5. Key Contributors to Income Levels
- Productivity is a key contributor to income levels.
- Using more capital and bringing more people into the labour force, for example through immigration, can help to increase total production in the economy. But this may do little to increase average incomes for individual New Zealanders.
- The increases in productivity needed to increase average incomes require a combination of:
- the entrepreneurial drive to identify and take advantage of new market opportunities for innovative products and services. This requires ongoing efforts to understand international and domestic markets, the capability to come up with and develop innovative ideas, and the capability to effectively manage firm growth and meet customer needs.
- increasing the amount produced from investment and labour. This, too, requires an appropriately skilled labour force.
- The preferred way to measure changes in these areas is to measure the joint productivity of investment and labour. This is called total or multi-factor productivity.
- However, in the absence of an official series for multi-factor productivity, the indicator used measures labour productivity (output per hour worked). This measure is more internationally comparable and suffers less from measurement errors than currently available multi-factor productivity data.
- As with GDP per capita, New Zealand's labour productivity is poor compared with other OECD countries. This is consistent with New Zealand's overall economic performance and is reflected in most of the broader measures of productivity.
Labour Productivity17: New Zealand Has Low Rates of Labour Productivity Growth
Why is it Significant?
Productivity is a way of looking at how efficiently production inputs are used in an economy. The economics literature suggests that productivity is a major contributor to long-run economic growth and improved living standards.
Labour productivity measures an economy's outputs in relation to its labour inputs. The relationship between economic growth (GDP per capita), labour productivity and labour utilisation is illustrated by the following equation.
Or, in other words, GDP per capita = labour productivity x labour utilisation.
Growth in labour productivity is, therefore, crucial to the government's goal of achieving higher economic growth and, ultimately, higher living standards.
We have used labour productivity as the main indicator of productivity. We would have preferred a broader measure of productivity, total factor productivity (TFP). However, a reliable measure of TFP for New Zealand is not available.
How Does New Zealand Perform?
New Zealand's economic growth over the past decade has been largely due to a significant increase in labour utilisation (contributing over 75 percent of real output growth), with a smaller contribution from labour productivity growth.18 New Zealand now has comparatively high rates of labour utilisation.19 While there may be some scope for further increases, this is likely to be limited, and ongoing economic growth is increasingly dependent on labour productivity growth.
Real GDP Per Hours Worked
Labour Productivity Growth
The charts above show New Zealand's labour productivity since 1990. Productivity growth picked up from the mid-1990s, to average 1.5 percent over the 1998-2002 period. However, New Zealand's growth rates are below those of the majority of OECD countries, which have averaged between two and three percent.20
The chart below illustrates the strong correlation between labour productivity and living standards (in terms of GDP per capita). It suggests that, in order to raise living standards, New Zealand must increase its labour productivity. This requires investigating the factors that contribute to labour productivity growth, such as capital deepening, investment in knowledge, and innovation.
Real GDP Per Hours Worked
The mix of industries in an economy has a bearing on both the level and growth of labour productivity. Labour productivity in the agricultural sector has been relatively good, with growth rates comparable to other developed countries in the 1960s and 1970s, and well above the OECD average since 1979.21 In contrast, the manufacturing sector's performance has been comparatively poor, although from 1979 to 1987 the difference between the New Zealand and OECD average was small. The service sector's productivity growth was behind the OECD for all periods except 1983-1988. That said, international comparisons for this sector are less reliable than for other sectors, due to substantial differences in the definition of services and measurement of service outputs.22
What Does This Mean for New Zealand?
In common with most other OECD countries, an ageing population and international competition for skilled migrants mean that New Zealand's rate of economic growth will become increasingly constrained by the supply of labour.23 Lifting New Zealand's already high labour utilisation rates is not likely to be sufficient to offset the decline in the relative size of the working-age population. Continued growth in living standards will come from labour productivity growth.
There is no magic bullet for improving productivity. Rather, research suggests that productivity growth is underpinned by a wide range of factors including technological change, accumulation of human and physical capital, firm organisation, openness, institutions, resource allocation and plant/firm turnover within industries. These factors will differ across firms. A method that improves labour productivity in one business or industry may not yield the same benefits elsewhere. Therefore, investment in improving productivity is largely a firm-level decision. Businesses will invest in improving productivity through innovation, capital investment or upskilling employees if they believe that benefits will outweigh the incremental cost of this investment.
Some economists expect significant increases in labour productivity to result from investment in new technologies, such as ICT. Work by the Australian Productivity Commission suggests that such increases have been obtained through the effective use of ICT, even without an ICT production industry. It appears that, while ICT and other new technologies have the potential to boost productivity, this is yet to happen in New Zealand.
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