Productivity in NZ’s urban areas

Are firms in large cities more productive? And if they are, what is the productivity premium of our largest city, Auckland, and how does it compare to our other urban centres? These questions were the focus of a recently released working paper from Motu Economic and Public Policy Research, Urban Productivity Estimation with Heterogeneous Prices and Labour.

The Auckland region, which contains 33 percent of the population, produces 37 percent of New Zealand's GDP. The paper’s author, Dr Dave Maré, explains that cities offer a broad range of productive advantages, “there is enhanced learning within cities, a sharing of infrastructure risk and markets, and improved matching of firms and workers. Empirical studies consistently find significantly higher productivity in larger, denser cities, with a doubling of population density associated with productivity that is around 4 to 7 percent higher.”

Dr Maré says this finding is confirmed by studies that measure productivity by wages, labour productivity, or multi-factor productivity, although there is some systematic variation among estimates.

“We documented an urban labour productivity premium, with Auckland firms having labour productivity that is 17.9% higher than that of firms in other urban areas, and 17.0% higher than firms in rural areas. Some of this premium is due to the mix of industries in different cities. Auckland has a disproportionately high share of employment in industries that have above average labour productivity. Adjusting for this composition reveals a smaller, but still sizeable, premium of 13.5% relative to other urban areas, and 11.3% relative to firms in rural areas. This estimate is lower than previous estimates using microdata.”

For urban areas other than Auckland, Wellington firms have relatively high average labour productivity, with levels that are 4.2% lower than Auckland. For other urban areas, the gap ranges from 9.4% to 20.1%, with lower estimated multi-factor productivity in less dense urban areas.

Some of Auckland's labour productivity advantage is due to more intensive use of non-labour inputs (plant and equipment) by Aucklandfirms. “Controlling for labour, capital, and intermediate inputs our preferred estimates show a premium of 7.9% relative to other urban areas when labour inputs are measures as FTE employment. Labour quality differences contribute around 5.5% to Auckland's relative productivity performance.

“We estimate multi-factor productivity differences separately for a more disaggregated set of urban areas, and find spatial productivity differences of between 7% and 15% [2% to 6% if adjusted for labour quality].

“Wellington is an exception, with Wellington firms having productivity that is estimated to be slightly higher, by 3.8%, than that of comparable Auckland firms [2.7% if adjusted for labour quality].”

The estimates of productivity across New Zealand urban areas are based on analysis of firm-level data from Statistics New Zealand’s Longitudinal Business Database. The methods used in the paper overcome some of the biases that arise in standard approaches to spatial productivity estimation - biases arising from imperfect competition, spatial price variation, firm heterogeneity, and labour-sorting across cities. Dr Maré explains that ignoring these factors leads to biased estimates of the Auckland’s relative productivity performance. The study also investigates industry differences in spatial productivity patterns.

In a recent presentation about what Auckland’s productivity performance implies for regional policy, Dr Maré said if New Zealand was a classroom, Auckland is the group of smart kids who sit at the front. “Should the teacher focus attention on Auckland? It’s hard not to, Auckland is big, it has the best performance. The challenge for teachers, however is to look at the ‘class’ as whole and direct their efforts to where they can make the most difference – not just to focus on the smart kids. Similarly, it is important to know the relative productivity of Auckland firms, but smart urban and regional policy for each individual region and the country as a whole is necessary if policy-makers want to make a positive difference.”

For a PDF of the working paper please see Urban Productivity Estimation with Heterogeneous Prices and Labour.