It’s the productivity, stupid

New Zealand's GDP figures show more people worked many more hours to increase output. That's not a rock star economy. That's a cover band economy.

It is the central task of any business or organisation or economy: how to produce more of a product or service (or a better one) with the same amount of resources, particularly the number of hours worked.

This is what productivity is all about and it's the only true way for any business or economy to get richer.

Yet we hardly ever talk about it and we don't target it.

This week's GDP figures appeared to show an economy cantering along at a healthy annual growth rate of 3.1 percent. So that was what reporters and politicians and business generally focused on. Overall growth in GDP in the December quarter was 0.4 percent, which was less than the 0.7 percent economists had expected. It seemed more than reasonable and solid compared to the rest of the world.

But it disguised an awful productivity performance that is now turning into a five year trend where growth was produced by simply throwing more resources and people into the economy. That 3.1 percent GDP growth only came after our population grew 2.1 percent.

The GDP figures showed per capita GDP actually fell 0.2 percent in the December quarter and was up just 0.9 percent for the full 2016 year. That is the second consecutive year of less than 1 percent growth in GDP per capita. It's not a healthy performance, but it's also not a true measure of productivity because New Zealanders could have worked fewer hours to get that extra output -- thus improving productivity. If only.

The earliest crude measure of labour productivity we can get is the amount of output per hour worked, which can be calculated roughly from the GDP figures and the Labour Force figures. The 0.2 percent fall in the measure of GDP per capita actually disguised a fall of 0.9 percent in GDP per hour worked in the December quarter and a fall of 1.4 percent over the last six months.

Essentially, more people worked many more hours to increase output. That's not a rock star economy. That's a cover band economy.

Former Reserve Bank senior economist Michael Reddell has written extensively about productivity growth over the last year and has picked up on the poor performance, and in particular about the relative under-performance with Australia.

He has documented how New Zealand's real GDP per hour worked has stagnated since 2011, while Australia's labour productivity has improved more than 5 percent.

Problem of success? Or symptom of failure?

That might surprise a few people and the Government in particular, given the way former Finance Minister and now Prime Minister Bill English has talked about "good problems to have" and how the the relative out-performance of the New Zealand economy was the main driver of our record high net migration.

New Zealand's labour productivity has lagged Australia's for decades, but it appears to have gotten much worse over the last five years. And remember that Australia's 30-40 percent wage advantage will not improve until we start improving our productivity. Narrowing that gap used to be one of the rallying cries of the current Government, but it has been rarely mentioned in recent years.

"You’d like to think this sort of gross under-performance would be getting some attention in the run-up to the election, but there isn’t much sign of that," Reddell wrote after Thursday's GDP figures.

He pointed to the negative productivity growth over the last year.

"That means all our pretty modest per capita GDP growth over the last year has resulted from throwing more labour and more capital at the economy, and (less than) none at all by using resources smarter and better," he said.

It's not only some on the dryish right of the spectrum who worry about New Zealand's lagging productivity performance.

Council of Trade Unions Economist Bill Rosenberg also focused on it in his comments after the GDP figures.

"There needs to be a much greater focus on raising productivity and helping people through change without big blows to their income and security," he said, calling for an increase in Government spending on research and development and training for workers.

Even the bank economists, who are usually more focused on the immediate overall growth figures, picked out the poor per-capita growth performance.

ANZ Senior Economist Philip Borkin noted the 0.6 percent rise in per capita GDP for the year was less than half the average seen since 1993.

"It could well invigorate the debate about the wider merits of current record net migrant inflows," he wrote.

So what do we do about it?

Some in the Government are more interested in it than the Cabinet and the Prime Minister.

The most focused and concerned is the Productivity Commission, which, ironically, Bill English set up in 2011. It coordinates a 'Productivity Hub' group within Government that includes Treasury, MBIE and Statistics New Zealand.

A comprehensive and influential paper published by the Commission in November addressed New Zealand's under-performance head on. The Commission's Director of Economics and Research, Paul Conway, wrote the 86 page paper which grappled with the reasons why our productivity has been weak, and is getting weaker.

The paper documents the productivity slowdown, which is worse here than a slowdown that is also happening in other parts of the world. Conway also challenges the rock star economy view of our performance.

"Given that framework policy settings are often regarded as fit for purpose, this long-run track record has puzzled international and domestic economists for decades," he said.

The 'puzzled' is bureaucrat speak for surprised, disappointed and confounded.

"The apparent disconnect between policy and performance naturally raises questions about the broad policy directions and institutions necessary to close New Zealand’s still-substantial productivity and income gaps relative to leading OECD economies," he said.

Conway's paper addressed some of the reasons why we have lagged without suggesting too many specific remedies.

So here's a few Questions and Answers around productivity that we can pose here:

Why is our productivity so weak?

New Zealand-owned businesses tend not to invest as much capital in new machinery, research and development and training as their foreign owned peers operating in New Zealand or overseas.

New Zealand investors prefer to buy land and make leveraged and tax-free capital gains, rather than invest without the addition of bank debt in the tougher job of making businesses and workers more efficient. It's just easier and less risky to buy a house or land and sit tight than to build a business.

Some also argue that our distance from markets and our relatively small scale make it difficult to invest in and create the businesses that are often (but not always) more efficient because they are bigger. But there's debate about that too, particularly given the advances of technology and the power of the Internet to bring us closer to markets. Some also say our still-large state sector has also underperformed on the productivity front.

But surely we've tried to fix that?

The last election was partly about whether to adopt a capital gains tax and whether to reintroduce some more lucrative Government tax incentives for research and development. Labour and the Greens proposed these change. The electorate chose to stick with the current settings, which favour investment in land and property over investing more in businesses.

Several Governments have also tried to deepen our capital markets to make it easier for businesses to raise money directly from savers to invest in new machinery, businesses and to improve output. The advent of Kiwisaver and the New Zealand Superannuation Fund have helped, but our stock market is still worth just a 10th of our housing market.

In other more developed markets with higher productivity and a higher propensity to invest in companies, the relative sizes of their stock and housing markets are radically different. New Zealand's housing market is worth 4.2 times GDP and ten times the value of the stock market. America's housing market is worth just 1.6 times GDP and is only slightly larger than the value of the US stock market.

The Government also used to talk a lot about increasing the export share of the economy from 30 percent when it took office in 2008 to 40 percent by 2025. Increasing the share of exports is seen as important because exporters tend to be more productive and competitive than local ones. More international engagement is seen as a key way of 'diffusing' more productive technologies and techniques used overseas out into the local economy. But the Government has failed to make any progress in lifting that share. It has actually gone slightly backwards over the last eight years, due in part to a currency that the Reserve Bank has repeatedly said is over-valued.

So what could be done?

The debate often circles back to the way investment in land and property is treated for taxation purposes. Leveraged investments in land and property are treated no differently to other assets, but the sheer fact that land can be leveraged much more easily than other assets and the interest can be offset for tax purposes means land is favoured.

Most think that some form of land taxation or a capital gains tax would shift the incentives towards investing in businesses and productive machinery and exports, rather than in land and houses.

Many would also like to see more favourable treatment of research and development investment.

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