migrants may also lift productivity in other ways, including improvements in the skill composition of the labour market, diversity effects and knowledge transfer.

And while they note that, relative to other OECD countries, our immigrants aren’t that lowly-skilled, the picture isn’t all rosy either

Recent evidence from the OECD’s Survey of Adult Skills shows that the skill level of the total overseas-born population in New Zealand is higher than for the overseas-born population of any other OECD country (Figure 5.8). This indicates that the migration system has done comparatively well at attracting high-skilled migrants. However, migrant skills are still lower than the skills of the New Zealand-born population, suggesting that migration inflows may be part of the reason for small decreases in the average quality of workers outlined in Section 3.

(Note that, as I have written about previously, the same OECD survey shows that our native workers are among the most highly-skilled in the OECD.)

Before concluding

Although up-to-date research on the impact of migration on employment and wages is lacking, it is possible that recent inflows of low-skilled migrants have restricted wage growth and the employment of low-skilled New Zealanders. In turn, this would encourage a reliance on cheap labour by some firms and industries. In conjunction with any macroeconomic effects on real interest and exchange rates, this may suppress investment and productivity improvements, and work against efforts to increase the employment of lower-skilled New Zealanders.

The Government’s objectives around migration for labour market purposes should be clearly focused on improving the skill composition of the workforce to improve international connection and the flow of new technology into the economy. New Zealand is currently a very attractive destination internationally and policy needs to use that advantage to target very highly skilled and well-connected migrants. Any reduction in the total number of migrants coming to New Zealand as a result of this sharper focus may help address New Zealand’s macro imbalances outlined in Section 4.

I couldn’t really disagree  (but anyone who read only the Key Points or the Conclusion wouldn’t have sensed that there might be an issue in this area).

One last substantial issue also relates to labour.  For a couple of decades now, at least since the labour market liberalisation in the early 1990s, there has been a story put around that perhaps our labour productivity growth (and MFP?) was lagging because we had put in place highly flexible labour markets which were able to absorb many people (typically lower productivity people) who would simply miss out on jobs in many other countries.  If so, society as a whole might be better off, even if measured average productivity was a bit lower than it might otherwise be.  There is quite a bit of that sort of flavour in the Conway/NZPC paper.  Indeed, it even pops up in the call-to-action Conclusion of the entire paper.

The paper argues that New Zealand needs to shift from a development model based on increasing hours worked per capita to one in which productivity growth plays a more important role in driving growth in GDP and incomes per capita.

It is certainly true that average hours worked per capita are higher than in the median OECD country.  And employment as a share of the adult population is higher here than in the median OECD country too.  But that was true decades ago too.  Our HLFS data only go back to 1986, but that isn’t such a bad starting point –  it was before the bulk of the reforms of the late 80s and early 90s had taken effect, and before the very large, but temporary, disinflation and structural change increase in the unemployment rate occurred.    In fact, New Zealand’s unemployment rate in 1986 (4.2 per cent) wasn’t much lower than the current unemployment rate.

But how do we compare against OECD countries?

employment-oecd

Our employment rate has increased slightly over the 29 years to 2015, but  the median employment rate in other OECD countries has increased a little more than that in New Zealand.  Increased labour participation/employment rates cannot be part of the explanation for why over that same period we have continued to lose ground against other advanced countries, whether one looks at GDP per hour worked or at total factor productivity.    And while it is hypothetically possible that the high level of the employment rate might be depressing the level of productivity, it is worth remembering that the three OECD countries with higher employment rates than New Zealand (Iceland, Sweden, Switzerland) also have higher GDP per capita and GDP per hour worked than New Zealand does.

There are plenty of other aspects of the paper I could write about, and I could touch on some of those here in more depth.  One or two I might come back to next week.  But to close, I would note that I was struck by this line from the final paragraph

With low productivity so entrenched in New Zealand, lifting this presents a monumental challenge for policymakers, business owners and workers.

Unlike most of the rest of the paper, it presents business owners and workers as part of the problem.  But I don’t think the paper offers any evidence to that effect.  Instead, we should generally assume that business owners and workers respond rationally to incentives, and to the climate they face.    Governments shape so much of that climate.    On my telling, governments have (perhaps unintentionally) consistently skewed the economy away from paths that could have allowed much better productivity and GDP per capita outcomes.

The issues are important and the paper is a valuable contribution.  I encourage people to read it, and hope it stimulates some more debate on how New Zealand might best, in the paper’s closing words, achieve its productivity potential.

 

Weak productivity growth: can composition effects explain it?

One of the charts I’ve run a few times in the last few months has had a bit of extra coverage in the last few days.

real-gdp-phw-to-q2-2016

It is a pretty straightforward chart (although it would be a little easier if SNZ followed the practice of the ABS and reported the series routinely, rather than leaving it for people to calculate).  I simply averaged the expenditure and production measures of real GDP, and divided the results by the total number of hours worked (from the HLFS).  And real GDP per hour worked itself is a pretty standard measure of labour productivity.

The interest, of course, has been in the now four years or so of no growth in labour productivity.  On the face of it, it is a pretty poor performance and tends to act as something of a counterpoint to a focus by the government (and its business and media cheerleaders) on headline GDP numbers –  which are high largely because the population has been growing so rapidly, rather than because resources are being used more productively.  Productivity is, in the long run, almost everything when it comes to improving material living standards.

I would add a few caveats around the chart, some of which I’ve made here before.  The first is that the very final observation should be heavily discounted or ignored.  SNZ introduced a revised HLFS methodology in June, which has resulted in a step up in the number of hours recorded (perhaps by around 1 to 1.5 percentage points).  At some point that might be reflected in a slightly higher level of GDP, but for the moment there is just an inconsistency.  (And, of course, there is always some quarter to quarter volatility in the data too.)

The second caveat is the old warning that when a number looks particularly interesting it might well be wrong.  Four years of no productivity growth at all is not unprecedented here or abroad (on current data, for example, GDP per hour worked in the UK now is only around 2007 levels) but….these series are prone to revision, and while they could be revised either up or down, it shouldn’t greatly surprise us if the picture for 2012 to 2016 looks a bit different when we review the data a few years hence.

The big revisions tend to happen as a result of the annual national accounts.  Statistics New Zealand gets a lot more detailed data, produces full annual data once a year (including revisions to earlier years), and then updates the quarterly series that have already been published.  The annual data for the year to March 2016 are out later this month, and the revised quarterlies will presumably be available with the September quarter GDP release next month.  Expect changes (including in the chart above).

But for now, the data is as it is.  Bernard Hickey gave the chart some prominence, with the editorial comment “We’re just pumping more low wage workers in the economy and working more hours”, and observing “Jobs soaked up by net migration & more >65 yrs working”

That prompted Eric Crampton of the New Zealand Initiative, writing on his Offsetting Behaviour blog,  to produce a post asking whether compositional changes in the labour force might account for some or all of the weak productivity growth in recent years.  As he quite rightly notes, if a lot of very unskilled people started working lots more hours (in total), while higher skilled people worked the same number of hours, at the same real output, average real GDP per hour worked would fall even though no one individually was less productive.

First, Eric noted that the number of people on welfare benefits has fallen quite a bit over the last few years.  If –  as seems reasonable –  those people had been of below average productivity, that might tend to lower overall productivity somewhat.

But here is my problem with that story.

working-age-benefits

Working age beneficiary numbers have certainly fallen over the last few years, but they rose a lot during the recession.  There is seasonality in the data so I’ve only shown one observation per annum (June), but in June this year the share of the population of working age on welfare benefits was almost exactly equal to the share as the recession was getting underway in 2008.  People moving on and off benefits might affect average labour productivity to some extent, but absent any sign of an upward surge in productivity over, say, 2008 to 2010 it is difficult to believe this effect explains much of the recent absence of productivity growth.  (And, of course, the decline in beneficiary numbers doesn’t appear to have been in the faster than in the five years leading up to 2008).

Eric also includes a graph showing changing employment rates for different age cohorts, observing

The youngest workers are least productive. They hugely dropped out of the labour market with the changes to the youth minimum wage, but that decline’s since reversed a bit. There’s been a long trend growth in hours worked among older workers, but typical wage patterns over the lifecycle have wages flattening out from the early 50s or thereabouts. Big increases in employment rates among cohorts with lower than average productivity, or at points in the life cycle where wage profiles (and presumably productivity) flatten out, will both flatten or worsen GDP per hour worked.

What to make of that?  Here is a chart of the changes in employment rates for each age group, both since 2012 (when productivity seems to have gone sideways) and since 2007, just before the last recession –  and it isn’t a misprint/error; we’ve had no change in the employment rate over the full period from 2007 to 2016.

employment-rates-by-age

Over the last four years, the least productive age group (15 to 24) had the largest increase in employment rates,  and the 65+ employment rate has kept on growing quite a bit.  But….employment rates for 25 to 44 years olds increased quite a lot too (more than the over 65s).    And if we take the full period (Sept 07 to Sept 16), we’ve had a big drop in the employment rate for the lowest productivity age group.  That fall was, of course, concentrated in the first half of the period, but there was no obvious corresponding surge in average productivity at that time (granting that one never knows the c0unterfactual).

And by New Zealand standards, there is nothing very obviously unusual going in the 65+ employment rates.  Between 2007 and 2016 the 65+ employment rate rose by 8.7 percentage points. In the previous nine years, it has risen by 8.1 percentage points.

Perhaps one could dig deeper (if the data existed) and the impression might change, but it isn’t obvious that the changing age composition of the workforce can explain four years of no labour productivity growth.

Sometimes people suggest that perhaps our labour market is performing so much better than those of other advanced countries which might in turn explain the poor productivity growth.   But here is a chart showing employment rates for New Zealand, Australia, and the median OECD country.

oecd-empl-rates

There might be something in the story relative to Australia over the last few years.  But comparing New Zealand with the OECD median, our employment rate fell about as much as that median did during the recession, and has rebounded only slightly more since.  Compare New Zealand and the typical employment rate just prior to the recession and almost half of OECD countries have had more of an increase than (the slight rise) New Zealand has had.

Eric also suggests that we need to think about the role of immigration

And, obviously, net migration’s increased over the last few years. New workers getting settled in New Zealand might take a bit to find their feet as well, while still being better off than they were before.

Just two thoughts.  First, around half the huge swing upwards in net inward migration has been the result of the sharp decline in the number of New Zealanders leaving.  They won’t have taken “a bit of time to find their feet”.    Second, for the other migrants, there might be something to the story (although there hasn’t been much variability in the number of actual residence approvals) through, for example, the increased number of foreign students working and people on working holiday visas.  But….the New Zealand Initiative and other business lobby groups can’t really have it both ways. They often tell us it is imperative that we have the sort of immigration policy we have now, because (for example) New Zealanders just can’t, or won’t, do the work (at a price firms can afford). There is a strong hint in that sort of argumentation that immigrants are on average actually quite highly productive relative to natives (even though the data show that for most immigrant groups it can take decades for the earnings to reach those of similarly qualified, similarly experienced New Zealanders).

I wouldn’t rule out the possibility that the compositional effects resulting from immigration are part of the explanation for the latest productivity slowdown (although we didn’t see something similar when Australia had its huge surge) but….if the Initiative is right about the general economic payoff to high immigration, we should be expecting a pretty big lift in average labour productivity (the more so to make up for four years of no growth) really quite soon.

One other lens on the composition issue is offered by our own official annual productivity data (for the “measured sector” rather than for the whole economy).   SNZ produces both labour productivity and multi-factor productivity estimates, and they also produce both series using both total hours worked and an estimate that attempts to adjust for the changing composition of the labour force.   The latter isn’t precise by any means, and won’t pick up all the sorts of issues that have been touched on in this post, or Eric’s, but they are just another angle on the question.  The MFP numbers are valuable because they help get round the question of whether, say, labour productivity is just poor because firms have substituted away from capital towards abundant labour.  Any such substitution would be less troubling if the result was showing strong MFP growth.

Unfortunately, the most recent data are for the year to March 2015.  In the labour productivity data, SNZ weren’t detecting any sign that a worsening average quality of the labour force was explaining the productivity slowdown – they reported much the same improvement in the average quality of the labour force as in earlier years.  And here is the MFP chart.

mfp-measured-sector

On this measure, of labour-quality adjusted MFP, there has been no productivity growth at all since around 2006.    There is some modest growth over 2012 to 2015 (a bit over 1 per cent over three years).

Where does all this leave us?

I remain a bit uneasy about the prospects the data could be revised, but then data revisions are always a risk.  But if the average real GDP per hour worked data are roughly right – and there really has been no average labour productivity growth for perhaps four years now –  I think we should be more inclined to believe that it is telling us something about overall economic underperformance, than that it is simply, or even largely, reflecting compositional changes in the labour force. To repeat:

  • the share of working age welfare benefit recipients has fallen gradually over the last few years, but then it rose in the previous few years, and there was no obvious associated productivity surge,
  • over the last few years the employment rates of the low productivity young age groups have risen, but not noticeably faster than those for, say, the rather large 25 to 44 age group.  Over 65s employment rates are rising more than those for other age groups, but that change has been underway for many years.  There was no obvious associated productivity surge (at least in the reported data) when youth employment rates dropped sharply.
  • there is nothing in cross-country comparative data suggesting employment rate changes here have been unusual, in ways that might help account for unusually weak productivity growth here.
  • compositional effects resulting from increased immigration of non-citizens (especially  working students and working holidaymakers) could be part of the story (averaging down real GDP per hour worked, even if no one individually is less productive), although it would be worth testing that story against other episodes in other countries.  If higher immigration is playing a role in dampening productivity growth, I suspect it isn’t mostly a compositional story, but one about overall pressures on domestic resources, which have contributed to holding up real interest rates (relative to those in other countries) and the real exchange rate.
  • and overall MFP growth –  whether SNZ estimated for the measured sector, with some labour composition effects accounted for, or the Conference Board’s estimates that I showed the other day – also seems to have been weak to non-existent.