Import-led growth and the productivity divide

Aaron Schiff writes about how the ratio of productivity between a 90th percentile firm and 10th percentile firm can be as much as 9.

This means that there are a lot of relatively unproductive firms that are surviving in New Zealand. Aaron argues that these firms are unlikely to bother going head-to-head with a firm selling a similar product from Denmark and thus New Zealand could be in a “low-competition, low-productivity, low-trade equilibrium”.

This is linked to the fact that most New Zealand firms do not have websites, use email or make online ordering easy for customers. These firms will die out because they are probably owned and operated by older people who have been able to tick along in an industry where they’re not facing ruthless global competition.

There are high returns to getting on a plane, renting a firm apartment in a target city and getting boots on the ground. Face-to-face is still how the world works, but I think we need to link both strategies together.

A firm at the 90th percentile of productivity in an exporting industry should not only have fully embraced the potential of doing business on the internet, but have a footprint in key export markets.

This means if you’re selling more than $1 million a year to a particular country, on say a 20% margin, you need to be building on that aggressively for the first few years you’re in that market.

It also means that language skills are becoming more valuable. English might be the language of business, but in 2013, knowing other languages simply makes doing business across borders even easier.

There are a lot of pieces to the puzzle but e-commerce and competition in whatever industry you’re working in is a good place to start.

 

Australia Is In For A Hard Landing

Starting in 2005 a resource boom in Australia has propelled their economy onwards and upwards. All good things come to an end, and I believe that Australia is in for a hard landing. The combination of a shock to commodity prices, piercing of a housing bubble and extremely poor productivity growth since 2005 could lead to a serious drop in Australian GDP when the day of reckoning arrives.

McKinsey Global Institute have produced an essential study that breaks down what has caused Australia’s growth spurt since 2005, and how the causes of growth have differed from previous growth spurts in the early 1990’s and early 2000’s. It’s called “Beyond the boom: Australia’s productivity imperative“.

Their analysis looks at five different contributors to growth:

Terms of trade: The effect of changing prices for imports and exports

The increase in terms of trade has been fuelled by massive increases in commodity prices. The Reserve Bank of Australia governor is quoted in the report that while one container of iron ore was worth 2,200 flatscreen TVs in 2005 it’s now worth over 22,000 flatscreen TVs. The Australian dollar is at very high levels and is currently at 1.03 USD/AUD – above parity!
Additional capital: The increase in capital stock

The increase in capital stock in Australia since 2005 is astonishing – some A$120 billion in additional capital investment has been made in iron ore and coal mines, roads, ports, natural gas exploration and other resource industry projects. That alone is responsible for 53% of the growth since 2005, meaning any reduction in capital investment would significantly reduce Australian economic growth.

Additional labour: The increase in the total number of hours worked in the economy

Since 1993 Australia has averaged 143,000 immigrants per year and its own growing population has led to a massive increase in the size of the workforce. Massive Kiwi immigration has thus played a key role in accelerating Australian growth. MGI state that the increase in labour is the steadiest contributor to Australia’s growth.

What does this mean if lots and lots of Kiwis return to New Zealand? Well, the Australian economy recovery could potentially be lower than if they stayed there. The same obviously applies to other sources of Australian immigration – Southeast Asia, UK, Ireland, South Africa. Birth rates in Australia seem to be propped up by the baby bonus they have there. If fiscal necessity means that has to be cut the rise in natural born population will decrease sharply and affect this contributor to growth by the 2020s/2030s.
Capital productivity: The amount of output generated per unit of capital stock

Between 2005 and 2011 capital productivity has plummeted and led to tens of billions of dollars in losses of national income. MGI argue that this is because of the massive time lags between planning a resource project and getting the first shipment despatched, which can feasibly take years because of the size of the projects.

This finding is amazing – all of this capital investment, yet the losing capital investments are essentially cancelling out many of the one-off gains from a resource boom. This does not bode well if commodity prices decline, because that would reduce the value of resource projects already committed to and underway even further.

Despite hundreds of billions in domestic wealth, hundreds of billions more is being borrowed from overseas to finance these capital investments. If Australia’s exchange rate plummets in the wake of reduced commodity prices the repayments on bonds issued in USD, EUR, JPY, RMB or even SGD will skyrocket and reinforce a downward spiral of investment.
Labour productivity: The amount of output generated per hour worked

Despite having 25% more capital at their disposal from 2005 to 2011, output only increased 7%. Over the past 6 years labour productivity increases have only contributed a roughly a third as much as they did between 1993 and 1999. (A$17 billion vs A$57 billion). Other sectors in Australia have been achieving lacklustre labour productivity growth of ~1% a year.

All in all, MGI conclude that at least 50% of the growth from 2005 to today is one-off effects of the mining boom. The reality is that Australian multifactor productivity is actually declining at 0.7% a year. McKinsey talk about four different scenarios for Australia, linked directly to how much they increase productivity. They call these scenarios “hangover”, “lucky escape”, “earned rewards” and “paradise”.

This is how they arrived at their numbers:

 

Using the methodology that MGI used to calculate these 4 scenarios, what happens if we make the assumptions slightly more negative? If the “hangover” situation occurs, there is not much breathing room until the total change of total income becomes negative.

In the “hangover” situation, if the relationship between additional capital and capital productivity (-43/120) holds the negative contribution of capital productivity would surely be (-43/120)*107= -$38.34 billion. That would change the “hangover” calculation to : -109+107+28-38+8= -$4 billion.

Any further deterioration in Australia’s terms of trade would make the reduction in total income even higher. Any decrease in additional capital would make the reduction in total income even higher. This report reinforces my bearish opinion of Australia – they’re squandering their resource boom resources and not focusing aggressively enough on improving multi-factor productivity.

And let’s not forget where a lot of this capital investment is coming from:

When Australia’s terms of trade decline, any foreign-denominated borrowings will be more expensive to repay. This could prove fatal to any recovery because a substantial proportion of national income will be spent on debt service instead of capital investment, further reinforcing the hard landing provided by a decline in commodity prices.

Australia is in for a hard landing because they’ve squandered their natural resource dividend on a housing boom and holiday homes in Bali. Their failure to address productivity issues in the resource sector and other sectors will make the inevitable recession far more painful than it could have been if a more responsible approach to shoring up the long-term prospects of Australia had been taken.

Charting Our Unemployment Crisis

Key Points:

  • Unemployment is at a 13 year high of 7.3%
  • Our recovery from the global financial crisis is pathetic. Our annual GDP growth rate is a national disgrace.
  • Labour costs have increased almost 40% during this period
  • While labour productivity has stagnated
  • There isn’t much of a relationship between business confidence and the unemployment rate
  • Exports have been growing and less labour intensive production methods favoured
  • Increased M3 since 2008 hasn’t reduced unemployment

The news that unemployment is at a 13 year high of 7.3% is absolutely shocking. It’s even worse when you realise the number of measurement problems that Statistics New Zealand can’t overcome because of the nature of macroeconomic data measurement. Statistics NZ does a reasonable job with the HLFS so we have to work with what we’ve got and not get sidetracked by “what counts as unemployment” sideshows.

John Key needs to urgently review his government’s policies. Saying that he won’t “change tack” when there is no hope on the horizon for the extra 78,000 unemployed people in New Zealand is not good enough. Blaming the global financial crisis is not an option when there is an underlying productivity sickness in the New Zealand economy.

Reserve Bank governor Graeme Wheeler should definitely consider a cut in the OCR before 1 January so my iPredict contracts pay out. It could also boost aggregate demand. There is still some room for New Zealand’s monetary policy to move before it hits the zero lower bound / liquidity trap situation. But that is neither here nor there. And US unemployment has barely changed despite the Federal Reserve cutting the discount rate to 0%.

A picture is worth a thousand words. I think charts can help us think about our unemployment crisis. The fact that they prompt more questions than provide answers is a sign that we are on the wrong track. A failure to implement different labour market policies could accelerate our decline into middle income nation ignominy. What those policies should be is a matter for a later post.

This chart clearly shows that the recovery from the global financial crisis is not nearly as fast as the recovery from the Asian financial crisis in 1998 and its impact on our exports and GDP. This does not bode well because GDP growth compounds over time – even 1% less growth now is an enormous reduction in living standards extrapolated out to the 2020’s and 2030’s when the retiree to worker ratio will be at its lowest and we need a lot of excess wealth stored to pay for superannuation and health care.

This chart clearly shows the rise of labour costs as shown by the Statistics NZ index. You can read more about how its calculated at Statistics NZ.  There has been almost a 40% rise in the cost of labour in 13 years. But what has happened to productivity during that time?

This graph shows that labour productivity has grown roughly 7.5% (8/106) during this 13 year period. That is substantially less than the increase in labour costs. Employers have to finance higher labour costs with something. They’re not getting it all from higher productivity and more output. This means that workers at the margin will find themselves laid off.

Tyler Cowen’s “zero marginal product of labour” theory he’s blogged about could conceivably apply to swathes of currently unemployed Kiwis. They were the last to be hired and the first to be fired. With structural changes in the labour market due to technology, an argument could be made that cyclical unemployment doesn’t explain all of the increase in unemployment since 2008.

Increases in GDP growth certainly reduced the unemployment rate in the early 2000’s. But with unemployment now at 7.3% that’s almost double what it was at the beginning of 2008. I won’t share the graphs from Trading Economics / Statistics NZ but the number of employed persons has grown from ~1.8 million to ~2.2 million. During the same time our population has increased from ~3.8 million to almost 4.5 million. It would be interesting to study the role that immigration has played on the domestic labour market and exploring if there is any impact from work visa or working holiday visas on the sort of jobs at the marginal end of the labour force.

M3 is defined by the Reserve Bank as the broadest monetary aggregate.

M3 is the broadest monetary aggregate. It represents all New Zealand dollar funding of M3 institutions and any Reserve Bank repos with non-M3 institutions. M3 consists of notes & coin held by the public plus NZ dollar funding minus inter-M3 institutional claims and minus central government deposits.

Since the beginning of 2008, M3 has grown around 25%. This has not had any significant impact on reducing unemployment, in fact it has accompanied the rising unemployment rate. Why aren’t banks lending more to businesses to spur a recovery? Why are all the anecdotal stories I hear about stingy bankers failing to fund another promising business proposition?

Monthly mortgage loan approvals are up 40% on two years ago and running at $1.3 billion a month. Imagine $1.3 billion a month being funnelled into net new business lending and the long-term implications for productivity growth. Banks are fuelling the fire with the likes of 95% mortgages while bending any businessperson wanting to buy machinery or get a letter of credit over a barrel.

An increase in credit of this magnitude should be going hand in hand with a major rise in business investment. But that’s being thwarted by bankers who’d sooner give you $500,000 for a villa in Newtown than $50,000 for a piece of machinery. They have no vision or ability to comprehend reasonable business plans and their “fairweather friend” attitude means they have no credibility as financing partners.

But if we grow our exports we can create jobs and catch up with Australia! This chart is for the kooks who think that higher unemployment is because our export sector is struggling. If that was true the unemployment rate would have plummeted over the past four years.

Despite the high dollar, exports have increased almost a third since the onset of the global financial crisis. This could be because of the commodities boom and demand from China. It could also be because exporting industries have switched to less labour intensive forms of production. This would lead to less need to hire more workers if you’ve automated your factory.

There are some people who take business confidence seriously. But how can you look at the following and not detect a certain partisan bias? I think business confidence cannot explain why businesses aren’t hiring. They’re supposedly more confident than they were in the middle of a massive housing boom yet don’t want to add more workers.

Note that business confidence was slightly negative when unemployment was low in 2006, 2007 and early 2008. Perhaps business owners really don’t like paying wages and are invested aggressively in cost reduction and automation so they don’t need to go anywhere near the labour market. With some of the rules surrounding employment law, I would not be surprised but will refrain from comment until I’ve looked into the data more closely.

This was my first post full of charts and my brief analysis. If you’d like to add something please comment. I’ll be performing this sort of analysis more regularly.

It’s not as rigorous as building an Excel model for your consumption but it does involve a bit of reality based thinking.

I’d like to know what you think of my analysis and would be grateful for any pointers to interesting working papers, commentary or journal articles.

It would be really appreciated.