How do you get productivity up?

The credit card is full. You can’t load any more debt on the house because its value has stopped rising. How now to keep the good times rolling?

That is the crunch economic question for the government. The country doesn’t get richer long-term on household debt or by redividing the cake in the workplace. Those are one-offs.

The answer is to lift productivity: produce more with no more sweat. And lift it faster than over the past 10 years, which is no easy ask.

Speeding up productivity growth, Michael Cullen said yesterday at a Treasury symposium on the topic, “is very close to my heart”.

Close enough to have put increasing effort into research, the universities, skilling, infrastructure development and trade agreements. But not to reduce the size of government and cut taxes, which is also important, economists say. That is Cullen’s political buffer stop.

After the 1980s-early 1990s economic reforms productivity growth — the speed of lifting productivity — doubled. That reversed the slide down the OECD GDP per capita ladder. This economy outperformed most in the OECD over the past 10 years.

The result is more health care, more resources for education, higher wages for those in work and more work available than would have been the case if the old pre-reform productivity growth rate had persisted.

Some individuals are worse off than they would have been without the reforms and there are hangovers from the social tensions the reforms generated. But the country as a whole is better off materially. If we had still been trundling along at the old productivity growth rate, that would have generated social tensions.

But if we are to catch up with Australians’ material standard of living or climb back into the top half of the OECD wealth rankings, we will have to lift productivity growth again — by about as much as we did in the 1990s.

That challenge has been masked from the public for the past few years by the mini-boom on the back of strong commodity prices and a period of a very stimulatory low dollar. Now it is back to the hard questions.

The government is on a hunt for ideas. Besides the Treasury symposium this week, there was a Labour Department workshop on workplace productivity in May and a working group is due to report this week.

Not least Cullen needs ideas of how to get the public to buy into the value of economic growth and the productivity improvements needed to achieve it. The reforms numbed the public’s mind: many equate “economic growth” with fattening cats who are already fat and “productivity” with losing your job.

So, as he said yesterday, Cullen knows he has an educational challenge: to persuade people productivity growth is good for them, that it is not just cost cutting, the obsession of the 1980s and 1990s but growing revenue in ways that do not mean longer hours for no more pay.

One way into people’s preconceptions is through the workplace. The working group has come up with practical examples of success from which other workplaces might learn. This is both in workplace practices and also in incremental improvements devised by managers and staff to push firms nearer to best practice.

“There is a tremendously important role for benchmarking,” keynote speaker at the Treasury forum yesterday, Professor Erwin Diewert of the University of British Columbia. “Try to figure out which enterprises are the most efficient so that less efficient enterprises can look at what they are doing and emulate them.”

In this unions have a part. They are reaching the end of the legislative road under this government in the Employment Relations Law Reform Bill and Labour Minister Paul Swain is looking to soften even that bill. From here on real wage rises will depend broadly on higher productivity.

For the government’s role Diewert laid the ground by scanning past reports and theories and laying out six factors, with their implications for the size of government.

He cited a 2001 report on the government’s role by Winton Bates, which identified the main determinants of economic output growth as the growth of inputs (capital and labour) and the growth of total factor productivity, which Diewert characterised as the amount by which output growth exceeds input growth.

Other influences on growth Bates identified were: resource discoveries and exploitation, notably in agriculture, forests, oil and gas and maybe fish; the terms of trade (which have moved in our favour over the past decade); immigration (slowing after a spurt) and population growth; savings (poor); foreign investment (welcome but slow); skill (work in progress); entrepreneurial capacity (allegedly high); and competition and efficient markets (diminished by re-regulation since 1999). (The comments in parentheses are mine.)

Then there is innovation which flows from high rates of investment. Innovation is not just high technology. It is, Diewert said, changes in knowledge at all levels — “figuring out better ways of doing things”. Diewert quoted economist Robert Allen: “As long as the rate of investment was high, the rate of experimentation and the discovery of new technical knowledge was also high.”

The Employment Contracts Act, Diewert noted, had greatly increased labour participation by putting downward pressure on wages. In effect that substituted labour for capital. Former Labour Minister Margaret Wilson always argued that her workplace law changes were intended to lift productivity — that is, drive firms to substitute capital for labour, to invest more and “deepen” the capital behind each employee.

Economies of scale drive up productivity, Diewert said, but that depends on big markets and big firms. “The smallness of the local market hinders specialisation and resulting increases in efficiency. This point is extremely important for a small, isolated economy like New Zealand.”

So, grow the market, he said, through: transport and infrastructure; population growth; reducing foreign trade barriers; reducing taxes on commodities, labour and capital (“high taxes inhibit the formation of specialised markets”); personal security and property rights; advertising improvements and improvements in communications; and growth of physical and human capital.

In a message to those who bemoan factory closures, Diewert quoted other research showing that new establishments coming into a market “tend to have higher productivity than exiting establishments”. Sure, people lose their jobs but other people (or the same people) get higher-paying jobs and so over time incomes as a whole rise.

Diewert’s final causal factor was macroeconomic stability: stable fiscal policy (yes), stable exchange rates (definitely not), stable prices (yes) and stable interest rates (more than in the past). While stability did not drive higher rates of growth, instability “often has strong negative effects on total factor productivity growth”.

So what are the implications for the government? Lower taxes and smaller government is one, a theme several presenters hummed.

Diewert distilled six drivers of faster productivity and the implications for the size of government.

* Rapid investment growth. “Low rates of business income taxation are the key. That leads to an argument for smaller government.”

* Rapid growth investments in education, training and human capital. Low tax on labour encourages individuals to make that investment (implying smaller government). �There is also an argument for the government to subsidise these investments.� That implies a larger government.

* Rapid growth in capital and labour inputs. Low tax encourages both, implying smaller government. The government can also boost immigration and encourage and even subsidise exploitation of natural resources. That implies bigger government.

* Increased specialisation and growth of the market. Diewert said lower taxes would favour specialisation. Free trade agreements expand markets.

* Improvements in the functioning of markets. Diewert listed: personal security, property rights, reducing trade barriers, telecommunications improvements and improvements in transportation and infrastructure. These imply an active and larger government.

* Access to knowledge about the development of new commodities and processes. Some subsidisation of universities � larger government — would help.

How is the government doing? It is increasing investments in education but without the flexibility that might get more value for money. It is going after desirable immigrants. It is pursuing free trade agreements. It has pushed telecommunications improvements and is now aggressively funding roads, though its rules limit the scope for public-private partnerships. It is building centres of excellence in universities.

But, judging from yesterday’s presentations, only half the story. Cullen is holding taxes up, not down. And that won’t change.