Amongst the excitement of the recent release of strong economic growth in the last quarter of 2012, a more important set of data got missed – year to March 2012 productivity data. Sure the data is even more dated than the latest quarterly growth rate, but it tells us much more about our economy’s capacity to grow and the challenges we face to grow faster than it does about the growth rate of the economy at a given point in time. As long-term investors that’s an important consideration when we are deciding where in the world we want to be invested.
Labour productivity rose 1.0% in the March 2012
year while the productivity of capital rose 0.4%. Multi-factor productivity (productivity gains
that can’t be attributed to labour or capital e.g. technological gains) rose
The increase in capital productivity over
the March 2012 year is the first in nine years.
The weak 2008-2012 average of -2.0% for capital productivity reflects
growth in capital inputs with no change in output. Expenditure-based GDP data tells us business
investment has been relatively strong over the last couple of years, but
increased investment does not always coincide with higher economic output. In that case we would expect higher
investment to be reflected as spare capacity in the capacity utilisation
measures. Assuming firms have made the
right investment decisions spare capacity will allow the economy to expand
without generating inflation as demand grows.
Longer-term, New Zealand has a problem with
the quality (rather than necessarily the quantity) of investment. That largely relates to strong
(non-productive) investment in residential construction.
The 2012 labour productivity result is
stronger than the average of 0.6% for the period 2008-2012, but lower than the
longer run average of around 1.5%.
Historically we have tended to meet the
higher resourcing demands of strong periods of economic growth through greater
utilisation of labour (i.e. employing more people) rather than raising the productivity
of the existing workforce or through capital deepening (a higher
capital-to-labour ratio). That has
tended to lead to skills shortages and over-full employment. In the last cycle the unemployment rate fell
to a low of 3.5% in late 2007. On the surface that’s a great outcome, but at
that level of unemployment we witnessed chronic shortages of both skilled and
unskilled workers, wages pressures that led to rising inflationary pressures
and ultimately tighter monetary conditions.
In economic upswings the Reserve Bank often
cops flak for wanting to pull the handbrake on before economic growth really
gets going. It’s not the absolute level
of economic growth that’s important for the Reserve Bank, but rather how fast
the economy is growing relative to its potential to grow. If growth runs ahead of its potential, spare
capacity is exhausted and we get inflation.
In its latest set of forecasts the Reserve Bank estimates potential GDP
to average around 2% per annum over the next few years. I think that’s probably about right.
That’s why I often say in regard to
achieving higher sustainable growth that too much is expected of central
banks. Achieving a higher level of
potential growth is not in the central bank’s sphere of influence, other than
keeping inflation expectations well anchored.
Post the Global Financial Crisis many developed economies are suffering
lower potential GDP. As I’ve said
before, while central banks have done a great job of supporting demand and
avoiding deflation, achieving both higher growth and potential growth requires
a far broader policy response.
How productive we are is a determinant of
potential GDP. Higher potential GDP means
the economy is able to grow at a faster rate without generating inflationary
pressures. Sounds like a relatively
simple concept, but a lot is needed from a number of different players to make
One of my perennial frustrations is the expectation
for achieving higher productivity often falls on the Government (and I'm not even a politician!). Government, firms and individual members of
the workforce all have a role to play.
The role of individuals is to invest in their knowledge and skills. The role of firms is to invest wisely
(including in the skills of their staff), be hungry for knowledge and
improvement in production processes and to be open to innovation.
In that respect yesterday’s release by
Statistics New Zealand of the 2012 Research and Development survey is welcome
news. Total R&D expenditure in 2012
is up 9% from 2012. While Government
R&D fell over the period, greater Government funding for R&D is at
least partly responsible for the 25% increase in private sector R&D over
the period. But remember the “R” is only
as important as the “D” that follows.
The Government’s role in achieving higher
productivity is largely environmental.
Theirs is essentially an enabling role; enabling access to capital, best
practice knowledge sharing, ensuring an appropriate level of IP protection, the
tax environment and facilitating access to new markets.
But above all, firms and individuals have
to want to be more productive and must be prepared to make the investment and
take the risks to achieve it. I know
productivity sounds boring, but it is the only pathway to higher economic growth,
higher profits and wealth creation and a greater quality of life. Here endeth my annual productivity sermon.