Measuring and monitoring the income gap
This report focuses on the policies and institutions governments can put in place to create the best climate for sustainable long-term economic growth in New Zealand. From among the various statistical measures of the difference in the performance of the New Zealand and Australian economies, the Taskforce has concluded that our primary benchmark should be the gap between New Zealand and Australian real GDP per capita, as reported by the OECD in purchasing power parity (PPP) terms. Real GDP per capita last year was 35 percent higher in Australia than in New Zealand[5]. On that measure, an average New Zealand family of four is worse off than their Australian counterparts by around $64,000 per annum[6].
- Figure 5: GDP per capita
- Source: OECD, OECD = 100, at constant 2000 PPPs and constant prices
Other measures each have advantages and disadvantages, but each shows a large difference in Australia's favour. As a measure of living standards, differences in real Gross National Disposable Income (RGNDI) might be preferable, but there are data limitations, and in any case RGNDI measures are thrown around by fluctuations in the terms of trade. Changes in the terms of trade affect real living standards, but as both New Zealand and Australia are commodity exporters the two countries both have quite volatile terms of trade. Moreover, governments have next to no influence on the terms of trade. We want to focus attention mostly on measures of economic performance that are more directly amenable to the impact of policy reforms. Sustained improvements in the terms of trade (more so than in Australia) would be a welcome windfall gain - but not something that can be counted on.
- Figure 6: Effects of changing terms of trade
- Source: Statistics NZ (note: real disposable income per capita - gross), Australian Bureau of Statistics (note: real disposable income per capita - net)
We will also report on developments in the other measures of income and living standards. But we will take little comfort if, say, the Australian minerals boom were to reverse over the next few years (which would narrow the RGNDI gap between the two countries), or even if our own dairy prices were to double again temporarily (also narrowing the RGNDI gap). In the long-run, better policy frameworks and economic institutions will provide the right environment for enduringly closing the gap with Australia.
Box 2: Formal measures of living standards
There are significant statistical challenges in attempting to measure living standards, both over time within a country, and between countries.
The most commonly quoted measure of economic performance, real Gross Domestic Product (GDP), is an approximate measure of the value of all the goods and services produced in a country, adjusting for the effect of changes in the general level of prices.
In developed countries, real GDP is measured relatively well but not perfectly. All countries struggle to measure the “volume” of output in service sectors. And where the “black economy” is larger, the measurement difficulties are more serious. However, even if GDP were perfectly measured, it would not be a fully satisfactory guide to living standards.
For example, the state of the physical environment isn't captured at all. And the implications of shifts between whether household services are undertaken within the market or within the family are ignored. If a person marries his or her housekeeper, GDP will fall even though well-being might reasonably be assumed to have risen. These things tend not to matter much from year to year (the underlying patterns of behaviour don't change much in the very short-term) but they can complicate comparisons between countries, or even within countries over long periods of time.
In addition:
- Some of the value of what is produced in New Zealand does not accrue to New Zealanders. The most important element of this is the income earned on foreign investment in New Zealand. In many developed countries, this issue is not hugely important. But it is a significant issue for both New Zealand and Australia. Both countries are highly dependent on foreign debt and equity capital, New Zealand materially more so than Australia. To measure the incomes accruing to New Zealand residents, statisticians deduct from GDP that portion of what is produced in New Zealand that accrues to foreign residents, and add back what New Zealand residents earn from overseas. The resulting measure is known as Gross National Income (GNI). At present, in New Zealand, GNI is around 7 percent lower than GDP.
- Real GDP or real GNI are measures of real gross income. But as any owner of plant and machinery, or of a house or commercial building, knows, physical assets deteriorate over time. Provision needs to be made to repair and eventually replace those assets, and the amount of that provision is not available to consume without undermining citizens' real future consumption possibilities. Statisticians subtract an estimate of the substantial annual depreciation of the physical capital stock to derive Net Domestic Product (NDP) and Net National income (NNI) measures. These measures are not widely quoted, probably for two reasons: they are less well-measured and the differences between the annual growth rates of net and gross measures are usually small.
- Measures of real domestic product and national income (gross or net) do not capture the direct impact on a country’s living standards of changes in the terms of trade. If the prices of the goods and services we export rise (relative to those of the goods we import), the overall purchasing power of New Zealanders rises. As a nation we are better off, but this is not captured in the real GDP or real GNI measures. Statistics New Zealand makes an allowance for the value of terms of trade changes in a series called real Gross National Disposable Income (RGNDI). The terms of trade adjustment can make a big difference at times, especially for countries that are heavily reliant on the export of commodities. In both New Zealand and Australia, the rise in the terms of trade meant that living standards rose by more than GDP did over the last decade.
Comparisons of living standards across countries get more awkward still because of different price levels, fluctuating exchange rates, and different spending patterns. The OECD produces the most useful international comparisons, reporting (with a lag) the real value of GDP in each of its member countries expressed in a common currency, translated using what is known as “purchasing power parity” exchange rates. If we simply translated GDP figures at current exchange rates, the measured value of our GDP would be high relative to that in other countries when our exchange rate is temporarily very high. But that will mean little in terms of living standards, as much of what we consume is not traded internationally. The PPP numbers attempt to look through these fluctuations to get a more comparable measure of how many real goods and services incomes in each member country will actually purchase.
Year-to-year comparisons of growth rates across countries are relatively easy to do consistently and reliably. Measuring absolute differences in living standards in a fully reliably way is more difficult. Differences in tastes and preferences, and even in the climate, shape what people actually consume and bedevil formal comparisons of living standards. To take just one trivial example, many more air conditioners are likely to be used in Brisbane than in Dunedin, but more will be spent on heating in Dunedin than in Brisbane. And in a more extreme climate, more of one's income has to be used for both heating and cooling to achieve the same degree of well-being the resident of a temperate climate might enjoy. And how does one value easy access to the beach and the outdoors, such as one might have in Christchurch, with easy access to great museums, art galleries and newspapers that one might have in London?
Notes
- [5]In 2008, nominal GDP per capita, in PPP terms, was 45 percent higher in Australia than in New Zealand. That larger difference reflects the impact of the extremely high terms of trade in Australia in 2008.
- [6]Of course, not all of this difference is in the direct consumption and savings of households. Around a third of all income is currently taken in taxes, to finance various public services.
