7. Changes in Investment
- Investment is driven primarily by the ability to generate returns on capital. Such returns arise from market opportunities. For New Zealand firms, significant market opportunities are mostly offshore due to the relatively small size of the domestic market. Making the most of market opportunities requires access to appropriate finance, a pool of appropriately skilled labour, innovative ideas and entrepreneurial drive.
- Confidence in New Zealand's economic prospects is likely to be shown through:
- offshore interest in investing in New Zealand, principally through foreign direct investment (FDI)
- domestic investment, particularly in plant, machinery and equipment.
- The high stock of FDI in New Zealand is similar to that of other small, open economies. Despite global increases in FDI from the late 1990s to 2001, flows of FDI into New Zealand declined and have since continued to decline in tandem with a dramatic fall in global FDI. While the decline in the quantity of FDI inflows is not in itself a concern, FDI is often regarded as high-quality investment because of its potential to generate significant spillover benefits (e.g. through its contribution to the dissemination of new technologies). Realising these spillover benefits requires a concerted effort by government to attract new FDI that can bring broader economic benefits to New Zealand.
- Investment in plant, machinery and equipment (PME) is also a sign of business confidence in the economy. It is, therefore, a leading indicator of future economic performance. Investment in PME has been increasing over the past decade. There is also a high ratio of capital per worker and researcher in New Zealand compared to a selection of OECD countries. This probably reflects New Zealand's small size, where production runs are lower in relation to the capacity of plant and equipment than in larger countries and overseas markets are needed to realise full benefits of the investment. However, given New Zealand's relatively poor productivity and income levels, this high ratio may also point to the appropriate skills not being available to take full advantage of the investment under New Zealand conditions.
Foreign Direct Investment: New Zealand Has a High Stock of Inward Foreign Direct Investment, But Has Recently Attracted Less Foreign Direct Investment than Many of its OECD Peers
How Does New Zealand Perform?
Foreign direct investment (FDI) measures the value of cross-border capital transactions, both debt and equity, between enterprises in a direct investment relationship (i.e. where an investor owns 10 percent or more of the equity) in an enterprise.
FDI can benefit the economy by adding to the stock of economic assets and by putting domestic factors of production (e.g. land and labour) to better use. More importantly, international experience has shown that FDI has the potential to generate valuable spillover benefits. For example, FDI can contribute to the dissemination of advanced technological and managerial practices within the economy, or improve New Zealand firms' access to export markets. FDI is also more stable than other types of foreign capital (e.g. portfolio investment and lending to financial institutions), exhibiting greater stability in the face of economic or financial shocks.
The following discussion details trends in both the stock of FDI and the flow of FDI into New Zealand over the past decade. International comparisons are also made.
The Stock of Inward FDI
The stock of inward FDI in New Zealand grew steadily between 1993 and 1998, before levelling off and, more recently, reducing to around NZ$50 billion as at 31 March 2002.31
Stock of Foreign Direct Investment in New Zealand
The following chart shows that New Zealand has a relatively high degree of FDI compared with most OECD countries. But it is important to note that a high stock of FDI is the norm for small open economies. Small open economies tend to rely more heavily on external sources of investment to compensate for a lack of domestic sources of finance (for example, where there is a low level of domestic savings).
Inward FDI Stock
FDI Flows into New Zealand
An examination of FDI flows provides us with a more dynamic picture. FDI inflows peaked with the large-scale privatisation sales of the late 1980s and early 1990s. But from the mid-1990s onwards, inward flows have trended downward despite a measure of volatility (the 'blip' in 2001 is partly explained by changes to methodology and data collection, which means that the figures for 2001 onwards are not directly comparable with those for earlier periods).32
FDI Flows into New Zealand: 1951-2002
It is useful to set this experience against the international picture. Comparing recent performance only, the chart below shows that New Zealand has attracted only moderate amounts of FDI relative to many of its OECD peers, albeit from a high base. The downturn in FDI flows into New Zealand in the late 1990s happened at a time when global FDI inflows were increasing significantly. More recently, global FDI inflows have fallen dramatically and New Zealand has not been immune to this downturn.
Average FDI Inflows 1997-1999
What Does This Mean for New Zealand?
A declining inflow of FDI into New Zealand is not simply an issue of the availability of finance - equity or debt. Potentially it means that the productivity-related benefits from FDI are not being realised.
As noted at the beginning of this chapter, international evidence suggests that inward FDI can bring with it valuable spillover benefits. However, research suggests that these benefits do not accrue automatically. Rather, evidence suggests that spillovers are most likely to occur where:
- the technological and managerial capabilities of the foreign firm are advanced but not so far advanced that they are not relevant for domestic industry
- local firms have the capability and motivation to develop forwards and backwards linkages with the foreign firm
- there exists a healthy and competitive domestic industry, especially where the investment is domestic market oriented
- the investment is export-oriented, especially in small economies since offshore markets generally offer greater scope for expansion than domestic markets
- the investment is skilled labour intensive, and involves recruitment and training of domestic employees
- the foreign affiliate opens up new markets for New Zealand firms.
It is noted that the above data does not provide us with any insights into the quality of the stock of FDI in New Zealand, and this should be an issue for further research.
Nevertheless, FDI has an important role to play in raising New Zealand's use of new technology, improving New Zealanders' skills, and promoting economic growth generally. New Zealand needs to continue to focus on attracting investment that has a good chance of generating these spillover benefits. This in turn will require careful management (e.g. government support for high-quality FDI and not solely a focus on the quantity of new investment).
Investment in Plant and Equipment: New Zealand Has Relatively Low Levels of Investment in Plant, Equipment and Machinery as a Proportion of Total Investment in Physical Capital
Why is it Significant?
Investment in more efficient physical capital can increase the productivity of the workforce. Total investment in capital (or gross fixed-capital formation) includes plant, machinery and equipment (PME), buildings, land improvements, infrastructure (such as roading) and transport equipment. The ratio of physical capital per worker illustrates the extent to which worker productivity is supported by investment in tools and machinery. As investment is a flow, and employment is a stock of resources, it is useful to also compare employment with the stock of capital.
How Does New Zealand Perform?
PME has been isolated from other capital investment. This type of capital is probably most substitutable for labour and most influential on labour productivity.
The charts below show that the ratio of PME to labour (measured as full-time equivalent employees (FTEs)) has been increasing over the last decade or so. This is indicative of 'capital deepening', and is likely to be a factor driving the recent growth in labour productivity.
Ratio of PME Investment to FTEs
In 2002, the Firm Foundations study of New Zealand firms with six or more FTEs revealed that 50 percent had invested in machinery and equipment in the previous 12 months. The study recorded only that investment specifically required for the introduction of new or significantly improved products, services or processes. This was the area where the highest proportion of firms chose to invest.
% of NZ Firms Investing in New or Significantly Improved Products, Services or Processes
The ratio of total capital investment (other than residential buildings) to FTEs exhibits a similar trend to investment in PME, generally increasing over the last decade.
Total Real Gross Fixed Capital Formation (ex Residential) Per FTE
Similar international data are difficult to obtain. International comparisons commonly measure investment in PME as a proportion of GDP. The OECD comparison presented below is in real (i.e. constant dollar) terms. The average ratio across OECD countries for PME investment was 9 percent in 1998. By this measure, New Zealand is below average, with 7 percent.
The OECD average for total investment as a proportion of GDP was 21 percent in 1998. The ratio for New Zealand, excluding residential investment, was 15.9 percent, and 21.5 percent for total investment. New Zealand therefore has a lower investment in PME as a proportion of total investment than other OECD countries.
Real Gross Fixed Capital Formation as % of GDP
Note: OECD data in 1995 US dollars using purchasing power parities. New Zealand data is in constant 1995/96 prices.
The chart below shows average annual growth in total investment from 1991 to 1998. New Zealand's growth rate was 4.2 percent, well above the OECD average of 2.2 percent.
Average Annual Growth in Total Real Gross Fixed Capital Formation
Note: OECD data in 1995 US dollars using purchasing power parities. New Zealand data in constant 1995/96 prices.
What Does This Mean for New Zealand?
Investment in plant and machinery is a leading indicator. It is expected that increases in levels of investment will contribute to productivity growth. However, this productivity growth depends on:
- the investment being in productivity-enhancing PME. This relies on PME investment being used to produce goods that permit attractive opportunities for New Zealand products to be developed and satisfied, particularly internationally, and to lower production costs
- having appropriately skilled people to realise the full value of the investment.
This is particularly relevant for New Zealand, where the composition of inputs is different from some of the leading growth performers in the OECD.
Investment in Plant, Machinery and Equipment is Driven by Returns
The growth in PME investment over the 1990s probably reflects increasing growth opportunities. Improving per capita income growth marks this period, preceded by decline.
The continued strong economic performance over the past few years means we can expect to see this growth continue. The economy's relative level of investment in PME may therefore improve. However, given New Zealand's economic structure and tax arrangements, we are likely to see other investments, for example in land, continue to be higher than other OECD countries.
New Zealand Has a High Capital to Labour Ratio Internationally
New Zealand has a high capital to labour ratio. A recent comparison of factor endowments (e.g. capital, researchers - skilled labour - and unskilled labour) for Finland, the United States, Australia, Canada and New Zealand found that New Zealand has the highest capital per unit of labour and capital per researcher of the five countries.33 This probably reflects New Zealand's small population in relation to the capital investment needed to produce many of the goods delivered by New Zealand businesses.
Limited Impact on Relative Productivity
Given their limited impact on productivity levels, New Zealand's high capital per unit of labour and capital per researcher may suggest that New Zealand has not had the appropriate skills to exploit the benefits of our investment in physical capital. The small scale of New Zealand businesses is also likely to be a factor.
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