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Economic Development - A Flutter on the Horses?

How do you pick a winner? Is there a system, or is it just plain luck? Who amongst us would risk other peoples’ money to back the last placed horse in this picture? 

In many ways, “picking winners” has been officially out of fashion since the 1980s, but we all still make choices that effectively pick winners – even if we don’t like to call it that. Whether it was think-big, “catching the knowledge wave”, biotechnology, cycle trails, tourism or minerals- successive governments in New Zealand have all succumbed to picking winners to some extent. And if you’re in the business of an economic development agency, how do you know where to direct your attention? How do you know where the best return is going to be made? Are some industries worthy of more attention than others? And what is the best indicator of likely success?

Is bigger better?

Large industries have often gotten to be that way because of some inherent advantage that they may have. For example, they may be built on some local comparative advantage; the largest industry in the Waikato region, as measured by value-added – is dairy cattle farming. This reflects, among other things, the plentiful supply of suitable land and a moderate climate.

So if, up to this point, the size of an industry reflects such advantages, might we expect that to be a good predictor of future success? Table 1 provides a list of the 20 largest industries in the Waikato region, ranked by their respective total value added.

Collectively, these 20 industries make up about two-thirds of Waikato gross domestic product. But this is certainly not the only way to measure the ‘size’ of an industry. Another approach is to look at those that create the most jobs. A list based on this measure would have largely the same industries – sixteen out of the twenty (shown in bold italics in table 1) would appear in both lists. It is worth noting too, that employment is even more concentrated in these industries – with the top 20 making up four out of every five jobs in the region. 

Getting more for less

If you combine the two measures of size, you get value added per worker – a measure of productivity. Given productivity is an important driver of economic wellbeing and potential economic growth (and, indeed, the more efficient use of resources), perhaps we should consider which industries tend to be categorised by higher productivity. The top twenty most productive industries in the Waikato are shown in table 2.

Industries that are reliant on capital rather than labour – such as mining and utilities – will rank highly by this measure. Even so, it is striking that only four of the largest industries in the Waikato appear in the list of the top twenty most productive.

Given that size and productivity seem to be so different, it is worth looking directly at which industries are growing the fastest. These are shown, for the period 2013-18, in table 3.

This list has a lot more in common with the size rankings than with productivity – fifteen of the largest industries also feature in the fastest growing list, but only four of the most productive industries are among the fastest growing.  (Only two industries appear on all 3 lists – property operators & real estate services and dairy product manufacturing).

This suggests that the fastest growing industries in the Waikato are not necessarily being driven by improving productivity. Looking at the industries in Table 3, many of them – such as property-related or service industries are strongly linked to population.

Given the strong growth in population in the Waikato region over the past five years (averaging around 2 percent per annum), it should be no surprise that industries driven by local consumption have also been growing. But, if the economic growth is simply a product of a growing population, are we really any better off? 

Measuring gross domestic product per capita provides a better indication of this and highlights rather modest performance. Figure 1 shows growth in real gdp, averaging 2.3 percent per year over 2013-2018, and growth in real gdp per capita, which has averaged just 0.3 percent per year over the same period. That is, over the last five years, nearly 90 percent of gdp growth in the Waikato has been the result of more people, rather than improving productivity or rising real incomes. 

This issue is not limited to the Waikato – it can be seen across New Zealand as a whole, and indeed, across much of the developed world. 

Out with the old…

In the 1950s, the economist Joseph Schumpeter popularised the concept of ‘creative destruction’, whereby new firms, technologies, processes or industries emerge and replace existing ones. This process, which Schumpeter described as ‘…the essential fact about capitalism…” is happening all the time, with a steady procession of businesses starting up and closing down. In the Waikato region, for example, there is a ‘churn’ of about 10 percent of firms with a moderate increase over time. On average, new business units make up about 10% of the population, while closures are about 9%.

If we look at the industries in the Waikato region from our tables above, we might then expect that those with higher productivity to have more start-ups, while those with lower productivity might have more closures. However, we don’t really see that in the data for the Waikato region, where there is only a weak relationship between productivity and start-up/failure rates.

There are many confounding factors which might influence his analysis – maybe there is indeed a creative destruction process going on, we just can’t see it in this data. Alternatively, it might well be that market and/or institutional arrangements in the Waikato are resulting in a misallocation of resources, with the result that productivity and real economic growth is stagnant. Reading these tea-leaves and deciding (a) whether it matters and (b) what action to take (if any) is not easy. 

Horses for Courses

The moral of the story is that we should be careful about picking winners based on simple high-level indicators of size, past growth performance, or even relative productivity, and we need to carefully judge each prospect on its merits.  We need to make sure that whatever scarce public resources and support we have available, is targeted towards improving productivity and value-add per worker. And even then we should only do this where and when the market is unable to provide the required resources itself. Every time we support/subsidise something which does not achieve this, or we block resources from being used for a more productive use - we prevent creative (destruction) processes from properly working  - and we all become a little bit poorer.

At the very least, it would be useful to consider whether there are barriers to entry for high productivity industries; barriers to exit in low productivity industries; and whether there are institutional arrangements that mask the incentives created by technology and productivity. The late Sir Paul Callaghan noted:

“Our brilliance has been in the "weird stuff" that the big players don't think to exploit. What we are good at is a result of brilliant entrepreneurship and business expertise. Such genius does not follow politicians' prescriptions.”[1]

So, do we really know what the Waikato’s high productivity “weird stuff” actually is? Who are the high productivity, knowledge-based entrepreneurs, firms, sectors and clusters, big or small, which might be worth our attention and indeed our support- if that’s needed?

So, what’s this got to do with horse-racing? 

In case you’re still trying to work out which horse you’d back from the picture at the beginning, here’s a clue: It’s a snap of the 1983 Melbourne Cup, and the caller at that moment was saying “…and last of all, Kiwi”. But Kiwi was, of course, an unconventionally trained stayer – and was just the horse for the long Flemington course that day.

Blair Keenan - Economic Advisor

[1] https://www.nzherald.co.nz/opinion/news/article.cfm?c_id=466&objectid=10755089