Part 5 | How to improve productivity

Productivity is the realisation of potential. How might we live within our means individually, as whānau, and as a globe, while still growing and realising our potential? I think this is a real challenge for this and future generations.

Hinerangi Edwards | Poutama Charitable Trust

This report presents a picture of Aotearoa New Zealand’s productivity performance, to support an informed debate about how we can improve the wellbeing of New Zealanders. The road to improvement sits with a wide range of actors. Successful economies are based on individuals and communities, firms and whānau, iwi, and education and research institutions all doing the best with what they have.

Over the past 12 years, the Productivity Commission has conducted inquiries into various aspects of productivity and the economy, providing detailed research, analysis, and recommendations (Table 5.1). Our current inquiry, Improving economic resilience, focuses on economic resilience policies that can proactively improve the capacity of industries and communities to adapt to persistent supply chain disruptions shaped by climate change, geopolitics, fragmenting trade or pandemics.

Through our past inquiries, we have made a wide range of recommendations to help improve understanding of productivity, and to inform and empower government and change makers to support productivity growth. As we reflect on the numbers presented in this report, we draw on some of the recommendations we have made in these past inquiries.

Table 5.1 Published Productivity Commission inquiries

There are many factors that influence Aotearoa New Zealand’s productivity. Some of these factors are harder to influence than others – for example, New Zealand’s size and distance from the rest of the world. Although the impact of these factors needs to be considered, we must take a broad view and be open to looking in other areas where we could work to improve our productivity.

Productivity is a long game. Productivity today depends on investments made in previous years and generations. The choices we make today will influence our productivity and standard of living tomorrow and for future generations.

In essence, it is investment in the wealth of Aotearoa New Zealand that is the key to improving productivity. In this chapter, we take the opportunity to build on the underlying determinants discussed in this report. We highlight the range of investments required in our physical, intangible, human, social, cultural and environmental capital, as well as in governance and the institutions that provide firms, markets, and civil society with confidence to engage in economic and business activity. To do so effectively, we should strive to better measure and monitor the outcomes of those investments.

Human capability

Investment in our people is one of the most important things that, as a society, we can make. Human capital is fundamental to prosperity and wellbeing, and an important explanation of differences in productivity across countries, industries and firms (Hanushek & Woessmann, 2010; Lucas, 1988, 2015; Mincer, 1984). Human capital includes knowledge and skills acquired through formal education as well as through “learning by doing”. It affects our economic development as a factor of production itself – similar to any type of productive capital – and through its effect on productivity. In particular, skills and knowledge enable innovation to disperse and be absorbed (Cohen & Levinthal, 1989; Kneller & Stevens, 2006; Robbins, 2016).

The nation’s education system is perhaps the single most important source of human capability. Aotearoa New Zealand has long had a high-quality education system, but the skill level of our learners when they leave the education system is falling, relative to previous cohorts and to other advanced economies. Evidence in national and international studies has shown wide disparities in educational outcomes across socioeconomic groups and ethnicities (Gromada et al., 2020; Jagger & Stevens, 2019; OECD, 2018). The disparities in the education outcomes across ethnicities in New Zealand remain a source of considerable loss of productivity and wellbeing. This represents a loss of potential now and for future generations, not only for individuals and communities, but for businesses and government.

Internationally, there are concerns about the long-term impact of COVID-19 on human capital (Hanushek & Woessmann, 2020). Human capital is cumulative – knowledge builds on knowledge – and missing out on education or other learning opportunities can have long-term consequences. The results of research suggest that, across the OECD, the impact of school closures due to COVID-19 is likely to lead to a loss of between 0.2% and 0.9% in human capital when all cohorts impacted have entered the labour force (de la Maisonneuve et al., 2022). Productivity losses due to this decrease in human capital are estimated to range between 0.4% and 2.1%, with the main impact being felt between 2030 and 2065. Although the time that students in Aotearoa New Zealand were out of school was shorter than in many other countries, policies aimed at improving the quality of education and adult training will be needed to offset, or at least alleviate, the impact of the pandemic on human capital.

Skills are becoming increasingly important. As technology advances, so do the skill requirements of those working with it. This “skill-biased technical change” will have differential implications across the labour market, as those with lower or older skills may find it harder to adjust (Card & Lemieux, 2001). A flexible labour market is vital to enable such adjustments to be made. It is important that workers can easily move between jobs and industries and not be unreasonably restricted from making needed changes in skills and technology. Government intervention may be required to support those negatively affected by the transition. This is one of the elements considered in our Future of work inquiry, discussed further in section 5.3 below.

To be successful, domestically or internationally, firms need access to motivated staff with relevant skills. Our Immigration settings inquiry (NZPC, 2022b) highlighted that, over time, Aotearoa New Zealand lost large numbers of skilled people through outward migration. This led to concerns about a “brain drain”. However, because the immigration system selects immigrants mostly on skill, immigrants are more likely to be tertiary educated than New Zealand-born residents, outnumbering tertiary-educated emigrants. This means immigration more than offsets the loss of skilled New Zealanders. In the last decade, immigration has reduced the risk of labour shortages for employers in diverse sectors of the economy – from aged care to the dairy industry and the IT sector.

Aotearoa New Zealand invests a great deal in the education and training of its people. It is important that these investments are focused in areas where they are needed, to minimise our reliance on migration as a source of skilled labour, and to ensure our investments are not wasted. This requires decisions about education and training to use information we obtain from the migration system about the skill needs of New Zealand firms. This information is valuable, as it is sourced from actual decisions made by employers to invest in bringing in staff. Our investigation suggests, however, that this flow of information and feedback is not occurring.

Currently, no consistent feedback mechanisms exist to link skills shortages evidence in the immigration system to potential responses in the education and training system. This limits the capacity of the education system to meet employer needs and weakens accountabilities on employers to train and develop local workers.

NZPC (2022), p. 6

The inquiry recommended several ways to address this issue, including regular Government Policy Statements which, among other things, describe how the Government will address the relationship between skill development and immigration.

Social cohesion

Socially beneficial norms, rules, culture, and understandings encourage inclusion and aid in the peaceful resolution of disputes, which allows society to focus on growth and development. For this reason, social cohesion can be understood to have a capital value. As an asset (or wealth) it creates ongoing benefits or value for New Zealand over time.

Fookes (2022), p. i

Market economies rely on trust and cohesion to function effectively (Knack & Keefer, 1997). Having a commonly accepted set of (often implicit) rules of behaviour, and a level of trust that others will engage under the same rules, streamlines market transactions. This “social contract” enables participants to engage in business and economic activity more efficiently.

Although difficult to measure, Aotearoa New Zealand’s social cohesion looks comparatively strong (Fookes, 2022), including the population’s trust in government (Figure 4.21). However, there are differences across groups within society, and we must recognise the unique challenges evident in combining the bicultural and multicultural dimensions of our nation (Gluckman et al., 2021). Generalised trust scores for Māori are around 10% lower than those for Pākehā, and reported discrimination is also higher for Māori and Pacific peoples.

Aotearoa New Zealand can be proud of the quality of its institutions and social capital. These institutions are vital in dealing with shocks, such as the COVID-19 pandemic (Barrett & Poot, 2023; Bollyky et al., 2022).³⁸ However, as with any capital, evidence suggests that investment is required to maintain the value of these institutions. Although we currently have a level of relatively high trust in the institutions of government, it is very apparent from our experience during the pandemic that trust is not universal and can be eroded (Gluckman et al., 2021). As noted in our recent inquiry, A Fair Chance for All (NZPC, 2023a), the cycle of persistent disadvantage faced by many in New Zealand risks eroding the social contract relied upon by businesses and communities. Investments in breaking the cycle of persistent disadvantage can be seen as protecting or strengthening the social contract, which will provide long-term benefits to all, in terms of productivity and wellbeing.

The natural environment and environmental capital

As we noted in Part 2, mismeasured economic growth achieved through environmental depletion reduces the total capital available for future years and impacts on the wellbeing of future generations. This is more than an issue of measurement. If environmental capital is not priced or regulated to reflect its scarcity and importance, market production and consumption decisions will not take it into account, and firms will be incentivised to treat it as a free and endless resource. This has implications for current and future wellbeing – particularly in Aotearoa New Zealand, where large areas of our economy are based on the quality of the environment and its ability to support economic activity. For New Zealand, it is not a choice between “the economy or the environment” but a choice between the “the economy and the environment, or neither”.

Aotearoa New Zealand has among the highest per person greenhouse gas emissions in the world (NZPC, 2018b), even though most of our electricity comes from renewable sources. Two major emissions sources in the New Zealand economy are agriculture and transport. In our Low-emissions economy inquiry (NZPC, 2018b), we noted:

Effective emissions pricing provides a strong incentive to reduce emissions at least cost and provides a clear and credible signal to investors contemplating long-term investments in new production assets that have different emissions consequences.

NZPC (2018), p. 4

Higher emissions prices, increased coverage across the economy, and greater clarity about the future supply of emission permits are needed, to make the Emissions Trading Scheme more effective. We also made a range of recommendations in our Low-emissions inquiry, to support three key outcomes:

• Transitioning from fossil fuels to electricity and other low-emissions fuels across the
• Substantial levels of afforestation to offset Aotearoa New Zealand’s remaining This will require sustained rates of planting over the next 30 years (mostly on land currently used for sheep and beef farming).
• Changes to the structure and methods of agricultural

Given the focus on investment and innovation in this report, perhaps the most relevant recommendation in our Low-emissions inquiry was that the Government should devote significantly more resources to low-emissions innovation than the modest current allocation. This is discussed further in section 5.2 below.

Financial, physical and intangible capital

For an advanced economy, Aotearoa New Zealand has low physical capital (that is, buildings, machinery, ICT and infrastructure) and invests only enough to maintain its level relative to others. It is not converging to the levels of other countries, as economic theory would suggest (all other things being equal). There are a range of potential reasons for this – from industry structure to the strength of domestic competition – which deserve further analysis. New Zealand has relatively small share markets and venture capital markets, and our firms face relatively high interest rates, and this may curtail investment.

Of particular concern is Aotearoa New Zealand’s low investment in research and development. We turn to this – and other elements of the innovation ecosystem – in the next section.

Innovation is an important determinant of productivity, and of long-term improvements in prosperity and wellbeing. Innovative products and services can fulfil unmet needs that are profound (such as new medical treatments) and mundane (the latest combination of chocolate with another childhood favourite lolly). Innovations in production methods and processes also underpin how we respond to climate change and environmental degradation.

Aotearoa New Zealand invests relatively little in research and development. There are both broad-based and focused approaches to find potential policy solutions to this issue. The benefit of a taking a broad-based approach is that the Government is not required to identify where innovation is occurring. Increasing the likelihood of investment for innovation across the board allows individuals and firms to identify areas of potential and make investments in them. The Government has introduced such a policy in the form of the Research and Development Tax Incentive (RDTI), which replaces the previous Growth Grant programme. In the recent Frontier Firms follow-on review inquiry (NZPC, 2023b), we noted that early teething problems appear to have been resolved with “more business-friendly guidance, greater familiarity with eligibility criteria, and in-year payment of the RDTI” (p. 25); that applications and submissions have risen, and the “profile of firms participating in the RDTI scheme is a reasonable match for relevant firms reporting R&D activity in Stats NZ’s Business R&D Survey” (ibid.). The report on the follow-on review also noted an increase in business R&D between 2016 and 2021 (although this also occurred in other OECD countries and was starting from a low base).

Both the initial Frontier Firms inquiry (NZPC, 2020a) and the follow-on review (NZPC 2023) state the importance of supplementing the broad-based approach of the RDTI with a focused and integrated innovation policy. Although some aspects of existing government processes and initiatives are promising, they lack key elements needed for successful focused innovation policy.

Focused innovation policy is fundamental to lifting productivity

Our New Zealand Firms: Reaching for the frontier inquiry (NZPC, 2020a, 2023b) found that creating conditions for the most productive firms to emerge and flourish was a feasible and promising route to significantly improve Aotearoa New Zealand’s lacklustre productivity performance. Other small, advanced economies (such as the Netherlands, Denmark, Finland, Sweden, and Singapore) appear to have managed this, and provide examples that can be adapted to reflect New Zealand’s unique context. These countries have outstanding records of exporting specialised and distinctive goods and services at scale and have achieved world-leading advantages in selected markets. The follow-on review set out six ways in which innovation policy should be improved to enable New Zealand firms to better compete in these specialised markets (Figure 5.1). Fundamental to this approach is focus. The RDTI is a broad-based policy, and it needs to be accompanied by a focused set of activities that support areas of greatest potential.

The first recommendation was to not reinvent the wheel, but rather to use existing initiatives to choose focus areas. We recommended that government use the National Research Priority process to prioritise areas for focused innovation. Importantly, this should not be a top-down exercise led by government, but a collaboration with industry, researchers, iwi/Māori, and educators.

To balance focus and accountability with responsiveness and on-the-ground knowledge, the second recommendation was to establish two levels of governance: a high-level national council to provide strategic leadership and broad coordination; along with a devolved governance body for each focus area, with devolved funding and decision rights.

The third recommendation was to concentrate resources to enable government to commit significant, long-term funding to the focus areas. To make progress, material levels of investment are required. International experience indicates this should be in the order of $30 to $50 million a year for each focus area, matched by industry contributions. Decisions on how to allocate this funding should be devolved to governance bodies for each focus area, rather than being tied to specific government portfolios.

Aligning broader government and business efforts with the focus area was our fourth recommendation. Identifying a small number of specific focus areas would help government agencies improve policy alignment and reduce fragmentation. Policy settings across areas such as exporting, innovation, infrastructure, education and training, immigration, and regulation may all need to be improved, to support world-class innovation ecosystems in the focus areas.

Our fifth recommendation was to include iwi and Māori voices in decision making and leadership, to build flourishing innovation ecosystems and improve support for Māori business. Māori leadership is required both within and outside government. This recommendation called for ongoing efforts to build capacity and capability, and to adequately resource Māori contributions and leadership.

The final recommendation was to embed evaluation, to enable learning and adaption. Arrangements for monitoring and independent evaluation need to be built in from the outset, with dedicated funding. Measurement of results should focus on outcomes, and evaluation should be transparent and visible, with evaluation findings published as a matter of good practice.

The Commission’s Technological change and the future of work inquiry (NZPC, 2019) focused on the impact of new technology on workers. In the inquiry, we noted that worker mobility and a dynamic labour market are vital for productivity, because they allow for the smooth and beneficial reallocation of resources to more productive firms. However, the closure of low-productivity firms and the associated loss of jobs can impact adversely on wellbeing, unless workers can move to other roles.

Research has found that the process by which resources are reallocated from poorer performing to better performing firms in Aotearoa New Zealand had an uneven impact on workers, with greater employment losses for low-wage workers, young workers and workers with short job tenure (Fabling & Maré, 2012). This result is surprising, given younger workers are likely to be more mobile than older workers, who may have greater ties to a particular region, and may be less likely to undertake retraining for new jobs.

Workers who are mobile and able to move jobs easily help facilitate reallocation. A voluntary move from one job to another is also an important way for workers to climb the job ladder and increase their earnings and job satisfaction. Changing jobs can be particularly beneficial for younger workers, as finding good matches for a person’s skills can have a large bearing on their career and future income.

Coleman & Zheng (2020) examined job-to-job transition across firms, industries and regions in Aotearoa New Zealand. They found that just over 20% of employees aged 18 to 64 (about 420,000 people) had a different job in March 2018 than they had a year earlier. Around 40% of these changes were to a new location, and nearly 60% involved switching industry, with only 20% staying in the same industry and location. They concluded that this implies New Zealand’s labour market is relatively dynamic. A dynamic labour market is beneficial now, and it could become even more important if productivity-enhancing technology changes at a faster rate in the future.

The Technological change and future of work inquiry (NZPC, 2019) concluded that Aotearoa New Zealand’s broad policy settings assist labour market dynamism by ensuring that access to healthcare, retirement savings and unemployment benefits is not linked to particular types of work arrangement, jobs or employers. However, income security, opportunities for development, career progression and social protections are also important for workers.

This consideration underpins our recommendations for greater income smoothing, and for increased access to training and labour-market programmes when people lose their jobs. Employment law should also be more effectively targeted (for example, by reviewing and updating the legal tests for employee status). All these measures are designed to increase resilience and opportunities for the workers of today and tomorrow (NZPC, 2019) (Box 10).

Strong policy foundations are crucial for boosting productivity. Successive governments have created institutions and implemented policies to tackle the productivity challenge. Some of these are broad, overarching policies that determine the macroeconomic environment, regulatory institutions and practices, and competition policy. Others are policies and institutional arrangements that govern particular institutions in science, innovation and education.

The performance of government in Aotearoa New Zealand is important. The public sector accounts for one-quarter of all employment in New Zealand. It is large and its output is difficult to measure. The services provided are critical, with many of these provided to the most vulnerable members of society. It also provides services to the rest of the economy: setting and maintaining regulations, enforcing the rule of law, providing and supporting physical and knowledge infrastructure, undertaking and funding research, supporting people in need, and building a healthy and educated workforce. It is imperative the business of government is undertaken effectively and efficiently. The cost of an ineffective or inefficient government is felt across society and the economy. These costs are not paid in lost shareholder value, but in lost opportunities, ill health, and low levels of wellbeing for the people they serve.

The business of government is hard. There are many reasons why it is more efficient or equitable for governments to provide services than to leave this to the innovation machine of the market. The key is to ensure the activities of government are directed to areas that can make the most positive (or least negative) impact, so new and innovative ways to support society and the economy are developed, tested, improved, and disseminated. In the absence of simple profitability or sales targets, other metrics must be developed. Monitoring and evaluation activities are crucial to determine whether things are going as planned, and whether those services benefit and deliver the right outcomes for those they are intended for.

The impact of public policies and government institutions on productivity is vitally important. It is necessary to evaluate the efficiency and effectiveness of specific interventions – not just to understand whether they work (in a simple, binary way), but rather to understand how they work and how their effectiveness depends on the context of their provision. Past investments in linked administrative and survey data, such as the Longitudinal Business Database (LBD) and the Integrated Data Infrastructure (IDI), have provided Aotearoa New Zealand with powerful tools to pursue these evaluations. These datasets capture the characteristics of firms and individuals before policies are even designed and can therefore help to account for the influence of selection effects – who is selected, and the impact this has on outcomes (Le & Jaffe, 2017; Morris & Stevens, 2010). Natural experiments, circumstances surrounding a programme, or evaluation criteria built into the design and implementation of policy and implementation, can result in clearer identification of the impacts of policies.

This information is crucial to underpin what the Commission calls a “learning system”. In our A fair chance for all inquiry (NZPC, 2023a), we concluded that, to be effective in supporting people to improve their wellbeing, the government needs a learning system that learns from the people it is trying to help and connects what is being learnt across all levels of government.

Such a learning system needs to:

• understand what people need, and are able to do, to improve their wellbeing;
• work alongside people to “learn by doing” in real time, to test different types of support and to get their input about how well these work;
• regularly bring together what is being learnt from these individual interactions to identify common barriers that are preventing people getting the support they need (for example, not being able to apply for identification because there is no transport to take a person to get their photo taken, or lack of access to the internet to access digitally provided services); and
• share what is being learnt with the rest of government to identify opportunities to remove system barriers, and to provide more effective support to people.

Investing in data infrastructure

Good policy requires good evidence, and good evidence requires good analysis and good data. Aotearoa New Zealand is fortunate in having access to two rich sources of evidence: the LBD and IDI. These datasets provide a unique asset for robustly examining the impact of government policy, without the need for expensive data collection. However, they require and warrant investment and maintenance, as they are fundamental to our understanding of the functioning of the economy for firms, individuals, and communities.

This document sheds light on the story of productivity for Aotearoa New Zealand. A productive New Zealand matters for our people’s material living standards and wellbeing, and its distribution across and within groups and communities. A productive economy enables investment in education, health, institutions, and infrastructure for our people. In turn, a well-educated and healthy population, working with knowledge and capital, is crucial for a productive economy.

Aotearoa New Zealand is blessed with a rich endowment of land, water, communities, and people. However, our historical approach to the use and protection of these resources raises concerns about their sustainability and the nature of the legacy we leave for future generations. We have a responsibility to those who follow us to preserve, protect and restore the natural and social capital that is a cornerstone of our wellbeing, waiora, and wairua.

Productivity provides an opportunity to better provide for the future at a lower cost to our people and resources of today. The evidence of recent decades shows New Zealanders are not lacking in their willingness to work – with both high employment rates and high average hours worked. However, although we are working harder, other countries have been benefiting from higher productivity – maintaining and improving material living standards, while also gaining more leisure time.

Growth in output production and improvements in productivity are two different things. To lift productivity, it is how we grow output production (in short, the inputs or resources we use in the process) that is critical. That is to address the productivity challenge, our understanding and insights indicate we need to shine the spotlight on the input side of the productivity equation. The common denominator is the need to commit to ongoing investments over the long term in the range of inputs or resources (that is, our endowments) currently under our watch, to ensure they are not only maintained better but are fit for purpose for Aotearoa New Zealand in the 21st century.