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Cullen Speech To Business Retreat

Saturday 10 March 2001
Hon Michael Cullen Speech Notes

Speech to the Ernst & Young Business/Government Leaders Retreat

Dr Cullen's address to the Ernst & Young Business/Government Leaders Retreat, Tongariro Lodge, Turangi

The government¡¦s economic mission is to transform the economy from low to high performance.

We have a clear idea of where we want to end up. We want an economy that is less vulnerable to the vagaries and long term decline of commodity-based production and trade. We want to compete in the markets we occupy with the best in the world. We want to reward our citizens with well-paid and interesting jobs.

That sort of economy is in the top half of the developed nations of the world.

We will have to play ourselves back into the first division at a time when the pace of change has never been faster. We have to adapt by innovating. We have the brains, the talent, and the institutional structures. We must now turn the great ideas they generate into great ventures.

In this, education is pivotal. It enables a fusion of technological and financial systems around a more sustainable, adaptable and higher yielding economic system.

That is the ¡§what¡¨ of the economic transformation. Now to the ¡§how¡¨ and the ¡§when¡¨.

In these areas there is less definition:

(a) of the specific results that need to be achieved (¡§goals¡¨ or ¡§targets¡¨);

(b) of the key drivers of the transformation; and

(c) of the time scale over which the transformation is to take place.

The economy is not just underperforming, it is also unbalanced. It relies too much on the savings of others, and until recently has relied too heavily on private consumption.

The result has been that we have spent before we have earned, and sold assets or borrowed abroad to bridge the gap.

This imbalance is, of course, crystallised in the balance of payments deficit, which peaked at around 7 percent of GDP ¡V or 8 percent using the previous classification system and measure of GDP.

Bringing this deficit back into a sustainable range remains one of the key challenges of the economic transformation, even if it is currently declining very rapidly.

This is an area where there is no clear consensus on what needs to be done. At one end of the ideological spectrum are those who see the deficit as inherently ¡§good¡¨. In this view it reflects foreign investors confidence in New Zealand and makes available foreign savings that we can use to maximise our growth potential. At the other end the deficit is seen as a direct measure of the rate at which we are losing economic sovereignty.

My view is that the key ingredient missing in this debate is the quality of investment. Net foreign inwards flows of capital are neither inherently good or bad. If, as in the recent past, they largely finance locals bidding up the value of residential properties, it is hard to see long term net national benefit. Equally, sales of existing assets free up domestic capital for use elsewhere, but apart from that does not have the benefit of stimulating greenfields expansions.

There is no firm evidence on this, but my intuition is that access to foreign capital has allowed soft investment into low quality assets. Given that there is no intention to impede inward investment, the challenge is to create an environment in which there are better quality destinations for that investment.

Apart from that, we need to realise that while foreign investment is welcome, foreign investors do take a share of the output it helps to produce, and that share is no longer available to lift the living standards of New Zealanders.

The last work done by Bryan Philpott stressed this point. He calculates that between 1984 and 1999, GDP ¡V the total value of output from within our national boundaries ¡V increased by 1.8 percent a year in real terms. However, because of our very poor savings record and our reliance on the savings of others, the net income paid overseas ¡V to the overseas owners of capital used in production here ¡V rose from $1.6 billion a year in 1984 to $7.4 billion in comparable dollars in 1999.

The result is that national income ¡V the total value of output accruing to New Zealand nationals ¡V only grew by 1.4 percent a year. When population growth is taken into account, national income per head grew by 0.2 percent a year. And this, ultimately, is what drives living standards ¡V the amount of output per person that New Zealanders can lay claim to.

So we have had a lot of change and a lot of pain, big new technological advances and over some decades even a lot of growth in total ¡V and we are virtually in the same place as we started out from.

That is why lifting the savings rate and the quality of investment ¡V not very sexy, headline grabbing targets ¡V have to be seen as central to the economic transformation project.

The external deficit also reflects an imbalance between what we earn from foreigners and what we buy from them. That is why a key part of the transformation also involves rebuilding the earnings base, especially earnings of foreign currency. For some very considerable time, and contrary to the doctrines of classical economic theory, there will be a premium on growing the export industries.

With any transformation, a small percentage increase on a large base produces bigger results than even large increases on small bases. There is a need to get away from analysis by anecdote, and to see particular novel developments as being the answer to our economic woes.

The fact is that 18 percent of our export income is earned from dairy products, 13 percent from meat, and 11 percent from forest products. Resource based industries will continue to provide the core of foreign exchange earnings, and any economic transformation must protect and enhance that core.

There is a myth that resource based industries are old economy and use crude technologies. That is not true. Most of New Zealand¡¦s knowledge based advances have been concentrated in the life sciences and applied to resource based industries. They are highly knowledge intensive.

That knowledge intensity needs to shift up a gear, be refocussed on the new scientific frontiers, and move further down the value chain.

There will always be the unexplained exceptions. But even the newer type of industry expansions ¡V jetboats, luxury launches, adventure tourism, and even film making ¡V tend to emerge from our adaptation to our natural environment.

A second target of transformation is the employment base. About half of the workforce is employed in the retail trade, in education, in the health sector and in other services. More than half of those who will be in the labour market in twenty years time have already left the formal education system.

Workplace training, second chance education and lifelong learning can help, but despite that the skill set and industrial distribution of the labour force is largely set and will change very slowly.

We therefore cannot embark on an economic project that ignores the employment base of the traditional economy.

Indeed, given the training flows that are already apparent, especially internationally, it is not unreasonable to anticipate that in a decade or so, New Zealand will be able to draw from a large global pool of people with high levels of technical proficiency in information technology, and face skill shortages in agricultural production and processing.

The very fact that the stock of skill only changes at the margin ¡V newly trained workers exiting the educational system form only 2 to 3 percent of the total workforce each year ¡V makes the quality of our education system absolutely central to effective economic transformation.

The existing structures in tertiary education are largely demand-driven bulk funding systems, with little opportunity, and few powers, for the exercise of discretion in the allocation of funding. To be blunt, the government gets the elephant¡¦s share of the pay, for a mouse¡¦s share of the say.

The result is that we have certainly increased levels of participation. Along with that has come financial difficulty for some providers; intense competition and duplication in the provision of high volume, low cost courses and programmes; and a lack of coordination and integration of the tertiary system as a whole.

The government is currently considering the second report of the Tertiary Education Advisory Commission. The main emphasis in the report is on finding ways to integrate the tertiary system around strategic targets.

Specifically, there is need to steer funding of tertiary education to reflect both national and local priorities, and to promote focus and specialisation among tertiary providers.

Economic transformation ideally involves a process of ¡§creative destruction¡¨. It builds the new, more secure, higher earning base out of, not instead of, the old. New Zealand will never replace its resource base, not should it try to. That resource base ¡V in agriculture, fishing, forestry and tourism ¡V in fact creates the source of long term competitive advantage. Gains in science, education, health and the like both flow out of and complement knowledge intensive resource based industries.

Other bases of advantage, such as stable institutions of government, a functioning democracy, respect for human rights and attractive lifestyle are important, but not sufficient. Other parts of the world have equal endowments in these areas, are closer to large markets and have advantages of economies of scale and deeper capital markets.

The task, then, is to foster a climate of innovation, to leverage off ¡V largely, but certainly not exclusively ¡V that long term advantage.

Innovation is a slippery concept.

The process involves a number of steps, some of which are:

„h researching product and market opportunities;

„h developing product or production processes;

„h ¡§seeding¡¨ the new venture with the appropriate mix of technological, managerial and promotional input;

„h ¡§incubating¡¨ the project until it reaches a critical commercial stage of development so that it is self-sufficient;

„h growing the business so that it makes a substantial contribution to economic wellbeing;

„h adapting it to constant changes in its operating environment.

The strength of the innovation process will be determined by the strength of the weakest link in this chain.

Comment from the business community indicates that historically there have been a number of weak links in this innovation chain, not just one. Hence traditional industries have languished and have not been renewed around more sophisticated technological or commercial processes.

Some of the weaknesses that have been identified are:

„h Levels of direct government assistance for R&D.

„h Lack of tax incentives for undertaking R&D.

„h Uncertainties and inconsistencies in the tax treatment of R&D.

„h Lack of profits or cash flows, especially among small business, for spending on R&D.

„h Poor commercialisation of science undertaken within the state scientific infrastructure (CRIs), and weak incentives to commercialise the intellectual property of CRIs.

„h Lack of venture capital, especially at the seed end of the venture capital spectrum.

„h Weak business supports at the incubation phase of the innovation process.

„h Thin capital markets, and a tendency to ¡§migrate¡¨ an established venture offshore to facilitate its fuller growth.

The government is moving on all of these fronts. It is important to avoid concentrating too heavily on only one aspect of any problem, and to avoid ¡§fads¡¨ whereby the latest trend or policy fashion distorts the innovation policy package and merely creates uncertainty.

It is also important to get away from very short-term and cash driven incentive regimes.

In some cases, we will prosper or languish depending on the quality of the regulatory environment within which our natural endowment is nurtured.

As an example, let me touch on the very politically sensitive issue of genetic engineering. I firmly believe that a large part of the process of economic transformation will have to involve the development and application of new biotechnologies. They offer major gains in both production efficiencies and product diversification. They also have the potential to make industries technologically obsolete if we fail to catch the right technological wave.

Biotechnology spans a wide spectrum from the absolutely uncontroversial to the highly scary. We have to get the pitch right, because there are as many risks from being too cautious as there are from being too cavalier.

Think back to the advent of the motor car. In its early days it was seen as a major threat to life and limb, so much so that drivers had to employ people to run in front of the car carrying a red flag to warn innocent bystanders. The people who saw the dangers of the motor car were wildly wrong. It was much worse than they imagined. In this country alone, each year, about five hundred people are killed and thousands are hurt, often with horrible long-term consequences.

Internationally, tens of thousands perish each year as a direct consequence of the deployment of this technology. But we do not turn our backs on the technology. We set rigid standards around the construction and maintenance of vehicles. We spend billions of dollars constructing an infrastructure that minimises the risks associated with their use. We run continuous education programmes, and have elaborate enforcement regimes.

We do not ban the car nor do we allow unconstrained use of cars. We try to set rules and contain damage, and then live with the residual risk because the advantages of the technology demand that we do so.

Setting the right controls, but also permitting the development of the full potential of biotechnology will be a real test of our national maturity. It will probably be the single most important strategic policy decision that governments will make in the next twenty years.

And all of this takes time. I see economic transformation as urgent. That does not mean that we can afford impatience. We need to be cynical about magic bullets and quick fixes. They do not exist. It is a broadly based, coordinated, careful and long-term project that is being implemented.

Inside this project, there is a limited amount that a government of a small, open economy can do. We are pushed and pulled by global investment flows, by international economic cycles, by new technological developments and by changing trade alliances.

What we can do is important, though. It is doubly important in a small economy precisely because there is a level of intimacy that is absent in large, faceless economic machines. Government and business can talk and there is an openness ¡V both ways ¡V that has to be a major source, not just of competitive advantage, but also of speed of response to changing circumstances.

My broad conclusion is that in the past we have done opposite things wrong. We either relied too much on governments ¡V especially to protect and subsidise ¡V or too little.

There is, I suspect, a new consensus emerging around the virtues of constructive engagement. But if I could go back to a theme that I developed at the start of this presentation ¡V it will be the quality, not just the quantity of that engagement that will determine success or failure.

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