The Sectoral Approach to Economic Growth

Third draft of Chapter 4 of Transforminng New Zealand. Comments welcome. (Second Draft).

Keywords: Growth & Innovation;

It is unwise to focus – as the last chapter had to – on the aggregate economy. Being excessively aggregate means that some of the most important features of the economic transformation are ignored. The growth and change occurs in businesses, and so we need to think about how businesses grow. Economists have a theory of how businesses behave, which informs their thinking. But at the policy level they need to avoid detailed intervention at the firm level.

So a useful level of disaggregation is to divided the economy economic sectors, a group of businesses with common characteristics which can be treated as unity for the particular analytic purpose. Since the purpose will vary there are a whole range of possible sectors. As the highest level the division is sometimes between the primary, manufacturing and service sectors. But for some purposes the primary sector may be divided into agriculture or farming, fishing, forestry, mining, …. The farming sector itself can be divided into pastoral, horticultural, cropping, farm services … In turn the pastoral sector can be divided into dairying, sheep, cattle, dairy, goats, horse … And so on. The term ‘sector’ is thus very flexible: its importance is that we can think of all the sector’s businesses functioning in a similar way. (Sometimes the text will refer to ‘industries’, a term usually interchangeable with ‘sector’. If there is a distinction, it is that industries tend to be smaller than sectors.)

The fundamental point, overlooked by the aggregate analysis which we had to use in the previous chapter, is that different sectors grow in different ways, under different circumstances, and at different rates. Aggregating them together obscures their differences, ignoring a vital part of the growth process.

Tables 4.1 and 4.2 gives a feel of how the balance between sectors changes over time. Table 1 is based on the contribution to GDP of each sector at roughly ten year intervals. Unfortunately the data base only really goes back to 1939, although some sectors go back to as early as 1920. It shows there have been major changes to the structure of GDP: a substantial reduction of the share of agriculture in GDP over the 80 years, a diminution of the manufacturing sector for about 20 years, with the service sector expanding but not uniformly. There are complex stories hidden within these sectors. For instance, the increasing share of the finance and business sector in the economy partly reflects outsourcing by other sectors, but it also is in part of its poor productivity record so its prices rise faster than average. Conversely, the IT part of transport and communication has expanded rapidly but with reductions in prices so the sector is relatively smaller in terms of its value contribution to GDP. The lesson is the more aggregate, the more that important changes get overlooked.

Table 4.1: Industry Shares in Nominal GDP

YEM 20 30 39 53 60 70 80 90 99
AGR 29.8 26.2 23.2 22.1 18.0 11.7 10.1 6.1 5.2
OPI     2.9 3.9 4.3 4.3 5.1 7.1 6.8
MAN 21.6 23.7 21.7 21.1 21.8 22.5 23.3 19.2 16.6
CON 4.0 6.6 8.0 7.1 7.2 5.7 4.6 4.2 3.9
WRT     15.2 16.4 18.7 20.7 20.0 17.7 18.3
T&C     5.8 8.5 7.4 8.0 7.9 7.6 7.1
FBS     7.7 7.3 8.2 9.1 9.6 14.2 16.3
OS     16.0 13.6 14.4 18.0 19.4 23.4 25.7

The data is from a variety of sources, and involves some issues of changed definitions over time.
YEM = Year ended March
AGR = Agriculture
OPI = Other primary sectors (including electricity, water and gas)
MAN = Manufacturing
CON = Construction
WRT = Wholesale and retail trade, restaurants and hotels
T&C = Transport and communications
FBS = Financial and business services
OS = Other services
Sources: Table 9.1, page 140, In Stormy Seas

Table 2shows the employment share in the three main sectors since 1841. The broad pattern is the same, with agriculture diminishing throughout the period, and manufacturing falling off in the last twenty years, while the service sector share grows. Economic growth is about sectoral change.

Table 4.2: Employment Shares by Sector (%)

Primary Secondary Tertirary
1841 36 32 32
1861 52 11 37
1881 40 23 37
1901 35 27 38
1921 29 26 45
1941 25 30 45
1961 15 36 49
1981 12 34 54
2001 10 25 65

Based of Thompson (1985). The census data uses various definitions, which vary over time. Maori are not included before 1941 (which is estimated assuming there was no war).

An important sectoral distinction is between those businesses which supply the domestic economy and those which export. The growth of the retailing sector will primarily be determined by the growth of the domestic spending of New Zealanders, which will be primarily dependent upon the growth of their incomes, or overall economy. On the other hand the film-making sector sells mainly overseas, so its growth will depend upon film demand in the world economy, so it hardly matters to the film-makers whether New Zealand stagnates or grows.

The term ‘tradeables’ is used to describe those sectors (or products) which are primarily involved in the external sector of the economy and ‘non-tradeables’ for those more domestically oriented. The tradeables can be divided into exportables, that is exports and also similar products which are also home supplied (like butter), and importables, which are supplied from overseas or a domestically produced and compete against imports. Historically importables – the import substituting sectors – were an important part of New Zealand’s economic growth. But over the last two decades, their protection (particularly import controls and tariffs) from overseas competition was stripped away and today the importable sector is very much less significant. So in today’s New Zealand the tradable sector is primarily about exports.

Since the growth of production and consumption of non-tradeables is dependent upon the growth of the economy as a whole, then they cannot determine the economy’s overall growth. There is a sort of ‘bootstrap’ approach which says that if we can get the non-tradeable sector to increase its growth rate that will lift the overall economic performance. (The image is like climbers lifting themselves by pulling on their bootstraps.) But higher domestic growth sucks in imports, but fails to provide the wherewithal to pay for them. Bootstrapping does not generally work for small economies.

The offset is small economies may have an advantage on the export side. For they can more easily increase its share in many foreign markets. Not all of them. New Zealand is unlikely to markedly increase its already high market share in Pacific Islands or Australia for the share. But the country’s exports to the enormous and growing Chinese market are minuscule. New Zealand businesses could double them, and hardly anyone would notice. Nor would the rapid growth drive the sales price down against the New Zealand supplier.

So all sectors are not equal for they have different roles in economic growth. As a general rule the sectors which can accelerate the growth rate of a small economy are the tradeables ones – usually nowadays exportables, but sometimes importables. They can grow faster than the world GDP by increasing their share of foreign markets and at the same time contribute to the funding of the imports the domestic sector needs. Supposing we are thinking about the possibility of an annual GDP growth rate of 4 percent p.a. We can assign numbers to each category,

The first group of – fastest growing – sectors are sectors which are likely to grow at 10 percent per annum or more in volume terms. Let’s call the category the tens. Typically these are very dynamic industries perhaps responding to a new technology or fashion. But ‘tens’ are small industries. As their rapid growth makes them larger, they tend to slow down to join the second category.

The second group – of faster growing – sectors category grow faster than the economy as a whole and are big enough and fast enough to drag the rest of the economy along with them they are the key sectors in economic growth. Let’s call this category the sevens. Characteristically the ‘Sevens’ sectors are generally export oriented. (Occasionally they are domestically oriented, but typically they are displacing some other sector – such as when telecommunications squeezed post al and courier services.) Tradeables sevens seems to be the only broad growth and development strategy available to New Zealand. That is the lesson of the ‘step-downs’ of the post-war era, for on both occasions the poor economic performance was associated with a poorly functioning exportable sector.

The third group – of average growing – sectors are those which grow about the same rate as the economy as a whole. They – lets call them fours – are the largest part of the economy. They are usually in the domestic economy, can be quite dynamic, butt they are not economic drivers.

In the final group – of slow growing – sectors are those which grow markedly below average. Not all sectors can grow above average, and if some are above, others are going to be below. Often, these – ones often have productivity growth faster than the growth of demand with. A key issue is how do we utilise the resources the ‘ones’ are potentially releasing, shifting them into the ‘sevens’ and ‘tens’ which need them for their rapid growth?

For if the tradeable sector can accelerate economic growth, poor performance in the non-tradeable sectors can hold it back Poor productivity growth means they can absorb resources that the fast growing tradeable industries need for their expansion. Poor quality service by those which supply the tradeable sector (e.g. the telecommunications sector or the financial services sector) can undermine the ability of the faster growing sectors to respond to overseas market changes. Despite being less glamorous, fours and ones are a part of the team. Not everyone scores, but the grinders are as important on a racing yacht as the skipper and tactician.

Of course these numbers are not exact: there are ‘five and halves’ as well as ‘sevens’ and ‘fours’. Once upon a time New Zealand practised quantitative indicative planning, which involved assessing each sector’s feasible growth rate. That has been abandoned (and the public debate is qualitative with random numbers quoted to give the impression that the analysis is not casual). So I cant tell you which sectors belong to each category. However here are some pointers.

First we would expect the important ‘tens’ and ‘sevens’ to be in the export sector. However the growth of some exports – in the farming, fishing, and forestry sectors – are biologically limited, although the sector may grow faster than this limitation as it adds more value to the raw material. Tourism may also face some physical limitations insofar there are constraints on the number who can stand on a scenic spot (although airport terminals and accommodation capacity may be bigger limitations at the moment).

It is not only these constraints which change the composition of exports. With the costs of distance coming down it is easier to export. Significant and continuing reductions in costs of airfreight and telecommunications means that the share of light but valuable (and just-in-time) exports will rise, as will those of information based services. Tourism is also being accelerated by lower airfares.

To share an irritation. The rhetoric of the exports of goods ignores the growing importance of service exports, now about a quarter of the whole. The share of services in the total is going to grow. Add to conventional services, that New Zealand is likely to be an exporter of intellectual property – notably from biotech, computers, and films – and the service sector is likely to be a ‘seven’ with a number of ‘tens’. Services use to be called ‘invisibles’ but that is no excuse for ignoring them or that the tourist services is our single largest export sector.

Similarly, the backward view emphasises shipping of exports, while exporting airfreighting (and broadbanding) are neglected. Certainly shipping will remain the most important transporter for a while, just as goods will continue to make up more than half of all exports. But the short term ‘tens’ (leading to long term ‘sevens’) will commonly – but not only – be in services and airfreighted goods.

It is easy to forecast by replicating the past. But the future is another country. Sometimes, though, we fail to learn from the past, often because we are casual over quantification. Just a couple of years ago the European Union was New Zealand’s single largest export destination. It is now second behind Australia. Nobody noticed the slide, because the data is collected by separate European states. Were the same to be done for the United States, we would find the US would no longer be third (followed by Japan, China including Hong Kong, and the Republic of Korea). We are still trapped in a world before the EU, still hoping that Mummy Britain will leave those dreadful continentals. While the prospects in China and the rest of East Asia look hopeful, why abandon the EU? And we need to be careful not to depend to greatly on Australia. The preferences which give us privileged access to the at market will be whittled away from the Doha round and as Australia exchanges preferences with East Asian. We will always be social, political and cultural mates with Australia, but it was not our major market for most of the past, and it is unlikely to be our major market in the medium future.

The Political Economy of Growth

That the balance between sectors changes is uncomfortable for the political process which tends to favour the past: the established sectors over the growing ones. Indeed the established and slower growing ones have the incentive to use the superior political position reflecting their past importance to pursue policies which benefit them in the short term, at the expense of the economy as a whole in the long term. Moreover, successful political leadership is dependent upon a well functioning relationship with the existing political economy – and hence with the well established but slower growing sectors. Any effective growth strategy disturbs that cosy balance, in effect undermining the very political bastions on which the politicians depend. That is why economic policies based on the aggregate growth theory of the previous chapter, are so politically dangerous. Their conservatism which comes from obscuring fundamental structural changes means that the policies which come out of them policies will retard the growth.

We saw this in the Muldoon era. Its growth performance, following the adjustment to the wool shock in the mid 1960s, was not bad – averaging about the same as the rest of the OECD. However Muldoon was reluctant to take the more-market measures necessary as the economy got more complex. It was partly because he was more comfortable with an older paradigm and which was more distrustful of the market, but he was also reluctant to disturb the political forces which had given him power. Since these forces tended to be the established sectors, Muldoon tended to be backward looking.

Muldoon’s dilemma is not unique, for it is faced by every political leader who has any ambition to stay in power. The short term tendency is to minimise political disruption, while long term success requires the politically disruptive transformation of the economy and its political actors. As I argued in The Nationbuilders, the great political leadership in New Zealand came from both the left and right, but it controlled the centre while progressively moving it. Even so the underlying changes in the political economy undermine every politician’s useby date, often before they are genuinely old.

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