Lifting productivity is the key to business success

Lifting productivity is the key to a successful business community and a more prosperous New Zealand. But moving from an economy based on low-cost labour and long working hours to one driven by productivity improvements is difficult and may entail some short-term pain for long-term gain, writes Paul Conway.

A growing high-tech sector is performing well in New Zealand, fuelled with a “born digital, born global” mind-set. For other businesses, new technologies are presenting exciting opportunities and challenges. But while some are making the most of these opportunities, they are in the minority, and the productivity performance of businesses in New Zealand remains poor overall. 

Putting productivity first is an important key to business success, but why should businesses care about productivity? Because lifting productivity is a win-win situation. It creates a combination of higher profits for shareholders, higher wages for management and workers and lower prices for consumers.

So why do so many New Zealand businesses have low productivity? 

First, and despite what we like to tell ourselves, New Zealand is not particularly well connected into the global economy. For example, the intensity of international trade is low and falling in New Zealand and foreign direct investment into the economy has gone sideways for years.

Being a long way from large international markets is the obvious explanation for weak international connection – distance from large global markets works against cross-country trade and investment flows, with negative impacts on an economy’s productivity performance.

It is also the case that some of the large foreign-owned firms operating in New Zealand are more interested in gaining a share of the domestic market rather than establishing a base for international expansion. For example, it is difficult to envisage the boards of New Zealand’s foreign-owned banks embarking on a substantial international growth strategy out of their New Zealand entities.

Weak connection to global markets slows the diffusion of new and productivity-enhancing ideas and technologies into the New Zealand economy. There is good evidence that leading New Zealand firms are generally not making the most of new ideas and technologies to the same extent as leading firms in many other OECD economies. And while foreign-owned firms operating in New Zealand tend to be relatively productive, there is little evidence that local businesses learn and improve their productivity as a result of engaging with foreign-owned firms. 

With domestic markets often small, insular and not particularly competitive, a lack of connection to global markets also means it can be difficult for productive firms to grow and expand. 

At the other end of the spectrum, unproductive firms often do not feel the heat of competition and exit. So many of these businesses survive by essentially doing the same thing year-after-year. While that might feel like an easy life, it is not exactly a recipe for lifting productivity and all the benefits that brings.

The second reason for low productivity is that many New Zealand businesses do not invest much in the capital assets that are essential in lifting productivity. While the labour market has grown rapidly over recent decades, business investment has lagged. So many firms are more inclined to add or remove workers as a low-risk strategy in the face of small markets rather than take the plunge and invest in capital. But done well, investing in capital is likely to yield higher productivity and profitability.

One reason for weak investment is that New Zealand firms face comparatively high borrowing costs, for reasons that are not well understood. Although interest rates are currently low everywhere, they are usually higher in New Zealand than on average across the OECD. In contrast, wages are relatively low in New Zealand, encouraging a “capital-shallow” economy. High inflows of low-skilled migrants may also supress wage growth in parts of the economy, further encouraging firms to run lean on capital.

The governance structures of some of New Zealand’s largest firms may also be part of the reason for weak investment. 

Amongst the $1 billion turnover per annum group of firms is a prevalence of farmer-owned cooperatives and partly-privatised state-owned enterprises. A common factor across these firms is a reluctance to provide capital for growth and a strong aversion to risk, especially associated with expansion into overseas markets.

The third broad reason for low productivity is that New Zealand firms have been slow to invest in various forms of intangible assets, such as knowledge and management capability. 

Most obviously, investment in R&D is low. R&D and innovation are not only important for leading firms operating at the technological frontier. Relatively less productive firms also need to do R&D if they are to successfully adopt new technology, adapt it to their needs and catch up to leading firms.

Successfully commercialising new ideas is all about translating knowledge into growth. This requires the right combination of organisational routines and processes aimed at acquiring and transforming new knowledge to grow and compete in markets. This can be a daunting managerial challenge, particularly for firms with a large existing asset base and workforce with a particular set of skills configured to work in a particular way. 

While some New Zealand firms are managed as well as any in the world, the data shows that there is a substantial tail of mediocre and poorly-managed firms. If these firms are slow to learn, then new strategies or technology designed to lift productivity will have only limited impact. To lift productivity, working on the business is just as important as developing new and improved products. 

It’s time for New Zealand businesses to step up to the productivity challenge. With rapid technological change and globalisation putting a premium on skills, flexibility, creativity and openness, businesses need to learn how to move quickly to spot and exploit opportunities early. 

To help Kiwi businesses find practical ways to improve their performance, the Government has recently launched a Business Performance Panel of experts, including the Productivity Commission, from New Zealand and across the world. Aimed at small and medium sized businesses, these experts have created resources on management, leadership and strategic finance, with more in the pipeline. The idea is to help businesses find practical ways to improve their performance and build happy, healthy and productive teams. You can find out more at business.govt.nz.

Lifting productivity is the key to a successful business community and a more prosperous New Zealand. But it is easier said than done and moving from an economy based on low-cost labour and working long hours to one driven by productivity improvements is difficult and may entail some short-term pain for long-term gain. 

But new technology and changes in the global trading environment are coming, ready or not. Now is the time to embrace these opportunities and make the transition to a more successful, productive economy. Will your business step up to the productivity challenge?  

 

Paul Conway is the director of economics & research at the New Zealand Productivity Commission, an independent Crown entity that completes indepth inquiry reports on topics selected by the Government, carries out productivity related research and promotes understanding of productivity issues.
See www.productivity.govt.nz 

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