Throughout the ups and downs of the global economy over the past decade, New Zealand has faced a relatively constant challenge: persistent stagnation in productivity.
Productivity compares the quantity of goods and services produced (output) with the quantity of inputs used to produce them.
Since the Productivity Commission was established in 2011, average annual productivity growth has been only 0.2% – one of the worst in the OECD.
In 2023, New Zealand experienced declines in key metrics: labour productivity fell by 0.9%, multifactor productivity (which includes labour, capital, energy, materials and purchased services) fell by 2.2%, and capital productivity fell by 3.8%.
Small business productivity has also fallen sharply, falling 19% since its peak in November 2022.
Productivity is not an abstract problem. It directly affects income growth, exacerbates inequality and undermines overall prosperity.
The productivity puzzle
But New Zealand’s stagnation is not inevitable. There are concrete steps the government can take to increase the country’s productivity. Here’s how.
Human capital
There are at least two ways New Zealand can improve its human capital – the set of skills and training a worker needs to do his or her job.
In the short term, the government needs to allow more highly skilled migrants to enter the country. This type of migration can reduce the skills gap and create knowledge spillovers – that is, migrants bring valuable knowledge, expertise and innovative ideas from their home countries that can be transferred to local companies, industries or individuals through cooperation and competition.
In the long term, investing in education and promoting STEM and digital skills will be crucial to counteract the country’s stagnating productivity and future-proof the workforce.
technology
Technological advances are a key driver of progress, but their integration requires careful planning.
Artificial intelligence (AI), in particular, has enormous potential to increase productivity. For example, one study found that generative AI can increase a worker’s performance by almost 40%.
But the large-scale deployment of AI requires not only a technological infrastructure, but also a skilled workforce and the ability of organizations to adapt.
regulation
Regulation, reducing adjustment costs and barriers, taxation and industrial policy are interconnected elements of the productivity puzzle.
But regulation in particular must be carefully balanced. The state must ensure the safety of workers and the environment while encouraging innovation.
The government must also encourage the development of new businesses, a key factor in increasing productivity. To do this, policymakers must reduce the costs of entering and exiting business.
Industrial policy
Industrial policy measures such as subsidies or tax breaks can, if used in a targeted manner, also increase productivity by supporting innovative companies rather than suppressing competition. One example is tax breaks for research and development to encourage innovation in high-tech industries.
Industrial policies can also slow productivity growth, particularly if they slow the movement of elements such as labour and capital from less productive or declining sectors to more productive or growing sectors.
To be effective in increasing productivity, industrial policies must target the most competitive sectors and reach a broad range of firms in order to benefit the most competitive sectors in each sector.
Tax policy
Another important factor is tax policy, which must be carefully designed.
For example, when tax policy subsidizes the use of equipment while taxing the employment of labor, policymakers increase incentives for automation and reduce incentives for creating new ideas.
This would dampen productivity gains. Instead, policymakers could consider an automation tax levied on technologies that automate tasks above a certain level.
Research and Development
Although research and development (R&D) spending in New Zealand rose by 17 percent last year, a study finds that these funds are not particularly effective at increasing productivity. Rather than encouraging widespread innovation, poorly targeted R&D funds can prop up otherwise unsustainable businesses.
Instead, the government must tax all companies uniformly, thereby encouraging less innovative firms to exit. This would free up resources for more innovative companies to intensify their research and development efforts. The introduction of targeted taxes could further support this selection process.
Creating clusters
Productivity growth is also influenced by where people work and how dense the networks are. Research has shown that technology clusters such as Silicon Valley in the US can play an important role in innovation, competitiveness and economic performance.
This idea is not new. Manufacturing clusters were touted as the key to improving New Zealand’s export competitiveness as early as 1991. But a 2018 report found that cluster theory had failed to gain traction – largely due to infrastructure problems and the spread of companies across the country.
Long-term productivity planning
Although New Zealand recognizes the importance of these factors, it continues to face challenges in implementing comprehensive reforms.
This is partly due to institutional inertia, a lack of government expertise in incorporating research findings into policy-making, fragmented policy approaches across sectors, inadequate funding and a historical dependence on traditional industries.
If we really want to improve our declining productivity, an integrated approach is needed.
Improving labor market flexibility, infrastructure and housing regulations increases mobility and efficiency and unlocks potential in all sectors.
In addition, trade liberalisation policies aimed at increasing foreign direct investment and cross-border mergers and acquisitions can lead to increased productivity.
By fostering innovation, improving the skills of its workforce and implementing targeted policies, New Zealand can pave the way to a more productive and successful future for all.
