International volatility and New Zealand economy

Thursday 30 August 2007, 4:06PM

By Michael Cullen



Speech notes for address to Trans-Tasman Business Circle Luncheon, AMP, Lower Albert St, Auckland.


Today I want to briefly give you an overview of my thoughts on the state of the economy, and update you on some recent developments. I want to bring you up to date on our priorities for locking in the underlying strength and resilience of the New Zealand economy. And I would like to comment briefly on the strong Trans-Tasman relationship we enjoy.

In recent weeks, the global financial system has been tested by a credit squeeze.

The shake-up was triggered by so-called sub-prime mortgages in the US, where some lenders found out the hard way they had been a little easy with the availability of credit in recent years.

This led to a wider re-pricing of risk, which is no bad thing. It is perfectly healthy for markets to move away from what has been very high risk activity in recent years to something approaching normality. But the growth of the derivatives industry has done such a good job of spreading risk, it is not entirely clear who is left holding which risks, creating some financial 'mist'. It will take some time for the mist to clear so there will still be some uncertainty and volatility in the short term.

There are some positives to take out of recent events too. The international financial system is in much better shape to cope than it was 10 years ago. And we saw major central banks assisting liquidity where need be.

Back in New Zealand, we don't have the same sub-prime mortgage problems - our banking system is sound. The riskier end of our financial sector is finance companies, where we have seen some troubles in the past year. But they make up a much smaller portion of the overall system than sub-prime mortgages do in America and there is no indication of the same sort of systemic issue. Of course, that is no comfort to those who have lost savings, and I do feel for those who have. The changes the government is proposing such as mandatory credit ratings should help make the risk/return profile of investments more apparent to investors in the future.

So New Zealand has been affected by the credit squeeze more indirectly through the re-pricing of risk. The danger, of course, is that the volatility in the short term through lack of liquidity can harm what are otherwise healthy firms. It was pleasing to see the NZX help reassure investors by seeking clarification from listed finance companies that they are complying with continuous disclosure regulations.

The global financial developments have emphasised the virtue of several key components of New Zealand's economic strategy:

· First, our strong fiscal strategy.

· And second, our strategy to increase savings and to increase the rate at which our economy can grow.

We are enjoying structural surpluses and - taking into account the New Zealand Superannuation Fund - we no longer carry any net debt at all. The government has been strongly attacked by the Opposition at every budget for running strong fiscal surpluses. These surpluses have helped to keep debt down and provide a cushion for shocks.

It is worth underlining this: we have been running some of the strongest government accounts in the developed world. Credit ratings agencies like Standard & Poor's acknowledge this as a key factor in maintaining our rating. Meanwhile, our main parliamentary opposition advocates increased debt. In the current global economic volatility, the alternative proposed for New Zealand would be simply irresponsible.

The strong fiscal surpluses we have operated have helped to keep our economy in robust shape.

We have enjoyed an uninterrupted seven years of growth. The economy has grown by over a quarter since 1999. Businesses have shared in the growth: company tax returns show profits grew fifteen percent year on year from 2003 to last year - compared to five to seven percent in the previous eight years.

Unemployment is at record low levels. There have never been as many New Zealanders in work.

I have to say I'm impressed at the resilience our exporting sector overall is showing. For example, the July National Bank Business Outlook showed that a net 15 per cent of exporters expect to increase export volumes in the next year. In times where the dollar has been reaching post-float highs, this could be much worse. Of course, the story differs between sectors, and exporters are wider than just dairy farmers.

It is not surprising that in an economy running at full capacity for as long as ours has, some imbalances have built up. We are seeing these in a number of ways:

The current account deficit is running at close to nine percent of GDP.

Inflationary pressure is persisting in the non-tradeables sector.

Household debt to income levels are well above their historic averages.

The prudent thing to do is to address these imbalances.

Beyond the conservative fiscal strategy I have already referred to, the government's response is two fold:

· Changing the mix of growth away from domestic demand toward investment in productivity growth.

· Putting in place structural incentives to save rather than increase demand through debt.

There have been a number of initiatives to help the economy grow faster.

These have included a heavy emphasis on skills training and knowledge investment.

The tertiary sector is being reformed to put a greater emphasis on quality and the needs of industry.

One of the Labour-led government's great achievements since 1999 was to breathe life into skills training with the Modern Apprenticeship Scheme and greatly expand industry training. We saw the importance of building the skills of our workforce. New Zealand workers want to invest their skills and knowledge on the job, and New Zealand employers want to see the immediate and longer-term benefits of creating a more skilled workforce.

Since its inception in 2000, over three thousand Modern Apprentices have completed their qualifications in crucial industries. The government annually funds $146.5 million for workers in industry to participate in structured workplace learning.

The Business Tax Package in this year's budget is the largest tax package in twenty years.

It included $3.4 billion of tax cuts. The headline rate was cut from 33 to 30 cents. International tax changes to make it more competitive for kiwi companies based here to do business overseas. An expanded market development assistance package will grow our connections to the world.

And in the light of the OECD report last week on levels of R&D in New Zealand, it is reassuring the government has already moved to introduce a tax credit for research and development.

Academic research is quite clear that, while wider economic benefits from R&D are difficult to observe, so-called "spillover" benefits exist, might be quite large and may be even larger than the direct returns to the person doing the R&D.

As this is a Trans-Tasman grouping, it is worth recalling the report of the Australian papers after the Business Tax Package was announced. The Australian Financial Review began its story by saying, "New Zealand is luring businesses across the Tasman."

To sum up our business tax package, the paper said, "R&D investment could flow back across the Tasman."

There are widespread economic benefits from lifting the sustainable rate of growth of the economy.

The steady economic growth New Zealand has enjoyed since the nineties has also had its effects elsewhere. It is clear that the investment property boom is having some influence on keeping house prices rising at the rates they have been recently.

Partly as a result, separate Select Committee inquiries are underway into both housing affordability and into monetary policy.

On the latter issue, the Finance and Expenditure Committee is examining what additional measures could support monetary policy in New Zealand.
The accepted consensus has been that our monetary policy framework helps keep the economy stable by moderating economic cycles, without impacting on the sustainable rate of growth of the economy. As I have made plain in recent weeks it is worth reviewing whether that consensus still holds.

It is useful to remember that the government has done its bit to support monetary policy.

Initiatives such as KiwiSaver will reduce pressure on monetary policy by removing demand from the economy. If we save more, we consume less.

Kiwisaver came into effect on 1 July. Everyone who saves four or eight percent of their income will get a $1000 contribution from the government into their Kiwisaver accounts to get things kick-started. They will get a $5000 subsidy to help buy their first home - $10,000 for a couple.

The government will provide a tax credit to savers that matches their contributions up to $20 a week. Employers will have to match their employees' contribution and they will receive a tax credit that fully reimburses them for doing so up to $20 a week. The cost to employers is far lower than that of the Australian scheme.

I am greatly heartened by initial take-up rates, which show the great bulk of people actively joining KiwiSaver.

Trans-Tasman business should need no reminding of the benefit that a substantial workplace savings scheme has provided for the Australian economy.

Australia's development over the last decade or more has been driven in large part by funds under management through the compulsory superannuation scheme - now worth a trillion dollars.

New Zealand has had no similar scheme.

We have seen the results in the somewhat frequent arrival of Australian private equity firms coming to New Zealand.

I welcome the arrival of foreign capital, the technical expertise and marketing opportunities those sales bring. But I also wish it was not a one way journey and more New Zealand funds were participating in Australian businesses.

Over time Treasury estimates KiwiSaver will grow to around $100 billion in today's dollars after thirty years. That is about sixty percent of GDP.

It is likely to result in a fundamental shift in our saving landscape. It will substantially deepen capital markets and significantly change the mix of growth from spending to saving and investing.

Overall, and combined with our smart, active policies to lift New Zealand's growth rate, KiwiSaver and the government's strong fiscal strategy are positioning our economy very strongly for the future.

The strength of our economy in the future is fundamentally determined by trade and investment. For New Zealand, Australia is our most important trade and investment relationship.

Fortunately, that relationship is strong. It has been proven again and again to be strong. Even when there are issues where we disagree - and there have been one or two recently - our relationship remains very close.

We share some very important interests in common. Next week APEC leaders will meet in Sydney. There are a number of very important issues on the agenda there. They include climate change, which is a doubly crucial issue for New Zealand - first because our economy depends on climate more than any other in the developed world; and, second, because there is rising concern about climate change in our major export markets. We are seeing the risks in the prominence of issues such as "food miles". The issue of food miles is spurious because the distance travelled to market is not important; it is the total carbon consumed in production that is relevant, and we have a good story to tell about that. But the issue of climate change is not spurious. New Zealand has an enormous opportunity to position itself as a world-leading source of sustainably-produced primary products.

I was at the APEC finance ministers' meeting in Coollum in July, where climate change and energy security were priority issues. As with other parts of the world, we have a dilemma in reducing carbon emissions, while maintaining economic growth and development. This discussion will continue next week, where climate change will be one of the central themes for the Sydney meeting.

APEC has also been a focus for co-operation between New Zealand and Australia in promoting world trade. Both of us are strongly committed to the Cairns group goal of freer trade in agriculture.

Of course, trade issues in the trans-Tasman relationship have cropped up in a couple of ways in recent weeks.

The most serious issue, from our point of view, is our decision to initiate WTO dispute settlement proceedings against Australia over access for our apples.

New Zealand has not been able to export apples to Australia since 1921, when fire blight was discovered here. Access was denied on the grounds that apples might be a pathway for the pathogen that causes the disease. New Zealand has sought since 1986 to have the ban lifted, because studies have found no scientific evidence that commercially traded apples carry fire blight.

It is our very strong view that the biosecurity issues raised by Australia to keep our apples out are spurious. There were very disappointing delays on the Australian side in coming up with a procedure to admit apples, and then restrictions were imposed that were not scientifically justified.

New Zealand feels we have exhausted every avenue for bilateral settlement of the issue and we have now gone to the WTO.

This is a very disappointing development, especially since Australia has committed itself internationally to free access for agricultural production. But we also need to keep the issue in the context of $16 billion worth of two-way trade between our two countries. Access for our apples has been an irritant in the relationship, but it does not define it.

One issue where I think the Australians have been very generous towards New Zealand is in being patient over the Therapeutics Bill.

The bill would have put all supplementary medicines under the control of a joint regulator - the Australia-New Zealand Therapeutic Products Authority. This Bill had to be placed on the back-burner when the government couldn't get the numbers to pass it.

What was simply extraordinary about that episode is that the National Party opted to play politics over this issue, at the expense of risking damage to the trans-Tasman relationship.

First, the National Party opposed the Bill. Then, Mr Key told the Herald that National would sign a proposal that carved out complementary medicines with a voluntary opt-in. Hours after the Herald published that u-turn, he changed again, and said the government had to completely remove complementaries from the legislation before National would support it.

This might be dismissed as the flim-flam of an opposition leader not on top of his policy briefs. But what it actually shows is how easy it is to play politics and damage the relationship in doing so.

Australia patiently waited for New Zealand to get our end of the new regime through. It has been very accommodating in giving us equal status in managing the new regime, despite the disparity in size between our countries.

And despite being let down by small-minded political games by the National Party in Wellington - the trans-Tasman relationship has proven its strength. You wouldn't want to pull a stunt like that on them everyday, and so it might be a good idea to think about whom to trust with the relationship.

But it remains in good hands now.

Overall the relationship extends far beyond the economy. The trans-Tasman relationship is vital to us. An English visitor once commented that "New Zealand is a small but incredibly beautiful country that sits like a semicolon at the end of the sentence that is Australia." (That was a comment about how most of them got there...)

Both our countries have enjoyed a good run of strong economic growth in recent years, and we can both look forward to continuing strength ahead. As we continue to grow, much of that expansion will come through mutually beneficial ties between us.