Solving the productivity puzzle

19:29, Mar 14 2013

So there I was at Treasury’s fiscal briefing last December, locked up with journos hoping to trap Bill English into saying something silly, economists looking for something their rivals had overlooked — when Treasury staff handed out a supplementary paper, unpromisingly titled Potential Output in the 2012 Half Year Update.

It was fascinating. No, really, it was. It shed light on a truly important question: how fast can New Zealand grow? 

It’s not an easy question to answer and there are multiple ways of tackling it: the paper used eight. The most intuitive one is what is called the production function approach.

It says, count up the capital stock, count up the labour force, measure how good we are at using the gear and the people — our productivity — multiply them together and that’s how much we can produce: our ‘potential’ output as we call it in economics.

Repeat for successive years, updating with new investments in equipment and new entrants to the workforce, and you find out what was the most we could have potentially produced over time.

The different methods show a broadly consistent picture, and it’s a sobering one. In the later 1990s, our economy could grow at between 2.5% and 3% a year.


In the early 2000s it picked up to something like 3.5% a year. In the later 2000s, however, our potential growth rate dropped sharply to around 1% and is currently somewhere around 1.5%.

Given our population grows at about 1.2% a year, one conclusion is that our economy is currently not capable of generating any per capita income increases worth mentioning.

A more important conclusion is that this is something we have done to ourselves. That maximum growth is mostly the result of how much hiring we chose to do, how much investment we made and how well we ran our businesses.

The Treasury paper had a go at unpacking the relative contributions of those three components. Weak levels of investment are mostly off the hook: it’s mostly stuff happening to the labour force and to productivity.

We are attracting fewer people into our workforce because of lower net migration, we’re working fewer hours and, over the 2006 to 2011 period, we had outright falls in productivity.

That’s a real concern for New Zealand business. Falling productivity means that, for the same workforce and same level of plant equipment, you’re actually producing less than you did before.

But falling productivity doesn’t necessarily reflect ineptitude at the level of individual businesses. It could be that, as the economy has developed, we have been growing our more low productivity sectors rather than our higher productivity ones.

The average productivity of the whole economy goes down, reflecting the fact that there are more low productivity businesses going into the mix.

That shift into less productive activities also seems to be part of the answer. In recent years we’ve been doing more of the low growth, low productivity stuff.

So either firms have become less efficient, or we’re doing more low value things, or a bit of both. The mystery is: why would we be doing this?

In policy circles, that question has a name: the ‘productivity paradox’. It’s a paradox from several perspectives. For one, it seems daft for any business or economy to choose lower productivity things.

For another, it shouldn’t be happening  in today’s interconnected, globalised business world: we should be able to buy the same technology as any other developed economy and churn out the same goods and services with the same level of productivity.

The question’s got a fancy name. So far, though, it hasn’t got any knockout answers.

Donal Curtin is an economist and rabid Warriors fan who has worked as a chief economist for a bank.