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