Part 4 | The underlying determinants of productivity

Innovation through research and development helps boost productivity, and as a country we still under-invest in R&D, both at a business and a government level, compared to other countries.

Catherine Beard | BusinessNZ

Part 3 of this report examined several aspects of Aotearoa New Zealand’s recent and long-term productivity performance. In Part 1 and Part 2, we noted that this productivity performance is not simply ordained by a higher power; rather, it depends crucially on investments we have made maintaining, improving, and adding to our productive capacity. To understand how we might improve New Zealand’s productivity and wellbeing, we need to understand more about the factors that underpin it. These are areas where government can help – or harm – the economy.

We will now look at some of the underlying determinants of productivity (see Figure 2.6), to shed some light on the elements that are not explicitly measured or do not appear as components in the national accounts.

• Innovation
• Investment, capital and financial markets
• International linkages
• Business dynamics and capability
• Skills and education
• Infrastructure
• Institutions

These underlying determinants broadly align with what The Treasury’s (2021) LSF²⁹ refers to as “The Wealth of Aotearoa New Zealand” and “Our Institutions and Governance” (p. 3). In this publication, we focus in more detail on the aspects that most impact wellbeing through their relationship with productivity.                                           

This examination will not be exhaustive, but it gives an indication of things that matter and areas where we might improve.

Innovation is fundamental to improving living standards generally and to productivity growth. It is the dynamic and uncertain process through which economic actors create new economic value by creating, adopting, and adapting knowledge into new or improved products and services, operational processes, organisational and managerial processes, and approaches to marketing.

Entrepreneurship is the activity of seeing these opportunities and undertaking the work necessary to take advantage of them.

There are four key elements underpinning the creation and use of knowledge:

• Creation – The creation of new or altered, economically/socially useful
• Dispersion – How this new knowledge
• Absorption – How individuals and organisations take in and understand innovations and the opportunities they create.
• Adoption – How individuals or organisations implement innovations, to action them and to generate benefits of their own from the new knowledge.

For our economy and society to prosper, all these aspects need to be functioning well. Our ability to do them depends upon the investments we make in our capabilities and how we use them.

For example, innovation requires individuals with certain skills. Not all innovation requires the same set of skills. Many innovations emerge from research and development by individuals or groups with a very specific set of skills. Knowledge in an area is often seen as the necessary foundation of innovation – we must understand a product or process, or the need for it, before we can improve it. However, the lack of what is seen as skills or knowledge allows people to think of entirely new solutions to problems. Other innovations appear out of the application of entrepreneurial skills to technical knowledge, or the bringing together of two types of seemingly unconnected knowledge.³⁰

A well-functioning economy creates new solutions to existing problems, as well as to things we never dreamed about. Many of these solutions will be unique to Aotearoa New Zealand and its economic, social, cultural, and environmental context. It is important to note, however, that most new ideas originate elsewhere in the world. The transfer of this knowledge to New Zealand and shaping it to fit our context is vital to building a healthy economy.

There are a range of explanations to account for why we observe slower uptake of new technologies in some countries, compared to others (Kneller & Stevens, 2006). These centre around:

• the barriers to new technologies that result from a country’s institutional arrangements (Parente & Prescott, 1994; Prescott, 1998);
• the usefulness of technologies – new technologies are typically developed in richer countries, and differences in economic conditions and factor prices can make these technologies inappropriate for less developed countries (Acemoglu & Zilibotti, 2001);
• economic geographical factors – for example, a country’s distance from where new technologies are being developed or used (Keller, 2002, 2004); and
• the potential of a country to absorb into its economy capital and new technology from elsewhere (Eaton & Kortum, 1999; Griffith et , 2004; Xu, 2000).

Aotearoa New Zealand’s ability to absorb, adapt and adopt new ideas and technology relies on complementary investments we make to improve our capability. Research and development and skills are vital in this regard (see Box 7).

Investing in innovation

Research and development, especially that financed by businesses, plays an important role in generating new knowledge, facilitating technology transfer, and the absorption of knowledge from other firms and countries.

Aotearoa New Zealand invests a lower proportion of its GDP in R&D than most OECD countries (Figure 4.1). Countries such as Finland and Denmark reinvest twice as much of their economic output in R&D in total than New Zealand does. This is particularly true when we look at New Zealand’s level of business expenditure on R&D (BERD). The figure has been increasing slightly, but remains well below that of our peers (NZPC, 2023b, p. 24).

Low levels of R&D in Aotearoa New Zealand can be explained in part – but not totally – by our distance from world centres, our small firm size, and an industrial structure weighted towards primary production (Crawford et al., 2007; OECD, 2017b).

Research and development is an input to innovation. We can also consider the outcomes of innovation. Figure 4.2 shows the proportion of firms in each manufacturing industry that have introduced a new or significantly altered product (good or service) in 2020 and 2021. Aotearoa New Zealand’s performance varies across industries. It sits in the middle of the pack in many industries (such as the manufacturing of food, beverages and tobacco products), but towards the bottom in others (such as the manufacturing of transport equipment, electrical equipment and basic metals).

Aotearoa New Zealand’s poor-to-middling performance across multiple industries can be partly attributed to a lack of large businesses, or else their nature, the industries they operate in, or their market power. In most countries, large businesses are between two to three times more likely than small and medium enterprises to introduce products that are new to market (OECD, 2017c, p. 154). In New Zealand, large businesses and SMEs are both low performers in terms of all types of innovation: product, process, marketing, and organisational innovations (ibid).

As we saw in (Figure 3.7) in Part 3, Aotearoa New Zealand is “capital shallow”. There has been little sign of convergence over the past half-century, except for an increase in the 1980s and perhaps a slight catch-up in recent years. A convergence would need a major shift in investment in New Zealand, relative to its peers. As noted in Part 2, one advantage of a low level of capital is that we have to put less aside from income to maintain it (Grimes & Wu, 2022), but this only makes sense if the costs exceed the benefits.

Gross fixed capital formation (GFCF) is the annual investment in products and structures that are expected to be used in production for several years. Aotearoa New Zealand’s GFCF, as a percentage of GDP, averaged 23.5% over the last decade (Figure 4.3). This is almost identical to the figure for the previous decade. In contrast, the GFCF as a percentage of GDP for several of New Zealand’s peers (for example, northern European countries) has increased; for others, such as Italy and the US, it has fallen. Although New Zealand’s recent investment in GFCF looks similar to that of its peers as a proportion of GDP, there are several reasons for concern. As evidenced by Figure 3.7, even an average level of investment over two decades has not been enough to narrow the gap in capital intensity with our high-income comparator countries. This may be a reflection of the distinction between investment per worker (or per capita) and investment as a proportion of GDP – with low GDP per capita and high employment rate and hours worked (Figure 3.5 and Figure 3.6), New Zealand needs to invest a higher proportion of output than our peers to maintain a constant capital–labour ratio. Aggregate figures may also hide some important differences between different types of assets. This is examined further below.

Machinery and equipment investment adds to the productive physical capital stock. It often embodies new technology and contributes to productivity (Boucekkine et al., 20 1; Johansen, 1959). Aotearoa New Zealand’s investment per employee in machinery and equipment is lower than that of most OECD countries. However, it remains above some common comparators such as Australia and Canada, which (along with others, including Denmark, Norway and Italy) have seen lower levels of investment in machinery and equipment in the decade to 2021 compared with the 2000s (Figure 4.4).

Investment in dwellings is another component of overall GFCF. This has been rising in Aotearoa New Zealand relative to our peers in nominal terms, but not in real terms, because prices have risen precipitously but supply has not. Despite an increase in residential construction in New Zealand over the last decade, the number of dwellings per inhabitant remains below the average for the OECD (Fitchett & Jacob, 2022). This increased investment is reflected in rising property prices. Although several other economies have experienced increasing house prices in recent years, the rate of increase is highest in New Zealand (Fitchett & Jacob, 2022). Work by the Infrastructure Commission (New Zealand Infrastructure Commission, 2022a) suggests that housing supply has become less responsive to demand in recent decades, relative to the period between the late 1930s and 1970s.

Finance

Firms need access to finance to invest. They can do this through retained earnings or profits, or from external sources such as banks, private equity, the share market, venture capital, and informal capital markets. These different finance sources can play different roles during the growth cycle of firms (Berger & Udell, 1998).

Well-functioning stock markets are important for economic growth in general, and for productivity (Levine, 2005; Levine & Zervos, 1998). Aotearoa New Zealand’s domestic share market capitalisation, measured by market capitalisation as a percentage of GDP, is smaller than that found in comparator countries (Figure 4.5). New Zealand’s share market did not experience as much growth as that achieved by comparator countries prior to the GFC. The market capitalisation of listed domestic companies in New Zealand has begun to rise in recent years, but is still much lower than in countries such as Australia, the UK and the US. This may reflect a lack of financial capital overall, the attractiveness of alternative investments (such as housing), or may reflect that New Zealand firms prefer to list abroad, because of the costs involved, or to be closer to their foreign markets.

Venture capital is a relatively small proportion of the economy in most OECD countries, but it plays an important role in the innovation and entrepreneurial ecosystem (Fenn et al., 1997; Hellmann & Puri, 2000). The size of Aotearoa New Zealand’s venture capital market industry relative to GDP is much smaller than in most other OECD countries (Figure 4.6). The US, Canada, South Korea, Finland and Denmark have seen investment in venture capital surge in recent years, but New Zealand has not experienced an increase in venture capital.

In the absence of deep share markets and venture capital markets, firms must turn to banks and informal sources of capital. However, the cost of bank borrowing in Aotearoa New Zealand is high. Our interest rates are high when compared to similar countries (Figure 4.7). Until the late 1990s, Sweden had much higher interest rates. Joining the Euro currency appears to have required much lower interest rates in many European countries. Since that time, few advanced economies have had higher interest rates, except for Australia post GFC. With its economy less affected than others by the financial collapse (because of its reliance on primary industry, which was fuelling China’s massive growth), this was a period in which Australia had to keep interest rates high to prevent its economy overheating.

Prior to the GFC, Aotearoa New Zealand’s interest rates were significantly above those in other advanced economies and have remained at or near the top. This high cost of borrowing increases the cost of investment, as it requires higher future returns to make investments viable.

Environmental capital

The environment is part of the bedrock wealth of society, particularly for those economies that rely on agriculture and tourism. As noted in section 2.3 above, measurement of the state of an economy’s environment is difficult, but developments have been made in this area. Although not usually considered to be a “produced capital” (in that it was here long before humans existed), we can invest in maintenance of our environment or, more crucially, we can disinvest in it. Natural resource depletion is the sum of net forest depletion, energy depletion and mineral depletion, and Figure 4.8 provides results from the World Bank’s (2011) analysis of the depletion of natural resources. Aotearoa New Zealand’s disinvestment in its environmental capital has been decreasing and is considerably lower than Australia’s, which appears to be trending upwards. Nevertheless, our rate of disinvestment is falling more slowly than in countries like Denmark and is still positive – that is, we are continuing to run down our environmental capital. This measure does not include broader measures of biodiversity or air and water quality, for example, but these measures are also being developed. New Zealand’s investment, or disinvestment, in all these aspects of environmental capital will be an important determinant of our future wellbeing, both directly, and through their impact on the economy, consumption and incomes.

International linkages are important for productivity and economic performance, because they support the flow of knowledge from overseas, help foster business relationships, provide markets for exports, as well as knowledge about these markets, and they support the import of technology embodied in new equipment. All developed economies import and export sizeable proportions of their GDP. Likewise, with capital flows, the stock of foreign direct investment (FDI) is equivalent on average to around half of GDP for OECD economies.

International linkages are also important conduits for the flow of ideas – through trade in goods and services, foreign investment, or the flow of people.

International trade creates linkages with external markets, purchasers, suppliers and competitors. This enables new products and techniques to be observed, and tacit knowledge to be transferred via personal interaction. This has been referred to as “trade knowledge spillovers”.³¹ Further, access to larger overseas markets enables successful firms to expand, shifting resources to higher productivity uses within the domestic economy and increasing the returns to innovation and capital deepening. Fabling & Sanderson (2013) showed that Aotearoa New Zealand firms that enter export markets increase both employment and their capital–labour ratio relative to similar non-exporters, increasing both aggregate productivity (through reallocation) and firm productivity (through capital deepening).

Foreign investment is usually accompanied by knowledge that is embodied in:

• organisational change – “use this money to do Y” or “you can only have this money if you do X” (see also example in human capital below);
• new capital – “here are some new machines”, or “use this money to buy Y”; or
• human capital – “we are sending our managers to run the show”.

However, even within multinationals, knowledge flows may be impeded by insufficient skills in subsidiaries (Birkinshaw et al., 2008).

As well as the benefits to the economy, the choices of firms to undertake internationalisation activities are related to their own productivity (see Box 8).

As knowledge is embodied in people, the flow of people equates to the flow of knowledge (although not all flows of knowledge may be new knowledge). Skilled workers potentially bring with them knowledge of different things to do, and different ways to do them. Movement of workers between firms (and the possibility of being able to do this) is an important mechanism that, it has been argued, underlies some of the benefits of migration (Bedford & Spoonley, 2014; NZPC, 2022a) and the agglomeration of economic activity (Andersson et al., 2007; Maré & Graham, 2013).

Trade

Aotearoa New Zealand has a relatively low export intensity (value of exports as a percentage of GDP) given its size (Figure 4.9), and this level is not rising, whereas, until the GFC, trade intensity was rising for many other small OECD countries. Small economies typically have high trade-to-GDP ratios, and New Zealand’s levels of trade are likely to be affected by its distance from major markets.

Consistent with international evidence, firms in Aotearoa New Zealand that export are more productive and invest more in capital and innovation than non-exporting firms (Fabling & Sanderson, 2013; Sin et al., 2014). The requirements for New Zealand firms will be greater because of the distance to markets, and the fact that a small domestic economy makes it difficult for firms to achieve scale (NZPC, 2021a).

The level of, and variation in, the exchange rate affects international trade. Although exchange rate movements are an important part of the economy adjusting to economic shocks, excessive medium-term exchange-rate volatility may reduce domestic activity and international trade. Highly variable exchange rates can make it difficult for firms to export goods and services. For example, a sudden rise in the value of the New Zealand dollar can turn a previously profitable sale to a loss, as the exporter receives fewer New Zealand dollars for each unit of currency the foreign buyer pays. The New Zealand dollar has experienced significant volatility compared to the currency of our major trading partners (Figure 4.10). This makes it riskier for firms to export and makes them less willing to do so. Fabling & Sanderson (2015) showed that the level and volatility of the New Zealand dollar against bilateral trading partners affect both the number of firms exporting to a given market and the average value of exports per continuing firm.

Aotearoa New Zealand’s exports are concentrated in animal and food products (Figure 4. 1), more so than exports from similar-sized economies. Other developed countries tend to export a wider range of goods – in particular, a wider range of elaborately transformed goods, embodying greater technological complexity. Research has shown that countries exporting a wider range of more complex products are more successful (Hausmann et al., 2007, 2014; Hidalgo et al., 2007). The lack of complexity in New Zealand’s exports may reflect the relatively low levels of frontier knowledge in our economy (Hartmann et al., 2017; Hidalgo, 2015), which would be consistent with our low levels of R&D

Foreign investment

Exporting (and importing) ideas via capital – by investing and producing abroad, rather than producing onshore and shipping goods and services overseas – is one way to overcome the physical costs of distance. Aotearoa New Zealand’s relative outward Foreign Direct Investment (FDI) performance, however, is even lower than its export performance. Whereas the OECD average, and that of countries such as Denmark, has increased considerably over the past decade, New Zealand’s Outward Direct Investment (ODI) as a percentage of GDP was low in 2005 and remained low in 2021 (Figure 4.12).

In contrast, FDI into Aotearoa New Zealand has traditionally been quite high – well above the OECD average in the early 2000s. However, although the stock of investment into comparator countries has continued to increase, inward FDI as a percentage of GDP in New Zealand has been largely stagnant for the past two decades (Figure 4.12).

Foreign Direct Investment can happen for several reasons. It could be as a substitute for direct trade in goods and services, or it could be resource seeking. Aotearoa New Zealand may have economically valuable resources that attract foreign multinationals and capital. These could be natural resources such as oil or minerals, logs, or good pasture. They could also be intangible resources, such as businesses with innovative products or services.

FDI is an important source of funding for investment by firms and can be an important way to spread ideas. The OECD has noted that Aotearoa New Zealand’s foreign screening process has traditionally imposed “significant compliance costs and uncertainties on foreign investors, constraining service trade” (OECD, 2022b, p. 51). These have reduced in recent years, but the jury is out on whether this is enough to attract additional investment.

Management capability has a significant impact on organisational performance. Skilled managers add to productivity and profitability by creating an environment where innovation and skill development can flourish (Fabling & Grimes, 2007). The (no-longer recent) Management Matters study (Agarwal et al., 2020; Green & Agarwal, 20 1) used the survey responses of managers in the manufacturing sector, who were questioned across three broad areas of management practice: operations management, performance management and people management. Overall management practices in Aotearoa New Zealand manufacturing were weaker than in most of the OECD countries for which data was available – New Zealand ranked 10th out of 14 OECD countries covered. A particular weakness identified in New Zealand manufacturing firms was in people management.

Aotearoa New Zealand was behind world leaders in all three dimensions of management practices measured (Figure 4.13). New Zealand manufacturing firms were weakest in people management (12th out of the 14 OECD countries covered) – managing human capital by attracting, developing and retaining talent. New Zealand ranked 9th and 10th for performance management and operations management, respectively. Although other countries have built measures of management into the ongoing suite of economic statistics (Scur et al., 2021), New Zealand participated in only a single wave of the study. However, longitudinal analysis of data on business practices from the Business Operations Survey suggest that there has been limited overall change in practices since the Management Matters study (Sanderson, 2022). These business practice changes have also been found to be related to the performance of firms (Fabling & Grimes, 2007, 2010, 2014).

Education levels, skills, and talent are fundamental to economic development, because more highly educated, skilled, and talented people tend to be more innovative and productive. Highly skilled and educated people create and embody knowledge and ideas, and they help facilitate the uptake of ideas from within Aotearoa New Zealand and internationally.

Skills and talent are influenced by formal learning processes, informal experiences, networking, and social and cultural norms.

The percentage of adults of working age with a bachelor’s degree or higher in Aotearoa New Zealand is close to the OECD average (Figure 4.14). A large proportion of these adults have a bachelor’s degree, with the numbers of those with a master’s or doctoral degree being much lower.

Aotearoa New Zealand’s average status regarding tertiary education in the young working population is partly due to our large diaspora. In 2020, the New Zealand diaspora was 17% of the resident population – there was one New Zealand-born person overseas for every six people living in New Zealand (NZPC, 2022a). This is comparable with eastern European countries such as Latvia (20%) and Estonia (16%). Tertiary qualification rates among the New Zealand-born population living overseas are notably higher than for the New Zealand resident population (Figure 4.15). In the short term, this reduces the supply of skilled labour for firms and affects their growth. In the longer term, there could be productivity benefits if these emigrant graduates return and bring with them knowledge of foreign markets and ways of working.

Cognitive skills provide an indicator of the quality of schooling and underlie the relationship between education and economic development. Aotearoa New Zealand participates in international studies assessing the quality of compulsory education – the Programme for International Student Assessment (PISA) and Trends in International Mathematics and Science Study (TIMSS). These tests have a broad focus on mathematics and science, and PISA has an additional focus on literacy.

In PISA, where the emphasis is on understanding and applying knowledge using data and examples, achievement levels by 15-year-olds in Aotearoa New Zealand have traditionally been close to the top of the OECD.³² Achievement levels in PISA, however, have seen a considerable decline in relative and absolute terms (Figure 4.16).

The above patterns could be explained by saying requirements for maths, science and literacy are somehow different in Aotearoa New Zealand, or that we value other aspects of the curriculum more highly. However, this is not supported by a New Zealand–specific study: the National Monitoring Study of Student Achievement (NMSSA). NMSSA is a large-scale assessment that monitors trends in student achievement and progress in the New Zealand curriculum. One aspect the NMSSA highlights is significant disparities in learning across the system. For example, students at the most economically disadvantaged 30% of schools display learning outcomes considerably behind the remainder of the population in all areas of the curriculum (Figure 4.17). There is one exception where the inverse is true – namely, the results for Te Reo Māori. Ākonga Māori (Māori students) scored higher overall than non-Māori students on the Te Reo Māori assessment at both Year 4 and Year 8, and they also made greater progress between these periods. This result reflects the concentration of Kura Kaupapa Māori in lower-decile areas and their success in teaching Te Reo.

Aotearoa New Zealand has invested a similar share of GDP into infrastructure as other high-income countries (Figure 4.18). We have invested heavily in telecommunications, and this is important for a sparsely populated country, far from the rest of the world. Despite our low overall population density, New Zealand’s investment in transport infrastructure is about the same as that of other OECD countries.

These numbers are relative to our low-to-middling GDP, and it is also important to note separate price and volume effects. If infrastructure is cheaper or more expensive than in other countries, our interpretation of these figures will be different.

Statistical analysis of data in Oxford Global Projects and produced by the NYU Marron Institute by the New Zealand Infrastructure Commission (2022) found that unit costs for urban and rural motorways, road tunnels and underground rail are higher, on average, in Aotearoa New Zealand than in other high-income countries. Cost differences for surface rail stations, transmission lines, wind farms and hospitals are not statistically significant.

The New Zealand Infrastructure Commission (2022) also notes that the existing evidence base for benchmarking infrastructure costs between countries is limited and does not usually cover Aotearoa New Zealand. Therefore, they have undertaken an exercise to collect and analyse relevant data. Figure 4.19 shows there is no simple story about whether our input costs are higher or lower than those of other high-income countries.

Construction labour costs are an important component of the costs of building infrastructure. Aotearoa New Zealand has below-average construction labour costs, and average construction wages in New Zealand are around 35% lower than in Australia. Concrete is another major component of physical infrastructure. New Zealand has higher concrete costs than other high-income countries (twice as expensive as concrete costs in Australia). Costs for steel are similar to other high-income countries but almost 30% more expensive than in Australia.

Overall, Aotearoa New Zealand has average costs for materials used in vertical construction (structural steel, concrete, timber and “finish” materials). Construction equipment costs, however, are high – around 50% higher than for the median high-income country, and similar to those in Australia.

Finally, infrastructure must compete for other uses of land. Despite our sparce population, Aotearoa New Zealand has comparatively high rural land prices, which is likely to reflect our comparatively productive agricultural land.

Cultural, economic, legal, political, and social institutions are fundamentally important to the functioning of the economy and society (North, 1991), and they are major reasons for the vast differences among nations (Acemoglu & Robinson, 2012).

The government plays an important role in the functioning of the economy. It sets the “rules of the game” by creating institutions that underpin the business environment. It is also a major player in the economy, itself, and it provides education, health and other services. Aotearoa New Zealand compares well with other OECD countries in dimensions such as the rule of law, control of corruption, and property rights – the bedrocks of a functioning society and economy.

Institutional quality

The quality of institutions is a foundation of successful societies and economic development. Data from the United Nations Worldwide Governance Indicators³⁴ ranks Aotearoa New Zealand highly in terms of government effectiveness and regulatory quality. The data also ranks New Zealand highly on a measure of “voice and accountability”, which captures perceptions of the extent to which a country’s citizens can participate in selecting their government, as well as freedom of expression, freedom of association, and a free media.

Trust

Trust forms a crucial cornerstone of well-operating democracies, as it fosters the implementation of policies and aids in the successful management of crises like the COVID-19 pandemic. It is an enabler of social and economic activity and an assessment of the quality of our institutions. Trust also plays a pivotal role in addressing future challenges, such as global warming, in a sustainable manner.

Figure 4.21 shows the share of people who report having confidence in the government. Trust in Aotearoa New Zealand is higher than the average in the OECD and other countries participating in the 2021 OECD Trust Survey. However, it has fallen in the last decade. In New Zealand, trust is highest in the police (73%) and the courts (65%), and lowest in local government councillors (45%) and the media (35%). Just over half (56%) of New Zealanders reported trusting the public service, which is above the OECD average (50%), but only in the middle of the benchmarking group of small, advanced economies and other English-speaking countries considered for this study.

Business environment

The business environment the government creates through its regulatory and other actions is an important element of the functioning of the economy. Fundamentals, such as corruption and the rules of law, can hold back economies at early stages of development. The competitive environment is an important determinant of the dynamics of the economy. There are a range of ways policy can affect this, such as through minimising the costs of entry and enabling flows of investment and goods. The OECD rates Aotearoa New Zealand’s product market regulation as generally good. Overall restrictions of competition are slightly lower than the average OECD country and small advanced economies (such as Denmark and Sweden). The OECD ranks the administrative burden on start-ups as low (see also Figure 4.23) but it considers high state ownership limits competition in the network sector.

Productivity is low by international comparison owing to muted product market competition, weak international linkages and innovation, and skills and qualifications mismatches.

OECD (2022b), p. 11

Aotearoa New Zealand’s small size and geographical remoteness may mean we must be even more vigilant regarding competition. It may be easier for firms with monopoly power to exercise market power. Smaller markets can also mean lower incentives for firms to enter the market and compete for economic rents.

Low costs (financial or otherwise) of entry create a more dynamic economy. This can increase “static” competition at any given point in time, but it can also enable new products and services or ways of working to emerge. Although competitive outcomes may be limited by our size and distance, Aotearoa New Zealand’s policy and regulatory settings are supportive of a well-functioning and competitive business environment (Figure 4.23).

Business dynamics

As at 31 December 2022, there were 711,599 registered companies in Aotearoa New Zealand. In the final quarter of 2022, 1,980 new companies were incorporated and 10,880 were removed from the company register.³⁵ However, not all these firms produce products and services at any point in time or employ staff. According to Stats NZ’s Business demography statistics, in February 2022, there were 592,704 “economically significant” enterprises in 628,940 business locations, employing 2.4 million paid employees (Table 4.1).³⁶ Around 13% of these firms were new, and 9% ceased.

Table 4.1 Firm dynamics

Number of enterprises, enterprise births, and enterprise deaths

Source: Stats NZ (2022).

Notes:  Care must be taken when analysing the 2022 births and deaths data. Deaths in particular are highly provisional. Turnover rate is the sum of the enterprise birth rate and the enterprise death rate; due to rounding, turnover rate may not always equal the sum of the birth and death rates.

Care must always be applied when comparing business dynamics statistics of countries. There can be a range of legal and data-collection reasons for difference. With this in mind, the statistics we do have suggest that Aotearoa New Zealand has high rates of firm births and deaths relative to other OECD countries (Figure 4.24). There does not appear to be a shortage of “creative destruction” in the New Zealand economy.³⁷

By looking at several of the underlying determinants of productivity, we are seeking to understand Aotearoa New Zealand’s performance and identify areas where we might want to improve. We appear to do the basics right, we have good institutions, and we have trust in them. These are necessary conditions for a functioning economy. However, we are not doing as well in some of the other determining factors.

Innovation is the engine of growth and productivity, and Aotearoa New Zealand invests in this much less than our peers do. We have relatively small share and venture capital markets, and the cost of borrowing is high. The quality of New Zealand’s education system shows signs of decline – in absolute terms and relative to our peers – and it produces highly unequal outcomes. Education is one of the most important investments we make in our people, and universal education provides us with the skills and knowledge we need to lead successful lives. The fact that educational outcomes are unequal suggests there is more we can do. This inequality is not only inequitable, but a terrible waste. Education can improve the lives of individuals and communities, as well as the performance of the economy.

Education is the most powerful weapon which you can use to change the world.

Nelson Mandela, speech, Madison Park High School, Boston, 23 June 1990