Governor bullish on growth

The Reserve Bank has raised its estimate of the rate of economic growth the country can sustain without inflation getting out of hand.

The bank estimated that the potential rate was now around 3.7 per cent.

"This might seem surprisingly high. However, our estimates show that growth in potential GDP has generally been higher over the past decade, with the lowest annual growth rate being 2.5 per cent in late 1998," said Reserve Bank Governor Alan Bollard in a speech to Canterbury employers yesterday.

However he warned for the economy to keep growing over the next 10 years as fast as it had over the past 10, labour productivity would have to improve to compensate for an ageing workforce.

Estimating what is known as the potential growth rate is a key judgment the bank has to make, because when actual growth outstrips that rate for an extended period, inflation pressures rise.

This requires corrective action from the bank through higher interest rates. The bank's view of the potential growth rate is therefore often seen as an effective speed limit on the economy.

Economic growth has averaged 3.4 per cent over the past 10 years, one of the highest among developed countries and up from 1.5 per cent in the decade before that.

"Partly as a result of this performance ... the Reserve Bank has raised its estimate of New Zealand's potential growth rate," Bollard said.

"However, despite this higher potential we have been growing at unsustainably high levels over the last year or two. We can't keep growing near 5 per cent without putting excessive pressure on resources."

Three things drive growth - labour, productive capital and productivity (how smart we are at using labour and capital).

The largest contribution has come from increases in the input of labour, but that is likely to decline as the population ages, limiting the working population.

Bollard said since 1996 the contribution from capital had been increasing faster than that from labour but the amount of capital employed per worker was still significantly lower than in Australia, even allowing for the importance of its capital-intensive mining industry.

"We expect the capital-labour ratio to rise in the longer term as we use more capital to do our jobs."

On the productivity front we might see larger gains yet from information and communications technology, Bollard said. Such technology had been credited with a major role in the United States' "productivity miracle"..

"The other main factor influencing [productivity] is the ability to reorganise and redirect resources to more productive and innovative uses. In all industries there are probably still efficiency gains that could be made, if only we could find them."

Labour productivity would have to improve from the 1.2 per cent annual growth it had recorded over the past 10 years to 2 per cent over the next 10 years, if economic growth was to stay around 3.3 per cent.

That would take "strong investment, clever innovation, good decision-making and skilled labour".