July 08, 2024

Tax cuts a bandage, but stitches needed to address productivity

Increasing productivity is essential to enhancing New Zealand’s standard of living

Like a bandage, the Government’s tax cuts will provide short-term relief, but stitches are necessary to address the biggest long-term determinant of wages and living standards, productivity.

Productivity growth contributes to higher profits, higher wages, lower prices, and stronger economic growth. Gross domestic product adjusted for inflation (real GDP), has declined in four out of the previous six quarters. When combined with strong population growth, this has seen the GDP per capita decline further.

Despite the 0.2 percent increase in GDP in the March 2024 quarter GDP per capita fell by a further 0.3 percent. After peaking in September 2022, it has now declined by 4.3 percent.

Source: Stats NZ

This decline in GDP per capita has been associated with sizeable declines in labour productivity, with GDP per hour worked falling by more than three percent since September 2022. New Zealand’s capacity to raise our standard of living depends on our ability to raise the quantity and value of goods and services each worker produces and the value they add.

Improving productivity has been a long-term challenge

New Zealand’s poor productivity has long been a challenge. Productivity growth for the whole economy averaged 1.4 percent per annum between 1993 and 2013, but only 0.2 percent over the last ten years. Although New Zealand’s productivity growth has been weaker than expected, other factors contributing to GDP have been stronger than expected, which has broadly offset the impact of lower productivity on incomes.

Since 2000, gains in productivity have been largely driven by the capital accumulation of unproductive assets. This has included investment in houses and land banking. Whereas multifactor productivity growth, which comes as the result of innovation, technology adoption, education, or a reallocation of resources, has remained stagnant. This slow productivity growth has contributed to the increase in New Zealand’s labour costs, which are undermining the competitiveness of our exports.

Treasury has identified that “raising our productivity performance is the biggest economic challenge facing New Zealand, and will require a sustained effort on a number of fronts.”

Improving productivity needs to come from a wide range of sources

The International Monetary Fund (IMF), in its recent review of New Zealand, agrees that efforts to boost productivity are critical for New Zealand’s long-term growth. Its recommendations, aka the stitches, include improving education outcomes and skills matching to address skills shortages, promoting innovative investment by expanding research and development (R&D) tax credits and other support measures, promoting take-up and scaling up government investment in R&D, as well as public investment to close the infrastructure deficit. Digital infrastructure is also critical given the small size of the ICT sector and the considerable productivity gains associated with technology uptake.

In addition to the role of education, innovation, and capital deepening, the IMF emphasised the need to improve housing affordability to reduce the number of skilled New Zealanders emigrating. Structural reforms are needed to boost the housing supply, and recommendations include reforming land use restrictions, addressing local infrastructure funding needs, and using land value and capital gains taxes to incentivise more efficient land use. Ensuring a more predictable infrastructure pipeline would also encourage construction companies to invest in technology and expand capacity.

The IMF has warned of productivity headwinds from New Zealand’s geographic factors, especially New Zealand’s low population density, relative remoteness, and specialisation in tourism and agriculture. A slowdown of the Chinese economy would lead to lower demand for New Zealand’s key goods exports and tourism, and heightened geopolitical tensions could impact New Zealand’s export performance.

Dairy remains our major export, and as New Zealand is likely to have the peak number of cows our land can sustain, producing more milk from these cows, or possibly fewer, is essential for the industry’s continued economic growth. But it is not just about cows. More high-quality apples per tree, or more wine from our grapes, will contribute to improving primary sector productivity, which has fallen from $172,000 per full-time equivalent employee (FTE) in 2015 to $151,000 per FTE in 2023.

Source: BERL Local Authority Database

Finally, the IMF noted that New Zealand’s economic geography means that policies and regulatory settings need to be high-quality and fit-for-purpose to enable the country to best take advantage of the opportunities presented by new technologies. With very little additional money likely to be available in the next two budgets for additional government investment, the Ministry of Regulation will be under pressure to deliver regulatory settings that improve productivity while maintaining the things that deliver the value added of New Zealand’s exports, namely the high quality of our products and our environmental reputation.