NZ’s productivity stagnation requires a long-term plan from politicians. Here’s how

In the ups and downs of the global economy over the last decade, New Zealand has had one relatively consistent challenge: persistent productivity stagnation.

Productivity compares the amount of goods and services produced (output) with the amount of inputs used to produce them.

Since the Productivity Commission was set up in 2011, annual productivity growth has averaged at just 0.2% – one of the worst in the OECD.

In 2023, New Zealand experienced declines across key metrics: labour productivity dropped by 0.9%, multifactor productivity (which includes labour, capital, energy, materials and purchased services) fell by 2.2% and capital productivity by 3.8%.

There has also been a sharp decline in small business productivity, with a 19% drop from its peak in November 2022.

Productivity is not only an abstract concern. It directly impacts income growth, exacerbates inequality and hampers overall welfare.

The productivity puzzle

But New Zealand’s stagnation doesn’t have to be inevitable. There are tangible approaches the government can take to boost the country’s productivity. Here’s how.

Human capital

There are at least two ways New Zealand can improve human capital – the sum total of the skills and education a worker has to do their job.

In the short-term, the government needs to allow more high-skilled migrants to enter the country. This type of migration can reduce skill mismatch and create knowledge spillovers. That is, migrants bring valuable knowledge, expertise and innovative ideas from their home countries, which can spread to local firms, industries, or individuals via collaboration and competition.

Over the long-term, investing in education and cultivating STEM and digital skills will be crucial for combating the country’s productivity stagnation and future-proofing the workforce.

Technology

Technological advancement is a key driver of progress, yet its integration requires careful planning.

Artificial intelligence (AI), in particular, holds immense potential to boost productivity. One study found generative AI, for example, could boost a worker’s performance by almost 40%.

But the widespread use of AI demands not only technological infrastructure but also a skilled workforce and the ability of organisations to adapt.

Regulation

Regulation, reducing adjustment costs and barriers, taxation, and industrial policy are interrelated elements of the productivity puzzle.

But regulation, in particular, must be balanced carefully. The government needs to ensure worker and environmental safety while also encouraging innovation.

The government also needs to encourage the development of new businesses – a key factor to boost productivity. To do this, policy makers need to reduce entry and exit costs of doing business.

Industrial policies

Industrial policies, such as subsidies or tax incentives, if appropriately targeted, can also increase productivity by supporting innovative firms rather than stifling competition. An example is to provide research and development tax credits to encourage innovation in high-tech industries.

Industrial policies can also reduce productivity growth, particularly when they slow down the shift of elements such as labour and capital from less productive or declining sectors to more productive or growing sectors.

To be effective in addressing productivity, industrial policies need to be targeted at the most competitive sectors. They also need to apply to a broad number of firms with the purpose of benefiting the most competitive in each sector.

Tax policy

Tax policy is another important driver which needs to be carefully designed.

For example, if the tax policy subsidises the use of equipment while taxing the employment of labour, policy makers will have increased the incentives for automation and reduced incentives to create new ideas.

This would put a damper on increasing productivity. Instead, policy makers could look at an automation tax, applicable to technologies which automate tasks above a certain level.

Research and development

Despite a 17% increase in spending on research and development (R&D) in New Zealand last year, one study found it is not that effective for increasing productivity. Rather than supporting widespread innovation, poorly targeted R&D funding can prop up otherwise unsustainable businesses.

Instead, the government needs to tax all firms uniformly, encouraging less innovative firms to exit. This would free up resources for more innovative firms to intensify their R&D efforts. Implementing targeted taxes could further support this selective process.

Creating clusters

Productivity growth is also influenced by where people work and the density of networks. Research has found tech clusters like Silicon Valley in the United States can play an important role in innovation, business competitiveness, and economic performance.

This is not a new idea. As far back as 1991, manufacturing clusters were touted as the key to improving New Zealand’s export competitiveness. But in 2018, a report found the cluster theory had failed to take hold – in large part due to infrastructure issues and the spread of businesses across the country.

Thinking long-term on productivity

Despite recognising the importance of these factors, New Zealand has faced persistent challenges in implementing comprehensive reforms.

In part, this is due to institutional inertia, lack of expertise among government officials in integrating research into policy formulation, fragmented policy approaches across different sectors, insufficient funding and a historical reliance on traditional industries.

If we really want to address our lagging productivity levels, an integrated approach is needed.

Improving labour market flexibility, infrastructure, and housing regulations enhances mobility and efficiency, unlocking potential across industries.

Furthermore, trade liberalisation policies aimed at increasing foreign direct investment and cross-border mergers and acquisitions can increase productivity.

By embracing innovation, up-skilling our workforce and implementing targeted policy interventions, New Zealand can chart a path towards a more productive and prosperous future for all.