2. A GDP recipe of sweat, toil and migration

The construction sector is often cited as having poor productivity, leading to higher costs. Photo: Lynn Grieveson.

New Zealanders are losing out to poor productivity and paying for it by working longer than their peers overseas, according to the Productivity Commission. Thomas Coughlan reports.

A new paper shows how pumping up our economy with new migrants and allowing big tax incentives for property investors is hampering our ability to improve productivity.

Productivity measures how much value a worker can create in a set amount of time. Unproductive workers create less value in a working day than more productive workers.

They have to work longer to achieve the same gains as their more productive peers. And when workers get more productive, their wages tend to rise.

Productivity is a good thing, which is why so many of our policymakers are dedicated to improving it.

An economy built on sweat and toil

Paul Conway, Director of the Productivity Commission talked to Newsroom about the “productivity paradox” in New Zealand. After a surge in the 1990s, our long-run productivity performance has been poor by international standards.

There are some established truths about productivity. Generally, investment is good — buying more machinery helps workers get more out of their days, creating more value for a business.

On the other side of the coin, low wages tend to be unhelpful. They encourage businesses to hire extra staff rather than investing in technology to make their existing staff more productive.

New Zealand’s low productivity indicates our economy sits on this side of the spectrum. Conway’s most recent paper for the Commission makes the point that recent GDP gains have been strongly tied to high immigration, showing firms are keen to add extra labour, rather than investing in making existing staff more productive.

“Our economy is built on sweat and toil,” he told Newsroom.

New Zealanders work relatively longer hours than most comparable countries. 

Small firms and small markets — the New Zealand productivity story.

The productivity story in New Zealand is different to international peers, many of which have also struggled with low productivity. Our situation must take into account things like economic geography — how our geography impacts the economy.

“Economic geography became a thing 20, 30 years ago. Prior to that the neoclassical economists didn’t really have space or geography in their model,” Conway told Newsroom.

New Zealand’s economic geography is unique. It has a small population, spread thinly over a large area, which is far away from other large markets. This has created an environment where the economy is dominated by small firms selling into small markets.

And the size of businesses matters to productivity.

“Big businesses tend to be more productive than small businesses,” Conway said.

“Small markets and small firms are one of the reasons for New Zealand’s poor productivity performance.”

An example of an industry beleaguered by low productivity is construction.

Housing Minister Phil Twyford told journalists at a recent KiwiBuild briefing that the house construction sector was dominated by small to medium enterprises, often with few staff. 

Fletcher Building, a comparatively large firm, has just 5 percent of the market for constructing new houses. 

This can lead to poor productivity and inflated construction costs as small businesses are poorly equipped to take advantage of economies of scale.

Twyford has explicitly spoken of his ambition to grow larger firms, particularly those creating prefab housing, which would raise productivity levels in the construction sector.

A lack of foreign and local investment

The paper makes the point that for a small country, New Zealand is not well-connected internationally, which means that businesses here can miss out from important foreign investment or technology advances.

These help businesses become more productive.

New Zealand’s international trade in both goods and services has declined in recent years and the stock of foreign direct investment in New Zealand (FDI for short) peaked at 50 percent in the 1990s and has fallen slightly since, bucking the international trend of growing cross-border investment.

Accessing large pools of foreign money can benefit New Zealand firms, allowing them to invest in technology and machinery that makes their workers more productive.

There are local sources of investment too. But in New Zealand investment that could be made in businesses is often directed to the housing market.

“New Zealand taxes savings in a way that is quite different to virtually all other OECD countries,” Conway said.

“A lot of so called investment goes into the housing market,” he said.

Conway noted that this could be about to change if the Tax Working Group suggests the Government change settings to level the playing field between income earned from savings versus income earned from property.

The group’s initial discussion document noted marginal effective tax rates on money in bank accounts, portfolio investment entities (PIE), superannuation funds, company or foreign shares sits between 47.2 percent and 55.7 percent. By contrast the effective marginal tax rate on equity in property is 11.3 percent on owner-occupied property and 29.4 percent on rental property.

This incentivises investment in real estate, but not in businesses where it might be needed more.

Finding the labour sweet spot

The supply of labour also has an impact on productivity. New Zealand firms have been on an international hiring spree, filling domestic labour shortages with foreign workers.

This has had the nice side-effect of boosting GDP growth as firms expand, but it has disincentivised investment in labour and potentially has local firms addicted to cheap labour.

National’s finance spokesperson Amy Adams said earlier this month that if Labour’s pre-election promises to cut immigration materialised the “economy would utterly tank”.

Conway is sympathetic to concerns that skills shortages need to be filled, but cautions that a growing workforce needs to be matched with growing investment.

“Because our labour market is growing so strongly private sector investment has only just managed to keep pace,” Conway said.

“The process of what we call capital deepening isn’t happening in the New Zealand economy,” he said.

But the immigration question inevitably comes back to the fact that New Zealand is a small country with a small workforce that might not be able to satisfy the needs of its employers.

‘“In a small economy like ours its harder to get skills matching right, because labour markets aren’t that thick,” Conway said.

This opens up another question: the role of the education system, policy makers, and business to train workers in the skills that they need for the workforce.

“How attuned is our system to meet demands from businesses coming out of that market?” asked Conway.

But this poses yet another question. Not only is it difficult to guess the skills needed by the workforce of the future, it’s not always clear whether the burden for training workers in those skills should fall on the employer or the education system.

And as always in New Zealand, the skills mismatch comes back to the property market. Often businesses can’t get the skilled - or even unskilled - workers they need because it would simply be uneconomical for workers to move to where the work is.