Cullen Address to Wellington Institue of Directors
Michael Cullen Address to Wellington Branch Institue of Directors
Thank you for the invitation to join you for breakfast today. I am sure that you will want to have some time for questions and to make comments about what the government is doing to improve conditions for business, so I will be brief in these introductory comments.
I want to touch on three issues: the outlook for the economy, the government’s programme for fostering economic growth, and the challenges that lie ahead to restore public confidence in the ethics of corporate behaviour.
If I could summarise our economic circumstance in one sentence it would be that we face near term uncertainty but from a solid base and with substantial capacity to deal with any downside risks.
You are familiar with the basic statistical indicators: growth at 4.4 per cent, unemployment hovering around 5 per cent, inflation running at 2.5 per cent and a current account deficit of 4 per cent of GDP. As I have said before, this overall picture is stronger and more balanced than it has been for nigh on a third of a century.
We need to go back to the mid 1960s to find a better mix of indicators. Since that time, we have been on a roller-coaster. Growth has often been stimulated by tax cuts or tax concessions, so it has been accompanied by rising deficits and rising debt. Reigning in inflation was achieved alongside and because of a blow-out in unemployment. Falling unemployment was achieved by real income cuts. Conversely, real wage increases tended to be inflationary. We just never seemed to get all of the ducks in a row since the loss of preferred access to the British market and the oil shocks of the 1970s.
For now, that has changed, and the economic cycle is virtuous. Sitting in behind a strong economy is a strong fiscal position, reflected in a significant fall in the level of government debt. Sovereign issued debt has fallen to a little over 27 per cent of GDP, but the Crown also has financial assets. Net core debt is 14 per cent of GDP and there is another 1.5 per cent of GDP sitting in the Superannuation Fund.
Sitting behind the fiscal position is a queue. For all of those with more good ideas about how to spend the surplus, I have a simple message: the in-tray is full. One of life’s little ironies is that ever since the budget was presented I have had to tour the country talking more about what wasn’t in it than what was. I have had to repeat one very simple message: I do not have $4 billion dollars to spend. The $4 billion that has been dominating media coverage of the budget is, in crude terms, the difference between cash in and cash out. Accounting conventions mean that contributions into the Superannuation Fund effectively come out of this surplus. Next year we will put $1.9 billion into the super fund. There have also been unrealised paper losses on some government funds like the Government Superannuation Fund and the Natural Disaster Fund. These losses may reverse out as stock markets recover, but they may not, so we do need to be prudent in case they don’t. The future costs of ACC liabilities and GSF pensions are estimated to have gone up. As interest rates change, those estimates may reverse out, but again they may not. We cannot just ignore them. We are also spending significant amounts of money to upgrade the infrastructure: roads, schools, hospitals and the like. If we do not finance some of that out of operating surpluses we have to borrow, and the government is determined to make sure that government debt doesn’t get away on us. If it does, more is spent paying interest on debt and less is available for our other economic development and social programmes. Finally, and most important, the surplus is a small difference between two large numbers: total revenue and total spending. Small changes in both can have big impacts on the difference between them. Experience in Britain and the USA shows that healthy surplus projections can vanish before your eyes. In a very uncertain world it would be extremely dangerous – to paraphrase the late Sir Robert Muldoon – to spend the lot. This brings me to that matter of near term risk to the economic outlook.
We face a future dominated by the longest global bear market in fifty years, weak investor confidence, uncertainty about the post-Iraq war reconstruction, pessimistic forecasts about returns to dairying, SARS, questions about the cost and supply of electricity, worries about the exchange rate, the effects of dry conditions in parts of the country and frosts in other parts, and I suppose everyone in the audience could add two or three items to that list.
It is the length of that list, and its complexity, that leads me to say that this is one of the most unpredictable environments that we have encountered since the stagflation and Third World debt crises of nearly twenty five years ago.
If you look at that list, it is possible to split it into two: those items that, on best estimate, are temporary, and those that are more fundamental.
Weather conditions have impacted on agricultural production and on electricity generating capacity. SARS and uncertainty over the conflict in Iraq have disrupted travel and increased uncertainty in the tourism industry and for some food exporters. The past is not a perfect basis for predicting the future, but at this stage it is the best we have got. Past experience suggests that the effects of temporary forces tends to be short-lived. In the interim, there are still the offsetting effects of higher net immigration, and the consumer confidence that is sustained by the wealth effects of rising house values.
The net effect of the temporary factors is that our best estimate is that the economy will hit a soft spot in the middle of this year, with the brunt of the effect being felt in the June and Septemer quarters. We do not expect any more generalised stagnation in activity. The nature of the temporary influences means that the soft spot will be softer in some sectors – and therefore regions – than in others.
It is harder to predict what sort of effect the more fundamental factors will have on the economy, and how long they will last. The timing and strength of any global recovery, what it will do to commodity prices and our terms of trade, and how it will impact on the exchange rate are all factors that are largely beyond our control.
It is especially here that not all of the risks are on the downside. Historically, once there has been a bit more certainty after a military conflict, the rebounds have been strong. At this stage I am not banking on a strong rebound, mainly because there is very little macroeconomic headroom left to stimulate activity in the larger economies. The best estimates are for a steady rebuiliding of global economic activity. In that scenario, growth in New Zealand slows to 2.1 per cent by the middle of next year as a result of the soft spot, and picks up to 3.5 per cent in the year after that.
At this stage I have no intention of reacting to the temporary factors that are creating the mid-year soft spot. There are a number of automatic stabilisers that will kick in if the economy slows, the main ones being the automatic fiscal stabilisers and lower interest rates if the Reserve Bank picks that activity, and the inflationary pressures associated with it, are dissipating more quickly than anticipated.
What, though, if the longer-term outlook softens?
We can take comfort in the fact that we approach an uncertain future with significant policy headroom and a range of policy options. This is not simply fiscal headroom. The monetary authorities also have room in which to move. Fiscally, there is scope to respond on both capital and operating fronts. If the economy does slow, we enter a slowdown with much more scope to absorb the labour market downside than we have had since the start of restructuring in the late 1980s.
Corporate, farm and household balance sheets are in a reasonably healthy state. We did not have the tech stock or even stock market asset bubbles that other countries did in the 1990s, so there has not been quite the same degree of wealth loss to shake consumer sentiment. We have taken steps to expand trade opportunities, to plug some of the gaps in the venture capital market, to upgrade our training programmes, to align immigration policy more closely with skill needs and to rebuild the infrastructure: all factors that will make it easier for New Zealand firms to find their way in troubled times.
We can approach the immediate future with a lot more confidence than many other OECD countries.
This leads me naturally into my second topic, which is what the government is doing to foster a better climate for business. I am going to start with the negative: the strategies we are not following. We do offer assistance to inward investors in the form of information, and in co-ordinating a whole of government approach to the various consents that may be necessary to set up here. Apart from that we are not in a bidding war to attract footloose opportunists. That sort of investment moves on with the latest offer.
We want to attract business that sees advantage in our underlying potential as an investment locality: an uncomplicated and corruption free regulatory environment, sound macroeconomic fundamentals, a skilled, adaptable and – by developed world standards – a cost effective wage structure, solid research, reliable infrastructure and the like. It is much better to put money into covering some of the weakeness there - like by ugrading the infrastructure – than to get involved in begger-thy-neigbour location bribes.
We are also not going to be rushed into cutting the company tax rate. It is far better to pay 33 per cent on a profit of one hundred dollars that 30 per cent on a profit of fifty.
That is why we have put the emphasis on getting the mix of supports right throughout the value chain. Let’s face it, business is hard in New Zealand. We are a small economy a long way away from the high income mass-markets of the northern hemisphere. We are geographically challenged and have a regulatory regime that produces fiercely competitive markets.
Bit by bit the pieces of an effective industry and economic development programme are coming together. We have upgraded the funding of basic research and product development. We have put more emphasis on the commercialisation of the science that is being done in Crown Research Institutes. A Venture Investment Fund is now up and running and able to plug the hole that market mechanisms left at the seed and start-up of the financing of innovation. The last budget extended that by allocating $19 million to a Pre-seed Accelerator Fund.
Skills needs are being addressed by a much more structured and targetted tertiary education system that better aligns the training on offer to the skill needs of employers. We are reorienting the immigration system away from border control to a more proactive recruitment of those with scarce skills.
In the next four years, there is $110 million set aside to respond to the recommendations of the task forces that have been established to promote growth in the biotechnology, design, screen production and information and communications technology industries.
More funding is going into business incubation programmes.
We are putting a lot of money into overcoming the tyranny of distance by directing public funding into offshore market development and inward investment attraction. The budget allocated an extra $15 million to promoting tourism in the USA and another $73 million to promote overseas trade. We have integrated the trade, investment attraction and industry development agencies of the government into a seamless, single agency.
I accept that infrastructure is crucial to business. It is a key to improving productivity. There is no point in investing in state of the art just-in-time production systems and high-tech transportation equipment if the best laid plans of mice and managers are idling on an Auckland motorway generating greenhouse gasses.
The government is committed to upgrading the infrastructure consistent with the needs of a modern, high productivity, developed economy. It is spending money to identify areas of greatest need, has set up a high powered committee of Ministers to steer infrastructure policy, and is encouraging innovative ways of financing infrastructure development.
At every level, the government is doing its bit to relieve the pressure points that frustrate business reaching its true potential.
I have to say, though, that in recent years, some business practice itself has generated problems for business growth, particularly insofar as weak ethical standards have caused potential investors to withdraw from equity markets. I readily concede that most of the poor practice is offshore, but it is sufficiently widespread to have impacted on investor confidence in every jurisdiction.
There are some things that governments can do in the regulatory and securities areas, and we are constantly trying to ugrade our laws and systems. At the end of the day, though, this is a joint responsibility. Directors have some responsibility to tidy up practices within the companies that they are responsible for governing, both in the specfic circumstances of a single company, and generically through organisations like your Institute.
I appreciate that there is much more attention now being paid to the role of auditors and the role of consultants, and to practices on valuation and disclosure. Despite that, a lot of reputational damage has been done and there is a need to be vigilant and determined to restore that reputation.
My concluding message is that too often we see our relationship as adversarial, when the reality is that we have much more to gain by focussing on where we have common interests, and working to promote them.
The three areas I have touched on this morning - responding to the threats that global economic uncertainty creates, assembling the pieces that make New Zealand an easier place to do business in, and upgrading the regulations and practices that contribute to sound business ethics – are three areas where this is particularly important.
Thank you. Your
questions and comments are