Small town dynamics

By international standards, New Zealand is a small town economy. True, Auckland now has more than 1.5 million people, but by global metrics this is not very large. In 2010 there were 449 cities with more than 1 million residents, and Auckland was ranked 307 in terms of population. Small beans indeed – even if Auckland is four times as large as the next two biggest cities in New Zealand.

So how does this small size influence outcomes for New Zealanders?

The growth of big cities has been one of the main features of the world economy since 1950. Back then, there were only 15 cities with more than 3 million people. Now there are over 110. People flock to big cities for a variety of reasons. Incomes tend to be higher, and the selection of occupations wider. Oftentimes education and health care are better. For young people, the social life tends to be more interesting, and less subject to traditional restrictions. Cities tend to have a lower environmental footprint, although it does always appear this way because any excesses are more concentrated.

In the last three decades, the growth of big cities in OECD countries has been associated with another dynamic – they have increasingly become centres for service sectors that rely on highly educated workers.

Up until 1980, this phenomena was not so noticeable. Big cities and small cities both had large amounts of manufacturing work, and big cities were a great places for people with middle levels of education (a full high school level education) as they offered a wage premium relative to small cities. As manufacturing and clerical jobs vanished, however, the earnings premium for people with medium levels of education disappeared (Autor 2019). Given big cities typically have higher real estate prices than small cities, big cities are now much less attractive destinations for people with moderate education levels.

The decline of manufacturing

The decline in manufacturing has been massive. New Zealand’s experience is typical – in 1976 25% of jobs were in the manufacturing sector, but now it is only 10%. Many of the jobs that have replaced them are in the health and education sectors, or in professional and business services.

Firms in the latter sectors seem to have a strong preference to locate in big cities. For example, when employment in New Zealand’s finance sector expanded from 4.9 to 6.7 percent of total employment between 1976 and 2013, or from 50,000 to 100,000 job, two-thirds of the increase occurred in Auckland. This might be fine if you live in Auckland or want to live in Auckland. However, it creates difficulties for smaller towns that lost their manufacturing jobs but could not easily take advantage of the expansion in employment in other sectors (Coleman, Maré and Zheng 2019).

Globally, the McKinsey Institute has identified 50 “super cities” which have very high incomes, a large fraction of the largest and most dynamic service sector firms, and highly educated workforces. Singapore but not Auckland features; Sydney and Melbourne are in the next tier above Auckland.

These super cities are attractive destinations for the most productive firms and the most skilled workers, creating a virtuous circle of high income, highly productive locations. Labour economists attribute a large fraction of the rise in income inequality to this assortative matching process, as the most skilled people earn increasingly large amounts in the most productive firms.

If other firms were able to copy the productivity performance of these frontier firms, the increased productivity would filter down to everyone, raising wages generally. This is not happening, however.

In the last two decades it has proven increasingly hard for other firms to copy the best firms. These means productivity gaps and wage gaps have widened. Big-time bankers in London earn more than “big”-time bankers in Auckland, who earn more than those in Christchurch. This seems to be an important component of the rise in inequality in OECD countries.

Questions of scale

At one level, the problem for small town New Zealand relative to Auckland is the same as the problem of small-town Auckland relative to major world cities.

If it is difficult to copy the production techniques of the best firms, a city needs to attract the best firms to obtain the benefits of the high productivity and high wages they offer. If a city can’t attract these firms or copy their productivity levels, wage levels will lag behind.

In this case people wanting the better life-styles normally associated with higher incomes will find it easier to move to where the good firms are located rather than wait for the good firms to locate where they live. Lots of New Zealanders have worked this out – both those that have moved from New Zealand to higher productivity locations abroad (or within New Zealand), and New Zealanders who have migrated here from lower productivity locations abroad when they had the chance.

To take just one example, the statistics are very clear that the easiest way Maori have found to make high incomes is to migrate to Australia – Maori earn nearly the same as other Australians and nearly the same of Pakeha migrants, as they take advantage of the high incomes and high productivity levels that are offered by Australian firms but which New Zealand firms do not seem able to match. (Kukutai and Pawar 2013 provide data on Maori incomes in Australia).

Nineteenth century America was characterised by boosterism – competition by cities to promote themselves to attract the best firms and the best people (Chicago was the bigtime winner, as William Cronon documented in his magnificent book “Nature’s Metropolis.”

Does this provide a clue to understanding New Zealand’s low productivity woes?

I am not sure, but understanding why productive firms choose to locate in one place and avoid other locations is a key part of understanding productivity performance when it is difficult to copy what the best firms do.  For years I have joked that New Zealand’s approach to attracting the best international companies is to give them the chance to pay some of the highest business taxes in the world. Unfortunately, the productivity statistics suggest this strategy is not enough. If New Zealand’s cities are not a desirable location for the world’s most productive companies, additional effort might be needed to work out how to attract them in the future.