New Zealand’s productivity paradox: Part V

By Shaun Hendy 09/05/2010 7


ResearchBlogging.orgI am getting towards the end of my discussion of Philip McCann’s paper, ’Economic geography, globalisation and New Zealand’s productivity paradox’ [1].

In my last post on this topic, I discussed the importance of agglomeration economies for knowledge based production.  Agglomeration in the modern economy is thought to maximise the efficiency and effectiveness of the knowledge exchanges required for the production processes of high value-added goods and services.  In other words, there is a spatial transaction cost for knowledge intensive activities.  This leads to localisation of such activities, giving regions like Silicon Valley, and large cities like Sydney or Melbourne, productivity advantages that become ’locked in’ as the scale of such activities grows.

With this post, I want to look at the impact of agglomeration economies in the New Zealand context.  Such effects are particularly evident in the relationship between the Australian and New Zealand economies.  Economists have developed models of what happens when a small economy and a large economy integrate, as New Zealand and Australia have over the last 25 years [1]:

’… Australia, exhibits both relatively larger agglomeration economies and also a larger home-market effect than the relatively smaller economy, New Zealand.  As the economies become increasingly open to each other with both trade barriers and transport costs falling, the greater industrial diversity of the larger agglomerations in the larger country provides for a greater variety of employment opportunities for mobile workers and a greater variety of input and output linkages for mobile firms.  The result is that Australia becomes relatively more attractive for both capital and labour than New Zealand.  The increased attractiveness of Australia for capital therefore implies that Australia will increasingly become a more important focus for global and multinational mobile investment than New Zealand.  An obvious manifestation of this would be that Australia would be expected to exhibit relatively higher levels of capital stocks per worker than New Zealand, and also an increasing number of higher-order top-level decision-making and corporate headquarter functions than New Zealand.  Meanwhile, the increased attractiveness of Australia for labour implies higher wages and increased labour migration flows from New Zealand to Australia.  In particular, highly-skilled workers will be particularly increasingly mobile as they seek to take advantage of the wage premia they can command in Australia due to higher capital labour ratios.’

The modern Australasian economy appears to be a text book case of what happens when small meets big.

In my own studies, I have looked at the effect of city size in Australasia on measures of innovation, such as patents per capita and degrees of scientific collaboration.  Sydney and Melbourne both produce more patents per capita than Auckland or Adelaide, and exhibit a higher degree of scientific connectedness.  In fact, both data sets exhibit a clear dependence on city size, which is exactly what one would expect if agglomeration economies were playing a role in innovation.  Furthermore, New Zealand cities perform just like their Australian counterparts if one corrects for city size.  And sure enough, South Australians are worrying about their own productivity paradox.

So I think we can declare the productivity paradox solved [1]:

’The major characteristics of the New Zealand economy, i.e. a small and extremely isolated economy, with small urban centres, and a low degree of export diversity, is a combination of structural characteristics that is not productivity-enhancing in the modern phase of globalisation, relative to other countries in other places.  As such, the observed productivity performance of New Zealand is more or less exactly as expected according to economic geography theory.  Moreover, many other characteristics of the relationship between New Zealand and Australia and between New Zealand’s own regions internally are also largely as predicted by economic geography.’

The question that remains is what can New Zealanders do about the economic situation they find themselves in?  Any economic policy that ignores New Zealand’s economic geography is likely to be of little relevance.  What options does this leave?  In my last post on McCann’s paper, I will discuss some of his policy suggestions and throw in a few of my own.

Part VI

[1] McCann, P. (2009). Economic geography, globalisation and New Zealand’s productivity paradox New Zealand Economic Papers, 43 (3), 279-314 DOI: 10.1080/00779950903308794


7 Responses to “New Zealand’s productivity paradox: Part V”

  • Hi Shaun,

    I enjoyed your discussion of McCann’s paper on New Zealand’s so-called “productivity paradox”. In the end, you sided with McCann and declare the paradox “solved”. I think you are too hasty.

    In the first place, are we really sure there is a paradox? Part II gives McCann’s list of 16 areas in which it is claimed that New Zealand performs well. I would want pretty solid evidence (i) that the items have been measured reliably and without bias, and (ii) that the items are in fact associated with productivity growth and economic growth. Here I was strongly influenced by William Easterly’s article in the 8 October 2009 New York Review of Books, “The Anarchy of Success”. Easterly surveys many attempts by economists to understand economic growth and finds that they generally suffer from confirmation bias (i.e., selective choice of evidence) and from far, far too small and short data sets.

    (Easterly’s article is here

    http://www.nybooks.com/articles/archives/2009/oct/08/the-anarchy-of-success/

    and an open version is here

    http://www.nyu.edu/fas/institute/dri/Easterly/File/NYR_sept09.pdf
    )

    Looking at the list of 16 factors, I see 3 that could plausibly be associated with either high or low growth (low taxes, low social expenditure, and light regulation). For example, low taxes might lead to poorer education and income inequality leading to social problems and decreased social mobility.

    Second, has New Zealand really performed so badly?

    Real GDP growth 1994 Q1 – 2008 Q3 (www.rbnz.govt.nz/keygraphs/Fig2.html)

    NZ: 65%
    US: 59%
    Aus: 73%
    Japan: 20%
    UK: 58%

    That looks just fine to me. Perhaps McCann could explain why, given our economic geography, our economy has outperformed the US and UK? (The time series is too short to say anything definitively, expect perhaps in the case of Japan.)

    Median household income

    US US$50K
    Australia A$67K (PPP US$46K)
    NZ NZ$63K (PPP US$41K)

    Giving the vastly different tax systems and costs of living, I don’t think the difference is anything to get excited about. Quite the opposite: the excessive media attention to Australian vs NZ salaries (“NZ 40% behind” is often seen) is misleading and potentially destructive.

    Third, there are many factors that can plausibly be linked to economic growth. It does not make sense to try and study two of them (e.g. “liberalisation” and “economic geography”) in isolation. How about education and investment, for starters? (Singapore’s “forced investment” model worked for them.)

    That brings me to my fourth point and the crux of the matter, McCann’s argument that there is presently a high spatial transaction cost for knowledge-intensive activities. Do you think he has really established that this is the case? Only two paragraphs consider this and they contain 12 citations to McCann himself and his coauthor Acs – not a good look to me. There are other citations to the OECD (a “rich-country think-tank” in the words of the Economist) and the World Bank. I suspect the studies are mostly qualitative and the risk of confirmation bias extreme (eg studies of Silicon Valley). There are also arguments and evidence on the opposite side, eg cheap electronic communications, the Indian and Irish IT industries.

    I think the most you can say is that it’s an interesting thing to study.

    I look forward to the last part of your survey.

    Cheers,

    Robert

  • Hi Robert, our GDP per capita and household income do look ok, but both reflect our longer working hours and higher labour force utilization – there is a nice discussion of this in the first chapter of Paul Callaghan’s book Wool to Weta. If you look at our GDP per hour worked for instance, you’ll see that we are indeed about 40% behind Australia: (http://www.nzinstitute.org/index.php/nzahead/measures/labour_productivity/). So the paradox involves our poor productivity not our net production.

    Now, as you suggest, one resolution to the paradox could be that economists don’t know what they are talking about, for reasons of conformation bias or otherwise (although I think McCann might argue that merely *most* economists don’t know what they are talking about 😉 ). I would be a bit gentler: many of these things might be necessary for growth, but are perhaps not sufficient.

    However, the role of economic geography in productivity performance does seem to emerge empirically, especially so in productivity data (and in my patent data, which is how I came to meet McCann). There seems to be quite a large literature on this (most of which is not written by McCann e.g. Edward Glaeser at Harvard is one person whose papers I have come across).

    It is another question entirely as to whether the models that economists use to understand the effects of economic geography are on the right track. McCann bases his models of economic geography on the role of spatial transaction costs, which I think comes from Paul Krugman’s work. I’m not sure how well this ideas are grounded in reality, but so far it’s one of only a few conceptual frameworks that I’ve found that seems to provide a basis for understanding my patent data (lack of ideas bias?). So I’m going to argue in part VI that we should take the idea of spatial transaction costs seriously, partly because of the patent and publication data I’ve looked at and partly because of my experience in participating in a delocalised Centre of Research Excellence. I think “cheap electronic communications, the Indian and Irish IT industries” are things we definitely need to look at.

  • Thanks for that Shaun.

    I read the report from the NZ Institute that you cited. On balance I will keep my sceptical position (while still trying to understand the issues behind productivity). To pick just two of the NZI’s 16 factors,

    (i) “Assault mortality” – I got so sick of the NZ media’s excessive attention to murders a while ago that I looked up our murder rate. The wikipedia entry on “Intentional homicide” rates (which is a slightly different thing, as I understand NZ adopts a particular broad definition of homicide) gives the mean rate per 100,000 since 1990 as

    England/Wales: 1.33 +/- 0.1
    Australia: 1.49 +/- 0.2
    NZ: 1.61 +/- 0.26

    the difference being not statistically significant. The NZI has our assault mortality rate more than 4x the UK and nearly 2x Australia! Something is fishy with the data.

    (ii) GDP/capita – Having read their report, I still think median household income is a more robust measure of economic wellbeing. Even so, most of the OECD countries are somewhat bunched in this measure – the standard deviation is small and NZ is about 0.5 standard deviations below the mean. (I know these aren’t random variables, but it gives some idea of the deviation involved.) Frequent reporting of our OECD “rank” gives a false idea of our actual performance. Italy, Greece, and Spain are just ahead of us in this ranking – we now know all too well what their economic growth has been based on in the past decade. One final point about this ranking – Germany is at 16/28, and yet the German economy and society are often thought to be a star performer in many ways – being until recently the world’s biggest exporter, for example.

    I will have a look at “Wool to Weta”.

    Cheers

    Robert