ANZ economists on why they have some optimism productivity growth will pick up – albeit not enough to offset a slow-down in population growth  

With population growth peaking, the New Zealand economy desperately needs a boost in productivity growth to keep it tracking along in the right direction.

But how plausible is it for New Zealanders to start working smarter not harder, when the world’s in the midst of a productivity slump?

ANZ economists believe it is “entirely possible”, however it’s “hard to have strong conviction”.

“Perhaps productivity growth is set to stage something of a come-back, at least in a cyclical sense. But it will need to improve quite dramatically to offset the likelihood of smaller contributions from population and labour utilisation growth,” they say.

In their latest NZ Market Focus publication, they explain:

“When thinking about future growth, it is useful to first decompose historical growth into its most fundamental drivers, namely growth in population, productivity and labour utilisation…

“[O]ver the past couple of years GDP growth has clearly been driven by strong rates of population growth and labour utilisation. These factors have offset a poor productivity growth performance…

“Specifically, in the year to September 2017, headline real GDP growth of 2.5% can be thought of being made up of population growth (+2.1%pts) and labour utilisation growth (+2.3%pts) offset by a large drag from a decline in labour productivity (-1.9%pts).

“Effectively, it signals that as an economy, we have been working harder, but not smarter.

“So what can we deduce from this decomposition about growth heading into 2018 and beyond? Ultimately it comes down to the question of whether you believe these strong contributions from population and labour utilisation growth can continue (we doubt it), and whether labour productivity growth is going to step up to the plate (the big unknown).

· “Population growth: Even ahead of potential policy changes, net migrant inflows appear to have peaked, especially with the number of departures of non-New Zealand and Australian citizens picking up. That should see population growth slow from current strong rates.

· “Labour utilisation: Both the employment rate and the participation rate are already at all-time highs. They could rise further, but surely we are approaching some natural upper limit. And even a decline in the rate of increase would reduce their contribution to growth.

“Alternatively, a boost could come from a large lift in the number of hours worked per worker, but this seems unlikely considering that this has been relatively stable now for the past eight years, and potential changes to labour market policy would seem more likely on balance to work in the other direction, if anything.

It effectively means that if recent GDP growth rates are to be maintained, then labour productivity growth will have to improve. Could it? Of course. But it is hard to have strong conviction in this as a forecast, given the recent weak productivity trends both here and abroad. However, there are reasons for a degree of optimism.

· “The negative impact from natural disasters should start to wane. It is logical to assume that the unfortunate string of natural disasters over recent years will have affected the efficient allocation of resources in the economy and thereby had a negative impact on productivity. How large? It is impossible to say. But with earthquake rebuild efforts maturing, the impact could fade.

· “Capacity and margin pressures could force an efficiency drive. Firms continue to tell us that finding skilled staff is difficult, and we estimate that corporate profit margins have begun to tighten off decent levels. A cost reduction focus could intensify.

· “Relative factor prices look set to shift. The capital-labour ratio (a key input into labour productivity growth – workers are more productive when they have better tools) has been disappointingly stable in recent years. However, this is hardly surprising when you consider the signal provided by the relative price of labour and capital, which has also been broadly flat.

“Throwing labour at a capacity problem has been a pretty cheap and easy option. Yet with signs now pointing to a lift in wage growth, we could see a shift in the balance back in favour of investment. This could result in capital deepening once again, eventually supporting an improved productivity performance.

· “Auckland house prices have calmed down. Auckland’s extreme house price relativities have tended to reduce labour mobility across the country, discouraging labour from moving to where it can be most productive. Auckland house prices are still extremely high relative to both incomes and to prices across the rest of the country. But at least the ratios have turned…

“Overall it [productivity growth] leaves us comfortable with our view that the pace of GDP growth going forward is set to be more modest than recently experienced. That doesn’t make us bearish on the outlook, even though we do believe the economy has some challenges to navigate.

“And we hope that we are pleasantly surprised by the economy’s productivity performance going forward. However, we are less optimistic than official (RBNZ and Treasury) forecasts, and if we are right, this will have implications for both monetary and fiscal policy going forward.”

ANZ’s economists see year-on-year GDP growth dropping to 2.6% in the June 2018 year, and 3.1% in the June 2019 year. Treasury meanwhile forecasts 2.9% for 2018 and 3.6% for 2019.