Introduction
This inter-departmental report provides a broad range of indicators relevant to New Zealand's economic performance. It has been prepared to inform economic policy making in general, and to feed into the government's work on economic transformation.
At the broadest level, democratic governments around the world aim to create a better life for their citizens by developing strategies to improve their economy, society, environment, culture and way of life. More recently, there has been a growing awareness of the need to pursue these improvements sustainably; ensuring that any improvements secured for the current generation do not limit the ability of future generations to meet their legitimate aspirations.
The New Zealand government has expressed its sustainable development challenge as being to:
- build a sustainable economy based on innovation and quality;
- sustain and improve family and community living standards in our open, competitive economy;
- sustain our unique culture, values and national identity in a world of globalised media and culture; and
- make a commitment to greater sustainability in our resource use and way of life.
Economic transformation is a key element of the government's sustainability goals. Along with families - young and old, and national identity, economic transformation is one of the government's three priorities for the next decade.
Economic transformation is aimed at creating a strong, healthy economy that will underpin much of what New Zealanders value and desire in life. Without higher economic growth, we will not be able to raise living standards or achieve the quality of life to which New Zealanders aspire. As well as raising incomes, lifting economic growth increases the resources available to finance better-quality public services and to care for and maintain our environment.
Characteristics of the New Zealand Economy
New Zealand can be characterised as a small, open economy that is far from most of the world's markets. In common with other advanced industrialised countries, New Zealand has a high share of its economy devoted to services and manufacturing. New Zealand, however, also has a relatively large agricultural sector by Organisation for Economic Co-operation and Development (OECD) standards, and a significant proportion of exports based on primary production. A relatively small share of New Zealand's export production comes from high-technology sectors such as ICT and pharmaceuticals.
Volatility in the domestic economy has decreased in recent years. However, New Zealand's small size and dependence on foreign investment and trade, particularly in commodity markets where we are largely a price taker, mean we are strongly affected by developments in the global economy. The New Zealand economy has experienced a number of economic shocks recently due to external economic factors (e.g., the Asian financial crisis of 1997). New Zealand can also be significantly affected by changes in climatic conditions.
These features of New Zealand's economy have consequences for many of the indicators collected in this report, and their impact is noted in the text where relevant.
Purpose of Indicators
Government agencies publish a number of sets of indicators covering a broad range of social, economic and environmental outcomes. This report focuses on the economic development dimension and its contribution to well-being, although - to recognise the interdependence of these various dimensions of well-being - it does cover a small number of key well-being and environmental sustainability indicators. The Ministry of Social Development's annual publication The Social Report provides information on the social health and well-being of New Zealand society and is a useful complement to this report. The Ministry for the Environment has published a number of environmental indicators on its website and is due to publish its latest State of the Environment report by the end of 2007.
Economic indicators can assist with several important objectives. Economic indicators allow us to monitor progress towards economic goals and to benchmark New Zealand's performance against that of other countries. A comprehensive set of indicators allows us to track and compare performance both in terms of high-level outcomes (such as income levels) and the underlying factors that may influence these outcomes over time (such as levels of innovation and skills).
Indicators can also help us to evaluate the effectiveness of economic policy. On their own they are not enough to do this, but over time the direction or pace of change in a particular indicator or set of indicators may provide us with information on whether policy is broadly on the right track.
Indicators provide information on areas of both strength and weakness within the New Zealand economy. Information on areas where New Zealand performs poorly relative to other countries may help to identify areas for policy consideration or intervention. Again, they do not alone confirm the existence or the nature of a policy problem but they can help highlight areas that may warrant deeper inquiry.
Determinants of Income Growth
To fulfil the purpose outlined above, indicators must be chosen that are relevant to the growth process. However, despite their fundamental importance to a society's well-being, and much research into them, the factors that collectively cause a country's incomes to grow are not fully understood and remain controversial.2 This section briefly outlines our views about the growth process based on this extensive literature and explains why the indicators included in this document are relevant.
The most important contributor to increasing incomes per capita is increasing productivity, or output per hour worked. Countries can become richer in the short term by increasing the proportion of their population that works, or encouraging those in the workforce to work longer hours or harder. But these approaches have clear limits. Over the longer term, the only sustainable way to grow income per head is to increase the level of output that each person in the workforce produces per hour - in other words, to grow productivity. Economic evidence suggests that, over the longer term, productivity growth is responsible for all but a small fraction of a country's growth in income per capita. For example, from 1820 to 1998, income per head in the developed world grew about 19 times, after adjusting for inflation.3 Most, if not all, of this growth has probably come from improvements in productivity rather than increases in hours worked per person.
The overarching challenge facing policy makers is therefore to better understand the factors that give rise to productivity growth.
Changes in productive knowledge (hereafter, called "technological change") play a vital role in promoting productivity growth. Technological change can be embodied in new products, new processes, new organisational forms and new methods of marketing and distribution. It is also embodied in each individual's knowledge and skills. Cumulative technological change has radically changed the productivity of developed countries' workforces. The discovery of electricity in the 18th century, for example, has allowed a number of further inventions (such as electric lighting and computers) that have literally transformed the way that our societies function, and which were not even imagined by the natural philosophers who originally investigated electricity. Similarly, the development of the production line by Henry Ford transformed the way manufactured goods were produced. New knowledge, and the capabilities needed to exploit it, provides a higher platform for further discoveries4 and a potential stepping stone to new, higher-value products and processes.5
However, technological change does not always, or immediately, lead to improvements in productivity. Its full impacts take time to eventuate and often require waiting for existing equipment to depreciate and further adaptation of related managerial capability, products and processes. One implication of this is that technological change can take some time to show up in the productivity statistics. Further, the immediate impact of technological change on measured productivity may even be negative. For example, an increase in business R&D, such as has recently occurred in New Zealand, diverts resources from current production (so reducing measured value added), even though its real purpose is to create new and better products and processes in the future.
While the benefits of technological change typically disperse beyond the country where they were first developed, they can only be adopted by other countries that find out about their existence and that have the skills and resources needed to absorb and exploit them.
As a result, the full benefits of technological change have not been equally captured by countries around the world. Some countries, such as Japan and Korea, have been able to rapidly develop their economies, and increase their incomes to developed world levels, through a strategy of adoption and adaptation of existing technologies. However, many less well-developed countries have so far failed to successfully emulate this strategy.
Thus, while technological change lies at the heart of productivity growth, it is only one of a broad range of complementary factors that must be present for growth to occur. While significant uncertainties remain, there is growing recognition of the importance of a number of key supporting conditions being present for productivity growth, and therefore economic growth, to occur. These key conditions span most aspects of an economy and involve entrepreneurs and firms, the government and the workforce. Many aspects of a country's broader environment are also important, such as its geographical location and natural resources.
Role of Firms and Entrepreneurs
The role of firms and entrepreneurs is central to this process of developing and applying new technologies and taking the resulting goods and services to market. The effort required is inherently risky and uncertain, the process can be complex, time-consuming and resource-intensive, and there can never be a guarantee of success.
The development and application of new knowledge and technologies therefore require significant potential financial rewards, both to provide incentives to pursue these new opportunities and to finance the growth of successful firms. They also require a complex mix of skills in the research and business communities, and strong innovation systems. High-quality financial markets are also needed: from angel investors and venture capitalists at one end of the spectrum, to healthy sharemarkets and debt markets at the other. Similarly, a dynamic business environment is required, with the flexibility for new firms to enter and grow, and less successful firms to decline and exit.
Role of Government
Governments play a vital role in creating an environment that is suitable for businesses to succeed and grow.
One of the key roles governments play is to establish an appropriate set of incentives to encourage entrepreneurs to focus on the right things (e.g., developing new products) and discourage activity on the wrong things (e.g., misleading consumers).6 This requires modern, high-quality policy settings and regulation across a wide range of areas. Key examples include tax policies, intellectual property rights law, company law, competition policy, consumer law, public sector and corporate governance, and international trade and investment policies. The quality of these institutional arrangements and policies impacts on the potential rewards for firms undertaking risky activity, the pressures they face to adapt and improve, and their ability to access offshore markets, capital and skills.
By creating a stable macroeconomic environment, governments can help to reduce the level of risk and uncertainty firms face. A low-inflation environment, low interest rates and a relatively stable exchange rate help firms prosper and grow.
Governments play a pivotal role in the provision of infrastructure. Modern economies require high-quality communications, transport and energy infrastructures. In all OECD countries, central and local governments take the lead in funding or regulating the maintenance and development of this infrastructure.
Most governments play a major role in the funding and provision of education, training and R&D. The quality of effort in these areas can have a major long-term impact on the skills and ability of a country's workforce (see below) and the capacity of the business sector to absorb and use new technological knowledge.
Further, most governments have an industry policy designed to help firms grow and internationalise, to encourage the development of future competitive advantage and to exploit the synergies among firms' activities and between their activities and those organisations such as universities.
Role of the Workforce
To grow and succeed, businesses need access to adequate numbers of suitably skilled workers. Managerial and professional skills are important. The successful management of large, internationally focused firms requires specialised skills in a wide range of areas.
Skill levels across the workforce as a whole are also vital. Over recent decades, new technology has required increasing skill levels to exploit it, with the result that the income of skilled people has risen, notwithstanding increasing skill levels in the economy. Companies increasingly need staff with strong literacy and numeracy skills to undertake increasingly sophisticated tasks, learn new tasks when faced with technological change, and operate complex machinery and computing equipment.
Further, workplace practices are important. Changes in working practices (such as more flexible forms of work organisation, employee involvement and strategic human resource performance management) can help to increase returns on investment in capital and innovation.
Other Factors
Lastly, a number of broader environmental factors have a strong impact on a country's economic performance. Some of these factors, such as geographical location and natural resources, are outside a country's control.
The geographical proximity and wealth of a country's trading partners is key. Australia's strategic and economic importance to New Zealand is in no small part due to its proximity. Its economic success provides many benefits for New Zealand - for example, creating a higher demand for our exports. But New Zealand also competes with Australia and its constituent states to some degree, such as for skilled workers and as a business investment location.
Large urban areas are also known to be especially important for innovation and specialisation. They provide easy access to deep and broad markets, which create the spur of competition and enable ready access to inputs to production. Auckland's performance is important to the performance of the New Zealand economy as a whole. However, the management of large and growing cities is often difficult. And, with a metropolitan population of less than 1.5 million, Auckland is quite small compared with most successful, high human capital cities.
Choice of Indicators
This report builds and expands on two earlier economic indicator publications in 2003 and 2005.7 It includes a larger number of indicators than in the previous reports and, in following the conceptual framework discussed above, is organised slightly differently. In addition, this report provides indicators in two new areas: New Zealand's economic relationship with Australia and its states and Auckland - an internationally competitive city.
The indicators used in this report were chosen according to their relevance to economic development and their availability. The relevance of an indicator was determined by the extent that it is clearly linked to productivity growth. We have chosen indicators that are informative, up to date, comparable over time and between countries, reliable and complete. Suitable indicators could not be found for all areas of interest. For example, it has proven difficult to find broad, objective and consistent indicators of the quality of countries' infrastructure, especially energy infrastructure.
For some of the indicators we could not find recent internationally comparable data. In these cases we have chosen to incorporate the older indicators that are available.
Benchmarking
We have used OECD countries, together with an OECD average or median measure, as the comparison group for the majority of the indicators in this report. The OECD, which includes the significant majority of the world's high-income countries, is a logical benchmark for New Zealand, given the government's objective of increasing New Zealand's average per capita incomes. Where a ranking is meaningful, we have ranked New Zealand with the 24 countries that compose the OECD prior to the most recent accessions,8 to allow comparisons between the various indicators and with previous economic development indicator reports. When we say we are, for example, "14th out of the OECD", we normally mean 14th compared with this group of 24 countries.
In comparing growth rates across time, we have focused on Australia, the UK, the US and Denmark, together with an OECD average or median measure. We have very close connections with Australia, while Denmark is a European country of similar size and industrial structure to New Zealand. The UK is also a common reference point for New Zealand, while the US is obviously a much larger economy but - as a world leader in many aspects of growth and innovation - provides a useful reference.
The Indicators
The 2007 economic indicators have been split into six core chapters:
- well-being and prosperity;
- immediate drivers of income growth;
- underlying determinants of productivity growth - firm and market performance;
- underlying determinants of productivity growth - business environment;
- New Zealand's economic relationship with Australia and its states; and
- Auckland - an internationally competitive city.
As with the previous two sets of economic development indicators, some qualifications need to be made regarding the indicators in the 2007 report.
A Comprehensive Approach is Needed
As a set, these indicators provide a comprehensive picture of the factors influencing economic growth in New Zealand. Viewed together and over time, they provide useful information about trends, New Zealand's future direction, and how different parts of the growth and innovation system relate to each other. Individually they provide, at best, only an indication of change in a particular area.
It should also be noted that the most recent available international data for some of the indicators provided in this report were earlier than 2006. Therefore, a number of the government's recent policy changes (such as the tax treatment of R&D) are not reflected in the indicators.
Visible Change Takes Time
Although this year's report updates many of the indicators in the 2003 and 2005 reports, two to four years is a very short timeframe in economic terms. It is not possible to draw definite conclusions on whether any changes observed since 2003 and 2005 reflect real underlying trends as opposed to cyclical or temporary influences. Many of the efforts of government and businesses to improve New Zealand's economic performance will deliver results only over much longer periods.
Links Between Overall Performance And Indicators are Complex
We have based our selection of indicators on what theory and empirical evidence tell us about the likely determinants of economic growth. However, the relationship between these underlying factors and overall economic performance is not straightforward. There is not necessarily a simple causal relationship between performance on a particular indicator and aggregate performance. Further, indicators are generally only a proxy for the underlying factor we are interested in (for example, educational attainment is a proxy for, but not a perfect measure of, human capital).
This means it is important to be cautious about drawing policy conclusions from the indicators: while poor performance on a particular indicator may signal the existence of a problem to be addressed through policy, this is not necessarily the case. Policy interventions to lift performance against any particular indicator(s) will not necessarily have a positive effect on growth.
Attributing Changes In Indicators To Specific Policies is Difficult
It is difficult to attribute changes in indicators to specific policies, as a variety of government initiatives will act on each indicator. In addition, government policy is only one of a number of factors that influence the behaviour of the indicators and the economy. However, we hope that these indicators will help businesses and government identify areas of policy interest, and stimulate further analysis where appropriate. This should enable a greater understanding of how policy action can impact on New Zealand's growth and innovation performance.
Issues Around Measurement and Comparability
When data is expressed in a common currency in this report, it normally means that the data has been adjusted to the common currency (usually the $US) using purchasing power parity exchange rates. There are measurement issues associated with many of the indicators used in this report. Some of the data is based on surveys of various people's opinions. Since opinions are not necessarily factual, this data must be interpreted with some caution. We have commented on issues around specific data sources throughout the report. Issues also arise when comparing New Zealand's performance with that of other countries, as different countries' data will reflect the unique characteristics of each country and the nature of the survey undertaken in each country, and there may be some methodological differences in the way that data is collected.
In spite of this, we are comfortable that the overall picture presented by this report is robust.
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