Roger Kerr: Perspectives on Productivity

A recurrent theme of economic commentary by the government and the Treasury has been that economic growth in the past decade owed much to improvements in ‘labour utilisation’ and that, with unemployment now down to low levels, future growth must depend more on improvements in ‘labour productivity’.

To this end the government has organised working party discussions including businesses and unions about improving workplace efficiency. The external environment established by its policy directions has been off-limits in these discussions.

Does the mantra about labour productivity make sense? Only to a point: it focuses on outcomes rather than causes and thus risks shunting policy thinking down the wrong track.

The productivity of labour, capital and other resources is certainly very important. Over the long run so-called multi-factor productivity growth is the main source of improvements in living standards for most countries. Thus Americans enjoy higher per capita incomes than New Zealanders because American workers are more productive and New Zealanders’ living standards are higher than those of Indians for the same reason.

Budget projections put the estimated trend growth in labour productivity in New Zealand at 1.5% a year. This is higher than rates achieved in the decades prior to the 1990s but well below that needed to return New Zealand to the top half of the OECD income rankings in any reasonable period of time.

Economists typically define labour productivity as output per worker or per hour worked. The concept has limitations.

First, output per worker in an economy would be higher if everyone worked 60-hour weeks. Few would regard this as an improvement in general well-being. Output per hour worked is more relevant.

Second, the output of goods and services depends on other inputs such as capital, which may be substituted for labour. If substitution is occurring, observed labour productivity may be increasing rapidly but when all inputs are taken into account, multi-factor productivity could be growing more slowly or even going backwards. It is multi-factor productivity that counts.

Third, improving productivity is not necessarily about working harder or even smarter. Many of the important gains come from ongoing economic openness and flexibility – the entry and exit of firms, shifting capital and labour out of unprofitable activities and into more profitable ones, and so forth.

This is why sound institutions and policies that increase economic freedom are the key to productivity and growth.

The economic reforms of the late 1980s and early 1990s improved both labour utilisation and labour productivity in New Zealand. But the scope for improvements in both is far from exhausted.

As the Treasury noted in its briefing to the incoming government, there are around half a million people in the working age population who are not in the workforce. These comprise:

201,000 beneficiaries, of whom the major categories are those on the sickness and invalids benefits (83,000) and the domestic purposes benefit (63,000).

165,000 non-beneficiaries with a working partner, of whom 109,000 have a dependent child at home, and

134,000 in other categories, mainly students (59,000) and early retirees (32,000).

Many in these groups could be productively employed, at least on a part-time basis. Changes to employment and welfare rules would facilitate higher labour utilisation.

If half the number in these groups could be absorbed into the labour force, it would be expanded by one eighth and would boost economic growth. The productivity of these workers would improve over time as they gained skills on the job – labour productivity and labour utilisation are linked.

Productivity is an outcome of a good environment, not a ‘driver’. The way to improve productivity is not to establish government working parties on work and management practices. It is to increase economic freedom and make business operation easier. This includes finding ways of improving incentives through such means as greater competition (eg in markets such as accident insurance), lower taxation and lighter regulatory burdens.

Investment needs to be encouraged by reducing the cost of capital (eg through lower taxes on investors) and the risks (eg insecure property rights) investors face. Investment gives workers more capital with which to work. Improvements to infrastructure and to education and training are also important.

Unfortunately, too many of the government’s moves have blunted incentives to be productive. For example, under the Working for Families package many people face high effective marginal tax rates if they work to increase their income, and in some cases they may be worse off. Employment law changes have made our labour market less rather than more flexible. Increasing regulation and inadequate infrastructure are making business operation more difficult.

If the government is serious about increasing productivity, it will have to broaden its thinking about the sources of productivity gains. It must also realise that its job is to set the rules of the economic game and to manage its own affairs well (eg to improve productivity in the government-dominated health sector), not to reach for economic levers.

Roger Kerr is the executive director of the New Zealand Business Roundtable.

ENDS

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