Michael Cullen to NZ Property Institute Conference
Hon Dr Michael Cullen Speech Notes
You have asked me to provide an overview of the state of the economy, which is probably the toughest task that anyone could be assigned at this point in time. The economy is in an incredibly complicated state, as evidenced by the massive differences in the forecasts of the different economic agencies.
The National Bank forecasts GDP growth of 3.3 percent this calendar year, and 3.5 percent in 2001.Westpac forecasts a slightly softer near term outlook, with growth at 2.6 percent in the year to March 2001, and 3.7 in the following year.Deutsche Bank has a similar track, with growth 0.3 percent lower in each year compared with the Westpac numbers.
Those three agencies tell a similar story. Domestic economic activity is soft, for a number of reasons. The declining dollar and high petrol prices have dented consumer confidence, but conditions for exporters are generally favourable. The world economy continues to grow, commodity prices are robust, weather conditions are kind, and the dollar is keeping returns up. The export led recovery will gain momentum, and will feed back into domestic incomes and activity. Because the eventual recovery of consumption is based on earnings, not on foreign borrowing like the last cyclical expansion, it is likely to be more sustainable.
That is a reasonably comfortable story, and it is a story that recognises that there were elements of our economic structure, and particularly our unhealthy appetite for the savings of foreigners, that had to change.
I will come back to comment on the risks that surround that story, and on the steps the government is taking to deepen and entrench a reconfiguration of economic activity on more sustainable foundations.
In the meantime I do need to note that there is the dark view on economic prospects. Infometrics has the growth rate slumping to 1.4 percent on the 2002 March year.
That is a wide variation: a scenario of 3.5 versus a scenario of 1.5 percent annual growth.
There are certainly some abnormal factors at work, and some forces that are beyond our control.
Construction activity – a subject close to your hearts – has been extremely volatile of late. Construction activity, as measured by Statistics New Zealand, was 22 percent higher in the March quarter than in the same quarter a year previously. It was 6 percent up on the strong activity level of late 1999, and contributed a quarter of the reported GDP growth in March. By contrast, a 13 percent slump in construction activity contributed 0.5 of the 0.7 percentage point decline in GDP in the June quarter.
These are strong and volatile components of growth as we measure it. As a rule of thumb, a ten percent change in the level of construction activity translates into a 0.3 percent change in the growth rate. When growth rate changes are often between 0.5 and 1 percent a quarter, it is easy to see how volatility in this sector can produce headline grabbing results!
I make this point because it illustrates how much of the short term changes in economic activity can be driven by factors over which the government has very little control. Construction is influenced by factors like trends in immigration and emigration, phases like urban renewal or apartmentisation, activity surges like building around the staging of the Americas Cup, and changes in interest rates.
Governments should not, and should not be expected to, take corrective measures in the face of these sorts of zigs and zags in the underlying economic trends. Indeed, our recent experience is that the over-reactions in policy terms – to the 1987 sharemarket crash and the 1997 Asian economic crises – were counter-productive.
So too with the other big items now confronting the economy; the falling dollar and uncomfortably high oil prices.
I want to make two points about the dollar. One, it is not a measure of economic wellbeing. Two, it is not the result of changes in the government’s economic policies.
The value of the dollar is the net result of inflows and outflows of funds: exports, imports, repatriation of profits, remittances by tourists, sales of assets, relocation of financial portfolios and the like. There is nothing magical or good about a high, or a low dollar. A high dollar can reflect a rash of asset sales, or large borrowing from foreigners, and is not in itself either a reflection of good policy or a signal of future prosperity.
Of the two high value currencies at the moment – the US$ and the Yen, one is in a high growth economy and one is in a stagnant economy.
Over the last year, our dollar has gone down by over 20 percent against the US $, about 3 percent against the Australian, and is virtually level with where it was against the Euro. There have been no government changes or policy shifts in those areas where our currency is essentially holding its own.
The exchange rate is something we have to live with and adapt to. It is putting pressure on some import costs, but equally it is boosting the incomes of those who are exporting and improving the competitiveness of those competing with imports. I would include in that tourism, where holidays at home are now looking quite competitive.
The decline in the exchange rate has been uneven. In some ways this is a plus. Traditionally, a declining dollar boosts returns to primary producers, we have a commodity led business cycle, the dollar appreciates, the Reserve Bank applies the brakes and we are back where we started.
Under the scenario that is now unfolding, the export growth is likely to be somewhat more broadly based, with fewer inflationary scarcities and bottlenecks. Exporters paying for inputs like petrol and computers in US$, but selling products in Australia and Europe will not have the full income benefits of a depreciating currency. They will be getting some advantage from better commodity prices, expanding world trade volumes and good growing conditions. They will also still be under pressure to improve productivity, diversify product range and penetrate new markets.
On the other side of the ledger, sales of high value products in North American and Japanese markets generate very large profit gains. The specialist products and the computer software applications are generating good returns, and I detect strong growth in some of the urban based export engines, especially in the South Island and in parts of Auckland. It is here that our natural advantages of pragmatism and flexibility can be used to fullest effect.
Petrol prices are a different matter. Reports I have received indicate that part of the problem with world oil prices is that for quite some period of time there has been little or no investment in refining and transporting capacity. When world economic growth rebounded from the Asian crisis, these supply side constraints were reflected in rapidly rising prices. While the current very high prices will probably not last, we should not expect a rapid return to the low oil prices of recent years.
That is probably the single most worrying aspect of the current outlook. As a net importer of oil products, we are seeing higher prices drain a portion of our national income and transfer it to oil exporters. We can’t avoid that. It means that in the short term at least, very good export growth is not being reflected in an equivalent improvement in the trade figures. I expect that to work its way through as oil prices stabilise and export growth gathers momentum.
There are a number of indicators that would lead even the most cynical observer to conclude that the outlook for now is comfortable. Let me list some.
Retail sales figures are holding up well. The sceptics would say that this is just because consumers are bringing forward purchases to anticipate import price rises. I think the figures reflect a more buoyant domestic economy than is sometimes assumed, reinforced by strong tourist spending. Where consumers are holding back it is in the areas of bulky durables like cars and houses.
Import data show continuing strength in imported capital goods. This suggests that a number of enterprises are gearing up to take advantage of good trading conditions.
Cost pressures may be building, but price increases remain muted. Leaving aside petrol and tobacco, the latest CPI increase was in the mid point of the Reserve Bank’s 0 to 3 percent target range. This suggests that capacity to increase prices is limited, but I suppose for some producers this means that trading margins are being squeezed.
The decline in construction seems to have troughed, although as I indicated earlier this part of the economy remains volatile.
Export figures all point to a continuing expansion.
The risks are of continuing high international oil prices, more rapidly slowing world growth, and increasing nervousness about currency markets. I get the impression that the markets are in something of a holding pattern pending the outcome of the US Presidential elections, but regardless of that, my feeling is that the risks to the outlook are risks of degree, not of substance.
Where, then, does the government fit into the picture? I suppose it comes down to a judgement as to whether the role of the government is passive or active. A passive government keeps its house in order and lets business get on with it.
This government is determined to keep its house in order. It is financially conservative, plus. For the first time that I can remember, we have a government that is prepared to face up to its emerging financial obligations, not just in the next year or even three years, but over the next ten, and twenty years. The government has also committed itself to key elements of the policy mix that maintains a business friendly environment: sound monetary policy, transparency in public finances through the Fiscal Responsibility Act, and so on.
It has improved that mix in key areas, such as by strengthening competition policy and upgrading the protection offered to minority shareholders in the event of takeover bids.
The government does believe, though, that businesses can extract far more value from the opportunities of the global economy if it plays a more active role in partnership with them. This is not the time to go through the details of our programme, but I will list the key elements of the approach.
The first is to improve the supply of skills, and to improve the relevance of that supply to the needs of the employer community. If needs be, short term gaps in the skills mix will be met by a more proactive immigration programme.
Secondly, we will upgrade our technological capability so that as a nation we will be in the best place to make the inevitable transition to a more knowledge intensive way of doing business.
Thirdly, the government will work actively to exploit the scientific and technological strengths that have been built up in our key scientific institutions.
With trade, we will explore opportunities for mutually advantageous expansions of trading partnerships.
The government will help to nurture innovation in a host of ways, including more effective incubation of small businesses, provision of facilities for export credit insurance and connecting venture capitalists with capitalist ventures.
Finally, it will facilitate change where change is desired, but where legislative or administrative assistance is needed to effect it. By way of example, the government cleared administrative paths to facilitate the establishment of a super-yacht venture in Whangarei, gave early assurance of support to the Stock Exchange to explore closer relations with its Australian equivalent, and has indicated to Producer Boards that it is willing to play its part in any restructuring that has broad support from the relevant producers.
In all of these areas, we can identify three systems operating: the skills system, the technology system and the financial or capital market system.
We need to improve the performance of each system, broaden the scope of their operations, and integrate them.
There is a coherent, comprehensive and complementary programme of measures in place or under development that does that.
It will not kick in with spectacular results overnight. It does, though, have the best, and arguably the only, chance of transforming the next business cycle into the next business launchpad. It is from that launchpad that we reach for security, sustainability and prosperity.
I am comfortable about the outlook for the next three years. I am excited about the prospects that we are creating for the thirty that follow.