Can New Zealand match Australian incomes?

Two weeks ago in Can New Zealand catch up to Australia?, Winton Bates looked at the discussion taking place in New Zealand on ways to bridge the economic gap between Australia and New Zealand. Winton summarised the background this way:

Incomes of New Zealanders have generally risen less rapidly than those of Australians over the last 40 years, resulting in a gap between average incomes of around 35 percent in recent years. After the 2008 election, the NZ government committed to closing this income gap by 2025.

I expressed some reservations about the discussion and promised to write a response. Time limitations have stopped me doing the investigation I wanted including properly reading the NZ material, but I thought that I should make a comment now to provide some base for further thought.

I have expressed reservation before about the value of policies based on national averages. An Australian example is bridging the gap, the attempt to bring Australia's indigenous peoples up the national average on certain key indicators. This seems bound to fail.

The reason for this is that the indicators are averages that conceal variation. Many of Australia's Aboriginal people live in regional areas that have lower incomes and fewer services than other parts of the country for the population as a whole. Even if you bring Aboriginal people up to the average holding in the areas in which they live, there will still be a statistical gap in terms of the national average.

The point of this example is that you have to drill down below the statistical average to understand just what it means before you can draw sensible conclusions. I haven't had time to check the statistics, but let me give you two impressions to illustrate my point.

First, it is not clear to me that all New Zealanders are worse off in real terms as compared to all Australians. Visiting the country over the years, I have often felt that the New Zealand standard of living was higher than that of Australia so far as the ordinary New Zealander was concerned, comparing like with like.

Secondly and linked, if you compare New Zealand not with the Australian national average, but with the big regional economies in Australia, you will get a different impression again. I write a lot on regional economic and development issues because it is personally important to me. If you compare New Zealand not with the Australian average but with, say, Northern NSW, New Zealand has out-performed the North in economic terms.

So we need to be careful in making comparisons.

I also think that it is helpful to adopt a longer time perspective.

Back in November 2006 in Changes in Public Administration - the New Zealand Model, I talked about the challenges New Zealand faced in economic terms in the 1980s.

New Zealand exports of primary products especially to a protected British marketplace had provided a solid international income stream. This allowed New Zealand Governments to follow a domestic protectionist policy. This imposed costs on the export sector, but also provided a range of domestic jobs, especially in manufacturing. To the degree that New Zealand did export manufactures, they went to an Australian market where the country enjoyed preferential access.

All this collapsed like a house of cards as a consequence of a sharp decline in demand for New Zealand's primary exports. The end result was Rogernomics and a savage restructuring of the New Zealand economy, along with equally savage cuts in Government services. By 1989, many New Zealanders were in a state of despair, yet the economy was already starting to turn round.

I make this point because I think that New Zealand has actually not done badly in economic terms when you compare the position in 1989 and that holding today. I haven't compared the New Zealand and Australian averages for 1989 and today, but certainly in 1989 all the measures I saw suggested that there had been a sharp increase in the economic gap between New Zealand and Australia.

In 1991 what was called the Porter Project reported. This project was named after the US management writer Michael Porter who had become well known for his writing on competitive advantage, including his influential 1990 book on the Competitive Advantage of Nations. Porter himself was a part author of the report.

The project attempted to report on what needed to be done to turn New Zealand's economic position around. It provided an incisive analysis on the causes of New Zealand's economic problems. However, its suggestions as to solutions were noticeably weak. It is very hard to define a pro-active development role for Government when your starting premise has ruled such a role out!

The political costs of Rogernomics proved too high, and successive Governments have wound elements of the New Zealand model back. Whether or not this was a good thing is open to debate. However, it did leave something of a policy vacuum.

In many ways, Australia and New Zealand followed very similar policies over the first seven decades of the twentieth century.

Both countries followed a policy that combined a globally traded sector on one side with a protected domestic industrial base on the other. Both countries did some very silly things in policy terms.

Starting with an Australian example, when I first joined the Australian Treasury I was involved in the enforcement of what, in retrospect, must be one of the dumbest policies ever introduced. The economic argument went this way.

Australia is short of capital to fund domestic development. We must conserve what capital we have. To this end, we won't allow the export of capital by Australian businesses. Further, we will restrict foreign owned firms borrowing in the Australian marketplace, forcing them to import more capital.

The practical effect was that we blocked Australian firms investing overseas at just the time that industry was starting to globalise. In 1968 as a young official, one of the cases that crossed my desk was the 1968 acquisition by Rupert Murdoch of London's News of the World. As I remember it, the only reason why this one got through is that Rupert Murdoch managed to arrange overseas borrowings so that there was no net exchange outflow. On such small things do business empires depend!

New Zealand policy was, if anything, a little sillier. In 1970 I was visiting Auckland and ended up at an anti Spiro Agnew party; the American VP was in town to much protest. There a New Zealand parliamentarian who later became a Labour Party  minister, carefully explained to me that New Zealand must maintain import quotas and exchange control because otherwise people might choose to buy cars instead of funding hospitals. I was gob smacked. I had never heard anything sillier in my life.         

If both countries followed similar and sometimes very silly policies, there was one difference between them that gave Australia a greater measure of protection, one that is relevant today. Australia simply had a larger and more diversified economic base.

Like New Zealand, Australia's exports of key agricultural products declined. Like New Zealand, Australia was moving away from a closed to a more open economy. However, unlike New Zealand, Australia had other exports and especially mineral products that gave it a greater buffer.

As the New Zealand economy entered the intensive care unit for radical surgery, Australian was experiencing significant economic growth. This allowed the Australian Government to proceed with fundamental economic change in a more controlled way. This was not necessarily better policy, although there was some of that. Most of all, it was just economic luck!

Today, Australia retains a more diversified economy, although there has been some hollowing out because of the mining boom. That gives this country an advantage. However, here I want to introduce another variable, head office jobs.

By head office jobs, I simply mean positions at organisational headquarters. These tend to be better paid and have more power. Further, higher paid service jobs clump around head office locations. 

It is not clear to me that New Zealand has fewer head office positions than Australia relative to the size of the population. What is, I think, clear is that those positions are less well paid simply because New Zealand organisations are smaller; there is a clear correlations between pay for equivalent positions and organisational size. There is an equally clear correlation between professional fees and the size of clients. Less certainly, I think New Zealand has fewer wealthy private business people relative to its size.

In combination, this means that the top of the New Zealand income pyramid is lower than the Australian equivalent. This affects average incomes.   

Statistical Interlude

In a comment, Winton kindly pointed to some stats.

The following table derived from the ABS shows gross household income per capita for the current Australian states and territories in 2009-2010 ranked by size. There is a 66% variation between top and bottom. Even if the ACT is excluded as a special case, there is still a variation of 19% between top and bottom. 

State/Territory	$	Variance against average %
ACT	76,815	+57.49
WA	53,899	+10.15
NT	50,303	+3.13
NSW	49,648	+1.79
Australia	48,774	0.00
Victoria	47,028	-1.73
Queensland	45,308	-7.11
South Australia	45,208	-7.31
Tasmania	44,306	-9.16

The ABS suggests that a better measure is gross household disposable income per capita. The following tables shows the numbers here. This shifts rankings around at the bottom. However, the difference between the variance against the average at top and bottom has actually increased. If the ACT is again excluded, it is about the same as before. 

State/Territory	$	Variance against average %
ACT	63,783	+69.12
WA	42,014	+11.40
NT	41,777	+10.77
NSW	37,847	+0.35
Australia	37,714	0.00
Victoria	36,975	-1.96
Tasmania	36,102	-4.27
South Australia	35,480	-5,92
Queensland	34,949	-7.33

My aim in providing this information is simply to re-emphasise the dangers of using averages for planning purposes or to set targets. You need to know what the averages mean, to drill down to the reasons for difference.

Conclusions

I have only browsed the latest New Zealand Task Force report. For that reason, I must be cautious in my analysis.

This  chart forms the centre piece of the latest report and shows movement in Australian and New Zealand per capita incomes relative to the OECD average.

You can see the precipitate decline from the early eighties associated not just with international conditions, but also the pain of restructuring before a return kicked in. Drawing from this graphic, the Task Force states:

There are two reasons why closing the income gap with Australia matters. First, our real incomes affect our material standard of living. People in Australia and most other advanced countries can afford better houses, better healthcare, higher levels of funding for education and more expensive investments in environmental protection.

Second, we need to ensure that there are opportunities for our people to realise their potential in New Zealand. The income gap will encourage more New Zealanders to join the hundreds of thousands who have already emigrated, mostly to Australia. Based on current projections of the income gap and its impact on emigration, a net 412,000 New Zealanders could leave New Zealand over the next 15 years. That is almost one in every ten people living in New Zealand today, and equivalent to the entire population of the Wellington region. The skills and enterprise of these emigrants would be a huge loss to the New Zealand economy, especially given that taxpayers would have spent perhaps $30 billion educating and providing medical care for them. Immigrants may reduce the impact, but they are not a perfect substitute for the rapid loss of so many people born and raised in New Zealand.

To catch Australia over the next 15 years, New Zealand's income is likely to need to grow at slightly more than two percent per capita faster than Australia on average. That is a formidable challenge, which requires policies that are much superior to those in Australia in their focus on growth.

The report then proposes a series of initiatives that essentially centre on conventional micro-economic reform.

In responding to Winton's discussion, my first point focused on the dangers of using raw averages, on the need to drill down to understand variance, what it all meant. In doing so, I pointed to some of the reasons that I thought underlay the average income gap, including the smaller number of head office jobs. I also made the point that the use of averages concealed the fact that many Australians were worse of than their New Zealand equivalents.

As a person who thinks of himself sometimes as a Kiwi, I have absolutely no problems with the aim of increasing New Zealand incomes. However, I also think that a simple structural analysis shows that the target of matching Australian average incomes in real terms will be hard to achieve. There is also no analysis of the costs involved. By this, I mean simply things like higher rents, a greater dispersion in income between top and bottom.

Will the proposals in the Task Force Report achieve the goal? I doubt it.

Good governance, micro-economic reform, is a necessary but not sufficient condition. They will improve New Zealand's competitive position relative to Australia, but are unlikely to overcome problems associated with location and resource base.

I suspect that to do this, New Zealand needs to move outside the frame set by current thinking. However, I am going to reserve this for another post. 

Postscript

In a comment, Randy wrote

Huh. Is it true that, as this source suggestions, New Zealand has a higher Gini index (i.e. more inequality) than Australia?

Winton Bates also raised the Gini issue. I responded to Randy that intuitively it was quite possible given the size of the Pacific Island and Maori communities.

However, the reason why I am including Randy's comment is that the link he provides is quite fun.