Saving is such a truly Nobel virtue

Nobel laureate Ed Prescott admits isolation affects New Zealand's economic performance.

"Isn't New Zealand getting a little bit worried about its productivity?" asks Nobel Prize-winning economist Ed Prescott down the phone from Geneva. "It should be. It stands out."

New Zealanders work as hard as Americans, clocking up in fact slightly more hours per week on average, but output per head, and therefore incomes, are about 40 per cent lower.

"It sounds like New Zealand has a savings problem, because your labour supply is quite high," he said.

"Get that savings rate up and I suspect it would help productivity, especially if some of the investment goes into the intangible, higher-tech things."

The professor is famous for, among other things, the view that the reason Americans work much longer hours than Europeans is not cultural differences but tax.

And New Zealand's data fits that theory, he says.

"I computed your average effective marginal tax rate and it's 40 per cent - the same as the US, Japan, Australia and Chile. And you work the same amount as those countries. In Europe, it's 60 per cent."

Output per hour in France is comparable to the US level but they put in a lot fewer hours. New Zealand has the opposite problem: Slogging away but to much less effect. It is the US that has got both bits of the equation right - hours and productivity.

Prescott is not dismissive of some of the factors cited to explain New Zealand's underperformance, like being small and remote.

"Isolation is a factor. The US grew rich because of the competition among member states beginning about 1865 after the Civil War. Transportation costs just plummeted. They fell by a factor of four between 1865 and 1890. And the development of the interstate highway system from the 1950s also dramatically reduced transport costs in the US. Now income levels are pretty uniform across regions."

On the other hand, Finland has only about the same number of people as New Zealand but it also has Nokia.

US productivity growth rates pulled ahead of Europe from the mid-1990s because it was better positioned for the high-tech boom.

"The US has the research universities, the centres to take advantage of this. I don't think New Zealand was in that position," he said. "Maybe if you get more integrated with Asian economies. Taiwan has 30,000 firms on the mainland and now they are making inroads into India. I don't see any of this happening with regard to New Zealand."

Research by Treasury economists attributes much of the gap in productivity between Australia and New Zealand to this nation being comparatively "capital shallow", that is, giving workers less physical capital such as plant and machinery to work with.

Between 1990 to 2002, the amount of capital per hour worked grew modestly in New Zealand. In Australia, it increased by about 25 per cent.

In 1978, New Zealand and Australia had about the same capital per hour worked. By 2002, capital intensity in Australia was 50 per cent greater than in New Zealand. To Prescott, the lower capital per worker suggests a system that discourages saving.

"You should move towards those deferred compensation schemes, where you can defer your receipt of income and payment of taxes until you retire and consume. In the US, they have pretty much done this completely."

The US has a exempt-exempt-taxed (EET) system, where New Zealand's is taxed-taxed-exempt(TTE). Americans saving for retirement do not pay tax on the part of their income that they invest or on the earnings of those funds as they accumulate, but only on the way out.

By contrast, New Zealanders' savings are made out of after-tax income, the earnings they generate are taxed in the hands of the fund managers, and they only escape tax on the way out.

Finance Minister Michael Cullen has described the introduction of that system by Sir Roger Douglas in the late 1980s as a massive exercise in intergenerational theft. But there are no plans to change it.

Contrast that with the US Government's right eventually to tax Americans' accumulating retirement savings. Prescott says that claim is a huge asset equivalent to about half of US gross domestic product.

* Edward Prescott, winner (with Finn Kydland) of the 2004 Nobel Prize in economics, is visiting as a guest of Auckland University and the Business Roundtable.

He will give a talk in Auckland tonight on the factors that optimise economic growth and New Zealand's economic future as well as a lecture to the Treasury on Thursday. Prescott teaches at Arizona State University and is an adviser to the Minneapolis Fed.