Brian Fallow: Cullen on a bumpy road to faster growth

We hear a lot from the Government these days - and on a Budget day most of all - about transforming the economy, increasing productivity and fostering innovation.

If pressed, Finance Minister Michael Cullen will even quantify the goal: a sustainable, long-term economic growth rate of 4 per cent a year. That compares with about 3 per cent now (and only with the tail wind of strong net immigration).

So how do we achieve such an increase?

The Economics 101 answer is to mobilise more labour and more capital and to use those inputs ever more efficiently.

Easier said than done.

On the labour front the challenge could be put like this: how do we harness at least some of the missing third of the labour force?

The labour force is about two million strong, but the best part of a further million people have either left for greener pastures overseas or are languishing on welfare.

So one yardstick by which to judge Government policy is what it is doing to lean against the powerful forces of globalisation which have created the Kiwi diaspora.

In this regard, the Government is running a risk with its tax policy.

It has increased the marginal tax rate for the 250,000 people earning more than $60,000 a year from 33c to 39c.

That group makes up only 8 per cent of taxpayers but contributes 43 per cent of the personal income tax take and around 20 per cent of the total tax take.

The risk arises from the fact that people in this income bracket, and perhaps more importantly people who can realistically aspire to be in it, are most likely to have the skills in demand in other countries.

In the end it is a political judgment whether 39c in the dollar is charging more than the market will bear.

But if the Government has got this part of its policy wrong, it will stultify much of the rest of it.

It makes little sense to bolster the long-term fiscal affordability of the pension by stashing away a couple of billion dollars a year if at the same time you are undermining a large part of the tax base.

Likewise, it makes little sense to pour money into tertiary education if the effect is only to produce better educated expatriates.

Then there is the question of what the Government's policy is doing to make it (a) possible and (b) worthwhile for people to move from welfare into the workforce.

At issue are the adequacy or usefulness of a range of spending programmes including adult literacy and skills training, programmes to help people with disabilities find jobs, and regional development initiatives.

The OECD considers the unemployment benefit generous by international standards.

But it is not obvious that the way to deal with poverty trap issues is to deepen poverty through benefit cuts, especially when a big proportion of children are in homes reliant on a benefit.

If there are no easy answers on the labour front, what about capital?

New Zealand tends to rely on imported capital. At the end of last year, foreign investors' claims on the economy exceeded New Zealand's claims on the rest of the world by $89 billion, or around 80 per cent of gross domestic product (GDP).

Providing a return on that investment creates a gap between GDP and that part of it which is available to local residents to consume or invest - what used to be called gross national product and is now called gross national disposable income (GNDI).

Over the past six years, GNDI has averaged about 94 per cent of GDP, compared with 98 per cent in the late 1970s and early 1980s.

Apart from the Government, no one these days seems to be in the business of aggregating New Zealanders' capital for large-scale equity investments, even when substantial assets are up for grabs such as the central North Island forests or Auckland City's airport stake.

The wood-processing strategy, vaunted as an example of industry-Government partnership, seems to be about how to attract foreign investment into new processing plant to add value to the wall of wood.

After initially expressing interest in the idea, the Government has backed away from the McLeod tax review recommendation that a special 18 per cent tax rate be offered for new inward foreign direct investment on the grounds that no self-respecting multinational with good tax advice would pay much more than that anyway, so New Zealand might as well stand out from the crowd by making it explicit.

In one key area where market failure is apparent - venture capital - the Government has acted.

By taking $100 million from the lazy balance sheets of the Crown Research Institutes, and lifting it 2:1 with private sector money, it has $300 million in contestable venture capital funding on offer.

There is prima facie evidence that New Zealand companies do not use capital very efficiently by international standards.

Research by the Institute for the Study of Competition and Regulation found that it takes more capital to generate $1 of revenue for New Zealand firms than for their overseas counterparts.

"New Zealand industries and firms have relatively high average costs that are in accord with poor productivity and/or absence of economies of scale."

Insofar as the problem is a small population and low population density, it is not obvious what the Government can do, short of a radical change in immigration policy.

But it can at least not contribute to a higher cost of capital by slippage in the indicators of fiscal rectitude, such as debt-to-GDP ratios, which might see the risk premium in New Zealand interest rates rise.

What then of productivity?

It is a slippery thing to measure, but a rough proxy would be to look at what has been happening to growth in per capita real GNDI - that is, growth in GDP adjusted for population growth and a return on foreign capital.

Over the past 10 years, it has averaged a little under 1.5 per cent a year. That is scant improvement in the long-run per capita growth rate of 1.4 per cent through the whole of last century.

But over the past five years the pace of per capita growth has picked up to nearly 1.9 per cent a year. That is more in line with the rate the US has managed over the past century.

Whichever is the more reliable guide to the future, the past 10 years or the past five, faster per capita growth than either will be needed to get anywhere near a 4 per cent sustainable GDP growth target.

Full Herald coverage:
nzherald.co.nz/budget

Budget links - including Treasury documents:
nzherald.co.nz/budgetlinks