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Wairarapa Business Community Breakfast - Cullen

Hon Michael Cullen
9 March 2004
Speech Notes

Wairarapa Business Community Breakfast
Copthorne Solway Park, Masterson

This morning is for me the beginning of a series of meetings with business people outside of Wellington and Auckland. I will be in Greymouth tonight, then Christchurch and Waipukurau early next week. These are always useful occasions for me to gauge the real mood of New Zealand business, and in particular the small to medium sized businesses that make up the lion’s share of the economy.

We have nowadays an increasingly diverse and complex economy. This is something we have been moving towards for many years, as a conscious strategy to reduce the impact of business cycles, in particular those relating to export commodities.

One side effect of course is that it is increasingly difficult to sum up the fortunes of the economy in one or two neat sentences. We now have an economy where one man’s meat is another’s poison, as is amply demonstrated by the current state of the New Zealand dollar against the US currency.

Nevertheless, what I intend to do this morning is to set out what I see as the key elements of the economic outlook for New Zealand, then comment on the specific implications for the Wairarapa economy, and the role that government is playing in supporting small to medium enterprises.

The outlook for the New Zealand economy is of course strongly linked to that for the global economy. Over the last three years growth in the global economy has faltered, due to a range of economic and political factors. However, compared to the situation in the first half of 2003 some of these factors have now diminished:

- We have seen an easing of geopolitical uncertainty following the end of war in Iraq;

- Asia has recovered from SARS which saw a dramatic reduction in tourism, retail and service sector activity (and hopefully the lessons learned in that outbreak will be applied to the current concern over bird flu);

- Japan is emerging from its recession, and has posted steady growth in the order of 0.5-1 percent per quarter, with recent, better than expected outturns, lifting growth to above 2 percent for 2003; and

- There has been some recent improvement in European leading indicators, although these have yet to feed into growth rates.

Any optimism must be tempered with realism, however. In the US, the world’s largest economy, we have seen significantly stronger growth in the second half of 2003, due to a combination of low interest rates and increased government spending which have supported consumption expenditure. The US corporate sector is starting to pick up on the back of improving profitability which in turn is feeding through into a recovery in business investment.

Nevertheless, concerns remain about the US economy, in particular the rising current account deficit, the government budget deficit, and a weak, though improving, labour market. None of these augurs well for a speedy recovery in the value of the US dollar, which would be very welcome in this part of the world.

Australia, our largest trading partner, has seen growth slow over the last 18 months with the combined effects of a rising currency, SARS and widespread drought conditions, all of which have hit exporters and the tourism sector hard. Economic growth for 2003 is expected to have slowed to 2.5 percent, but is forecast to rise again as the effects of the drought wear off and the global recovery takes hold.

So the tentative expectations are for steadier growth in the global economy in 2004, indeed for growth to be the highest since 2000.

As we know, New Zealand has been bucking the global trend in the last three years:

- Our GDP growth rate was 3.9 percent over the year ended September, which was considerably faster than in the United States, the UK, Europe, Japan or Australia.

- Steady economic growth has brought jobs. The unemployment rate has fallen from a peak of 7.7 percent in 1998 to 4.6 percent in December 2003, in spite of rapid working-age population growth.

- Government debt, at 28 percent of GDP, is the lowest it has been since the mid 1970s.

- As could be expected, last month’s National Bank survey shows a slide in general business confidence from net 16 per cent negative to net 28 per cent since December, in line with concerns about the exchange rate. However, it also showed that the own activity indicator is still firmly in positive territory and employment and investment intentions are robust, consistent with the economy growing at near full potential.

- The survey also showed that anticipated export volumes have remained reasonably upbeat at a net 20 percent, which was the level they fluctuated around for most of last year.

- Short-term interest rates are low compared to the historical average, although higher than global rates. The Reserve Bank has not reduced interest rates by as much as central banks in other countries because of the strong domestic demand growth New Zealand has experienced. Most recently, the Reserve Bank actually increased the official short-term interest rate by 25 points, to ensure that the inflation rate remains stable and low over the medium term.

The concern, however, is that our economy is like a twin-engined plane where one engine is revving at full throttle while the other sputters due to excess oxygen in the fuel mix.

The engine at full throttle is the domestic economy, where demand has built up momentum, and is expected to continue growing strongly over the short term. Consumer and business spending, and investment in housing in particular, have grown strongly. Real gross domestic expenditure rose 6 percent over the year ended September, driven by immigration, relatively low interest rates, and rising house prices.

The other engine is the export sector. While export volumes have increased steadily over the last year, and export incomes remain high compared to the historical average, the rising exchange rate and falling international prices for some commodities led to a reduction in nominal export earnings by 6.4 percent over the year to September.

The New Zealand dollar has rightly come in for a lot of attention. Standing back and seeing the bigger picture, we should note that it underwent a protracted decline between 1997 and 2000, and therefore a significant appreciation against the currencies of our major trading partners was inevitable given the stronger than average performance of our economy. So the trade-weighted exchange rate has appreciated by 15.1 percent since the start of 2003 and is currently around 46.4 percent higher than its 2000 low. Overall the TWI is currently around 14.4 percent higher than its post-float average.

While much of the attention has focussed on the substantial appreciation of the Kiwi against the US dollar, some 25 percent during 2003, the story is more complicated than that. The New Zealand dollar has actually depreciated against the Australian dollar and appreciated more modestly against currencies such as the British pound and the euro.

Even so, as I have said on several occasions recently, I believe the New Zealand dollar is over-valued given the strength of the New Zealand economy relative to our major trading partners, especially Australia, and given the rising current account deficit.

This is my judgement, based on the facts of the case. Unfortunately, the money markets remain irrationally exuberant about the New Zealand economy and are valuing the currency accordingly. To my mind this merely illustrates the extent to which they are spooked by the weaknesses in the US economy. Sadly there is nothing I can do to alter international perceptions around the US economy and fiscal position.

I am concerned though that a continued high dollar may lead to lasting damage to our export sector by discouraging investment in future capacity. We do not want a situation where our ability to take advantage of a global upturn and a lower dollar is impaired.

By mid 2004 the impact of declining export incomes should be felt more widely than just the export sector. Currency hedges will have worn off by then, and exporters are likely to cut back their domestic spending. Also a lower number of immigrants is expected to reduce economic growth.

It is important to note that the growth rate is not expected to slow much. There is no suggestion that the engine will fall off or cease to function; just that it will not run smoothly.

Growth is forecast to “bottom out” at 2 ½ percent over the next year or so. By 2005/06, it is predicted to return to an average of 3-3½ percent per annum, thanks to a recovering global economy, and some assumed exchange rate depreciation, which will revive export earnings.

Along with the slower rate of GDP growth, the rate of job creation will ease. Nevertheless, employment growth will still be above zero, and the unemployment rate is expected to remain in the 4½-5 percent range.

What we should see is that our strong “economic fundamentals” and flexible economy allow us to adjust to a changing international environment and fluctuating prices without getting caught in a large economic cycle.

What does all this mean for the Wairarapa region? A mixed bag in terms of major export industries such as pastoral farming and wine making.

The total value of pastoral exports for the year ended March 2003 fell to $12.3 billion, caused by a 21 percent fall in price which negated the effect of a 12 percent rise in volume. The price fall was mainly due to the appreciating New Zealand dollar. The general trends for the next few years are:

- A rise in the value of meat exports to $4.36 billion in 2004 and reasonably steady returns in the outyears;

- Fluctuations in the value of wool exports, falling to $956 million in 2004 and projected to increase to $1.06 billion in 2007, reflecting price changes;

- A sustained increase in the value of dairy exports from $5.92 billion in 2003 to $8.02 billion in 2007, an overall rise of 36 percent, reflecting both higher prices and volumes;

- The total export value of pastoral products is projected to rise from $12.4 billion in 2004 to $14.5 billion in 2006, a rise of 17 percent, reflecting higher dairy product prices and higher volumes.

The situation with wine exports is somewhat more positive with respect to viticulture. Last year MAF’s “Situation and Outlook for New Zealand’s Agriculture and Forestry” noted that the wine industry is well placed to capitalise on the trends towards premium and super-premium quality wine, in particular with the Pinot Noir and Sauvignon Blanc varieties.

The report forecast that export volumes would increase by over 160-percent to reach 60 million litres in 2006/07. In export revenue terms, that means an increase from around $280 million to around $750 million over that period.

Of course, achieving this is contingent upon the New Zealand wine industry overcoming some significant challenges, including:

- Relatively static consumption (particularly in the major markets in Europe) combined with worldwide oversupply;

- Competition from other New World wine producers in key markets such as the UK; and

- A need for investment in processing capacity, branding and marketing development, to maintain the ability of the New Zealand product to command the higher prices needed to offset the disadvantages of our distance from markets and higher average production costs.

I have every confidence that these challenges can be met. And my view is shared by some of the best minds in the global wine industry. Indeed, it is very heartening to see an increasing level of foreign investment in the New Zealand wine industry, and the creation of marketing and distribution alliances which link New Zealand wine producers into the global industry.

One of the constants in the Wairarapa economy, as for much of the country, is the importance of small to medium sized enterprises, or SMEs. These are commonly defined as businesses employing 19 or fewer employees, and they represent 97 percent of all New Zealand companies, employ 43 percent of all employees and produce 39 percent of all the goods and services.

They are more than just the backbone of the economy; but a large part of the skeleton and musculature as well. It is in all our interests that these businesses grow, if not in size (since big is not always beautiful), then in productivity and profitability.

The Labour-led government is engaged with the small business sector and listening to its concerns. We cannot always offer immediate fixes, but our experience shows that if we focus on the real issues and the important goals we can make progress.

We are currently undertaking a series of Small Business Forums around the country, which combine an opportunity to put new issues on the government agenda with practical sessions aimed at providing better skills and new business management tools.

As Revenue Minister it is often suggested to me that I could invigorate small businesses in New Zealand with the stroke of a pen, by a wholesale lowering of business and personal income tax rates. The reason I do not do this is partly because the revenue loss would endanger the public services that sustain our communities and our economy (services like border control, law and order, education and health). But it is also because the evidence shows lowering taxes is no magic bullet.

Compared to many of our trading partners, and taking into account the total tax burden rather than just headline tax rates, we are in fact a relatively low tax country. It is folly to believe that some further marginal reduction in tax rates will have the effect of leapfrogging us over our competitors. Instead, the key factors that will drive the next round of growth in our economy have to do with utilising better technology, building and retaining a higher skilled workforce, better marketing of our products and services, and better management practices.

Nevertheless, as I indicated in the December Budget Policy Statement this year's Budget will deliver tax relief to low income workers, and that in itself will directly benefit small business by removing pressure for wage increases.

In addition, we are working on making the processes surrounding payment of taxes easier for businesses. Last year we released the discussion document Making Tax Easier for Small Business.

It includes initiatives such as a subsidy for small businesses to use a payroll agent, standardising GST and provisional tax rates to the 28th of the month, and a 6.7 per cent discount for new businesses as an incentive to pay tax in their first year of business. The Government will make decisions on these proposals in coming months and legislation would be introduced later this year.

We are also well down the track towards implementing Inland Revenue’s 5-year e-enablement project. Already SMEs are able to file electronic tax returns, make on-line payments, access tax calculators and receive advisory support. Next steps include enabling all major forms to be completed and submitted electronically and allowing taxpayers to view their account information online

Turning to the issue of compliance costs, here again, it is important to set aside the naïve view put about by some of my political opponents that the world would be a better place if there were no regulation of business.

The truth is we all benefit from regulation, although we are less aware of the protections it provides than we are of the requirements it imposes. The Resource Management Act, for example, ensures that we have a say in what others may do, where it impacts upon our business or personal interests. And Occupational Safety regulation protects us from the possibility of unsafe work practices by others.

We do not want to jeopardise the benefits that these regulations provide to the community. What we do want to do is to deliver those benefits at least cost, both in financial terms and in terms of management time.

The issue of compliance costs is always a major one for SMEs. On the one hand, it is important to recognise that the burden of regulation and compliance costs on business in New Zealand is light relative to other developed countries. The 2003 Index of Economic Freedom, published by the Heritage Foundation and the Wall St Journal, noted that “it is easy to establish a business in New Zealand”, and described the regulatory regime as “relatively light” and “transparent”.

And in its 2003 Economic Survey, the OECD commented that “in New Zealand, government regulation is generally of good quality, and compliance costs are not high by international standards.”

On the other hand, as the OECD noted, compliance costs are a source of concern for small businesses, for which they represent a proportionately much larger burden than for larger firms.

SMEs cannot generally develop in-house expertise in areas such as resource management. That’s why we have already introduced or planned a number of initiatives to cut back the compliance burden:

- In December 2000 we set up the Ministerial Panel on Business Compliance Costs. The panel submitted 162 recommendations on ways of reducing compliance costs, and the Government has implemented, or is implementing 80 percent of those recommendations.

- Since 2001 the Cabinet has required that a business compliance cost statement be completed for any proposals that have red tape implications for business. This provides a robust, transparent process for considering the impact on small business up front, before any regulation or legislation is implemented, rather than trying to tidy up afterwards.

- Last year we launched the Biz portal that allows businesses access to a range of information and Government agencies through one Internet site. That means accessing the information needed to comply is much quicker and easier.

- On the Resource Management Act in particular we are addressing the long waiting times on resource consents by working with local authorities to improve the level of skills amongst those who make decisions.

We are actively dealing with the compliance issues, but this is only one side of the ledger. Many countries can boast of low compliance costs. The more important question is: do they have high earnings potential?

It is more important that we give attention to the revenue side of the ledger; to the real issues driving business and growth. The fact is New Zealand has had relatively low rates of growth in productivity and labour productivity. While our performance has been trending upwards since the mid-1990s, at 1.5 percent average per year over the last 4 years, we continue to lag behind other OECD countries with 2-3 percent productivity growth.

Here the government is actively engaged, in partnership with businesses, to create a more productive economy based on higher-value goods and services.

For example, we need to build a more highly skilled workforce. The government is contributing to that through schemes such as the Modern Apprenticeships which, along with other initiatives, has increased the number of people engaged in industry training by more than 25 percent since 1999.

We are also reforming the tertiary education system, making it more affordable for students and encouraging better alignment between the training that tertiary institutions provide and the skill needs of regional businesses.

We also continue to have an immigration policy aimed at attracting skilled and motivated migrants who can contribute quickly to our economy.

We need to shift our economy away from a commodity basis to a value-added basis, and one of the key imperatives is to appropriate new technologies at a faster rate and to develop our own technological expertise, in particular in the area of biotechnology. The Wairarapa is a good example of a region where there are probably very few productivity gains left to be made within the bounds of existing technology.

The government’s response has been to set up the Biotech Taskforce. The taskforce recommended an ambitious 10-year vision of increasing the value of biotechnology exports from the current $250 million to more than $1 billion a year. The government has taken all but a few of the taskforce’s specific recommendations on board. For example:

– A new $12 million fund will be established to support trans-tasman joint ventures in biotechnology. This will offer partnership funding to New Zealand and Australian companies working together on biotechnology development, manufacturing and marketing.

– A $2.3 million programme will support best practice in commercialising biotechnology research, to support the flow of good ideas from our laboratories to our farms and then to our markets.

– We will also be spending $1.2 million over four years to get better statistical information on the biotechnology sector, to track its growth; since, as we all know, accurate information is the lifeblood of a growing economy.

Finally, we need to create a more vibrant venture capital market, so that New Zealanders with new ideas and ambition to expand their businesses can access the capital they need.

The government is playing a role through the $100 million New Zealand Venture Investment Fund which we established in 2001 with a mandate to accelerate the development of the local venture capital market and boost the level of venture capital available to New Zealand businesses. Of that $100 million, $25 million is earmarked specifically for biotech investment.

I could go on, and talk about our investment in our transport infrastructure and in extending broadband internet coverage to the regions. The point I want to stress, however, is that a strategy of tax cutting and deregulation – for all its appeal to many small businesses – is short-sighted and not in the best interests of the economy.

Certainty we need to find efficiencies wherever they exist and reduce the cost of doing business as much as we can. But what matters more is that we invest in a high-quality workforce, an efficient infrastructure, first-class management and the best technology available. That is where this government is placing the emphasis on behalf of New Zealand businesses and communities.


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