Tuesday, July 7, 2020

Preparing for a Post-Covid19 Economy: capacity building or building capacity?

We seem to have the pandemic under control - what next?
Now that community transmission has been eliminated in New Zealand and some rigour brought to border control, it is timely to think about economic recovery. That’s not straightforward. As the pandemic rages globally restricted travel, limited trading opportunities, and disrupted supply chains mean that we have to make the most of an inevitably shrunken economy.

Making decisions about where to put economic resources – including spending on recovery – is made harder because we have no idea what the future holds. We can no longer predict economic conditions and the outcome of policies with any confidence if we rely on past experience.  We can, however, make decisions about how to deal with today’s crisis in a way that prepares us for tomorrow’s unknowns. 

This post suggests focusing early recovery on employment-intensive sectors that better equip the community to rise to the unknown challenges of the new normal, rather than building the infrastructures associated with the old.

The Infrastructure Capacity Consensus
To date, New Zealand’s rebuilding strategy has been defined mainly in terms of building physical infrastructure to cater for economic activity as we knew it.  Among other things, the Government has just committed $3bn to start on its list of shovel-ready projects. While it's early days, the National opposition already says we need more infrastructure. While there may be debate about how much, what projects, and in what order, there is no obvious disagreement with the notion of building our way out of the darkness.

This risks justifying spending on uneconomic infrastructure that undermines productivity and prejudices long-term growth. Promoting infrastructure to create jobs simply promotes investment that cannot otherwise be justified in sectors already facing supply chain and skill bottlenecks. When these are publicly funded they not only increase fiscal risk; they potentially starve activities that promise greater employment and a more assured long term return.

Building Capacity as an Alternative
What about another approach? What about building the capacity of people, rather than structures, to deal with a future that will not be a rerun of the past? This will emphasise more jobs more immediately, maintain better short-term domestic demand , and build the adaptability and resilience needed in the long-term.

It does not mean dismissing infrastructure, but calls for spending on it to be moderated, focusing on what we know is needed and not the nice-to-have or me-too projects, favouring instead activities that deepen the skill base, develop talent, promote creativity, and encourage entrepreneurship.

Investing in people
Today we are confronted by a deficit of demand, not a deficit of infrastructure. Investing in people will lift demand directly, hold together a fractured domestic economy, and lay the groundwork for long-term recovery and resilience. Our nation’s capacity to respond will be best served if the population is in good health, well housed, well educated, and well employed.

So, what are the best sectors for promoting employment?
Employment multipliers are used here to address this question.  The multipliers relate job numbers to output in each of the 106 sectors used to define the economy.  The jobs may be direct (within the sector in question), indirect (associated with supplying materials, components, goods, and services to that sector),and induced (from the spending of employees in the first two categories). [1]

Table 1 lists the sectors with the highest employment multipliers. Among other things, this indicates that one million dollars of additional output (or funding) in pre-school education would give the most jobs for $1,000,000 spent: around 29 in total, comprising  around 21 in the sector itself, 3 in activities supplying it, and 5 from the resulting household spending. Specialised food retailing also scores well, with a strong indirect effect reflecting how it draws on domestic suppliers.[2]   

Table 1: Sectors with Highest Output:Employment Multipliers (2017)

Table 2 compares multipliers from the most employment-intensive industry groups drawn from Table1 with those for the industry targeted by infrastructure spending, construction.

From this we see that:
·   The employment boost from spending in construction sits close to the median for all sectors, but well below education, health, and social care services.
·  Residential building is a slightly better job-booster than civil engineering (roads, bridges, and the like) and non-residential building.
·  Residential and non residential building both generate significant indirect employment, reflecting reliance on local suppliers and subcontractors.
·   Non-tertiary education sectors have a substantial direct employment impact, with a relatively high induced impact suggesting that the sector’s typically “middle incomes” sustain above-average household spending.

Table 2: Employment Contribution, Selected Industries (2017)

·   Spending on tertiary education may generate less immediate employment because of higher overheads and salaries.
·   Medical and residential care and social assistance also have significantly greater employment impacts than construction.  Some of this will come from low paid “care” jobs, an issue highlighted by the critical nature of this sector to the Covd19 response.

Promoting job-intensive sectors may seem two-edged: they tend to pay the lowest wages (Figure 10).[3] However, low income households are likely to direct most of their additional spending to food and consumables, ensuring a large share of increased earnings flow through the retail and service sectors.

Figure 1: Average Wages by Sector, Q4 2019

In addition, these are the sectors that promote well-being across the community and should increase people’s skills and their abilities to deal with change.

Creating value
The benefits of recovery driven by employment-intensive industries also depend on how much value they add to the economy. According to the 2013 National Inter-Industry Tables, the share of output that is value added in the construction sector is modest, although low margins are offset in part by the substantial purchase of intermediate goods and services by the sector. 

While gross output is substantially lower in health and education than in construction, more value is created, largely in salaries and wages.  And because health and education each generate more household income than construction, funds channeled into these industries will lead to greater downstream demand in retail, services, and hospitality.

Table 3: Value Added, Imports, and Compensation of Employees, Selected Sectors (2013)

Towards a Multi-Layered Recovery – Scaling back the Infrastructure Sell
Infrastructure still has a role to play, especially in accommodating extra capacity in the priority sectors indicated by these figures. And, to be fair, the first $2.4bn of spending outlined by the Government included a strong commitment to social and affordable housing, well distributed sanitation and community enhancement projects, and environmental initiatives (Figure 2). Just under 30% was directed towards transport. However, this omits the big promises made to Auckland transit projects and major highway developments.

Figure 2: Distribution of the First Round of Shovel-Ready Spending

Investing in Human Resources
It is time to back off spending on mega-transport projects for which demand is uncertain and, instead, to focus on building the capacity of our people to deal with a changing economy.

Already there has been a commitment to step-up health funding in the May 2020 budget. The Simpson report on reorganising health and disability delivery (by consolidating and centralising administration and “professionalising” governance) may also help with a reset, although on the face of it looks a little like an expensive rearrangement of deckchairs.

Beyond that, a step up in new and innovative educational and vocational projects and initiatives across society may be the best means of ensuring that the recovery from Covid19 can be sustained, and that the country will be even better placed to deal with such crises in the future. 

Directing funding towards a more diverse, inclusive, and flexible education sector may mean increasing funding to both the educators and the educated. A simple start could include: increasing the funding of pre-school education; lowering staff student ratios in schools; developing applied tertiary courses in technology, production and distribution, agriculture and horticulture, and resource management; and encouraging and funding applied research.

Infrastructure should serve recovery, not shape it
Without doubt, initiatives in these areas will drive demand for further infrastructure.  But this investment will be focused on the needs of the sectors that underpin social well-being and economic productivity, and that foster the capacity of people to adapt to whatever demands the new normal might make. 

[1]    The multiplier estimates are based on the national input-output tables (Statistics NZ, 2014) calculated and updated to 2017 by Insight Economics in Auckland. I gratefully acknowledge access to them, and am solely responsible for their interpretation here.
[2]    Employment in retailing largely reflects the induced effect of growth in other sectors. Spending by overseas visitors in retailing (and hospitality), though, represents additional external demand.  
[3]   Although wages in sectors like medical care span a wide range.