The Sectoral Approach to Economic Growth

Chapter of TRANSFORMING NEW ZEALAND. This is a draft. Comments welcome.

Keywords: Growth & Innovation;

It is dangerous to focus – as the last chapter had to – solely on the aggregate economy. Being excessively aggregate means that some of the most important features of the economic transformation are ignored, especially how a small part of the world economy – New Zealand – can grow at a different rate from the world as a whole. The growth occurs in businesses, and so we need to think about how businesses grow. However being too disaggregated can also lead to misunderstandings. Some businesses grow at the expense of others, as they increase their market share. But we need not be detained by such activities despite their being important in terms of inter-business competition, indicative of business striving.

Sectors in Economic Growth

The useful level of disaggregation is economic sectors, which is a part of the economy with certain common characteristics so that the sector 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 (or divisions of businesses, where one overlaps sectors) 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, is that different sectors grow in different ways, under different circumstances, and at different rates. Aggregating them together, as the theories of the last chapter did, obscures these differences, losing the heart of the growth process.

These sectoral differences become overwhelmingly important in regard to the difference between those which mainly 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 (tourists make a small difference), 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. It hardly matters to the film making sector whether New Zealand stagnates or grows at 10 percent p.a.. The same applies to the dairy sector, which is dependent upon the growth of overseas’ accessible markets. But it also is limited by biological constraints in its production of its base raw material milk. (It can add more or less value to the milk – as when it strips out some chemicals from the milk to create pharmaceuticals.)

The term ‘tradeables’ is sometimes 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 home supply of export like products such as butter, and ‘importables’, which compete against imports or supply from overseas. Historically importables – the import substituting sectors – were an important part of New Zealand’s economic growth. But over the last two decades, their protection from overseas competition (particularly by the use of import controls and tariffs) was stripped away and today the importable sector is much less significant. That does not mean importables should be totally ignored, and certainly they should not be unnecessarily discouraged. But in today’s New Zealand the tradable sector is primarily about exports.

If the growth of non-tradeables is dependent upon the growth of the economy as a whole, then non-tradeables cannot determine the economy’s economic 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. (It is like climbers lifting themselves by pulling on their bootstraps.) The difficulty is that higher domestic growth sucks in imports, but fails to provide the wherewithal to pay for them. So bootstrap strategies generally come unstuck. The imports of larger economies can stimulate enough growth in the countries exporting to them, to result in almost enough exports to pay for the imports. Additionally, if they are the US, and perhaps increasingly the European Union, they can issue the currency to pay for the extra imports. Alas, there is not the same world demand for the New Zealand dollar.

(Advocates of bootstrapping tend to support protection in order to prevent imports from flooding in. The protection issue is discussed in a later chapter – the main point being whatever its merits, it is not a very practical option. Moreover, the growing domestic industries in a bootstrapped – or indeed any – growth usually require imports as vital inputs, which limits the suppressing of importing via protection.)

If small economies such as New Zealand wanting to accelerate their growth rate are handicapped in bootstrapping their growth, they have an advantage on the export side. A small country can more easily increase its share in foreign markets. Not all of them. New Zealand is unlikely to markedly increase its market share in Pacific Islands or Australia for the share is already high. But the country’s exports to the enormous and rapidly 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 a consequence of disaggregation is that it draws attention to that not all sectors are 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.

But 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. One has to think of the different sectors as a team, with different requirements. But not everyone scores, but the grinders have as important a role on a racing yacht as the skipper and tactician. .

The Political Economy of Growth

There is one further implication of this disaggregation into sectors compared to the standard growth theory. Uncomfortably for the political process, the balance between sectors changes. The whole point of an economic transformation is that economy is different as a result. but the political process tends to favour the established sectors over the growing ones, and indeed the established and slower growing ones have the incentive to use the superior political position refelcting 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.

Even more fundamentally, 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. Yet a growth strategy means they have to disturb that cosy balance, in effect undermining the very political bastions on which they depend. The easy solution is to articulate economic policies based on the aggregate growth theory of the previous chapter, since that obscures the fundamental structural changes that are required. The consequence is an unsatisfactory growth performance.

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 the political actors which reflect it. Not surprisingly then, the political rhetoric tends to be ambiguous, and to require some subtlety of interpretation a subtlety which New Zealand political commentators are not noticeably good in identifying. Meanwhile the politician has the skilled task of walking away from the old political economy towards the new one with out alienating the old. 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.

National-Sectoral Projections

Once upon a time, New Zealand economic management was very explicit about the role of sectors in the growth process. It sort of arose out of indicative planning, which was a popular notion in the 1950s and 1960s, but it probably still has a role to play today. The last major attempt was a ‘national-sectoral’ projection published in 1991. Here is a simplified account of what was done.

The economists asked each sector of the economy what was its sustainable growth rate. Typically, the domestically oriented sectors said they could grow at virtually any rate if the domestic economy did. Some asked for subsidies – they always do. Some drew attention to government policies which were practically inhibiting their growth. (For instance, today the biotechnology sector might say that the regulatory framework had high compliance costs compared with key overseas competitors).

The export sector responses were more restrained. Some said their sustainable growth depends upon the growth of world markets. (If one is exporting to saturated markets in Australia, then the exports are likely to grow at about 4 percent p.a. at most.) Others – notably farming, fisheries, forestry – mention the practical biological limitations on their supply side. Some sectors cite supply restraints from other sectors – energy supply may prove to be a bit of a problem in the future, while the tourist sector worries about the availability of hotels and the capacity of airports. And, of course, there may be specific labour shortages – not all skill deficits can be quickly resolved – in addition to a total labour constraint. Similarly there may not be sufficient investment to meet all the requirements. (Can we build the power stations, hotels and airport extensions in time?)

The economists then took all these various sectoral projections and used a quantitative model to assess to what extent they were consistent with each other and an economy as a whole. (Would there be enough labour, enough investment, enough savings? Would the assumed prices ensure that sectors would be profitable?) After some iterations – going back to sectors where they seemed over-optimistic or unnecessarily pessimistic – the study ended up with an overall economic growth rate.

We can see this today in the projections for the energy sector. As I write (in mid-2003) they are predicated upon the growth of the economy of 3 percent p.a. (about the average growth rate over the last decade), and there are worries that there will be electricity shortage in ‘dry years’ (years in which the hydro lakes do not get filled as much as normal). Meanwhile the government hopes to accelerate the growth rate to, perhaps, 3.5 or 4.0 percent p.a. Not only is there an inconsistency between the two projections but it seems possible that if the weather is unfortunate, energy shortages may slow down the economy. Additionally, those who advocate higher growth rates – sometimes higher than the government thinks possible – ignore that with the running down of the Maui field, there will be a change to primary energy sources (coal will be used in some gas fired stations, others are to be closed down), but the petrochemical industry based on Maui will be closed and there will be a lost of export revenue. Another concern is if the energy sector meets the supply that the growth requires, there are going to be major investments. How are these going to impact on the economy? There does not seem to be any systematic analysis of these changes, and the focus on aggregate growth ignores a lot of the complications contending underneath.

Do not place too great emphasis on the precise quantitative growth rate of the projections. If targets worked, the Soviet Union would have been an economic success. But the exercise does assist thinking systematically and practically about economic growth. It does so by focussing on the different sectors, and their diversity of circumstances. It identifies practical policy issues which can be addressed. This is sometimes called bottleneck planning, that is identifying the obstacles which are retarding key growth sectors. Bottleneck planning does not require a national-sectoral projection framework, but the systematic analysis helps focus on the relative magnitude of the obstructions, and the potential return from addressing them.

There is a further advantage from developing national-sectoral framework, which if political should not be underestimated. By bringing the sectors together – that is business people, unionists, those involved in the social sectors, government officials, and politicians – it gives a sense of national purpose and direction. In the past the very activity of the players in different sectors coming together within sectors (as when business and unions work together to progress their joint sector) and between sectors (for the various business may not know a lot of what is going outside their sector) has social and national benefits. It is almost ironic that the focus on the disaggregated sectoral economy, leads to an aggregate unity, as the business community works together. It is a reflection of the more general phenomenon of aggregation (such as the centralisation by dictators) being intolerant of diversity resulting in a repressed social fragmentation and potential unrest. To an extent a market economy avoids this because it allows diversity through market expressions (if one has sufficient income to express oneself), but only where the market acts reasonably effectively.

Perhaps it should be added that these benefits are likely to arise most in small societies. As the society gets larger it is harder to maintain social cohesiveness. Thus the dominant economic paradigm tends to underestimate the political and social gains, from approaches such as national-sectoral projections, which can ultimately be converted into economic ones. It reflects the practicalities of large economies like the US, rather than small economies like New Zealand.

How Fast Can New Zealand Go?

A further advantage of a National-Sectoral Projection is that it anchors expectations about growth in a reality, since businesses can look at how reasonable the outcomes are – whether their markets can expand that fast, whether they can attain the productivity assumptions made of them, whether the investment projections look realistic. Even so the projected growth rates have tended to be on the optimistic side, although not as outlandish as those who do no calculations or depend only on aggregate calculations which hide a multitude of assumptions which can be tested.

Instructively, the 1991 study concluded that it would take almost twenty years to return to the top half of the OECD (The 1991 slogan was ‘10 in 2010′). The stretch growth rate was about 4 percent p.a. In the 1990s the New Zealand economy grew about as fast as the OECD (3 percent p.a.) so there was no significant movement up the OECD relativities. Perhaps the growth targets were over-optimistic, perhaps the government’s policies inhibited their attainment.

A salutary image from the America Cups was the sleek black yacht limping back to port. Twice they tried to sail it faster than conditions allowed, the boat shipped (literally) tonnes of water, bits broke, and they gave up the race. Economies can also be like that. In the early 1970s, the National Development Conference projected a growth rate of 4.5 percent p.a. for the economy. Impractical in the circumstances, the economy averaged nearer half the target over the next few years. Today’s calls for an economic growth rate of 6 percent p.a. are probably even more irresponsible, and the demand that New Zealand should return to the top half of the OECD in GDP per capita terms by 2011 is totally unrealistic.

One does not know what the conclusions of a National-Sectoral projection exercise would come to today. But we are unlikely to be able to turn the ship around much faster than in 1991. Certainly the sorts of demands being made by the strident but uninformed look quite unrealistic. They need to remember that trying to sail a boat – or an economy – too fast, can turn a boom into a bust.

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