We need to think about the pattern of the economy in 2050 (or whenever), not just its level of production. Focusing on productivity (and population) growth is a trap. Long-term strategic analysis requires attention to the composition of those aggregates.
Nor should we over-focus on GDP as the ultimate outcome of the economy or the principle target of economic policy. We need to consider the (admittedly vaguer) notion of wellbeing. My most recent thinking is encapsulated in Chapter 2 of my just published In Open Seas.
Productivity
Productivity is an arithmetical ratio between two aggregates (output and input) and profoundly uninteresting. The factors which determine the arithmetic ratio are not, but they are not well established or even researched (which allows the commentariat to promote its ideological policy preferences even though there is no empirical backing for them).
Productivity growth is usually attributed to ‘technology’ which is best thought of as blueprints – of how to do things. (See Chapter 4 of In Open Seas which also elaborates the earlier point that economic development is a much more complex phenomenon than growth in aggregate output.)
The ownership of the blueprints raises many difficult economic issues. However, more relevant to this paper’s focus is that around 99.7 percent of blueprints are created offshore. (Every country tends to claim its R&D sector punches above its weight; even were that true here, New Zealand’s contribution would still be tiny.)
Not every blueprint is relevant to New Zealand but there are also areas where local activity, such as geology, where it makes a significant contribution. Generally, the New Zealand challenge is to import and adapt blueprints created elsewhere. In many areas this would hardly modify the local research effort. The effective introduction of new medical treatments requires a vibrant local medical research program – if it sometimes makes world-innovative breakthroughs New Zealand is twice blessed. (On the other hand, failure to adapt the internationally generated can be catastrophic; economic policy’s willingness to import economic models from overseas without adapting them for differences in size, structure and other circumstances has contributed to poor economic performance.)
But economic growth also comes from the shift from non-market which is not included in the measures to market activity which is. One such shift involves the depletion of natural resources. (Chapter 5 of In Open Seas.) A second major one has been the shift from production within the household to commercial activity as when food preparation in the kitchen is replace by purchases outside the home. (Chapter 4 of In Open Seas but also Chapters 29 and 38 of Not In Narrow Seas.) These are long-term shifts, which is why a perspective from economic history is so valuable.
There is a substantial literature on necessary conditions for sustainable economic growth. The Ministry of Economic Development used to publish an annual list which evaluated New Zealand’s attainment against them. Generally, it scored high grades. The exception was the performance of local managers. The empirical evidence is sparse although it is consistent with anecdote. It suggests that New Zealand management is not of high quality. In my view this reflects culture. New Zealand’s management for small enterprises and agencies – which historically dominated – is probably good, but as the agency size increases the small-business style of management proves increasingly ineffective.
A caveat to all this is that it is clear that historically New Zealand’s economic performance has been intimately involved with the external sector. There is a tendency to analyse with the ‘Econ101′ closed economy and neglect the significant difference in the way that the small open multi-sectoral economy works. (In Stormy Seas)
The Evolution of Aggregate Output (GDP)
I have done considerable work measuring long-term productivity going back to the 1860s. It has not been easy because of data measurement difficulties.
I gave a paper on my findings to the Ministry of Economic Development in 2004. [1] It does not contain the presentation graphs which are attached here as a power point.
I do not propose to summarise the paper but the discussion around Chart 6 is pertinent here. I’ve underlined the key notion:
I have cobbled together the various GDP series, to give a 142 year run from March year 1861 to 2003, always using the better quality data. Chart 6 … In summary the last hundred years have seen an average growth of per capita GDP of about 1.6 percent p.a., a doubling of output per person every 44 years.
Chart 6 also shows a trend line based upon a fourth order polynomial. It recognises the nineteenth century stagnation, but sees a strong upward trend in the twentieth. However notice that the trend bends down late in the twentieth century. (For the record, the point of inflexion is 1938.) It may reflect the stagnation of the following years, an interpretation supported by the fact that GDP levels have been above trend in the past few years. Alternately, it may indicate a slowing of the long-run growth rate for New Zealand.
I have not updated the paper (yet – it is somewhere in the work program). But the observation that the growth rate of GDP seemed to be slowing down remains pertinent today. (Note that the variable discussed here is total output, not productivity.)
While I had forgotten I had made the observation, I have been continuing to ponder on the general issue of secular stagnation. The problem does not seem confined to New Zealand. I need to check that New Zealand per capita GDP still seems to have been growing at similar rate to other affluent economies (see Chart 7 of the 2004 paper) once one allows for shocks like the wool price crash and Rogernomics. Of course, there are short term differences related to different cycles and minor secular differences which may be attributed to measurement differences.
Internationally there is an argument that the affluent economies have entered a long-term phase of secular stagnation. I discuss this in Chapter 7 of In Open Seas, which sets out seven possibilities why this may be happening. They are:
1. The shift from the non-market economy to the market economy may be nearly exhausted.
2. If economic growth has been dependent on consuming natural resources we may be reaching the point where the exploitation is ending.
3. It is possible that there is a slowdown of new growth-promoting technologies compared to the last two centuries.
4. It is possible that the new technologies do not give a commercial return.
5. There may be increasingly severe difficulties measuring conventional economic growth as we shift from the product economy to the service economy.
6. The rising degree of monopolisation which inhibits innovation. [2]
7. I wrote in Globalisation and the Wealth of Nations about the possibility that stagnation is a rich economy phenomenon because the rich countries offshore production to poorer economies.
The World Economy
I have also given considerable thought to the future shape of the world economy, which will reflect both the changes in relative economic growth and population. Briefly, there is a long-term transition going on from an international order dominated by a hegemon – which characterises the last two and more centuries – to a multipolar world. The argument is set out in Chapter 8 of In Open Seas. More recently I have begun thinking more about the challenges the transition poses for New Zealand. See ‘The Meaning of MAGA’.
It is not just that China and India are going to play a more prominent role in the world economy and international order, and that there is likely to be change in the second rank – especially pertinent to New Zealand is likely to be the growing influence of Indonesia. How the world economy – indeed international relations – functions when there is no hegemon is far from obvious.
How a small country – especially one as geographically isolated as New Zealand – functions in such a multipolar world is not obvious either. There is a danger of policy inertia – of thinking in terms of the past world order. Certainly, that is the way that public international-relations discussions seem to be grounded. [3]
This concern, of course, applies to wider issues than just economic relations. A particular immediate one is the degree to which the open international economy is being replaced by economic isolationism and what can be called ‘trade wars’. I have yet to work through the ultimate outcome in a multipolar world. The wider issue is the degree to which the international order – including its economic dimension – will be based on a rule of law.
The Structure of the Economy
The narrative in Not in Narrow Seas demonstrates the crucial role of the changing economic structure in the history of New Zealand. My research in the area of the structure of the economy has focussed on sector shares. It is no accident that the first quantitative item in my 2004 paper tabulated the change in sector contributions to nominal GDP as far back as I can trust the data. (Again, I have not got round to updating the table.) I have since looked at labour force shares by sector and can get back a reasonable series to the middle of the nineteenth century.
We haven’t thought much about trends in the future structure of the economy. But there is a hint in a projection to 2050 commissioned by the Climate Change Commission, although it reports only the export structure. This is not as limiting as it might appear, since New Zealand’s domestic economic structure will largely mirror those of other affluent countries, reflecting common patterns of consumption.
The details of the CCC’s CGE model have not been published, but in Chapter 29 of In Open Seas I explored what is available. In summary, the export composition is going to shift markedly away from natural-resource-based exports (unless we classify tourism as resource-based) to service-based ones. (Perhaps not in passing, the service sector has markedly increased its share in the domestic economy – I am not sure we have thought enough about this either.)
The primary reason for this shift is that the resource-based industries are physically constrained (and may be more so by environmental factors including climate change policies and consequences).
The slack is not going to be taken up by manufacturing because New Zealand is too small to reap the economies of agglomeration on which an advanced manufacturing sector depends, compounded by its location which adds the handicap of the costs of distance. (There will be occasional exceptions but Fisher and Paykel – which used to be the exemplar of New Zealand’s manufacturing success – moving offshore indicates the general problems facing New Zealand manufacturing.)
New Zealand manufacturing could compete with that in the new industrialising nations, which would mean paying their wages either directly or by shifting the wage reductions across the entire economy using border protection and the like. I shant pursue this possibility further, except to say lower incomes mean more out-migration, which is discussed more generally below.
The export gap in the model projection is filled by the service sector. Unfortunately, CCC’s CGE model treats the service sector as a single activity so there is no indication what, among the diversity of services, the model has in mind when it projects a trebling-plus of service exports over the third of the century.
Today’s single biggest component of export services is the tourist sector, which vied with dairy products to be our single largest export sector before the covid pandemic. The model seems to project tourist receipts to about treble. Is such a growth feasible? In which case can we envisage a New Zealand with three times as many tourists as our last good year of 2019; thrice as many hotels, thrice their contribution to congestion?
Tourists to New Zealand come here for the natural resources. It is less obvious that New Zealand has any comparative advantage in rest of the service sector, where economies of agglomeration may be powerful (although the costs of distance may be not the same handicap where cable is involved). There are some outstanding service businesses based in New Zealand, but perhaps they face the prospect of Fisher and Paykel.
The Terms of Trade
The CGE model implicitly poses the gloomy prospect of New Zealand not having the industries to generate the foreign exchange it needs. There may be one upside.
Forty years ago, there was the expectation that New Zealand would face falling commodity terms of trade for its primary exports (perhaps offset by faster than average rises in farming productivity). Since then, those terms of trade have begun to rise. The reason is rising incomes from industrialisation and prosperity in a group of (particularly East Asian) countries which has increased their demand for food faster than their local supply. New Zealand farming, which tends to supply higher quality foods attractive to a rising middle class, has benefited and may benefit further as other heavily populated countries with limited food supply sectors join them. The FAO, in particular, is gloomy about the prospect of the world being able to supply sufficient food in 2050.
I had hoped to explore this issue when I asked for an extension of my three-year Marsden Fund grant. Despite the project having already written Globalisation and the Wealth of Nations. it was declined. (Apparently future of the economy was not a high research priority.) [4]
(The book uses an interesting but complicated model which explains the economic rise of Japan and, later, China and East Asia, and the change in the trend direction of the food terms of trade based on the costs of distance and the economies of agglomeration. The model underpins this meditation. See here for more details of the analysis.)
My impression is that the CCC’s CGE model assumes a constant terms of trade account. (Its full documentation has not been made available.) [5] If they rise, the export economy will not have to rely so heavily on service exports. However, it seems unlikely that any terms of trade gain will be sufficient to cover the likely under performance of service sector exports. Which leads to the question of whether the New Zealand economy – New Zealand – is viable in the long term.
The Future Scale of New Zealand
This brief section explaining that the population size of New Zealand cannot be taken as given is an alert rather than a detailed discussion.
Usually, long-term economic projections involve separate projections of population and productivity. However, the population is not independent of the level of affluence, since income relativities between New Zealand and elsewhere (particularly Australia) affect the level of (net) migration. There have been periods of poor economic performance which led to net out-migration – the Long Depression of the 1880s is an example.
Out-migration generates economic difficulties, since it usually involves the best and brightest. They who leave behind the debt servicing and welfare serving obligations of the economy.
To illustrate the issue starkly, a number of the more ‘peripheral’ regions have already suffered out-migration to the urban centres of New Zealand. Typically, the loss is of the most able of working age. They leave behind the less able and those not in employment (especially the old), who must carry the region from their more limited resources – those regions are struggling. There is an offset became the leavers still pay taxes to the central government which passes some of that revenue to those left in the regions. That tax circuit does not apply when the leavers go offshore.
Conclusion
The purpose of this note is to demonstrate that the economic issues confronting New Zealand are much wider than its productivity growth. The ‘pattern’ of the economy matters – we can, to some extent, shape it; it shapes us.
There is a second lesson here. Focusing on productivity treats the local economy as isolated from the international economy. The world outside New Zealand has had an important role in shaping the economy – its has been so ever since the isolation of the Māori economy ended with the arrival of the first Europeans, now a quarter of a millennia ago. That impact will continue. How we respond to those external changes and pressures is critical to Aotearoa New Zealand’s future.
Endnotes
[1] Here is the short version (which directs to the long version).
[2] It may not be relevant to this paper, but competitions policy is finding challenges from service markets in contrast to the product markets about which it was originally developed.
[3] On the other hand, New Zealand has made some brilliant diplomatic redirections on occasions in the past.
[4] Without funding I could not pursue the topic, mores the pity. The offset was that I wrote my economic history of New Zealand.
[5] Another issue I do not know is the ‘closure’ of the model. This may seem a technical issue, but it critically determines a CGE model’s outcome. For example, offshore borrowing is critical.