Donald T Brash: Faster growth? If we want it
Address by Dr Donald T Brash, Governor of the Reserve Bank of New Zealand, to the "Catching the
Knowledge Wave" conference, Auckland, 2 August 2001.
* * *
Fundamentally, this conference is about economic growth, and how New Zealand can get more of it.
Many New Zealanders do not see increasing growth as a high priority objective. What we want is to
have access to better housing, better health-care, and better education. What we want is to protect the
relatively egalitarian society of our past from increasing income disparities. What we want is more
attention paid to preserving our natural environment. What we want is less stress and more leisure
time.
But the reality is that if we want better housing, better health-care and better education, we certainly
need economic growth - we have difficulty funding our collective desire for health care and education
now, and those costs look certain to rise in the years ahead. If we want to retain a relatively egalitarian
society, we absolutely need economic growth - without it, too many of our highly skilled people will
leave our shores, forcing up the relative incomes of the skilled people who choose to stay. Perhaps
surprisingly, even if we want more attention paid to preserving our natural environment, we need
growth - international experience suggests that it is the relatively affluent countries which can afford to
spend resources on protecting the environment.
So a conference on economic growth is not "just about money" but concerns many of the issues of
vital relevance to all of us. It also concerns issues which go well beyond the statutory responsibilities
of the Reserve Bank, and for this reason I must stress that my comments this morning reflect personal
views, and not necessarily those of the Bank.
Our growth performance: much improved
How have we been doing in the economic growth stakes? Unfortunately, not too well if we judge from
the last three decades. Over that period, our growth in GDP per capita has averaged 0.8 per cent per
annum, compared with an average of 2.0 per cent per annum in the countries of the OECD.1 As a
result, we have slid from 9th in the OECD "rankings" in 1970 to 20th in 1999 (comparisons made on a
purchasing power parity basis, rather than at market exchange rates), and have also been well
surpassed by some countries which are not OECD members at all (Singapore being the best
example).
As recently as 1990, New Zealand's GDP per capita was roughly on a par with Ireland's and
Singapore's. By 1999, both countries had very considerably surpassed us. In 1990, Australia's GDP
per capita was only some 5 per cent above New Zealand's; by 1999, it was nearly 40 per cent above
New Zealand's.2
What should we make of these figures? The first thing to say is that for a whole range of reasons GDP
per capita is not a very precise measure of human well-being. We New Zealanders have more cars
per capita than people in all but a tiny handful of countries. We have substantially more EFT-POS
terminals per capita than any other country in the world. We have easier access to uncrowded
beaches and countryside than people in most other countries. We spend much less time commuting,
even in Auckland, than people in many other countries. Our life expectancy at birth is the same as that
in, say, Germany, the United Kingdom and the United States, and infant mortality is identical to the
developed country average. As Paul Carpinter recently observed, quality of life measures often show
Auckland in the top ten cities world-wide3, something hardly consistent with New Zealand's being
towards the bottom of the OECD "ladder".
But having said that, there can be little doubt that there has been some relative decline in our living
standards in recent decades.
At first sight, our relatively slow growth seems surprising. We have many characteristics which make
for rapid economic growth. For more than a decade, we have had macroeconomic stability, with a
sound fiscal position and monetary policy delivering consistently low inflation. We have a competent
and corruption-free judiciary implementing a legal system based on British common law. We have a
civil service which is also competent and corruption-free. We have a stable political environment, with
a substantial measure of consensus across political parties on the important aspects of
macroeconomic policy. We are an English-speaking society, and one where people tend to be highly
receptive to the adoption of new technology. On several indices, we are ranked among the freest
economies in the world.
And we've had an extensive period of economic reform, specifically designed to help us to grow more
quickly. Doesn't our poor growth performance suggest that the reforms were seriously flawed? Not at
all. I don't think there is much doubt that the reforms of the mid-eighties and early nineties have helped
our growth potential a great deal. I have mentioned the decade of macroeconomic stability - which
also delivered a huge reduction in the net public sector debt, from over 50 per cent of GDP in the early
nineties to under 20 per cent at the present time. The reforms also delivered a very big improvement
in the quality of service in areas such as banking, retailing, telecommunications, postal services,
health-care, and airlines.
Recent years have also seen very rapid growth in a whole host of relatively new industries - wine,
mussels, software, furniture, specialised manufacturing, education services - to say nothing of a rapid
increase in the sophistication of some of our traditional industries.
Moreover, while GDP per capita grew at a rate of only 0.8 per cent per annum over the last three
decades on average, it grew at almost 1.7 per cent during the nineties, virtually identical to the
average OECD per capita growth over the same decade.4 So the reforms seem to have arrested our
relative decline, but not, as yet, enabled us to begin the process of reducing the gap in per capita
incomes which emerged over earlier decades. We are now keeping up, roughly, but not catching up.
Why have we not done better still?
Given that many of our reforms were, at the time, regarded as world-beating, why haven't we done
better? I don't think anybody has a totally satisfactory answer to that question, but let me suggest a
few factors which seem relevant.
First, New Zealand is a very long way from all of its export markets, and there is a growing awareness
that this imposes a considerable handicap on our performance. As The Treasury observed in its
Briefing for the incoming Government in 1999, "Draw a circle with a radius of 2,200 kilometres centred
on Wellington and you capture within it 3.8 million New Zealanders and rather a lot of seagulls. Draw a
similar circle centred on Helsinki and you capture within it a population of over 300 million, from
39 countries."5 And for Helsinki, The Treasury could equally well have said Dublin or Singapore.
Second, our natural resource endowment makes us extremely efficient at producing some things that
we are effectively banned from selling to many of the consumers of the world. Thus for example,
although we are one of the world's largest cheese exporters, and have developed a range of
sophisticated cheeses in recent years, we are limited to a tiny quota of about 0.6 per cent of the US
cheese market. If New Zealand producers want to sell butter to Japan, they find that Japan has limited
total butter imports, from all sources, to less than 2,000 tonnes each year, with sales beyond that tiny
quota facing a tariff of more than 500 per cent.
Our distance from world markets and a resource endowment which favours the production of goods
which face major obstacles in international markets are facts of life. To make matters worse, we have
compounded matters by creating some of our own obstacles to economic growth.
For example, as a country we squandered a large amount of capital investing in projects of very low or
negative value in the late seventies and early eighties, most as a result of strong government
encouragement - the Clyde dam, NZ Steel, and the synthetic petrol plant to name just three.
4
Scobie and Mawson, op. cit.
Second, because of very high effective rates of protection in many parts of the manufacturing sector,
we probably squandered even more capital over several decades by investing in industries where
New Zealand had no prospect of ever being internationally competitive. (Many studies have suggested
that economic growth tends to be fairly closely correlated with the degree of openness of the
economy, and, while New Zealand is now a very open economy, that was not true until about a
decade ago.)
Third, we have paid a high price for years of encouraging investment in real estate while discouraging
investment in plant and equipment - the result of the interaction between a period of high inflation and
a tax system based on the assumption that prices are stable6, plus perhaps the bitter memories of the
1987 share-market crash.
Fourth, we have paid a high price for not encouraging the acquisition of education and skills - the
result of decades of protection for industries requiring only a modest level of skill and, perhaps, a
welfare policy providing benefits of unlimited duration.
Fifth, we have paid a high price for tolerating an education system which produces too many people
with inadequate literacy and numeracy skills, unable to fill the jobs available in a modern economy.
And we have paid a price too for disdaining commercial success, with the consequence that too few of
our youth aspire to make money growing a business and too many of our most able entrepreneurs
have chosen to leave our shores. (It has to be a strange society which cheers somebody being paid
millions of dollars for a few minutes of belting the daylights out of his opponent in the boxing ring, or
somebody who wins millions in a highly regressive game of chance; but criticises somebody paid one
million dollars for a year of running a complex company providing services to hundreds of thousands
of customers, or somebody else paid $300,000 for running a large hospital with hundreds of staff and
thousands of patients.)
What about the future?
Can we be optimistic about the future? There are clearly some factors adversely affecting our growth
rate which we can never change. Most obviously, we will always be thousands of kilometres from our
major markets, and it will take years before the high protection impeding our agricultural exports is
eliminated. We can not avoid the fact that, as a country, we have squandered large amounts of capital
on projects which have only a minimal benefit for future growth.
But perhaps the significance of our distance from major markets is diminishing as transport and
communications systems become ever cheaper and more efficient (I suspect that there are both costs
and benefits for New Zealand in that development), and barriers to our exports continue to reduce,
though painfully slowly.
Moreover, within New Zealand we have eliminated the protection and the subsidies which caused so
much misallocation of resources in the past. Inflation no longer interacts with the tax system to steer
investment into real estate and out of investment in plant and equipment. And most of the other factors
which have adversely affected our growth are ones which we ourselves can change, if only we have
the will to do so.
In recent times, many political leaders have suggested that as a country we should be aiming to return
New Zealand's income levels to the top half of the OECD. As far back as 1990, the Trade
Development Board, now Trade New Zealand, proposed that that goal be achieved by 2010.
Would it now be feasible to raise New Zealand's per capita GDP to the median OECD level by 2010?
What such a goal would imply in terms of growth rates over the next decade would clearly depend in
part on how fast other OECD countries themselves grow over the decade, but plausible numbers -
which assume that other OECD countries achieve the same per capita growth rates over the next
10 years as they did in the nineties - would require GDP per capita growth in New Zealand of about
3.6 per cent per annum, somewhat more than double the growth in per capita GDP achieved by New
Zealand in the nineties.7
Can a doubling of our per capita growth rate, as compared with the average of the nineties, be
achieved? I am sometimes surprised to hear people argue that such a goal should be easy to
accomplish. Why, it is occasionally argued, some companies have grown by 10 per cent annually for
years! Even whole regions sometimes grow at rates which are well above the growth rates suggested
as being necessary to raise per capita income levels to the median of the OECD. But what is often
overlooked in making such comments is that a company may grow at a high rate for years because it
can absorb resources of people and capital from outside itself; regions can similarly grow rapidly by
absorbing people and capital from other areas. New Zealand as a whole may increase its gross output
more rapidly by bringing in lots of additional people and lots of additional capital, but that increase in
gross output may produce only a modest increase in the per capita incomes of New Zealanders.
No, doubling the growth in per capita incomes would be extremely difficult. But perhaps it would not be
impossible. Some other small countries - Finland, Ireland, and Singapore are the most frequently
cited examples - have achieved similar or even greater increases in per capita income, but it has
been a very rare achievement, sometimes made possible in part by starting from a situation of
economic collapse (Finland), and sometimes made possible in part by being able to bring very large
numbers of unemployed people into the workforce (Finland and Ireland). Finland and Ireland also
derived substantial benefits by being inside the European Union. We do not start from a position of
economic collapse, and our unemployment rate is already low compared with that in many other
OECD countries. We do not have large numbers of unemployed people with appropriate skills and
attitudes waiting to leap into the workforce. We are not part of a very large market of 300 million
people. To have any chance of doubling our per capita growth rate we will need to see quite radical
changes in people's attitude and behaviour, and quite radical changes in public policy to encourage
those changes in attitude and behaviour. Minor changes at the margin simply won't do the trick.
Even major changes might not do the trick, since we seem to have some deeply-engrained cultural
characteristics which are not conducive to rapid growth - surprisingly widespread disdain for
commercial success, no strong passion for education, and a tendency to look for immediate
gratification (as reflected in our very low savings rate and strong interest in leisure) - and it usually
takes years, and perhaps generations, to change such cultural characteristics.
Indeed, this attitudinal change is probably the most important single need if we are to radically
increase our per capita growth rate. We need to want faster growth or, in personal terms, higher
income. This may sound like a rather odd comment, but many of us know people who, having started
a successful business, were happy to sell out of it for a few million dollars because that was more than
sufficient to buy a nice house, a bach by the sea, a boat, and a decent car. And let's not criticise those
who make that choice - after all, economic growth is a means to an end, and not an end in itself - but
recall that retiring to enjoy the good life is not usually the attitude of entrepreneurs in the United States
or other more successful economies.
But let's assume that most New Zealanders do in fact want to see faster economic growth, so that our
more able children will not feel obliged to leave as soon as they can afford a one-way air-ticket to
Sydney or London, so that we can keep and attract able people without creating Latin-American-style
income disparities, and so that we can afford the health-care and quality of life which our Australian
cousins will increasingly enjoy.
What might be required?
Increasing per capita GDP is about increasing the proportion of the population who are contributing to
the production of goods and services in the market economy, and about increasing the productivity of
those people.
What scope is there for increasing the proportion of the population who are contributing to the
production of goods and services in the market economy? Not very large. Certainly, not nearly as
large as was the case in Ireland and Finland when they began their period of rapid growth, with very
high levels of unemployment. Participation in the workforce by those between 15 and 64 is currently
around 66 per cent in New Zealand, not far below participation rates in Singapore and Ireland (68 to
7
Scobie and Mawson, op. cit.
70 per cent) currently, and unemployment, while higher than anybody feels comfortable with, is
already approaching levels which are relatively low by OECD standards.
Getting still more people into employment in the market economy may involve making some difficult
social and political trade-offs. For example, does the present welfare system - with largely unrestricted
access to benefits of indefinite duration, and with a very high effective marginal tax rate for those
moving from dependence on such benefits into paid employment - provide appropriate incentives to
acquire education and skills and to find employment?
Nobody that I have ever met in New Zealand wants to deny those who are temporarily down on their
luck sufficient income support to enable them to get back on their feet. In that respect, we are not
willing to pay the price which Singapore paid to achieve very high growth, a society almost devoid of
taxpayer-funded income support. But increasingly it is recognised that we will not achieve a radical
improvement in our economic growth rate while we have to provide income support to more than
350,000 people of working age - 60,000 more than when unemployment reached its
post-World-War-II peak in the early nineties - to say nothing of the 450,000 people who derive most of
their income from New Zealand Superannuation.
This is partly because of the huge fiscal costs of these transfer payments - amounting to an estimated
$13 billion this financial year, or some 11 per cent of estimated GDP (both figures include the fiscal
cost of New Zealand Superannuation). This cost substantially constrains the government from
devoting more resources to education, law and order, research and development, and tax reduction.
Indeed, it is probably fair to say that there is no other part of the government budget which can provide
resources for these things. Certainly, it is hard to see scope for big reductions in the health or
education budgets, the only other really major categories of government spending.
But I mention these transfer payments and the very high effective tax rates faced by those trying to get
off them at this point not simply to draw attention to the fiscal costs but mainly because these
payments have an influence on the numbers of those contributing to the production of goods and
services in the market economy.
Are there ways in which we can change the incentives facing people now receiving such transfer
payments? There are clearly a number of alternatives to the present way in which we provide income
support short of adopting a cold-turkey Singaporean approach, and there is no single "right" way of
doing it. Could we, for example, drop all benefits to the able-bodied and scrap the statutory minimum
wage, so that pay rates could fall to the point where the labour market fully clears, but simultaneously
introduce a form of negative income tax to sustain total incomes at a socially-acceptable level? Could
we introduce some kind of life-time limit on the period during which an able-bodied individual could
claim benefits from the state? Could we, perhaps, gradually raise the age at which people become
eligible for New Zealand Superannuation, reflecting the gradual increase in life expectancy and
improved health among the elderly? One of my colleagues has suggested the idea of abolishing the
unemployment benefit but introducing some kind of "employer of last resort" system, perhaps run by
local authorities with support from central government, under which every local authority would be
required to offer daily employment to anybody and everybody who asked for it. Clearly, there would be
huge benefits not just to economic growth but also to social cohesion if we were able to achieve a
radical reduction in the number of those dependent on income transfers from the state.
Increasing productivity
But even more important than increasing the proportion of the population who produce goods and
services in the market economy is increasing productivity. Ultimately, it is productivity - output per
person - which mainly determines the standard of living, and it is clear that increasing GDP per capita
by 3.6 per cent per annum means at least trebling the rate of productivity improvement which New
Zealand has achieved in recent years (not much above 1 per cent).
How might we move in this direction? Before attempting to answer that question, let me stress that,
while the Reserve Bank makes a useful contribution to the economy's performance, it can never make
the difference between 1.7 per cent per capita growth and 3.6 per cent per capita growth. The
Reserve Bank can and does operate monetary policy to maintain stability in the general level of prices,
and that is a necessary condition if New Zealand is to maximise its growth, but it won't produce a
doubling of our growth rate. The Reserve Bank can and does promote the stability of the financial
sector, and that too is a vital contribution to maximising New Zealand's growth, but it won't produce a
doubling of our growth rate.
No, most of what now needs to change if we want to double our growth rate involves policies and
behaviour which fall well outside the Reserve Bank's areas of responsibility, as I have already noted.
The second point I want to make is that it is important as we talk about all the opportunities afforded
by the "knowledge economy" not to forget that for many years to come most New Zealanders will not
be employed in software companies or biotechnology research firms. They will be employed in "the old
economy". But that does not mean that they will be employed in industries which lack scope for
improving productivity. On the contrary: it is useful to recall that over the last 15 years, with average
productivity improving by little more than 1 per cent per annum, productivity in agriculture improved by
almost 4 per cent per annum - a rate of productivity growth which, if achieved across the economy as
a whole and sustained for a decade, would easily see our per capita incomes reach the OECD median
within a decade.
Improving productivity involves a whole host of things which can be loosely grouped under three
headings - improving human capital, improving physical capital, and improving technology.
Improving human capital
To improve our human capital, we urgently (I almost said "desperately") need to improve the quality of
our education system. And I say "improve the quality of our education system" rather than increase the
resources devoted to our education system. We might need to increase the resources devoted to
education, but we already spend a higher fraction of our national income on government support for
education than the great majority of other developed countries. Despite this, international surveys of
educational achievement suggest that we are not getting educational outcomes consistent with this
high level of expenditure.
It must be a source of grave concern that so many of the people coming out of our high schools have
only the most rudimentary idea of how to write grammatical English; and that while Singapore, South
Korea, Taiwan, and Hong Kong occupied the top four places for mathematics in the Third International
Maths and Science Study, New Zealand ranked only 21st (out of the 38 countries in the study).8 It can
not be good for our economic growth, or for the employment prospects of many of our young people,
that, according to an OECD report released in April 1998, nearly half of the workforce in New Zealand
can not read well enough to work effectively in the modern economy.9 It must be a matter for particular
concern that 70 per cent of Maori New Zealanders, and about three-quarters of Pacific Island New
Zealanders, are functioning "below the level of competence in literacy required to effectively meet the
demands of everyday life".10
The University of Auckland is one of the two main hosts of this conference, so you would be surprised
and disappointed if I did not stress the importance of doing more to improve the quality of tertiary
education in New Zealand. And clearly, I believe that that is vitally important, though whether that
means even more public sector resources going into the tertiary sector or other kinds of reform I am
not in a good position to judge.
But I strongly suspect that improvements in pre-school, primary, and secondary education are even
more important for our long term growth, and for the long-term social cohesion of our society, than are
improvements in tertiary education. Indeed, it may well be that improvements in these pre-tertiary
areas are the fundamental prerequisites for improving the quality of tertiary education in New Zealand.
But although there can be little doubt that improving our human capital by securing improved
educational outcomes would contribute to New Zealand's long-term growth, the higher-growth
dividend from improved educational outcomes would almost certainly accrue well into the future, not
within the next few years, or possibly even within the next decade. Indeed, it is sobering to reflect that
some of the countries which have had particularly good economic growth in recent years, such as
Australia and the United States, have literacy levels not significantly higher than New Zealand's. It may
well be that better educational outcomes would be more important in ensuring that more of our people
have access to higher paid jobs, and thus in assisting social harmony, than in assisting economic
growth directly.
Improving physical capital
One obvious way of increasing the output per person employed is to give people more physical capital
to work with. (And by "physical capital" I mean not just plant and machinery but also roads and other
infrastructure.) Of course, more physical capital is of no use whatsoever if it is the wrong sort of
physical capital, and that points towards the huge importance of "getting the signals right" - by which I
mean ensuring that investment takes place in areas which maximise the goods and services produced
by that capital. As the Japanese have discovered in recent years, all the investment in the world will
not encourage growth if the extra capital produces few of the goods and services which people
actually want. Happily, as I have mentioned, we now have most of the signals right - businesses are
no longer encouraged by high levels of protection to invest in industries where New Zealand will never
be internationally competitive; the financial sector is free of the regulation (and the irrational
exuberance which immediately followed the removal of that regulation) which used to distort the
allocation of resources; and the misallocation caused by the interaction of inflation and the tax system
is also now a thing of the past.
Under these circumstances, what might we do to encourage investment in more physical capital?
At very least, we need to seek and destroy those obstacles to investment which are within our own
control. There is little doubt, for example, that businesses, especially small and medium-sized
businesses, find the compliance costs of many public sector rules and regulations a significant
obstacle to more investment. The recent report of the Ministerial Panel on Business Compliance Costs
highlighted these issues, and noted that complying with a multiplicity of rules and regulations stifled
the ability of businesses "to expand, innovate and compete". Businesses saw the biggest single
problem as the way in which the Resource Management Act was being implemented, and described
dealing with that legislation as being "cumbersome, costly and complex". It should not require two
years to get all the approvals needed to set up an early child-care facility catering for only 30 children,
or ministerial intervention to cut through the red-tape involved in setting up a boat-building yard. Most
of us know similar horror stories.
We may also need to look at whether there are deficiencies in our national infrastructure which are
acting as a deterrent to investment. Do we, for example, need to improve the transport infrastructure in
some parts of the country - perhaps in some of the areas where forests are reaching maturity by
upgrading roading systems, perhaps in Auckland by completing the originally-planned motorway
system and by introducing more appropriate congestion charges?
Could we do more to encourage investment by expanding the size of the market? If the small size and
isolation of the New Zealand market discourage investment in New Zealand, should we be doing more
to encourage those with the skills and attitudes which can assist our growth to immigrate to New
Zealand? Should we more vigorously seek economic integration into a much larger market? We have
made a great deal of progress through our free trade arrangement with Australia, and the bilateral free
trade arrangements with Singapore, and potentially Hong Kong and other countries in the region, are
greatly to be welcomed. But if we really want to encourage investment in New Zealand for a much
larger market, perhaps we should be devoting every effort to negotiating a free trade arrangement and
greater economic integration with the United States also. There can be little doubt that one of the
major reasons for the recent economic success of both Ireland and Finland is their membership of the
European Union, as I have mentioned. A closer economic integration with the United States would not
make New Zealand any closer physically to California, but it would carry potentially enormous
economic benefits.
It is in this context that the time may have arrived when we need to give serious consideration to the
pros and cons of alternative currency arrangements. Far be it from me to advocate the abolition of the
Reserve Bank of New Zealand and, as I have said on a previous occasion, any decision to abandon
the New Zealand dollar in favour of some other currency is finally a political decision, not a decision for
central bankers. And frankly, I do not know whether there would be net economic benefit in adopting
some other currency arrangement, but if we are to have a no-holds-barred discussion on how to
improve New Zealand's economic performance, one of the issues which should be looked at is this.
Another matter relevant to how we might encourage more investment in physical capital is the tax
regime. Do we need a substantial change in the tax structure to encourage investment in New
Zealand by New Zealanders, by immigrants, and by foreign companies? And if so, what might that
change look like? This isn't the place to go into detail, but it would probably involve a significant
reduction in the corporate tax rate (it is disturbing that New Zealand's corporate tax rate is now the
highest in the Asian region). The rate of company tax is rarely the only factor determining the location
of a new investment, and indeed it is not often even the dominant factor. But it is a relevant factor, and
is one of the issues to look at if we are serious about encouraging more investment in New Zealand.
Improving technology
And finally, how might we increase the growth rate of productivity, or of GDP per capita, by further
increasing the rate at which we adopt new technology from abroad, and develop new technology of
our own? Roger Ferguson, Vice Chairman of the Federal Reserve Board, cites research done by Fed
economists which suggests that "the consolidated influences of information technology investments
account for about two-thirds of the acceleration in (US) productivity since 1995".11 And there can be
little doubt that a radical improvement in New Zealand's productivity growth rate will require a more
rapid adoption of new technology than has been the case in recent y