In a previous
blog I showed that Kiwis supply more labor (hour worked) than the Australians
and the Americans. The supply of labor depends on the marginal income tax rate,
the share of factors in production, the relative price of leisure, and
consumption-income ratio. In addition to higher supply of labor, estimated
reservation wage has been falling over time, which increased employment and
hours worked. That explains why the average real wages is relatively low in New
Zealand. However, both
the supply and the demand curves, and the elasticities affect wages. Let us
look closer.
The share of
labor is relatively larger in New Zealand.[1]
Here I plot
estimates of the demand for labor for New Zealand and Australia.
The marginal
productivity of labor is on the vertical axis and the change in log working age
population is on the horizontal axis.The Australian and the New Zealand curves look similar. The Australian curve is
slightly flatter. These curves suggest that shifts in the supply of labor
(imagine a positively slopped supply of labor cutting through the dots and
shifting up or down) are not associated with very large changes in the real
wage of labor productivity.
However, there are
two observations in the New Zealand data that are extremely large and I cannot
explain why. One observation is in the 2000 and the other is in 2012. Removing these observations gives us this:
The New Zealand
demand for labor curve becomes infinitely flat. It means that employment is
totally irresponsive and unrelated to wages and marginal productivity. As the
supply of labor shifts up, wages and productivity do not significantly change in New Zealand.
What do we know
about the supply and demand for capital?
New Zealand has
a shallow level of capital stock. Here are the shares for New Zealand and
Australia.
Australia
should substitute more capital for labor in production because the share of capital
is relatively larger. The marginal rate of technical substitution (MRTS) is the ratio
of the marginal productivity of labor (MPL) to the marginal productivity of
capital (MPK). Here are the estimated marginal productivity for labor and capital.
The MPL is higher in Australia.
The MPK is higher in Australia, but the gap between the two countries is narrowing.
The MRTS measures the substitution between capital and labor along the Isoquant, i.e., output
is unchanged. Whatever they have been producing remains the same, but the combinations of
factors used in the production change. Clearly, it says that as time goes by
both Australia and New Zealand have been substituting more capital for labor to
produce the same output. Australia substitutes relatively more capital
for labor than us, probably because they have more of it and thus the real cost
of capital has been lower than the marginal productivity of capital. The gap,
however, is widening. Australia continues to substitute more capital for labor
than New Zealand. Adding more capital will increase labor productivity over time.
These productivity changes have been happening, but less so in New Zealand.
These endogenous processes continue until the rates of returns to factors equal
to the marginal productivity.
Given the
shallow supply of capital in New Zealand, we should have an excess demand for
capital in New Zealand. Here is a graph of the estimated demand for capital in
both countries. Indeed, the demand for capital is higher in New Zealand, and
the curve is relatively steeper.
Excess demand
for capital (excess demand for investments) puts upward pressure on the real
interest rate. This is consistent with the observed high level of real interest
in New Zealand.
The real
interest rate is determined in the market not by the Reserve Banks. Monetary
policy plays no role in the productivity debate. However, there is a role for
fiscal policy, i.e., taxes. On average, taxes are similar across the Tasman. Thus,
the after-tax real returns on factors probably differ not because of the tax rates,
but because of differences in the real interest rates and real wages, which are
determined in the markets not in Treasuries.
Why does
immigration to New Zealand increase when the demand for labor is low or flat, and
the supply of labor is high?
From the immigrant’s
standpoint, immigrants consider the New Zealand real wage rate when they
immigrate. Why do people immigrate to New Zealand if the real wage is lower
than Australia? Everything else constant, they should not come to New Zealand. However,
immigrants take many more factors into account that could outweigh the low real
wage factor when they make their decision such as taste, family connections,
etc. It is also possible that they do not have full information and do not know
what the real wage rate in New Zealand is. Sooner, they learn that Australia
offers a better real wage so they immigrate / relocate again across the Tasman.
I do not have statistics on the number of immigrants to New Zealand who
re-settled in Australia.
It is more
difficult to explain why the New Zealand immigration policy objective is to
increase immigration if New Zealand has been substituting away from labor
towards capital (albeit less so than Australia). In this case, adding more
people cannot increase labor productivity. The data suggest that in order to
increase productivity we should focus more on adding more capital not more labor,
perhaps increasing savings.
[1] The
average share of labor is the ratio of compensations to employee / nominal GDP
ratio over the sample from 1987 to 2015. Assuming a constant return to scale
Cobb-Douglas production function implies that the average share of labor is also
1-the share of capital, where the share of capital is measured as the ratio of
gross operating surplus / nominal GDP ratio. To compute the MPL and MPK I assume a constant return to scale Cobb-Douglas production function. I take the derivatives with respect to labor, hence the MPL, and with respect to capital, i.e.,MPK. I use the average of the shares over the sample and the observations for GDP, capital stock and working age population to compute the marginal productivity.
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