How to get rich

Yesterday the Productivity Commission sponsored a Government Economics Network seminar, 'Reallocation and Productivity', presented by the University of Toronto's Diego Restuccia. It's not the most revealing of titles, but if you read the abstract of the speech you'll see it actually deals with one of the most fundamental issues in economics - "What explains why some countries are rich and others poor?"

My summary of Restuccia's analysis is that the richest countries have gone through a series of sectoral reallocations - first realising the large productivity gains that are typically available in the very inefficient (often subsistence level) agricultural sectors of poor economies; then using the freed-up resources to realise the large productivity gains possible in manufacturing; and last in the piece, shifting resources into the services sectors that typically dominate activity in a modern economy. For more developed economies, aiming say at the living standards of a US, "productivity in the services sector is the most pressing issue" (quoting from the abstract), which explains the Productivity Commission's involvement, given that it is now well-advanced with its inquiry into 'Boosting services sector productivity'.

Restuccia also splits the services sector into two - what he calls a "traditional" services sector, which is often non-market and non-tradable (education, health) and a subsequent "non-traditional" or "modern" one, which tends to be market-based and tradable (think entertainment, media, sports, culture, IT). If you're going to have the living standards of a US, you're going to have to be able to cut it in those modern services sectors.

There's nothing inevitable about this sequential process: policies, institutions and culture can assist or retard it. Some countries never get started, for example, or even become even poorer subsistence economies. Some rattle through the process at a great rate (China, for example). And his data showed that some countries may have done the agriculture thing, and the manufacturing thing, but haven't been able to go on and do the services thing, or have achieved some of these gains, but then have given them up again (Argentina being a long-standing example that always figures in these sorts of analyses, while some of the peripheral Eurozone economies are more recent cases). New Zealand, arguably, is making heavy weather of the services transition, too.

One important characteristic of this process is that at any point in time, there tends to be a very wide dispersion of performance across any given sector, so development tends to be a combination of advancing up the chain from one sector to another but also of reallocation of resources from least productive to more productive entities within each sector. The productivity gains from having resources within a sector used by the most efficient businesses can be immense: conversely, policies that prevent or impede resources moving to their best use within each sector have the potential to seriously gummage up the whole process.

Thought-provoking stuff, in sum, and if you'd like to hear more of it, Restuccia is presenting what I'd guess will be much the same again, at the Southern Workshop in Macroeconomics at the University of Auckland on Friday.