Paper to the Labour, Employment, and Work Conference 7, at Victoria University of Wellington, November 28-29 1996, published in Labour, Employment and Work in New Zealand 1996, pp.148-156.

Keywords: Growth & Innovation; Labour Studies;

Abstract

Earlier this year Wolfgang Kasper produced a book “Free to Work: The Liberalisation of New Zealand’s Labour Markets” (Centre for Independent Studies). By reviewing this book, this paper is able to shed some understanding of the effectiveness or otherwise of the Employment Contracts Act. On the basis of the emperical evidence it is very difficult to reach, in a systematic way, Kasper’s conclusions about the beneficial effects of the ECA. In particular, the poor productivity growth rules out the likelihood that the ECA was a major contributor to the macroeconomic expansion of the mid 1990s. The Act would, however, seem to have contributed to the poor real wage growth, and the failure of many workers to obrtain a share in the increase in propserity of the 1990s.

Introduction (Methodology)

Were he alive, John Stuart Mill would be greatly puzzled by the naivety of the methodology used in the economic debate in New Zealand. Suppose the advocate has a theory which says if event A occurs, then event B will occur, and then something like event A does occur, and some time after something like event B occurs. This is then treated as proof of the validity of the theory. There is no attempt to consider whether A caused B, for association is sufficient. Moreover, suppose the theory also predicts that if A occurs then event C will occur, and in fact not-C actually occurs after A occurs. That not-C may be ignored, since the evidence of B is sufficient to “prove” the theory’s truth, and so there must be some other mitigating factor which invalidates the theory’s account of the causal impact from A to C.

Thus are theories are defended, and the policies derived from them are justified. It is extremely difficult to challenge any theory in such circumstances, because there is always some event B, predicted by the theory, which will occur, while numerous other not-C events which occur cannot be used to discredit the theory. Moreover numerous theories will be confirmed by this weak methodology, which has no criteria for deciding between them. It becomes a matter of the belief of each theory’s supporter. Where there are more than one supporter, their mutual belief reinforces one another’s confidence.

John Stuart Mill would despair at being unable to make any progress towards resolving the macroeconomic questions which confront New Zealand. He would want to use a much tougher methodology. At the very least he would want to compare various theories and see which gave a consistent account of more of the events which occurred.

In order to avoid some of these difficulties, this paper uses those in Wolfgang Kasper’s Free to Work. [1] The merit of using his criteria – selecting his concepts, definitions, and periods – as the basis for a critique, is that it stacks the odds in favour of his support for the Employment Contracts Act (ECA). Yet we shall see that the case he makes of the macroeconomic benefits of the ECA is not compelling.

GDP Growth

Kasper claims that the ECA stimulated economic growth, but is rather vague about how that occurred. Figure 1 repeats the first graph of Kasper’s Figure 2, but includes more recent (and revised) data, and projects the GDP figures through to March 1999, using the September 1996 NZIER consensus forecasts, which average the predictions of 14 forecasters. [2] In addition a “trend” growth rate of 3 percent p.a. is shown.

The story it shows is clear enough, if unrecognized by Kasper. The New Zealand economy contracted and stagnated from 1990 (in fact from 1989) through to end 1992. From late 1992 the economy began a rapid (and widely hailed) expansion. [3] However this was not long enough to catch up to the 3 percent trend line. After 10 quarters the growth petered out, and was expanding at 2.8 percent in the year through to March 1996 and, according to the forecasters’ average, by 1.8 percent in the (current) year to March 1997. Further out they expected growth to hover around 3 percent a year. [4] This contrasts with Kasper’s claim that “the projection is for the economy is to keep growing for the remainder of the decade at a trend growth rate of around 4 percent.” (p.16)

Real Wages

Kasper used a different presentation for his second graph of real wages changes. As Figure 2 shows, his presentation obscures the minuscule real (income) wage growth over the period has been – about 2 percent over seven years, with little prospect of further gains. [5] Probably part of the gains are due to labour force composition effects. Hence the increase as the economy contracted and so lower paid workers were laid off, and the fall during the early part of the upswing. Kasper’s own estimates is a .4 percent average growth of real wages, which can just be seen in the middle of his diagram. In summary, within the margin of error, and allowing for composition effects, real wages have hardly increased over the period.

Labour Productivity Growth

As the third of Kasper’s graphs shows, employment numbers rose sharply from mid 1993, as one might expect in a cyclical upswing. Initially firms expanded output by increasing the intensity of labour usage within the firm, and as under-utilized labour became exhausted they turn to an extensive expansion of hiring more workers.

However Kasper seems quite oblivious of the implications of high employment growth with modest output growth. As Figure 3 shows, the productivity growth record for the New Zealand economy has been poor. In the seven years from 1990 there was a total gain of around 5 percent, and the forecasters do not expect any major increases in the immediate future. It is also evident that the big gains came during the period of the early upswing, when firms used their existing labour force more intensively.

One might contrast this with the story which Kasper tells about the Australian economy. It has not been possible to check his statistics, but an eyeball of his data (p. 50-1) shows almost the same output growth over the period from 1990 to 1995, except the Australian upswing was later and faster than the New Zealand one. However Australia experienced much less employment growth, by about 1 percent a year. Thus Australian productivity growth has outperformed New Zealand productivity growth – by about 1 percent a year.

Kasper not only ignores such data but insists there has been substantial productivity growth. “We can conclude that the Employment Contracts Act has substantially enhanced the productivity of labour …” (p.51) The data, had he presented it, would have given the lie to such a claim. [6]

The Productivity Puzzle

The productivity puzzle deserves further investigation. Detailed work by Bryan Philpott has provided a productivity series for the New Zealand economy back to 1977/8. [7] Three sectors – importables, exportables, and non-tradeables – are graphed in Figure 4. It is extremely hard to discern any significant change in the trend of any of the three series, once allowance is made for cyclical effects and measurement problems. [8] Despite all the changes in the last decade, there is no perceptible impact of the reforms on the long run trend of overall productivity. This is true for the post-ECA era, but it is true for the post 1984 era as well.

One could even argue there has been a reduction in productivity growth in the five years after March 1991 compared to the five years which preceded it. Table 1 makes it hard to argue that there has been a definite increase in the productivity growth rate after the ECA was introduced, in contrast to the previous quinquennium. Indeed, as a rule the sectoral productivity growth rates in the first part of the 1990s appear to be lower than the rates before the restructuring began.

Even the exceptions can be explained. Figure 5 summarizes Philpott’s division of the economy into a restructured and unrestructured sectors. The former covers mining, forestry, electricity, and communications, characterized as those which were largely government owned in 1984, and experienced substantial corporatization and privatization. It is evident that the sectors experienced a substantial increase in their productivity growth following these reforms, although this boost stopped after 1992/3.

Because the restructured sectors contributed only 10.3 percent to GDP in 1997/8 rising to 15.7 percent in 1995/6, their substantial productivity gains do not seem to have impacted greatly on overall economic performance. One way of judging this is that had the restructured productivity grown after 1987/8 as it had before that date, (average) labour productivity for the whole economy would been only 2.8 percent higher in 1995/6. [9] On this measure the corporatization and privatization program added a fraction less than .5 percent to productivity growth between 1987/8 and 1993/4. [10]

A further complication to this story is illustrated in Figure 6, which shows a downward slopping relationship between productivity and employment as PP. The relationship is a variation of a production function in which (at any time) output is merely a function of employment. [11] It shows that if employment is OE, then the economy can produce on the production at X, so the average productivity is given by OA.

An increase in productivity can occur in two different ways. First the production function may move out, say to P’P,’ so for the same employment OE the economy now produces at X’ and productivity increases from OA to OA’. This is called a “shift of the production function”.

Alternatively if employment contracts from OE to OE’, but the production function remains at PP, productivity also goes up from OA to OA’. This is called a “shift along the production function.”

These two sort of shifts are staple items of first year economics teaching. They are very different causes of a productivity gain, and they have different policy implications. It matters a lot whether the policy has resulted in higher overall productivity (that outward shift of the production function), or whether it has simply reduced employment (so unemployment rises by EE’), put a lot of firms out of business, and junked a lot of old capital without increasing (or even reducing) output or social welfare (the shift along the production function). [12] Regrettably, claims that productivity has or has not increased are often made without reference to this important distinction.

In summary, Kasper’s and others claims that the ECA increased productivity growth cannot be sustained on the basis of the available data. [13] But can it be argued that the ECA decreased productivity growth, as Tim Hazeldine has done recently. [14] That argument is more consistent with the available data, but the complexity of the situation is such, that more work needs to be done before we can be certain, for there are so many other things going on. It seems likely that the research will show that the ECA had very little impact on productivity in either direction.

The Economy and the ECA

The story the data tells is that the post-ECA economy was in a stagnation phase until late 1992. It then began to expand rapidly, initially by using the internal resources of firms but later by an employing more labour. Productivity gains were not high. It would appear that this extensive rapid growth phase was over by the end of 1995, and the New Zealand economy has now settled down to a modest long term growth rate of just under 3 percent p.a, based primarily on increased application of labour and capital, with little underlying productivity growth.

Kasper is keen to explain this not very impressive expansion on the effects of the ECA. “It would be hard not to attribute most of this enhancement to the improved institutional framework surrounding labour markets.” (p.45). Indeed Kasper could have been more explicit and said it was “easy” to explain the enhancement by the ECA. But easy explanations are rarely correct ones.

A richer account of the New Zealand growth experience of the mid 1990s, is that there was a bounce back from the contraction/stagnation phase of the late 1980s and early 1990s, fuelled by a favourable fall in the real exchange rate (which has since been reversed), a substantial improvement in the terms of trade (which are about 10 percent higher in the 1990s than they were in the late 1980s), and the upswing of the world economy (especially in New Zealand’s case, Australia which is the main market for manufactures). However this expansion was based on additional applications of labour and capital, rather than improved productivity performance. When the available capital and appropriately skilled labour ran out, economic growth slowed down.

Which of these two accounts are to believed? Surely the poor productivity performance discriminates between them. If the Employment Contracts Act had worked in the way its proponents say it did, in the way which Kasper thinks it did, there should have been substantial an ongoing productivity gains. There have not been these gains, and so the ECA explanation of the expansion is not a viable one. It is unfortunate that Kasper’s account leaves out the evidence of the key data which demonstrates he is wrong.

Enthusiasm for the ECA

Despite the lack of evidence of significant improvements in economic performance from the ECA there remains considerable enthusiasm for the legislation. Undoubtedly some of the enthusiasm among managers is because of the change in the industrial relations balance it engender over managerial employee relations. However in economic terms there has been one substantial economic gain for employers.

Figure 7 shows the real (income) wage (of Figure 3) divided by the labour productivity index (of Figure 2), which gives a measure of the degree to which productivity gains had ben shared with workers. [15] The overall pattern is that the index fell about four percent in the mid 1990s, suggesting that workers’ wages have not shared in the (albeit small) productivity gains over the period.

It would not be unreasonable to attribute this to the Employment Contracts Act. Such gains workers have had over the period have been the increasing number of jobs – which we have suggested are unlikely to be attributable in full to the ECA. There is therefore little evidence that the ECA has been beneficial to workers.

(Two further issues – unemployment, and the paper by Tim Maloney which Kasper extensively quotes, are dealt with in appendices.)

Summary

On the basis of the empirical evidence it is very difficult to reach, in a systematic way, Kasper’s conclusions about the beneficial effects of the Employment Contract Act. In particular the poor productivity growth rules out the likelihood that the ECA was a major contributor to the macroeconomic expansion of the mid 1990s. The Act would, however, seem to have contributed to the poor real wage growth, and the failure of many workers to obtain a share in any increase in prosperity of the 1990s.

APPENDIX: Unemployment

Undoubtedly there has been a substantial fall in the New Zealand unemployment rate since its peak in 1991 of 11 percent (or its shoulder of 1993). [A1]This is not surprising given the sharp rise in employment. However Figure 8 shows forecasters do not expect any further gains through to 1997 or thereafter. [A2]The slow GDP growth rate means that insufficient labour is being taken on to reduce unemployment, despite the poor productivity growth. Forecasters expect the unemployment rate will hover above 6 percent throughout the late 1990s.

In assessing the unemployment rate it should be noted that the rate was probably below 4 percent in 1984 when the reforms began, [A3]and as recently as 1988 the unemployment rate was below 6 percent. [A4]

Kasper compares the patterns of unemployment rates for Australia and New Zealand. Given his difficulty with dealing with New Zealand data, one is reluctant to rely too heavily on exact figures – comparisons of international data are always difficult. However undoubtedly New Zealand has had a greater fall in is unemployment rate than Australia, since its employment growth has been greater.

A note of caution needs to be added. Comparison of unemployment rates, assuming consistent definitions of employment rates, are dependent upon some assumption about labour force participation rates (LFPR). It is well established that LFPRs are subject to cyclical variation, tending to be more depressed when unemployment is high when those not employed are less active in seeking work while, conversely, when unemployment is low those previously in the not-in-the-labour force category seek work and may become unemployed. There are also secular changes – both the youngest and oldest age groups have had falling LFPRs, [A5] while the female LFPRs have been rising.

How then are we to compare LFPRs (and hence unemployment rates) between different countries (even if the statistical definitions are exactly the same)? This is a troubling question in the case of the Australia New Zealand comparison. Historically the New Zealand LFPRs were higher than the Australian ones (but we do not know why). However males LFPRs have generally been falling faster here than across the Tasman (so that Australian male LFPRs are now similar to the New Zealand rates), while New Zealand females LFPRs have been stagnant while Australian ones have been rising (although Australian female LFPRs are still lower than New Zealand ones). This presumably reflects Australia’s more vigorous secular employment growth, which has better retained men in, and attracted women into, the labour force compared to New Zealand. However we would want to know more about the LFPR levels before we told the story with confidence.

This is not to deny that measured unemployment is lower in New Zealand, and fell more between 1991 and 1995. The appendix simply notes that the comparison – indeed any international comparison – is complicated.

APPENDIX: The Maloney Study.

This is not the place to provide a full review of Tim Maloney’s “Estimating the Effects of the Employment Contracts Act on Employment and Wages in New Zealand.” [A2-1] However, Kasper quotes the paper favourably, so to ignore it might seem to practice that which the introduction condemned. All that is done here is warn that there are problems in using the work as significant evidence of the impact of the ECA on employment and wages.

The study depends heavily upon a measure of union density, the proportion of workers who are union members. The union membership series comes from two sources: the Register of Unions up to first quarter 1989, and Raymond Harbridge’s survey of trade unions in fourth quarter 1991 and 1992. (p.326-327) The two series are spliced together and the missing quarters are interpolated. Both actions raise difficulties.

Since the ECA is effected from second quarter of 1991, the series are on either side of the phenomenon which is being investigated. Any conceptual or measurement inconsistencies in the series may be econometrically magnified into a statistical difference which merely reflects the different data series. Even if Harbridge was as successful as he hoped in maintaining continuity, two further difficulties would remain. First, the series were measured at different times in the seasonal cycle. Second, many unions reported spuriously higher membership numbers under the old regime, but the new regime forced them to be more accurate (as when union amalgamation resulted in the acquiring union discovering here were far fewer members than were claimed).

The interpolation generates a spurious accuracy in the data. Altogether Maloney has 8 data points (6 before the ECA was introduced and 2 after), which he increases to 30 by interpolation. Now the econometrics is unaware of this, and so treats the data as though there are 30 independent observations of union density from a single data set, whereas there are only 8 independent observations from two separate data sets. The econometric impact of this is complicated, but as a first approximation we would expect the addition of interpolated data could halve the standard errors of the estimates of the coefficients on the union density variable. [A2-2] There is only one set of equations where the union density variable is identified as significant (albeit at only a ten percent level on a two tailed test). (Table 3) Allowing for the interpolated data would make these results even less statistically significant.

What this means is that in none of the estimated equations does Maloney find convincing statistical evidence of the impact of either the Employment Contracts Act directly, or indirectly via its impact on union density, on employment or wages. Maloney as much as acknowledges this when he writes “[s]uppose we accept that the ECA … has resulted in increases in employment?”. This is a paper based on such suppositions.

But suppose that the econometrics had found a statistically significant relationship between the ECA and employment (and/or wages), after full allowance for the splicing and interpolation. Correlation is not the same thing as causation. There were many other policy (i.e. broadly exogenous) changes happening at about the same time. [A2-3] To be compelling, the study needs not only to find a statistically significant relationship, but to demonstrate that there is no more plausible alternative explanation.

As it happens the study did not find the former, and we are left with the impression that the main factors determining employment and wage rates over the first two post ECA years were macroeconomic variables like output and relative prices.

If the study had had more substantial findings there would have been more to say on it. However the inadequacy of the data series, the poor statistical outturn even under such favourable assumptions, and the reliance of correlation as causation are sufficient to classify this study as of no great significance, and certainly of little support to theories that the ECA had much influence on the macroeconomy.

Endnotes

1. W. Kasper (1996) Free to Work: The Liberalization of New Zealand’s Labour Market, Policy Monograph 32, Centre for Independent Study, Sydney.
2. NZIER (1996) Consensus Forecasts, April 1996, NZIER, Wellington.
3. Kasper says the recession came to an end in early 1991, but that gives more confidence to the quality of the GDP data than many would trust. The general impression, supported by the NZIER Quarterly Survey of Business Opinion, is that 1991 was a depressed year.
4. Since September, many forecasters have been revising down their forecasts for the 1996/7 and 1997/8 years, so the December consensus forecasts are likely to be even more pessimistic.
5. Kasper does not define his variables even there are a number of possibilities. The numerator of Figure 2 is Average Hourly Earnings (ordinary time), the denominator is the Consumer Price Index.
6. If Kasper is to believed, the productivity gains are even less. “Some knowledgeable observers believe that employment statistics under-report employment growth since the ECA.” (p.49) Who these “knowledgeable” people are is not explained.
7. B.P. Philpott (1996) A Note on Recent Trends in Labour Productivity Growth, Research Project on Planning Paper 281, Wellington, October 1996. (The employment series is adjusted for part-time working.)
8. The non-tradeable sector has higher labour productivity levels than the tradeable sectors, is because it includes the capital intensive energy, communications, and home ownership sectors.

9. The calculation assumes that the sectors’ output would have grown at the same rate without the additional productivity growth.
10. Conversely, and making a series of assumptions to get an order of magnitude, there would have been an extra 39,000 workers employed in the restructured sectors, and unemployment would have been 77,000 or 4.1 percent in March 1996. This was the level similar to that which it was in the mid 1980s (there was no HLFS at this time).
11. If Y = f(E), which is a production function, then Y/E = f(E)/E, which is the form of the function shown in Figure 6.
12. Output when the production function shifts is OEX’B which is definitely larger than previous output OEXA. Whether output under the shift along the production curve increases (i.e. whether OE’YA’>OEYA) depends upon the slope of the production function.
13. The NZIER reports that a survey of managers reported “increased productivity and operational flexibility and greater training.” Given there is no statistical evidence for substantial gains in productivity above the long term trend, one might conclude that mangers are attributing normal productivity gains to the ECA, in a similar manner to Kasper attributing favourable economic events since 1991 to the ECA, despite there being little economic evidence to support his contention. QSBO March 1996.
14. T.Hazeldine, “Employment Contract Act makes for bad economics,” New Zealand Herald, November 25.
15. There is an issue as to whether the real income wage or the real product wages should be in the numerator. Real income wages were used here because they were illustrated in Figure 2. Thus the measure indicates that workers have not benefited from the productivity gains in their takehome pay.

1. Kasper’s data seems to be seasonally adjusted. They have since been revised. Presumably the “white” male unemployment rate refers to the European/Pakeha rate.”White” is not used in this context in New Zealand because of its racial connotations. The official categories involve ethnicity rather than race.
2. Unlike Kasper’s graph, the vertical axis of Figure 5 is not truncated, avoiding the impression of greater relative gains than actually happened.
3. This particular series does not begin until 1986.

4. But note endnote 10 of the main paper.
5. The falling youth LFPR reflects more young people staying on in tertiary institutions (but also perhaps the greater difficulty of their finding work, since a full-time university who was doing a little work appears in the labour force statistics as part-time employed). The falling LFPRs for older age groups are thought to reflect changes in retirement choices, but again may also be influenced by job scarcity inducing early retirement.

1. Maloney, T. (1994) “Estimating the Effects of the Employment Contracts Act on Employment and Wages in New Zealand,” Australian Bulletin of Labour, Vol 20, No 4, December 1994, p.320-343.

2. (8/30)^.5 is approximately .5.
3. For instance while one is not surprised by the conclusion that the ECA reduced union density (indeed one would be astonished otherwise), the successful econometric equations demonstrating this are hardly compelling evidence.

Labour Employment and Work in New Zealand: 1998 Proceedings of a conference, 26-27 November, 1998, pp.38-46.

Keywords: Growth & Innovation; Labour Studies;

Abstract

Deindustrialisation is the phenomenon of the secondary sector growing more slowly than the rest of the economy, whether measured by share of GDP or of employment. Almost all rich OECD countries have been expereincing it. However New Zealand has been deindustrialising faster than the OECD average (even if the energy based industrie developed in the 1980s are included). The paper describes rthe phenomenon and discusses why it happened.¹

New Zealand is not usually thought of as an industrial society. In the nineteenth century it did not have the dark satanic mills of Europe from whence fled the Pakehas’ ancestors. Today its factories are usually smaller than those of most industrial societies, and their products do not have the prestige that symbolizes modern industry. The international and national vision of New Zealand is a rural country, whose economy specializes in rural products.

Certainly by international standards New Zealand’s modern farming sector is exceptionally important. Yet for most of the post-war era the size of New Zealand’s industrial sector has been comparable to that of other OECD countries, with a manufacturing sector larger than the agriculture sector by contribution to GDP since the 1950s, and by employment since the 1940s. In the early part of the post-war era the majority of the manufacturing sector created jobs and saved foreign exchange, thus contributing to goods and services to material welfare and to the full employment of psychological welfare. Much was produced behind high levels of border (and internal) protection, although economists disputed the extent that this protection was beneficial or detrimental to overall economic welfare. A smaller part of manufacturing was directed at adding value to the key foreign exchange earning pastoral exports.

From 1966, following a fall in the terms of trade which made pastoral exporting less attractive, the manufacturing exporting sector developed from its processing of terms of the traditional exports, to adding value to new primary products of forestry, fishing, mining, and non-pastoral farm products, together with some general manufacturing mainly to Australia but to other nearby countries in Asia and the Pacific. Manufacturing experienced another major change in the early 1980s, when the energy surpluses from the Maui gas field and the Waitaki basin hydro-scheme created “think big” energy intensive production, which were typically substitutes for imports.

But from the 1970s, border and internal protection had been systematically lowered (very quickly after 1984), so that today there is very little general manufacturing competing against imports. It either exports – value added to primary processing, manufactured commodities, or elaborately transformed manufactures – or provides products which cannot be practically imported. Nevertheless, until the mid 1980s the relative size of the sector remained roughly constant at a 21 to 24 percent contribution to GDP, and a 23 to 27 percent share of the labour force. Thereafter, both shares began falling. The employment share is now about 15 percent, and the GDP contribution share is under 19 percent. This is “deindustrialization”.

This paper details the change, sets down the major reasons for it, examines the macro-economic implications which suggest the decline should be arrested, and suggests policies to do this. While some deindustrialization is inevitable, we shall see that its rapidity is a threat to the viability of the New Zealand economy.

1 The Pattern of Deindustrialization

This study uses two measures of the relative size of manufacturing and other sectors. The first is the contribution the sector makes to GDP. The second is the share of the sector’s employment in national employment (the labour force less the unemployed). Statistical measurement always involves complicated issues. In particular these indicators are for long periods, so they are especially prone to conceptual and statistical drift. But the trends are likely to be broadly correct.

1.1 Manufacturing’s Contribution to GDP Share

1919/01929/01938/91952/31959/01964/51969/01974/51979/01983/41989/01994/5Agriculture29.826.223.222.118.014.2 11.77.710.17.37.06.2Other Primary  2.93.94.33.74.33.05.15.56.86.0 Manufacturing21.623.721.721.121.822.522.523.323.322.318.818.9 Construction4.06.68.07.17.26.35.77.44.65.14.75.2Domestic Trade  15.216.418.721.920.721.920.020.614.916.5Transport & Com  5.88.57.47.48.07.67.98.58.78.7Finance  7.77.38.28.69.19.99.611.115.415.1Other Services  15.513.614.415.418.019.219.419.523.723.4TOTAL100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0100.0

Source: Easton In Stormy Seas, p.140, updated with SNZ data.
Note: The definitions are aligned, as far as possible to the Philpott & Nana definitions of 1959/60 to 1983/84.

As Table 1 shows, between the end of the First World War and the mid 1980s, the Manufacturing Sector’s contributed between 21 to 24 percent to GDP, averaging 22.4 percent between 1954/5 and 1983/84. But from the mid 1980s, that share deteriorated to 18.8 percent in 1989/90 and 19.4 percent in 1994/95. This apparent stability in the 1990s does not represent a structural change so much as a cyclical recovery in commodity prices for base metals and forestry products. Preliminary figures indicates that the structural decline has continued since.

The decline represents about 3.5 percentage points of GDP. That does not simply convert into a 3.5 percentage fall in GDP. Because manufacturing purchases inputs and generates flow-on economic activity the impact on GDP is greater.

There is good reason to expect the share will continue to fall. Two major factors are the closure of the car assembly and associated component industry as a result of the 1998 tariff elimination, while further plant closures are threatened as a result, of the proposed tariff reductions after 2001.

1.2 Manufacturing’s Contribution to Employment

Source: Population Censuses.
Note: Definitions change slightly between some Censuses.

As Table 2 shows, manufacturing’s share in employment exceeded 24 percent of the total for much of the postwar era, although perhaps the share was declining at around 1 percentage point a decade from the mid 1960s. That the average employment share from 1954/55 to 1983/84 was about two percentage points higher than the manufacturing’s share in GDP indicates that labour productivity in manufacturing was a little lower than the economy wide average. This was because manufacturing has not been as capital intensive as agriculture, mining, energy, communications, and housing. ² That the employment share had been falling slowly while the output share had been broadly constant reflects the labour productivity rising faster in this sector than on average.

From the mid 1980s, the employment share begins falling quickly – to 16.8 percent in 1991 and 15.2 percent in 1996. If the employment share had followed the gently falling trend line of the pre 1986 era, it would have been closer to 22 percent, some 7 percentage points higher. Today, manufacturing has the lowest proportion of total employment since the 1860s when gold prospecting drained off other domestic production. In recent years, the employment share fall has been faster than the added value fall, so manufacturing labour productivity has risen sharply and is now above the economy wide average.

1.3 The International Evidence

Table 3
MANUFACTURING SHARE OF VALUE ADDED

Source: OECD

That the New Zealand economy has been rapidly deindustrializing since the mid 1980s parallels an international phenomenon. Table 3 shows that New Zealand ranked 15th out of 25 in contribution to GDP terms in 1974, with a share of 24.1 percent. This was a little above the OECD average share of 22.9 percent. By 1993 New Zealand was still 15th, but its share of 18.1 percent was below the OECD average of 20.4 percent. The evidence of the table is that most OECD countries experienced deindustrialization (Korea is the marked exception), but on the contribution to GDP measure New Zealand was deindustrializing faster. (Figure 1)

Source: OECD

Table 4 shows that New Zealand ranked 12th in employment terms in the 1960-1973 period, with 27.2 percent, just above the OECD average of 27.0 percent. By the 1990 to 1995 period New Zealand was 20th at 17.0 percent, well below the OECD average of 19.5 percent. On this measure the OECD also experienced deindustrialization, but again New Zealand’s was one of the most drastic. (Figure 2)

A complication in interpreting the comparative data arises from the development of the energy intensive development which took place in the early 1980s. In 1974/75 the chemical subsector contributed 2.0 percent to GDP, but in 1994/5 it was 2.6 percent. If it had grown as slowly as the rest of manufacturing, the manufacturing sector would have been over one percentage point of GDP smaller, and New Zealand manufacturing would have been more like 20th on the contributor to GDP in the mid 1990s OECD league table. Thus “Think Big” obscures the high rate of deindustrialization of the New Zealand economy.

2 Why the Deindustrialization?

Any explanation of why the New Zealand manufacturing sector has been getting relatively smaller needs to address two issues. Why does the phenomenon occur elsewhere in the world too (Section 2), and why New Zealand’s is experiencing a greater one than most (Section 3).

There is a well elaborated theory of the structural change which most economies experience as they develop. Initially the primary sector share of economic activity contracts, as workers shift to more productive and higher paid (often urban) sectors, and as relative demand for primary products, especially food, diminishes.

These mechanisms do not quite apply to New Zealand – generally New Zealand agriculture is (and has been) a very productive part of the economy, while as a major food exporter New Zealand farming is not as pressed by the diminishing share of foodstuffs in local final consumption. Nevertheless since before the war the share of farming in economic activity has been diminishing. ⁵ (Tables 1,2) The deceleration of the decline of the whole of the primary sector has not been as great, because forestry and deep sea fishing has expanded, and new hydroelectricity and hydrocarbon energy sources were exploited. The service sector absorbs the resources released from the primary sector, as the share of services rises in final consumption, and because the primary and secondary sectors outsource work to the service sector (as when a farmer hires an accountant). Meanwhile the manufacturing sector retains its share of economic activity.

There are exceptions to the general pattern. A resource boom, as occurred in Australia and Norway, will increase the size of the primary sector, and squeeze the manufacturing sector, because it is difficult to import services, which tend to be produced at the point of sale. This distinction between that which can be transported between point of production and of sale/consumption, and that which has to be produced at the point of sale/consumption is a key in the separation of the economy into a tradeable and non-tradeable sector, which becomes central in the Section 3. There are manufacturing products where transport costs have been so high that they are located close to their consumers. The plethora of local breweries half a century ago illustrates this, but their demise also illustrates that transport and communication costs have dramatically lowered in recent years – a key element in the story. It is also true that some services are tradeables, most obviously the tourist industry.

These changes are sometimes summarized as “economic globalisation”, which involves production shifting to locations of minimum cost. This has especially involved low cost, labour intensive manufacturing production moving to East Asia, with the result that the manufacturing sector share of economic activity declines in the local economy, and rises in East Asia (as was reported in regard to South Korea). There may also be an element that manufacturing’s share in final consumption is declining, as increasingly affluent consumers increase their demand for services.

So in recent years manufacturing’s share in OECD economic activity has been decline. (The share of manufacturing in nominal OECD GDP fell from 28.6 percent in 1960-1973 to 20.4 percent in 1990-95. The figures for employment share are 27.0 percent and 19.5 percent respectively.) This deindustrialization seems to be a long term structural change. It is unlikely that New Zealand can resist the trend, any more than it was able to resist the long term trend of the agricultural’s falling share of economic activity. But that does not explain New Zealand greater deindustrialization.

3 The Faster Deindustrialization on New Zealand

Here are three closely related explanations for New Zealand’s faster deindustrialization.

3.1 The Weakness of Microeconomic Industrial Policy

As will become clear in the Section 4, the tradeable sector has a special role in the growth process of a small open economy, because it earns (or conserves) the foreign exchange needed to pay for imports. Current economic policy does not recognize this role. It professes to treat all sectors equally although, in practice, policy is pro-finance at the expense of production. Moreover this claimed neutrality towards the various production sectors ignores their fundamental differences. Phenomena such as industry externalities and the need for long term investment, and needs such as infrastructure are ignored in favour of an idealised impractical theory which most closely mirrors the situation of the finance sector, and as a result benefits that sector.

This ideologically driven vision has meant that the government has no industry policy. Instead it has stripped away industry support, without any clear understanding of its role or the positive benefits that the economy obtains from it. A good example has been the withdrawal of border protection at a rate faster than the industry could adjust, without there being any alternative employment. Coupled with the unfavourable macroeconomic environment from an overvalued exchange rate and high interest rates the manufacturing sector in particular, and the tradeable sector in general, has suffered.

To simplify, a manufacturing sector makes STMs (simply transformed manufactures) and ETMs (elaborately transformed manufactures). Strictly the critical difference is the processes involved and any manufacture may be a mix of STP(rocesse)s and ETP(rocesse)s. Typically the level of the last process usually defines whether the final good is an STM or an ETM. The distinction is mainly about the sophistication of the work skills and quality standards involved in the production process. Given access to the raw materials or the components, STPs can be manufactured offshore by low skilled workers. In effect a New Zealand STP involves competing against low paid Asian and other workers. Ultimately there is little future in New Zealand industry attempting an industrialisation strategy based on STPs. While some worker’s wages in STP industries may be subsidized one way or another by the state via border protection, fiscal subsidies, or some other intervention, the entire workforce cannot be so subsidized. In any case low wage work (or a high cost goods to consumer, which is often the consequence of the interventions) has the inevitable consequence of the workers migrating to a high wage economy such as Australia.

An indication of how unsatisfactory the New Zealand ETM performance is, appears in some New Zealand Manufacturers Federation estimates. They found that in the December 1995 year, only 16.8 percent of all exports of goods were ETMs, just over half of which went to Australia. However Australia exported over a $1b more ETMs to New Zealand, than New Zealand did to Australia. The structure of New Zealand exporting remains predominately primary products and commodities (albeit more diversified in type, destination, and added value than 30 years ago). Moreover unlike most other OECD economies, the share of ETMs in New Zealand’s exports has not grown since 1985. Commodity manufactures (STMs) expanded in the 1980s with the commissioning of the energy intensive plants, and so over the decade they grew faster than ETMs by about 4 percent p.a.

This partly reflects natural advantage, but it also leaves New Zealand as a commodity exporter vulnerable to the vagaries of international trade policy, and to international shocks, especially sudden deteriorations in the terms of trade. The ETM failure is a major reason why the New Zealand’s deindustrialization has been stronger than that of the OECD average.

3.2 The Macroeconomic Repression of the Tradeable Sector

In this subsection, we shall look at the tradeable sector of which the manufacturing sector is an important part, and only of goods for there is no suitable data on services. Figures 3 and 4 graph the volume of (i.e. constant price or real) exports and imports since 1976. They suggest that up to 1985 New Zealand exports grew faster than the OECD, and up to 1986 (or 1988) New Zealand imports grew slower. Allowing for the import substitution effect of the energy intensive industries which came on stream in the mid 1980s, the import turning point is probably 1985 too. After 1985 New Zealand exports grew slower and imports grew faster than the OECD average. ⁶ By no means coincidentally, New Zealand GDP grew slightly faster than the OECD in the pre 1985 period, and slower in the post 1985 period. ⁷

Not only was there an increasingly antagonistic industrial policy, there was also a hostile macro-economic environment. While the removal of export incentives and tariffs requires a fall in the real exchange rate to maintain export sector profitability, the real exchange rate rose sharply. This not only transferred the benefits of the higher terms of trade to the domestic sector, but was the central element of the disinflation of the economy, as the New Zealand inflation rate shifted from among the highest in the OECD, to one of the lowest.

The consequences on the tradeable sector was that its profitability was undermined, while importing became more attractive. Export volume growth slowed down and import volume growth accelerated. The high import volume growth in comparison to the OECD average is all the more astonishing given the lower GDP growth of the New Zealand economy. New Zealand’s import penetration was rising even faster. The slower growth of the tradeable sector inevitably translated into slower economic growth.

At the crucial time when macroeconomic policy was pressuring the tradeable sector its productivity growth performance deteriorated. Productivity growth in the exportable sector slowed down in the late 1980s. (Importable sector productivity growth is cyclical but an underlying secular slowdown from the early 1990s is also evident.) This was partly the failure of a supportive industrial policy, like that in the 1970s and early 1980s which had encouraged expansion, diversification, and productivity growth, compounding the poor macroeconomic environment. ⁸ Exporting is not an activity which can be conveniently turned on and off like a tap, or a financial transaction. It is not just that domestic production requires investment and process development. The action of exporting of sophisticated products requires market development in the locality including the building of a distribution network, and market identification and reputation. It is hard to quantify the deterioration, but anecdotally it is reported that much export development fell off from the mid 1980s, as exporters were profit squeezed and facing high borrowing rates.

This market development point applies less to commodity exporting, which typically involves a less sophisticated product, with a simple specification, usually going to a manufacturer as a product input. In any case, an overvalued exchange rate discourages domestic value adding, and so the primary product is more likely to be exported as a commodity, with a minimum of processing.Thus the New Zealand economy remained trapped into a colonial export mode, of producing the materials that the metropolitan country would convert into sophisticated products. Commodity exports remain more vulnerable to fluctuations in market conditions and prices.

3.3 The Increasing Dominance of the Finance and Business Services Sector

Table 1 and 2 showed that the finance, insurance, real estate, and business services sector increased its share of activity from the mid 1980s. The contribution to GDP share grew slower than the employment share underlying the poor labour productivity performance of the sector over the period. In 1996 the finance sector employment share was 14.0 percent compared to 15.2 percent for manufacturing. While the tradeable sector on which the nation’s economic prosperity has been in decline, the financial sector has expanded. Between the 1986 and the 1996 Census the numbers employed in the Finance, Insurance and Property sector increased 104,000, (or by 83.9 percent) over the decade, while those in the rest of the economy grew only 27,000 (2.0 per cent). (The top three tradeable sectors lost 76,000 jobs, or 15.6 percent). If current trends continue the finance and business services sector will soon be employing more than the manufacturing sector in the near future.

Now the finance and business services sector has a crucial role in a well functioning economy. As its name says, that function is mainly to service the rest of the economy. In 1981 each worker in the sector was servicing 13.5 other workers. By 1996 each sector worker was servicing 6.2 workers.

One factor has been outsourcing of finance and business services (which once took place within the productive firm (or farm) or in the public sector. ⁹ In addition some consumer financial activities have increased. But government policy has been supportive of financiers in contrast to its antagonism to the tradeable sector. ¹⁰

Not only has the finance sector filled deindustrialization’s value added and employment gap, but it also fills the foreign exchange gap. Because the tradeable sector is no longer earning and conserving sufficient foreign exchange, foreign exchange receipts are supplemented by borrowing, via the finance sector. Unlike earning the funds by tradeable production, the borrowing strategy of the financial sector is not sustainable.

4 The Ongoing Balance of Payments Crisis

Traditionally the management of the New Zealand economy has included the Balance of Payments rule that the annual current account deficit (a.k.a external deficit) should average about 3 percent of GDP, with a comfort zone of 1 to 5 percent. A rise (or expectation of rise) of the deficit above 5 percent triggered a macroeconomic policy response, usually aimed to reduce imports by a reduction in aggregate demand or by increased import controls. In that traditional economy, the government was the main borrower for the overseas funds to cover the deficit, so the comfort zone represented an assessment of what could be reasonably be borrowed in any year before lenders became uneasy. The underlying theory pointed out that if the net foreign current payments deficit percentage exceeded the nominal GDP growth rate, the Net Foreign Debt to GDP ratio would rise.

At the time of presentation of the paper the external deficit was about 7 percent of GDP, perhaps moving slowly back to just above 6 percent of GDP, according to the more optimistic forecasters. This is outside the traditional comfort zone, so we may expect foreign lenders to get increasingly anxious.

We can explore how the productive economy might respond given the task of halving a external deficit, by simulating a simple model of an economy which looks a bit like the New Zealand economy in 1998, with an external deficit of 8 percent of GDP. ¹¹ I identify four strategies, each of which aimed to get the deficit down to 3 percent of GDP. Here is a summary of the findings.

4.1 Reducing aggregate domestic demand

Suppose aggregate demand in the economy was reduced (with no extra exporting). Aggregate domestic demand had to decrease 9.5 percent and production 7 percent to get the required (8.5 percent) reduction in imports. The parameters and assumptions can be varied, but the basic conclusion remains. Obtaining the 3 percent target external deficit by reducing imports from cutting aggregate demand, requires very large cuts which would almost certainly generate record post-war unemployment.

4.2 Increasing exports

Suppose exports were to increase, generating some extra economic activity, which increases imports. Thus the export increase would have to be more than 3 percentage points of GDP. The model has exports increasing 11.3 percent, production by 4.5 percent, imports by 1.1 percent, and domestic expenditure by 1.4 percent to get down to the 3 percent of GDP external deficit target. This may not be very feasible (see below). At this point it should be noted, the strategy vitally depends upon a very tight fiscal stance, with additional tax revenue (and savings) not being spent.

4.3 Import replacement

Suppose import replacement increased but there was no change in exports. The extra production in the economy would draw in more imports, so spending would go up, as well as production. In summary the simple model predicts a 5.3 percent increase in production, a 2.1 percent increase in expenditure, and a reduction in the propensity to import of 12.9 percent. Again it requires a very tight fiscal stance.

4.4 Growth

Thus far it has been assumed that the changes are instantaneous. The fourth scenario, using a different model from the previous three, assumes that GDP grows at 3 percent p.a., the average propensity to import remains constant, and exports grow at 4.5 percent p.a., considerably higher than the current forecast of 3 percent p.a. In this projection it takes eight years before the economy reaches the 3 percent of GDP external deficit, although it enters the comfort zone of less than 5 percent of GDP after three years. Note again the fiscal stance has to remain tight.

The simulations illustrate some general propositions.

1. Simply cutting domestic spending – be it by government spending cuts, higher taxes, or increased savings – is too draconian. It would result in a major contraction and record unemployment. But all successful policies require a degree of self-discipline of domestic spending.

2. Slow adjustment requires considerable confidence by foreign investors over a longish period. Further shocks could delay the return to the comfort zone, and confidence may not necessarily hold. A slow adjustment is a high risk strategy.

3. The increases required in the tradeable sector are substantial. Are they feasible?

There are significant short-term supply-side constraints to many New Zealand tradeable producers. Farming, fishing, and forestry products face biological limitations. The production capacity of many manufacturers and service exporters is fixed or difficult to change quickly. Much of the import substitution component of manufacturing has already been gutted by lower protection, while the little which remains faces a similar threat.

Thus any short term export supply response relies on general manufacturing and tourism. Whether they have the production capacity to grow considerably faster is debatable. There may not be a lot of spare capacity for the sort of growth that is required. Moreover modern exporting requires considerable market development. Even ignoring that most major Asian export markets are in disarray, profitability has been so unfavourable in recent years that there has been insufficient market development.

In summary the prospects that the tradeable sector can quickly save the New Zealand economy from an eventual severe balance of payments crisis are not great.

Epilogue

While New Zealand continues with its current policies, it continues to face the prospect of low economic growth, based on commodity exports vulnerable to international trading conditions, with its best people migrating, and a socially and culturally impoverished nation. Few of New Zealander’s ancestors – brown, white, and yellow – came with such a mean vision.

There is a different approach: one which can be illustrated with industrial policy. It involves a vision of New Zealand as a full member of the international community, active in all its transactions – peace, human rights, cultural, sporting, intellectual and social as well as economic – with a firm commitment to New Zealand as an independent nation, as autonomous as international responsibilities permit, flourishing in the interests of all the diversity and energy that makes up the ordinary New Zealanders.

There is a national vision which desires a green and pleasant land. But without manufacturing, a deindustrialized New Zealand would be a severely depopulated ones, isolated from the vibrancy of international metropolitan life.

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Endnotes
1. A precipitant of this work was the statement that
“.. from the 1950s to the mid-1970s the manufacturing sector accounted for a growing share of employment in New Zealand – from 4 percent to just under 26 percent. With deregulation and lower trade barriers, this number fell rapidly to some 18 percent by 1992.” (R. Kerr, “The New Zealand Employment Contracts Act: Its Enactment, Performance and Implications,” Californian Western International Law Journal, Fall 1997. p.93
Manufacturing’s share of employment was 24 percent in 1951 and 1956.
2. See B.H. Easton, In Stormy Seas (University of Otago Press, 1997), Chapter 14.
3. B.H. Easton (1996) “Brendan Thompson’s New Zealand Work Force Series”, Labour Employment and Work in New Zealand: Proceedings of the Seventh Conference, ed. P. Morrison, p.277-285.
4. My views on “Think Big” will be found in In Stormy Seas. Suffice to say here that while Chapter 11 expresses numerous reservations, it points out most of the critics are stronger on rhetoric than analysis.
5. And back into the nineteenth century according to Brendan Thompson’s census based industrial employment tables. Easton (1996) op cit.
6. It is arguable that the two periods are even more distinct, because some of the new exports of the mid and late 1980s were the consequences of earlier decisions, such as the heavy subsidization of horticulture in the 1970s and early 1980s. A similar effect on the import substituting side has already been mentioned.
7. In Stormy Seas.
8. See B.H. Easton (1998), “Microeconomic Reform: The New Zealand Experience”, Microeconomic Reform and Productivity Growth: Workshop Proceedings, Productivity Commission and ANU.
8. For instance, given the way ACC is levied, some manufacturers have set up separate service companies. Information technology has been another potent cause of outsourcing.
9. In Stormy Seas.
10. In the standard notation
C+I+G = 106
X = 30
M = 36
Y(GDP) = 100
With the marginal propensities as follows
tax = .4
import = .5 out of disposable income
consume & invest = .5 out of disposable income.

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Why is Output Per Worker Growing So Slowly?

Listener:12 September, 1998.

Keywords: Growth & Innovation; Labour Studies;

A scientist puzzles most when a prediction fails. The generally poor performance of the New Zealand economy since 1985 (inflation excepted), was expected given the overvalued exchange rate as a part of the disinflation strategy. However the poor productivity performance was a surprise. By a careful selection of period or industry, or relying on anecdotes, it is possible to claim the growth of output per worker has been high. But a comprehensive review shows that productivity growth appears to have slowed down since the reforms, despite the pro-reformers promises that it would accelerate. Even those who might have expected the reforms to fail must be perplexed.

So it was with hesitation that I accepted an invitation to present the New Zealand evidence to an Australian Industries Commission conference in Canberra in February. The Australians have maintained a keen economic debate in which all views are represented, unlike here where it is de rigueur to exclude views that do not conform to official policy. Thus I knew my contribution would be in the middle of the Australian economics spectrum. Even so, I expected them to be doubtful of the evidence, despite my reworking and reworking it, trying to reconcile the promise and the facts. But most at the seminar seemed relaxed about our poor productivity performance. They were conversant with the overall poor performance of the New Zealand economy, for we have done much worse than the Australian economy since the mid 1980s. Perhaps I had been mislead by the Australian business journalists, who often are as off with the fairies about the effects of economics reforms, as their New Zealand compatriots. But Australian economists are considerably more sober, no doubt because of the robustness of their debate.

The conference seems to have arisen from growing doubts that microeconomic reforms do not appear to have generated the predicted productivity improvements. For instance, as in New Zealand, there appears to be no serious study which supports the notion that privatisation increases productivity. (There is evidence that corporatisation did.) Economic liberalisation of markets, commercialisation, and tariff reductions do not appear to have generated the promised gains. The contributor on the labour market, a woman of impeccably right wing credentials (she has worked for the Business Roundtable), was reduced to arguing that the Australian reforms had not produced productivity gains, and there would have to be further changes to obtain them. (Her argument is not supported by the New Zealand evidence. The Employment Contracts Act is associated with a slowdown in longrun labour market productivity growth.)

Perhaps because it was outside the conference remit (or perhaps Australians do not take the promises of significant gains seriously), there was no consideration of the productivity effects of reforms to the government sector – say in health and education. The New Zealand experience does not provide evidence of the gains either.

The Australian evidence is not as dead as ours. An interesting paper by Steve Dowrick of ANU suggested that Australian productivity growth accelerated in recent years. But having seen a similar boomlet for a couple of years in New Zealand in the early 1990s, it may be they are just seeing the effects of a cyclical upswing.

The right wing economists only quibbled with the evidence in my paper. The main theme of one commentator, who has worked as a consultant in New Zealand, was that there would be benefits from the New Zealand micro-economic reforms at some time in the future. This has been a consistent theme of the pro-reformers for the last fifteen years: their promised outcomes have not occurred, but they will eventually. I reminded the audience of historian G.M. Trevelyn’s 1945 assessment of the events of 1789: “It is still too early to form a final judgement on the French Revolution.”