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Cullen Address to the Auckland Business Network

Hon. Michael Cullen
Finance Minister
17 July 2003
Speech Notes
1.15pm Thursday 17 July 2003

Address to the Auckland Business Network.

Thank you for your invitation to talk with you today.

The format for these sessions is the briefest of comments from me, and then an open exchange of views.

In setting the scene for our discussion, I am going to give you an overview of where I see the economy heading, talk very briefly about the exchange rate, which seems to be a topic of conversation in some business circles, and make mention of what we are doing on the question of the infrastructure, which is very relevant to the Auckland agenda.

Auckland is such a big part of the economy that the outlook for Auckland is difficult to distinguish from the outlook for the economy as a whole, and vice versa.

At the time of the budget, the central economic scenario was still moderately benign, especially considering the state of the world economy. It envisaged us hitting a soft spot in the middle of the year as dry conditions, SARS and uncertainties over electricity supply impacted on farm production, tourism, export education and process industries that use a lot of electricity. These temporary forces were assumed to dissipate as 2003 progressed, but a lot of uncertainty still surrounded the main drivers of the economy going forward. The best guess was for a relatively quick rebound.

If I look at the economy today, the key indicators are pretty much in line with the track forecast in the budget. The March GDP figures were entirely consistent with budget numbers. Many of the downside risks have dissipated rather rapidly.

The power crisis was averted by early and cautious conservation measures. SARS seems to be in retreat, the winter is looking rather warm and wet – but I have to say that the last few weeks will have tested the credibility of that long range forecast. Construction remains strong, global stockmarkets are showing some resilience at last, and even business confidence is rebounding.

All in all that is a picture that leads me to think that the downside risks have faded, although we must be continually aware of the remaining global and domestic uncertainties.
Some of this uncertainty arises out of the strength of our currency. This is an area where commentary is based on a slightly inverted view of the world. The fact is that our dollar is a microscopic element in the global financial system. It is not so much what we have done in relation to the US dollar but what the greenback has done in relation to the rest of the world, of which we are but a tiny part. Important as the exchange rate may be, we are global price takers not price makers and there is very little that governments can do about it. This is an area where businesses have to build exchange rate volatility into basic corporate strategies.

I tend to be a bit more concerned about how we are performing on the Australia/New Zealand dollar cross rate, because that is a more employment sensitive exchange rate and it can have quite sharp impacts on things like tourist flows. The Kiwi-Aussie cross is also in a slightly different category, because in theory anyway there is something that the government can do about it, particularly in the longer term: it could work towards a common currency and remove both fluctuations in the trans-Tasman exchange rate and the risks of a steady appreciation of the Kiwi against the Aussie.

It is worth repeating the comments I made two months ago to a similar meeting to this in Sydney. I drew their attention to a recent study done by Westpac economists. They developed a model to test the factors that might drive variations in the Kiwi/Aussi cross-rate. Now almost by definition all models are wrong: it is just that some are useful. We also have to be careful not to select only those models that produce results that confirm our personal instincts and prejudices.

Those reservations aside, I took some comfort from the results of the Westpac study. They tested variations in the cross-rate against some fundamentals that would logically drive change. They identified five such fundamental factors: differences in our productivity growth rates, relative domestic inflationary pressures, interest rate differentials, commodity price movements and current account balances - which reflect our relative savings rates.

Interestingly, the variations in our exchange rates were explained by differences in the performance on four of these: productivity, inflation, commodity prices and savings. They could be called the economic fundamentals.

This suggests three things.

There does not seem to have been an exchange rate impact of what might loosely be described as speculative flows. A common currency would therefore not insulate us from what some see as a potential source of Trans-Tasman destabilisation.

Differences in interest rates did not have an observable effect on the Aussie/Kiwi cross. The implication here is that we are able to maintain separate monetary settings, each geared to the circumstances of our economies at different points in time, without worrying about exchange rate effects distorting production and trade.

Finally, because the exchange rate is driven by those economic fundamentals, it seems to be acting as a natural buffer. When our fundamentals deteriorate relative to theirs, our dollar goes down and vice versa. Relative prices adjust to reflect relative economic performance.

A side result was that when there was a deviation between actual exchange rates and the – shifting – equilibrium rate that the fundamentals are driving, the correction was quite quick. The rate returned to the equilibrium within a few quarters.

What does this tell us about recent trends in our exchange rate?

There are four possibilities.

One, the model is wrong, so we really don’t know what will happen next!

Two, the model was right historically, but things have changed, so we really don’t know what will happen next!!

Three, we are in the middle of a deviation from the equilibrium exchange rate, so the Kiwi will depreciate against the Aussie in the very near future.

Four, we have been outperforming them on productivity, inflation and savings, and have encountered better commodity prices than them, so the appreciation of the Kiwi simply reflects the fact that we are in a better shape than them!

I am not going to speculate on which of those four possibilities best explains recent experience. Funnily enough, at the time of that speech the Kiwi was in the middle of quite a sharp correction. It fell from around 93 cents in March to 87 cents in June, which of course lent some credibility to the study. It has since bounced around a bit, and when I left the office this morning was sitting at 88.9 cents.

The study confirms my basic instincts that a common currency would not be a good idea, certainly at this stage of our comparative economic development.

This brings me to infrastructure, which is of course a matter close to the heart of Aucklanders. Infrastructure is an unusual element of government operations in many respects. For a start it is both easy and very difficult to neglect. Governments can neglect spending on the infrastructure and nobody notices. Then it sneaks up on everyone and the costs of neglect and delay suddenly become urgent. It was easy to neglect the infrastructure in the 1990s and it is impossible to neglect it now.

Secondly, responsibility for the infrastructure is highly dispersed: central government controls some, regional government some, local government some and the private sector a lot. Blame for inadequacies in the infrastructure, though, always seems to come back to central government.

Third, fixing the problem is always very expensive and very slow, and everybody wants it fixed and nobody wants it in their own back yard. Finally, there is a vast array of permutations and combinations on offer around how do to it, who does it, how it is to be funded and how the costs of providing it are to be recovered.

This is also an area of short memories and self interest. Take Auckland roads as an example. It is simply a matter of record that for decades Aucklanders paid more in petrol taxes than they got back as their share of the petrol tax that was spent on roads. When we tried to correct just some of that imbalance the cries went up that “we” – the rest of the country – were paying for Auckland’s roads. When the government tried to point out that delays on Auckland’s roads were causing national economic loss the argument barely rated attention.

What I am suggesting here is that with infrastructure there is a need for patience: no matter how well intentioned and determined the relevant parties are, solutions are seldom quick. There is a need for pragmatism: we need to be open to new ways of planning, constructing, operating and financing different components of the infrastructure. In particular, there is no reason why rescheduling the pet project in the priorities queue cannot happen if a community is prepared to meet the cost of doing that.

With roads, an Auckland specific charge – be that a regional petrol tax, or congestion charging, or any of the other options that have been floated in the public arena recently – shifts part of the cost of relief of congestion onto the users of Auckland roads. It doesn’t take all of the cost off central government but it rebalances it, and can accelerate infrastructure development and expand the range of options that can be considered.

To sum up; the outlook for the economy is on track with the central scenario in the budget, with the downside risks dissipating; much as business might worry about the exchange rate, it is largely an influence that we have to adapt to, rather than one we can manage; and with the infrastructure we need to stay focussed, but need to accept that fixes take time and cost money.

With those introductory comments, I look forward to your views on how you see the outlook for your businesses, for the Auckland region, and where you see the priorities for extending the government-business partnership in our and the country’s mutual interests.


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