Tractatus Developmentalis Economica

How New Zealand Grows: Some Propositions

VERSION 3: Updated 9 December. Original 17 October.

The following propositions largely reflect my research program on the New Zealand economy. It is summarised in my In Stormy Seas. Page numbers in square brackets refer to that book.

There is additional material in the areas of globalisation, innovation, intra-industry trade, monetary policy, and workforce development. I have also updated New Zealand’s economic performance.

0. The Historic Context

0. New Zealand has grown at broadly the same rate as the rest of the OECD in the post-war era when it has not been subject to severe prolonged external shocks. [p.15-28; p.258-262]
0.1 Thus far the post-war New Zealand economy has shown no ability to grow at rate markedly faster than the rest of the OECD.
…. 0.1.1 The last time New Zealand did was in the decade from 1935 to 1945, where it grew at around 7 percent p.a., doubling output over the decade. No one has investigated how this happened.
0.2 There have been three periods in the post-war era when New Zealand has grown markedly slower than the OECD average. [p.15-28; 73-88; 231-248; 258-262]
…. 0.2.1 In the immediate post-war era to 1955 all OECD economies which were not ravaged by the war (not just New Zealand) grew more slowly than those that were recovering from the destruction.
…. 0.2.2 In the decade after 1967 New Zealand grew more slowly than the OECD. This may be attributed to a marked (and permanent)deterioration in the terms of trade – especially as a result of the fall in the price for cross-bred wool.
…. …. In 1966 the export price of wool, which made up about two fifths of exports, fell about 40 percent. This reduction in the terms of trade has been broadly permanent, and was reinforced by milder deteriorations in the relative price of meat and dairy products. [p.73-88]
…. 0.2.3 The third poor relative growth performance was in the seven years from 1985. This can be attributed to the unusually high real exchange rate, which inhibited the growth of the tradeable sector.
…. …. In the late 1980s and early 1990s the exchange rate was maintained at an overvalued level (exacerbating the withdrawal of export subsidies in the mid 1980s) as a central part of the disinflation strategy. [p.231-241; 258-262]
0.3 The two latter periods are characterised by poor profitability in the export sector.
0.4 In two thirds of the 47 years of the post war recovery, the underlying growth rate of GDP has been much the same – or perhaps slightly higher – than the OECD average. In one third of the period, when the New Zealand economy was subject to severe prolonged external shocks, the economy grew markedly slower.

1-3: Some Fundamental Propositions

1. Every economy is unique . While there is a general growth process it applies to each economy differently. [p.7-14]
1.1 The large, partially closed, US economy grows differently from the small open New Zealand one.
1.2 Too much of the New Zealand economic debate is based on the US experience.

2. Economic growth is about relative change as much as it is about aggregate increase: it is about different sectors growing at different rates, about new products and processes, not just more of old ones.
2.1. Some sectors will grow faster than others.
…. 2.1.1 The focus is on sectors because some businesses will grow faster than the sector average but others will grow slower.
2.2 A better expression than ‘growth’ for the medium and long term process of economic change is ‘development’
…. 2.2.1 Sectors will grow at different rates puts substantial stresses on the political and social system.
…. 2.2.2 Thus economic development requires political management.
…. 2.2.3 These is a danger that the political management will talk the rhetoric of development, but will practice policies which lead to stagnation because of the threat to stability that development poses.
…. …. This was the greatest failure of Muldoon’s economic management regime.
…. 2.2.4 It seems likely that standard measures of economic growth underestimate the significance of quality change and variety expansion, and this lacuna flows into standard economic growth models.

3. The fast growth sectors in an small open economy such as New Zealand are mainly in the external sector . [p.73-88; 139-148]
3.1 There does not seem to be a lot of prospects for significant import substitution, and hence importable expansion.
3.2 Thus the economic growth rate for New Zealand depends upon the growth of exports, the exportable sector.
3.3 Because New Zealand is a small economy it can envisage rapid growth – even many stagnant international markets – by increasing its market share.
3.4 While the arithmetic says the export sector has to grow faster than the economy as a whole, it is also necessary because the rate of import penetration (the ratio of imports to GDP) tends to rise with affluence.
3.5 It would be helpful to have indicative quantitative projections of the potential of the key growth sector.

4-7: The Export Structure

4. Historically New Zealand’s export growth has been dependent upon the growth of commodity exports based on sophisticated (technologically innovative) production processes. [p.41-52]
4.1 The growth of most commodity exports are usually constrained by a biological or physical process.
…. 4.1.1 It seems likely that hydrocarbon energy based exports will decline in the next decade.
4.2 The maximum growth capacity of the commodity export sectors is probably below the economy wide growth rate that is thought desirable.
…. 4.2.1 The main exception is the ‘wall of wood’.

5. When New Zealand could no longer depend upon pastoral exports to sustain the tradeable sector growth rate it diversified to other commodities, to adding value to them, and to general manufactures and services.
5.1 In the long run these other commodities will be unable to sustain the export expansion that is desirable.
5.2 General manufactures and services are overly dependent upon relatively low cost structures.
…. 5.2.1 New Zealand’s success in general manufactures has been largely due to export markets in Australia (which is high cost by world standards). They will get undercut as Australia lowers its external protection and other cheaper countries enter the Australian market. [p.146, 257-259]
…. 5.2.2 The rise of China as an export manufacturer has the potentiality of further reinforcing the East Asian trend of undercutting high wage exporters and forcing them to move towards specialist high quality manufactures for their survival.
5.3 The value added strategy (of increased processing of commodity exports) has had some success, but needs to be progressed.
…. 5.3.1 The prescriptions below for ‘intra-industry trading’ apply to that part of the value added strategy which is not general manufacturing (i.e which primarily depends upon cost competitiveness of routine technologies). [p.144-7]

6. The new phenomenon in post-war international trade is intra-industry trade, that is the phenomenon where countries trade similar products.
6.1 Today about a quarter of world trade is in oil, a quarter is other commodities, a quarter is general and specialist manufactures to destinations which do not produce them, and a quarter is intra-industry trade.
…. 6.1.1 Intra-industry trade is the fastest growing of the four quarters.
6.2 New Zealand economic thinking has largely been around inter-industry trade, that is using pre-war economic models of comparative advantage to explain growth in which trade involves exchange of quite different products.
…. 6.2.1 I cannot recall an official report which uses the term ‘intra-industry trade’, even though the phenomenon has been burgeoning for fifty years and the notion has been in the economic literature for around twenty five years.
…. 6.2.2 Meanwhile, the rest of the affluent OECD has been growing via intra-industry trade.
…. 6.2.3 While New Zealand thinking has been trapped into the framework of a commodity exporter trading with other countries which make sophisticated manufactures and services.
…. 6.2.4 This restricted thinking has occurred even when New Zealand has talked about diversification.
…. 6.2.5 Basically New Zealand has pursued the comparative advantage model introduced by Ricardo, while the rest of the OECD has pursued a competitive advantage approach.
6.3 Intra-industry trade differs from inter-industry trade because it depends upon economies of scale and the falling cost of distance.
6.4 Trade between sophisticated economies is driven by intra-industry exchange.
6.5 Their intra-industry trade is based on technologically sophisticated and complex products.
…. 6.5.1 The sophistication includes high quality design and high standards of quality control.
6.6 That intra-industry traders are under competitive pressure in their domestic market from foreign businesses with which they are also competing in their export markets requires them to be highly innovative.
…. 6.6.1 The vigorous innovation in a tradeable sector based on intra-industry trade spills into domestic producers.
6.7 Intra-industry trade depends on ‘competitive advantage’ and not comparative advantage.
…. 6.7.1 Intra-industry trade explains how a firm like Nokia can have such a dominant role in the world economy despite being based in Finland, where there is no obvious comparative advantage for mobile phones.
…. 6.7.2 Unfortunately the theory cannot predict what will be the ‘Nokias’ in a country like New Zealand. The best advice it (and the Porter approach) offers is how not to stifle such developments.

7. In order to succeed the New Zealand economy is going to have to shift its trading structure so that it has a significant intra-industry trade component. [p.140-147]
7.1 The only economy with which New Zealand has mature intra-industry trade relationship is Australia.
7.2 With the exception of Australia, New Zealand has an immature trading relationship (in terms of intra-industry trade) with all other economies.
…. 7.2.1 There has been little shift towards maturity over the last two decades.
7.3 Outside concern with agricultural protection, New Zealand international trade thinking has tended to focus on its Australian trading relationship and to a lesser extent its US trading relationship, while ignoring the other two thirds of export markets – which are likely to become even more important in the future.
…. 7.3.1 About 30 percent of New Zealand’s exports go to Asia. Australia sends over 50 percent.
…. 7.3.2 Has New Zealand almost entirely abandoned the European market as a growth prospect? It will shortly be the largest single market in the world and is New Zealand’s second largest trade partner (a point disguised by our usually recording the data by individual European country).
…. ….. In the June 2001 Australia took 19.5 percent of New Zealand merchandise exports, and the EU took 17.5 percent, followed by US 14.5 percent, japan 13.9 percent, and China (including Hong Kong) 6.1 percent. (The UK was 4.9 percent.)
7.4 The biggest single trade gain would be from a substantial reduction in world protection, especially of agricultural commodities.
…. 7.4.1 The resulting terms of trade gain would favour a return to an inter-industry trade strategy.
…. 7.4.2 Quick and substantial reductions in international agricultural protection are unlikely.
…. 7.4.3 Even so New Zealand should still keep pressing for reduced protection, while it adopts the realistic strategy that they wont happen soon.
7.5 The test of the success of the government’s structural transformation goal and its growth and innovation framework will be most evident (and most measurable) in the growth of a significant intra-industry trade sector.
7.6 Much of the value adding to commodities will involve intra-industry trade, or akin to it.

8-15: The Supplyside

8. The institutional framework – the national legal and corporate governance – of New Zealand is of high quality.
8.1 Of course it can be improved, but there does not seem to be any major deficiencies.
8.2 New Zealand has a robust efficient tax structure, and there is no evidence that its levels are so high as to inhibit growth.
…. 8.2.1 The effect of the average tax level determines the balance between available public and private goods, rather than the rate of economic growth.

9. New Zealand seemed to be relatively deficient in regard to capital compared to other OECD economies, and seems to use it relatively inefficiently. [p.200-203]
9.1. The capital shortage may reflect no more than New Zealand’s low level of production relative to the OECD average.
…. 9.1.1 International comparisons are difficult and must be done at the sectoral level.
…. 9.1.2 Some reforms of the 1980s should have improved the efficiency of the application of capital, although various statistical effects would obscure this for at least a decade.
9.2 There has been no recent updating investigation of the apparently high capital to output ratios of the post-war era.

10 An important contribution to economic capacity is infrastructure.
10.1 The role of infrastructure implies that there are externalities (non-market interactions) in the growth process.
10.2 Infrastructure has a wide meaning in this context, ranging from the engineering structures (which may be publicly or privately owned), through the skills of the work force and the institutions which create them and the research and development (or innovation) system, to a range of social institutions such as law, measurement, accounting, and the integrity of the public service.
10.3 Because the last two decades have focussed almost exclusively on market mechanisms, New Zealand has tended to under-invest in infrastructure.

11. It is not been to quantify the quality changes in the post-war labour supply (because of data problems). [p.193-200]
11.1 There is some evidence that there has been a dilution from less-market valued labour increasing faster than more-market valued labour.
11.2 The current educational performance meausures place New Zealand 15 year olds near the top of the OECD.
11.3 New Zealand adults (i.e. the population as a whole) are reported to be in the middle of the OECD on literacy measures. However this may reflect some survey response problems, and New Zealand adult literacy is probably in the top half of the OECD.
11.4 The New Zealand workforce appears to be above the OECD average in terms of formal vocational training. However, New Zealand has a lower proportion of high level qualifications (such as degrees), and it appears that the proportion with a formal qualification has deteriorated in recent decades.

12. Innovation (some of which is technological innovation and some social and organisational) is at the heart of a successful intra-industry trade development strategy. [p.203-208]
12.1 Innovation is a pervasive phenomenon and does not only occur in laboratories and head offices.
…. 12.1.1 Twenty percent of patents are taken out by people who are close to the workshop floor.
…. 12.1.2 The statistic is all the more astonishing since most workers involved in the innovation process do not take out patents. They just do it.
12.2 New Zealand has tended to follow the British tradition of an elitist innovation strategy.
…. 12.2.1 This approach pervades management and has resulted in a workforce which is unskilled in comparison to some of New Zealand’s competitors.
…. 12.2.2 The greatest exception is the farm sector, where farmers are proven innovators.
…. 12.2.3 A quality workforce and environment will attract overseas capital and its associated technology – as occurred for Ireland.
…. 12.2.4 In a democracy the elitism threatens innovation insofar as the public is likely to resist novel innovation opportunities because it does not trust (or understand) the relevant science.
12.3 The innovation problem is not to generate innovation but to transmit it. Once there is a a good transmission process underway, upstream innovation in the right places will largely follow.
…. 12.3.1 We have immensely improved the transmission of innovation from the research centres (CRIs and Universities) to business in the last decade.
…. 12.3.2 The transmission of innovation from the business to the shop floor still seems inadequate.
12.4 The research suggests that OECD economies with below average per capita output tend to grow more rapidly than those with above average per capita output. [p.207-8]
…. 12.4.1 This ‘convergence’ is not strong, but it favours New Zealand insofar we are currently below average.
…. 12.4.2 The most likely explanation for the convergence effect is that it is easier to import developing technologies than develop them.
…. 12.4.3 To do this there has to be a capacity to import and apply the new technologies. That involves an increasing sophisticated level of domestic technological competence. Practically, that means New Zealand has to maintain an internationally first rate domestic technological capacity.
…. 12.4.4 Thus while New Zealand is likely to be a net importer of technology, to succeed it will have to be an exporter of technology in its own right.
…. 12.4.5 Additionally, New Zealand has to maintain a considerable technological capacity to transform its particular domestic resources (such as radiata pine, milk based products, sheep meat based products, crossbred wool, fish …).

13. Innovation contributes to productivity growth which is obtaining the maximum output from the available inputs. [p.203-208]
13.1 New Zealand has a poor to average post-war growth productivity record.
…. 13.1.1 We know this as an arithmetical fact. We know little about why.
…. 13.1.2 One contributing factor seems to be that we may be under-measuring output growth from insufficiently allowing for quality change and variety expansion.
…. 13.1.3 New Zealand’s post-war growth record has been more about increasing the labour and capital available than of using the factors much more efficiently.
13.2 Productivity is deeply involved with processes which occur at the level of the shop floor.
13.3 Productivity gains in the domestic sector are important insofar as they release inputs for the tradeable sector to expand.
…. 13.3.1 Thus the redevelopment of the textile clothing and footwear industry is vital for the growth strategy in that it can join the export sector, and its productivity improvements releases inputs to other sectors.
13.4 International comparisons and comparisons over time show that the New Zealand service sector has a poor productivity performance. [p.205, 281-284]
…. 13.4.1 This seems likely to be in part – and possibly entirely – due to measurement error.

14. New Zealanders see distance as an export disadvantage. But the costs of distance are coming down, for that is what globalisation is about.
14.1 The costs of distance may limit what New Zealand can export. As they decline the limitations decline too.
14.2 New Zealand’s economic prospects involve opportunities where the costs of distance are falling, are least unfavourable or even favourable (such as season differences, time differences or where isolation and security is significant).
…. 14.2.1 While New Zealand’s resource base offers important prospects, the falling costs of distance threatens the added value strategy, since it is also increasingly less costly to ship the raw product offshore and process overseas.
14.3 Clusters of excellence are important.
…. 14.3.1 The role of clusters implies that there are externalities (non-market interactions) in the growth process.
…. 14.3.2 The domestic sector also contributes to innovation by providing quality inputs (at low cost) to exporters.
…. 14.3.3 While in the past clusters were seen to have a geographic proximity, under increasing globalisation some future clusters will be highly dispersed, and even involve cross country arrangements.

15. New Zealand is a small economy, which both limits it and offers it opportunities.
15.1 While greater size would provide some advantages, the international research shows that high population growth slows per capita output growth.
…. 15.1.1 The probable reason for this is it dilutes the available capital.
…. 15.1.2 Rapid increases in population size from high general migration will not increase per capita GDP in the short to medium run.
…. 15.1.3 However population increases from selective migration has the potential to accelerate innovation growth by adding to scarce resources such as knowledge, skills and capital.
…. 15.1.4. There are social and political reasons for immigration, even if they diminish (possibly only slightly) the per capita economic growth rate.
…. 15.1.5 It is possible that New Zealand, like much of the Western World, will use immigration of young people as a part of the long term resolution of the otherwise ageing population.
15.2 New Zealand’s small size gives it a political and special coherence, which can be a considerable economic advantage if it is used effectively.

16-20. Macro-management of Growth

16. In a modern market driven economy returns on the factors of production are critical – especially on capital, intellectual property and labour skills.
16.1 In a globalised world almost scarce valuable factors are mobile.
16.2 Economic policy has to take into consideration the absolute and relative prices of factors.

17. Because the performance of the tradeable sector in a small open economy is central to the economy’s growth prospects, the return to the factors in the tradeable sector is crucial. In particular its rate of profit is closely (but inversely) linked to the real exchange rate. [p.231-241]
17.1 The real exchange rate is related to ‘competitiveness policy’ defined by the OECD as ‘supporting the ability of companies, industries, regions, nations or supranational regions to generate, while being and remaining exposed to international competition, relatively high factor incomes and factor employment levels on a sustainable basis.’
17.2 A high real exchange rate mean a low return (low profitability) to exporting and a consequently poor export performance.
17.3 The overvalued real exchange rate in the late 1980s and early 1990s was the single most important reason for the poor economic performance of the period.
17.4 The level of the real exchange rate is greatly affected by the nominal exchange rate and the wage path.

18. The nominal exchange rate has been used as an instrument of monetary policy to control inflation. [p.98-103; 226-238]
18.1 The control of inflation should not be so dependent upon a high nominal (and real) exchange rate, the wage path and fiscal policy have to contribute.
…. 18.1.1. The notion that each policy instrument is assigned solely to a single policy objective is a simplification for teaching. It depends upon particular assumptions about how the economy functions, which do not apply in practice.
18.2 An sustainable aggressive real exchange rate which makes exporting profitable requires a surplus in the current account of the balance of payments which is arithmetically equal to a surplus in net domestic savings.
…. 18.2.1 Since private sector savings have been weak (in the household sector) or average (in the business sector), a surplus on net domestic savings requires a (fiscal) surplus on the government account.
18.3 A macro-economic strategy which uses the exchange rate to control inflation is inimical to economic growth.

19. The wage path sets one of the most important prices. [p.89-106]
19.1 In a globalised world there is a tendency for margins of skills to open up, especially as skilled workers are more internationally mobile than unskilled workers.
19.2 One partial resolution to the consequence of this tendency is to upskill the labour force.
19.3 A second partial resolution is to pay attention to the social wage, that is the market wage less tax, plus the social benefits which arise from government spending.
19.4 This setting of the wage path in the context of the social wage is a central element of any social compact.
19.5 The social wage needs to be designed to favour internationally mobile labour which stays in New Zealand.

20. A key element of the economic growth rate in the past has been long peaks in the business cycle. [p.107-122]
20.1 A macro-economic strategy which restrains the business cycle peak because it threatens inflations therefore compromises the growth process.
…. 20.1.1 Conversely it behoves others involved in macro-economic settings to participate in the restraint of inflation, so that monetary policy does not have to cut off the business cycle peak unnecessarily early.
…. 20.1.2 Business cycle management requires a disciplined approach to fiscal management.
…. …. Counter-cyclical fiscal management is difficult but has a role to play if the managers are competent enough.

21-22. Social Epilogue

21. The task is about transforming the economy.
21.1 In fact an economy is always transforming. At issue is trhe amount of control New Zealands have, and can have, over the transformation.
21.2 Any economic transformation impacts on politics and society.
22. Whatever the growth strategy it has to be integrated with sustainability and improving the quality of life of New Zealanders. That will be the focus of Tractatus Developmentalis Socia [p.263-280]
22.1 The social wage has an important role in the quality of life.