The agricultural sector in NZ’s economic future

Speech Alert
14 September 2009

The agricultural sector in New Zealand’s economic future

Presentation by Lachlan McKenzie, Federated Farmers Dairy chairperson, to the New Zealand Labour Annual Party Conference

I would like to thank Mike Smith, your retiring Secretary-General, for the opportunity of being here today. I believe I’m right in saying that this is a first!

I am here today with David Broome from our Wellington office and with Selwyn Pellett to engage openly with you on a subject we are passionate about - our collective future.

I would like to thank the Hon David Cunliffe, the Hon Damien O’Connor as well as members of your rural caucus for this opportunity. I would also like to thank the Hon Jim Anderton.

A full version of this speech is available on the website, so I will canter through the highlights so that we can talk interactively.

We believe in the future of our country and wish to be an active part of that future. Yet to go forward, we need to first go back a little in history.

In 1988 the late David Lange said:

“Farming is a sunset industry and manufacturing and tourism will take its place.”

In 1990 Harvard Professor Michael Porter said:

“New Zealand exports in a range of structurally unattractive and therefore low profit industries.”

In 2007 economist Brian Gaynor said:

“New Zealand and Ireland have a great deal in common. They both have 4.2 million inhabitants, traditional agriculture bases and are two small island countries with large and dominant neighbours. These characteristics benefited New Zealand in the past but are now perceived as economic disadvantages, whereas the Irish economy has been transformed into the Celtic Tiger.”

The Guardian in February 2009 observed:

“Seven billion euros were injected into two of Ireland's major banks yesterday as part of a desperate plan not only to rescue the country's financial institutions but also to save the republic's entire economy.”

Perhaps Mark Twain would have commented:

“The rumours of agriculture’s death have been greatly exaggerated.”

The 1970s revisited – have we really fixed our six main structural problems?

1. While there had been considerable external diversification, the domestic economy was still insulated and lacked the responsiveness that the external sector required.
Today:
a. Of the NZX top-50 shares, 20 export something, while of the NZX top-10, only three export something.
b. The annual trade deficit for the year ended July was ‘down to’ $2.5 billion - we are still living beyond our means. Trade figures out two days ago represent the worst quarter since 1980 and annualised, the worst since 1951.
c. The assets of Fonterra and Foodstuffs (both cooperatives) are almost the same as the market capitalisation of the top-seven shares on the NZX.
d. There is a lack of exporters and too heavy a bias toward the domestic economy.

2. An increasingly sophisticated population, especially the well-travelled, rising urban middle class, were not always able to obtain the consumer goods and services they desired.
Today:
a. No shortage of consumer goods and services but have we gone overboard as the trade deficit and debt statistics reveal?

3. New Zealand faced a complicated energy problem. While traditionally self sufficient in electricity and coal, New Zealand imported transport fuels. In the late 1960s, the Maui gas field was found, then the fourth biggest in the world by size, it far outstripped the standard industrial uses for gas in New Zealand. Adding to this energy supply was a growing excess of hydro power in the South Island. Meanwhile, world oil prices rose in the 1970s (and fell in the mid 1980s).
Today:
a. The Bradford ‘Reforms’ and subsequent tweakings have not succeeded. Renewables, though welcomed, need to have back-up. The current Electricity Market Review is a step in the right direction.
b. Maui is nearing the end of its life with New Zealand increasingly an importer of LPG and a dependence on oil.
c. Transmission infrastructure is being renewed but the Cook Strait cable is in its dotage.
d. On top of this, shifting energy policies and the impacts of the ETS on prices and investment are yet to be felt.
e. New Zealand still faces an energy problem with a growing population.

4. New Zealand was in a strong inflationary mode (compared to other OECD countries). Typically the annual inflation rate exceeded 10 percent throughout the 1970s.
Today:
a. Tradable inflation is under control by way of politically independent and better focused monetary policy, but non-tradable inflation acts as an economic millstone.

5. There was a severe fiscal deficit in which the New Zealand Government was spending much more than its revenue This deficit was hidden by inflation because while the Government’s debt grew in nominal terms, the value of the old debt was reduced in real terms.
Today:
a. It’s a case of Groundhog Day as 15 years of surpluses reverse to a decade of deficits to provide fiscal stimulus - $30 billion over the next four years.
b. Private debt has increased over the past ten years by 36 percent to $302 billion (September 1999 it was $195 billion).
c. New Zealand still has an issue with deficits but the state has been joined by business and consumers and collectively, this creates demand for the kiwi dollar as money is sucked into the economy.

6. The system of Government suffered from a “sclerosis” in that it became increasingly hard for it to tackle anything but the most urgent problems. Its structures and processes had evolved to the point where there was little rationality in them and yet they were unable to rationalise.
Today:
a. Is MMP, with its central tendency towards consensus to ‘reign in Government’, now repeating the same pattern?

Source: Based upon Easton, B. The Commercialisation of New Zealand. July 1, 1997.

Agriculture – the past influences the present

Treasury, that bastion of orthodoxy, went cold on agriculture in the 1970s, reflecting the seismic shift of Britain’s accession to the European Union.

The UK, a country that once accounted for 68 percent of all New Zealand exports, shrank rapidly to around six percent. If we plot the economy’s radical transition in terms of the vehicle fleet, we swapped our Morris Marina for a Toyota Corolla within a few short years.

Think Big was an attempt, albeit a crazy one, to diversify away from agriculture into energy and manufacturing. Eastern Bloc economic planning courtesy of a National Government.

When you think about it, the 1970s and 1980s were not halcyon days for agriculture, with Government throwing money at farmers by way of subsidy. The Lange Government delivered a dose of cold water realism that got our industry back on its own two feet.

Yet a perception of decay has tainted successive Government’s view of the agricultural sector. You could call it benign neglect, but one that has seen agriculture surge.

Some facts and figures about the economy’s backbone

In 1999, exports from the entire agricultural sector (excluding fisheries) generated $13.1 billion in export revenue (60 percent of all exports)

In 2008, exports from the entire agricultural sector (excluding fisheries) generated $23.4 billion in revenue (61 percent of all exports)

Agriculture really does underpin the New Zealand economy.

Economic development is not a template

The biggest problem with economic development has been an obsession with template solutions.

Commentators love to look at tiger economies, whether Ireland or Singapore, and apply that economic mix to New Zealand’s economy. We can thank God we did not emulate Ireland.

Michael Porter’s advice wasn’t new either, but New Zealand could never become the next ‘silicon padi’ or a ‘Switzerland of the South Pacific’ because it’s not part of our psyche. We don’t have that institutional intuitive grasp excepting a few niche successes.

Yet policy is still inculcated in the past view that ‘agriculture is in eclipse and the future is tourism, services and manufacturing’.

Except of course, agriculture has not played the role of the dying swan. In terms of merchandise exports, the agricultural sector remains the economy’s backbone. ‘Why not?’ is the question that must be asked of New Zealand management and structural policy advice that has failed to build off this backbone.

The inescapable lesson to draw is that successful economies don’t copy, they leverage out of what makes them unique in the first place. What makes us truly unique is agriculture.

From Federated Farmers prescription

A new take on Professor Porter:
“New Zealand’s geopolitical position and export profile makes it attractive in a resource hungry world. There is massive scope to develop a number of highly profitable companion industries leveraging of its agricultural base.”

Here’s some numbers that highlight New Zealand’s opportunity:

The current global population is 6.7 billion people
60 percent of humanity live in the Asia-Pacific region
Over the next 40 years, the global population will increase to over 10 billion people
New Zealand currently produces enough food to feed over one percent of the world’s population or four percent of the developed world

To quote the Hon Dr Michael Cullen from a speech delivered to Simpson Grierson in 2008:

“For the first time in New Zealand’s history, we are living in the right part of the world at the right time.”

Let’s look at how public policy could assist in developing the New Zealand economy

“It’s the research, stupid”– The New Zealand research and development sector is fractured with Crown Research Institutes increasingly vying with universities and other providers for a small pool of cash. Add to this mix the research monies collected by industry good levies and you have a sector that needs tidying up.

New Zealand needs to retain and attract the best brains. Yet are our institutions focused on research that will be of most benefit to our economy?

The research sector needs an overhaul, whereby the CRIs are blended into the universities as centres of research excellence. Lincoln and AgResearch went down this track. While that fell over, Federated Farmers thought it to be a good start in seeking a comprehensive solution. The debate needs to be had.

New Zealand cannot build a world-class economy unless we fund and reward scientists with the freedom to innovate alongside research of a tactical nature. The Fast Forward Fund was a step in the right direction, but that has now been replaced by the Primary Growth Partnership.

As a nation, we need to ensure that three percent of GDP is committed to R&D by 2029. This requires incremental but bipartisan steps. The adoption of science is our economy’s future.

“Play to New Zealand’s competitive advantage” – New Zealand has a primary production focused economy but while it is our backbone, there has been limited leverage into the thousands of products and industries that support agriculture, which is incidentally, the world’s biggest business. For example:

Seeds and genomics (such as Monsanto of the United States)
Animal remedies (such as Novartis of Switzerland)
Finance (such as Rabobank of the Netherlands)
Machinery (such as DeLaval of Sweden)
Information Technology

Nufarm, while a lost opportunity, provides a pointer to the future.

Just a dozen years ago, Nufarm was known as Fernz, a New Zealand company struggling in fertiliser but showing promise in agrichemicals. It exited the former to focus on the latter. In 2000, Nufarm moved its head office from Auckland to Melbourne and its listing from the NZX to the ASX. While it is now under a takeover bid itself from the Chinese, its current market capitalisation is AUD$2.4 billion. Put another way, if still listed on the NZX, it would be the fourth largest share in New Zealand.

We need New Zealand businesses to interrogate what the rural sector needs in terms of consumables, then develop opportunities based on the needs identified. If it will work in New Zealand, it will work overseas.

It interlocks with greater R&D investment, as investing in research, which plays to New Zealand’s competitive advantage, can develop new industries that will get New Zealand ahead of the game in the ‘Asian century’. Incubating a new crop of companies that will grow, employ and expand out of what we do best and what we intuitively ‘get’.

“Fixing a lack of equity depth or breadth is not easy…but” – New Zealand’s love affair with property and debt belies a fundamental distrust of shares, which has never properly recovered from 1987. Private equity funds are missing a golden opportunity to leverage off agriculture’s institutional knowledge into manufactured and intellectual property. It also reflects the paucity of big or attractive agricultural/exporting stocks. Fixing this is not easy.

The model Infratil adopts, being a cornerstone investor in infrastructure both here and abroad, is one approach where commercialism is brought to low growth industries. The fact there is no ‘agrarian Infratil’ shows the scale of the challenge. Another model is private equity focused on key areas to exploit such as Rank Group. Either way it’s essential to give current operations a shot in the arm but to avoid a repeat of Glaxo or Nufarm.

There is another solution in the cooperative model - the third-way. In this, we look to CRT, Fonterra, Ravensdown, Ballance or overseas examples such as CHS in the United States or the John Lewis Partnership in the United Kingdom.

Being a cooperative or a major listed or privately held company are not mutually exclusive things. The sharemarket, private equity and cooperatives are not magic bullets individually, yet collectively, they are.

“Fonterra is to New Zealand, what Nokia is to Finland” – Building a company that has a turnover of $18 billion into a global giant profitably turning over, say, $60 billion will come from a clear vision. Structure, as they say, follows strategy.

New Zealand can increase production through water storage but a major expansion in milk supply will come from Australia as well as from operations in other countries such as China. The key is control. The current capital structure review will likely leave New Zealanders in control of Fonterra’s future, the question being what’s next?

The important thing to stress is that capital can be raised from within the shareholders. A $4.52 share returns a healthy $0.55 dividend. The first order is to build the balance sheet through a clear strategy that has member buy-in. Retaining a larger proportion of profit in order to fund the development of ‘smart ingredients’ and branded products is key. To illustrate this, if $0.20 had been retained from profits since Fonterra’s formation, its capital would be a full third larger today.

The focus is upon leveraging value out of the Fonterra brand itself, similar to the ‘Intel inside’ flag on computers. This enables greater value to be driven from the goods we produce. Farmers also fully accept the need to invest back into Fonterra and that includes a greater commitment to R&D.

“Water is New Zealand’s future” – While Mark Twain once quipped ‘buy land, they’re not making it anymore’, we do have a finite volume of land. Yet its full potential is not currently exploited and what differentiates New Zealand from Australia is water. We have it on an annualised basis and in many parts they don’t. Then again, very little is being stored here.

In the Canterbury region alone, we have identified water storage potential to fill the equivalent of around 650,000 Olympic sized swimming pools; enough water storage to supply ten cities the size of Auckland. New water storage and increased water take from some existing rivers has the potential to irrigate a further 325,000 hectares of land. That expands the productive land in the Canterbury region by a full third. We are not just talking about massive projects but a mix of schemes, like the award winning Opuha Dam. We are not just talking about dairy either, but enabling all agriculture and horticulture to fully bloom.

Even if all of Canterbury's town water was supplied and every single centimetre of farmland on the Canterbury Plains were irrigated, only 12 percent of the water in Canterbury currently running out to sea would be utilised. That gives some scale to the amount of water that we have.

Water storage needs to be given a serious economic hearing. The El Nino influenced drought of 2008 cost the economy $2.8 billion and tipped the economy into recession. The Environment Canterbury supreme environment award winning Opuha Dam by contrast, generates an economic payback ratio of over 8:1.

Water storage is an economic ‘no-brainer’ except in Treasury’s eyes. Water storage, unlike other forms of economic development, doesn't need a lot of central Government support, just more than the current $700,000 a year and regulatory reform.

Yet rights in property do carry obligations.

Some criticism is deserved but some is a legacy from the 1970s and 1980s. On dairy farms, effluent is now recycled as fertiliser and we are working to use technology and riparian plantings too. Councils, though, still discharge to water and in some communities, it’s not even treated.

There is risk to New Zealand’s brand from these urban impacts. It’s a real blind spot that farmers have woken up to and are addressing with snap council inspections and publicly transparent reports. Not seemingly, however, our urban communities.

A future Government must treat councils, industry and homeowners the same as farmers. There is no excuse for a direct discharge to water and a council warning sign does not absolve culpability. That means councils and individual CEOs being charged under the Resource Management Act (RMA) as farm owners currently are.

Horizons Regional Council is to be congratulated for taking the first step to challenge urban New Zealand’s perception of itself. There is much to be done as water is our most precious resource and the responsibility of everyone.

We want to be there with you on this.

“Climate change opens doors, as well as closes them” – The global environment is changing and there are opportunities for new technology and industries to be developed by way of research-led solutions. New Zealand’s farmers will have to change and adapt to meeting consumer preferences and demand. Old systems of farming, pastures, species and technique will continue to adapt. This will open new doors and close others.

Where we hopefully are in agreement, is the need to invest heavily in research, science and technology. Federated Farmers for one would like to see all OECD countries commit 0.05 percent of GDP to low carbon research. This would raise some $88 million annually within New Zealand and $34 billion globally. In the New Zealand context, ruminant physiology is one we’d like to tackle directly. New Zealand could take a strong lead, again, in an area we happen to know a lot about.

From the agricultural sector’s perspective there is a holy trinity in the offing – more production with fewer inputs generating less emissions.

If agriculture is enrolled in the ETS, the technology cupboard is currently bare. Millions of years of ruminant evolution cannot to be corrected in the next nine years.

There are just nine years until 2018, when agriculture is enrolled in the current ETS. Agriculture accounts for 16 percent of all private debt worth $46 billion. That level of debt is lent on the basis of current agricultural practices. A super tanker takes many kilometres to stop and nine years is insufficient lead-in time to radically change business or farm practices.

Longer lead-in times enable markets to adapt and adjust. Time for a new generation of farmers to enter the production system focused on a new reality.

The closest analogy I can draw is national superannuation. It would be a brave Government to tell all 56 year-olds that super will not be available at age 65. Any change would have been signalled decades in advance. Say by telling those aged 35 and younger to save for their retirement by the time they are 65.

I realise this represents a seismic shift in policy, but without any technological solution, an ‘all-in’ enrolment in 2043 rather than a phase-in between 2018 and 2029 delivers the time for markets, farmers and that $46 billion in debt to reach an equilibrium. If not, the entire economy is placed in jeopardy.

“Fixing the RMA’s compensation anomaly” – For farmers, there is a major anomaly in the RMA and that is a lack of compensation. Reform of the RMA must enshrine one of the western world's first tenets, property rights. While it may sound abstract, it recognises property has a physical and intellectual dimension.

If physical land is required under the Public Works Act, say for a motorway, compensation is payable. If, however, land is indirectly affected by that public work or in our case, farmland has a designation placed upon it under the RMA, no compensation is payable. Yet the effect on the ‘property right’ can be the same as if it was being appropriated for a physical work. Absolute regard for property rights must be incorporated into Section 6 of the RMA.

This is even more critical now that the Act can fast track projects of national significance. Economically as well as socially, this creates certainty to invest for the long term. Greater certainly encourages strategic investment and that benefits the entire economy. The lack of compensation in the RMA provides a disincentive to invest.

“New Zealand’s brand is also being 100 percent pest free” – The cuts to biosecurity risk scoring an almighty own goal. At the moment, less than 1:10 containers are physically inspected.

The southern saltmarsh mosquito and the painted apple moth didn't walk here but hitched a lift by sea, costing us all tens of millions of dollars to eradicate.

The aggressive and invasive Argentine ant that's now endemic and, hard as it is to imagine, wasps only came to New Zealand in the 1940s. Better inspection at the border could have prevented these pests from entering New Zealand.

There are tens of billions of reasons to invest and each reason will be the dollars we are putting at risk. Biosecurity is one area of Government that could have hundreds of millions of dollars poured into it to increase physical inspection. While it is unrealistic to have 100 percent screening, even increasing to 1:3 will substantially reduce risk in an area that is important to New Zealand’s brand and the economy.

“Reforming the funding of local government” – As home ownership declines, now is the time for rational debate on local government and its long term funding. Federated Farmers view is that all wage earning citizens should contribute to the services they consume.

Since sacred cows are on the agenda, let us talk about a poll tax or some such other variation like partially funding councils by using one percent of GST. The level of low democratic participation in local government reflects a general disengagement. People living at home often have their bills paid by parents, people renting have their rates partially paid by rent, but more often than not, absorbed by the landlord. In the case of Housing New Zealand (HNZ) tenants, all rates are paid by HNZ direct.

Getting all citizens to contribute to the services they use gives them a direct reason to engage with their councils. Greater democratic participation is what we need and changing the way councils are funded will drive vitality locally.

The Boston Tea Party’s slogan may have been "no taxation without representation", but the issue with council funding is that we have representation without taxation. It doesn’t work and must be changed.

“The role of central Government” – Irrespective of whoever occupies the Treasury benches, the size of Government has grown. Now is time to reflect on what it has achieved. For those who lived through the 1980s’ reform of Government, far from being apocalyptic, it actually had a liberating effect. The risk is that in policy navel gazing, decisiveness is replaced with inaction.

Central Government’s role is to do things that are too difficult for anyone else. Its role is the truly hard stuff; to create a new economic vision of New Zealand demands avoiding anything that brings a lot of heat with no action or entropy.

This is a philosophical change of which, in most instances, Government is better on the sidelines than on the field of play.

To our mind, Governments ought not be judged on the volume of legislation passed, but on the quality of legislation. In this case, we have to reduce the volume of legislation passed.

In summary:

We need better research
Play to our strengths
Allow Fonterra to be New Zealand’s Nokia
Water storage is a ‘no brainer’
Fix the RMA property rights and compensation anomalies
Reform local government funding

ENDS

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