Brian Fallow: Lucky country moving further out of reach

How can we expect an Australian standard of living when their productivity is about 40 per cent higher than ours?

And if we can't, must we settle for a future where New Zealand is just a great place to be from?

These are the questions the 2025 taskforce chaired by Don Brash has to wrestle with.

Its first report is due at the end of next month. In the meantime, submissions and background papers it has been considering, now available on a website (www.2025taskforce.govt.nz), make sobering reading.

To close by 2025 the income gap, measured in GDP per capita, which had opened up by 2008, New Zealand would need to grow 1.8 percentage points a year faster than Australia, Treasury economist Michael Reddell points out.

The lucky country has escaped recession during the global crisis. If you take the two countries' Treasury forecasts for 2013 as reliable, by then the gap will have widened to the point that it would require New Zealand to grow 3.2 percentage points a year faster than Australia to catch up by 2025.

If history is any guide we haven't got a dog's show.

Over the past 40 years Australia has remained securely above the OECD average in terms of per capita GDP. Currently it is about 15 per cent above.

That is where New Zealand was 40 years ago before two big downward lurches in the second half of the 1970s and then in the era of radical economic reform between 1985 and 1992. Since then we have remained pretty much stuck around 15 per cent below OECD average levels.

"This shows that not only did those reforms mean we missed a cycle of economic growth, but we have not had any real dividend from that reform period," says the Council of Trade Unions. "It would be foolish to head down that path again."

Lifting real wages requires investment in skills and education, it says. It also requires more capital per worker. A lot more.

By 2002 the amount of physical capital New Zealand firms had per worker was about half the US level, compared with 80 per cent in Australia.

The CTU attributes this "capital shallowness" to the Employment Contracts Act, depressing real wages and making it easier for firms to grow by piling on more labour than by undertaking productivity-boosting capital expenditure. It was strategy of all hands to the pump, instead of investing in a better pump, as Australia, with its more regulated labour market, did.

Some capital deepening occurred during the most recent boom, but with the economy having shrunk nearly 3 per cent since then businesses have plenty of spare capacity and investment intentions are weak.

Looking beyond such cyclical factors at the structural challenge, there is wide agreement that lifting the capital-to-labour ratio is crucial.

However, in that respect we are up against a combination of unfortunate facts.

One is that the cost of capital is high in New Zealand and capital markets are thin.

But evidently interest rates are not high enough to encourage households to save. They continue, in aggregate, to spend more than they earn. And now the Government is running deficits as well.

All of which means New Zealand will continue to rely on imported capital, when our starting point is a level of external debt - 95 per cent of GDP - which is conspicuously high by international standards.

Meanwhile, the tax system all but compels domestic investors to put their hard-earned dollars into bricks and mortar rather than enterprises which might help the country earn a living as a trading nation.

The monetary policy response to an overheated housing market inflicts collateral damage on the tradeables sector. It stagnated during the most recent "boom" and is now about 10 per cent smaller than it was five years ago.

It remains to be seen (next year) if the Government can summon up the political valour to do something about those tax distortions.

If capital is a problem, so too is labour.

On the one hand there is the long "tail" of educational underachievement among school-leavers.

"Employers have long been concerned about the levels of literacy and numeracy found in the workforce," Business New Zealand told the taskforce. Maladroit or not, the Government's national standards initiative is at least an attempt to address those concerns.

At the same time we have high levels of outward migration. According to the OECD, almost a quarter of all skilled New Zealanders live abroad and a sixth of the total New Zealand-born population do so. The Australian diaspora, by contrast, is relatively small.

Executive search firm Seqel Partners in its submission points to a looming shortage of business leaders over the next 15 years as babyboomers retire and so many of their potential successors from Generation X are expatriates who, survey evidence suggests, are not particularly interested in coming home.

"A very substantial leadership deficit of up to 40,000 people will hollow out the leadership capability of New Zealanders business," they conclude.

Even now, the Institute of Management talks of New Zealand management as having "plateaued at a level of mediocrity".

To deficits in physical capital and human capital must be added a third, intellectual capital.

Andrew West, chairman of Innovation Waikato, points out that research and development spending is little more than 1 per cent, less than half the rate in the United States, Singapore or Denmark, all of which - and not coincidentally - have much higher GDPs per capita than we do.

Dr West also notes that pro rata only half as many New Zealanders as Australians embark on advanced degrees.

In the light of such fundamental challenges, Business New Zealand's recommendations are a pretty unprepossessing wish list.

It includes the repeal of Working for Families, "simplifying" labour law as it relates to dismissal and collective bargaining, allowing the private sector into accident compensation, and including property rights in the Bill of Rights Act.

Let's hope Dr Brash's committee can come up with something better than that.