Cullen Speech: Address to Remuera Probus
Michael Cullen Speech: Address to Remuera Probus Club Remuera Golf Club, 120 Abbots Way, Auckland
When I spoke to you around this time last year I reported that the New Zealand economy had performed exceptionally well in 2002, in the face of some considerable offshore adversity. But I predicted turbulence ahead in 2003, due primarily to some adverse conditions for our primary producers and a weak global economy taking its lead from a slump in asset prices and confidence in the US.
In addition the Iraq War was looming, with the potential to disrupt key industries like tourism and to further depress confidence amongst our major trading partners.
At that time most forecasters were expecting growth in the New Zealand economy to fall to around 2.5 percent in 2003, and then bounce back to over 3 percent in 2004.
Now that we are able to look back on the year, we see that the expected slow down in the New Zealand economy did occur, although not exactly as predicted.
The Iraq War was mercifully short and its immediate impact on the world economy fairly modest, although the situation is by no means settled. The SARS outbreak was eventually contained and its impact on tourism and other export industries, though severe for a short while, has now been turned around.
Nevertheless, over the year to December 2003 the economy grew a total of 3.5 percent, which was considerably higher than the forecast 2.5 percent. There was a marked slowdown over the course of the year, however, with most of that GDP growth occurring in the first half of the year. Growth in the September quarter fell to 0.3 percent, with a slight rebound to 0.6 percent in the December quarter. The annual growth result is still considerably faster growth than in the United States, the UK, Europe, Japan or Australia.
The domestic economy carried most of the momentum, and continues to do so. The GDP statistics for the December quarter confirm that consumer and business spending, labour income and investment in housing in particular, have grown strongly. Household expenditure remained buoyant in the December quarter, up 0.8 percent. Indeed the real gross national disposable income which is a more sophisticated measure of spending power – increased 4.9 percent in the December 2003 year.
And New Zealanders are still in jobs in record numbers. 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. It is also in spite of the Employment Relations Act, which commentators on the right predicted would stop economic growth in its tracks.
The big challenge ahead is in the export sector, and it is primarily with export returns rather than export volumes. Indeed export volumes increased by 1.3 percent over the last year, with a 5.2 percent rise in the December quarter showing a pleasing trend following declines in earlier quarters. There was a 7.8 percent rise in export of services in that quarter, and a 4.3 percent rise in exports of goods, with dairy exports the outstanding performer, up 24.6 percent.
It is export incomes that are being hit, although they remain high compared to the historical average. The rising exchange rate has already reduced nominal export earnings by 7.8 percent in the year to December, and there may be worse to come in the short term.
For example, merchandise trade data up to the end of December 2003 shows that the total value of meat, dairy, forestry and wool exports was $12.5 billion in the year ended December 2003, down 10.1 percent from the December 2002 year. A large fall in prices has offset a lift in volumes of meat, dairy and wool of around 5 percent. The price fall was mainly due to the appreciating New Zealand dollar.
Fonterra is now forecasting a payout to its dairy farmers of $3.50 per kilogram of milk solids for the year to 31 May 2005; down from $4.15 per kilogram in the current year. Assuming the forecast is accurate, that will be the lowest inflation-adjusted payout in 14 years. The effect across the sector will be a loss of around $750 million from the domestic economy as a result of the lower payout.
The net effect of these internal and external trends is that growth will slow by mid-year as the effects of declining export incomes flow onto the domestic economy. By that time, currency hedges will have worn off, and exporters may cut back their domestic spending. A fall in the number of immigrants might also reduce economic growth.
Nevertheless we should not underestimate the resilience of our economy and the strength of its fundamentals. While the growth rate is expected to slow, it is forecast to “bottom out” at 2.8 percent over the next year or so.
There are also clear signs of a recovery in the US, with the latest employment figures showing something of a turnaround. And more importantly for New Zealand’s agricultural exports, world commodity prices are showing some very strong increases.
So by 2005/06, thanks to a recovering global economy, and some exchange rate depreciation, which will revive export earnings, growth is predicted to return to an average of 3-3½ percent per annum. (These forecasts are from the December Economic Update. Since that time we have seen the February floods and the downside risks around growth further out (especially in 2005/06) have increased, with the exchange rate at a higher level than expected and immigration slowing a little quicker.)
Again, although job creation will ease with the slower rate of GDP growth, it will still be above zero, and the unemployment rate is expected to remain in the 4½ -5 percent range.
Importantly, the government did not lose its nerve in the face of adverse conditions and alter fiscal or monetary settings. The economic management regime we had put in place, along with the set of long-term strategies for investing in New Zealand’s productive base, stood us in good stead and continue to do so today.
Indeed with the New Zealand economy coming off a period of unusually strong and sustained growth there is a danger in becoming obsessed with short term concerns and losing sight of the long term trends and opportunities. It is no time to create additional uncertainty by attempting short term fixes.
This is a message that many New Zealand businesses understand. That is why when surveys of business confidence show declining expectations of growth in the economy at large (as is currently the case), they often combine that with relatively high levels of confidence in businesses own activity. In other words, while business people are caught up in a general atmosphere of gloom, many of them believe they themselves are well placed to ride it out.
Thus, over the course of 2003, while business confidence steadily dropped, actual investment by businesses in plant, machinery and equipment went up 11.6 percent. Of that increase, 3.7 percent was in the December quarter, when it was very clear that the high dollar would be hitting the export sector very hard.
So the question is – do New Zealand businesses see the glass as half-full or half-empty? The answer, sadly, is: a bit of both.
The NZ Herald’s recent “Mood of the Boardroom” survey gives a picture of gloom, interrupted by a few shafts of brilliant sunlight, notably around the future of the trans-Tasman single economic market. There was an interesting response to the survey in Rod Oram’s column in the Sunday Star Times the week after it was released. Entitled “Myopic Leaders Hold NZ Back” his objection to the survey is that it portrays New Zealand business leaders – with a few notable exceptions – as “a miserable bunch”, long on complaints about government and short on ideas and vision, despite the fact that New Zealand has a set of economic fundamentals and government policy settings that place us in a very favourable position compared to most other OECD nations.
I will not rehearse his arguments in detail today. Suffice it to say that they are strongly worded, and I suspect Mr Oram will find he is left off the Christmas party invitation list of most the NZX 50. The main point I want to pick up is his contention that businesses need to relinquish an obsession with cost cutting and open their eyes to value creation.
For some parts of the New Zealand business community, cost cutting has been an important way of increasing productivity over the last two decades. Nowadays there are increasingly fewer opportunities for gain in this area. It is essentially a zero-sum game, and in the area of labour costs in particular a strategy of cost cutting will most likely fall foul of a labour force that is internationally mobile at almost all levels of the skills spectrum. This is part of the logic of the recent changes to leave provisions.
In the last decade we have seen relatively low productivity and labour productivity growth. While our performance has been trending upwards since the mid-1990s, at 1.5 percent on average per year over the last 4 years, we continue to lag behind other OECD countries with 2-3 percent productivity growth.
The focus has to switch to value creation, and indeed that is where the attention of New Zealand’s most successful companies has been for quite some time.
My government’s growth strategy – which many respondents to the Herald survey claimed did not exist, because it did not focus on cutting costs – is about creating value in areas where government is best placed to do that, and facilitating innovation and value creation through partnerships with industry around cross-cutting technologies and competencies.
The most crucial contribution that government is making to value creation in the economy is investment in human and capital assets which benefit the whole of the community.
Our tertiary education policies are aimed at improving the performance of the tertiary system in creating a skilled and productive labour force.
Recently the Ministry of Education released figures which showed that only 40 percent of domestic students starting a qualification in 1998 had completed it after five years. Fifty-one percent of those who started a qualification in 1998 had left without completing it five years later, and 9 percent were still studying towards it five years later.
Even allowing for part-time study and legitimate reasons for abandoning study – such as gaining employment – this is a worrying statistic. Education is too important to us to allow large numbers of young people to wander aimlessly around the system using up resources and putting themselves into debt, and then having no completed qualification to show for it. This is the downside of the National government’s market-led tertiary system that we are attempting now to fix.
While we recognise the importance of a broad and liberal education for young New Zealanders, we believe that outcomes can be enhanced by more explicit links between education and industry.
For example, we have placed a high priority on industry training, and as a result the number of workers participating in industry training jumped by nearly 20,000 last year to a new record high.
Total numbers in industry training during 2003 reached 126,870 trainees, a 19 percent increase on the number participating during 2002, and a 56 percent increase over the number in late 1999. The number of employers involved in the industry training programme also increased substantially, with 29,206 firms now on board (up from 24,576 in 2002).
On the basis of these results, our target of getting 150,000 New Zealanders learning on the job by the end of 2005 should be achieved.
At a more general level, the reforms require tertiary education providers to develop detailed charters and profiles that demonstrate, among other things, that they are actively working with their local business communities seeking ways of collaborating that are mutually beneficial and generate positive spinoffs for students. Many institutions have been doing this for many years, but the charters and profiles process encourages a more consistent and disciplined approach to integrating the work of a tertiary institution with the needs and priorities of the businesses and communities around them.
We are starting to see some very innovative partnerships between tertiary institutions and business. Some are focussed on research and development, and on providing a stronger commercial edge to research programmes. Others involve local governments as partners and are focussed on building stronger clusters of businesses in areas which have been relatively depressed in the past.
The other crucial area in which government is investing in value creation is in improving our infrastructure.
There are numerous examples of this; but one that will affect all of you here today is the recent confirmation of a $1.62 billion investment in Auckland's transport system. For too long, confused and inefficient lines of responsibility have inhibited Auckland's transport development and the establishment of a single 'business-like' transport organisation for the Auckland region. The package delivers an unparalleled, long-term investment by central government, and a clear, fair solution.
The main features are:
A 5 cent increase in the fuel excise levy, and an equivalent rise in road user charges for vehicles five tonne and under, raising an estimated $200m annually for investment in transport around the country, including about $72m for Auckland per annum;
An additional specific funding allocation for Auckland transport of an average $90 million per year over ten years;
The development of options for raising revenue from tolls and borrowing in the future;
The establishment of a single organisation accountable to the Auckland Regional Council (ARC), named the Auckland Regional Transport Authority (ARTA), with key responsibilities for land transport in Auckland;
The establishment of an 'appointments panel', comprising seven representatives from the Auckland territorial authorities and eight representatives from the ARC, to select an independent 'business-like' board to run ARTA; and
The transfer of the assets held by Infrastructure Auckland into a new body called Auckland Regional Holdings (ARH), also under the auspices of the ARC.
This is part of a larger transport package addressing both Auckland’s problems and also some of the other key transport bottlenecks elsewhere in the country.
This should be the watershed event that Auckland needs. Providing regional and territorial authorities in Auckland continue to meet their responsibilities for transport funding, Aucklanders will finally see the steady development of a world class, well integrated transport system.
We have sought to strike a balance between the need for a regional approach to transport, and the need for input from the region's territorial authorities. With this in mind, the panel appointing the independent directors of ARTA will be chaired by the ARC but a majority of 10 members of the panel must agree before an appointment can be made.
ARTA’s role will be to make operational decisions that give effect to Auckland’s Regional Land Transport Strategy. ARTA will issue a public statement about what transport initiatives are needed to comply with this strategy, and it will decide (other than for state highways and the national rail network) where and when the initiatives will be put in place. ARTA will be responsible for seeing that they are implemented and funded according to plan.
In addition to skills and infrastructure, there are other ways in which government is contributing to creating value. By freeing up trade and investment flows, we are releasing latent value, in particular in the Trans-Tasman market.
Progress towards a single market stalled somewhat in the 1990s, with the missing ingredient being active sponsorship at the highest level. Since my government took office in 1999, making progress on the Trans Tasman relationship has been a particular priority.
In the last few years Peter Costello and I have developed a strong consensus on the benefits to be gained from greater economic integration and the need to clear away obstacles expeditiously. We are convinced that there is untapped value in a single market of some 25 million people. New Zealand businesses will benefit from greater opportunities to sell into the larger Australian market and a freer flow of investment within the trans-Tasman economy as compliance costs and other regulatory barriers are reduced.
We have agreed to meet annually to advance a formal agenda which encompasses business law, taxation and regulation of securities. Some significant steps forward have already been made, and there are more in preparation.
A single economic market across the Tasman is within our grasp and will deliver significant new opportunities for New Zealand businesses, both in terms of export earnings and in terms of investment in both directions.
Finally, underpinning our efforts to create value in the New Zealand economy is stable fiscal and monetary policy. It is easy to forget this, and easy for governments to undermine their good work in other areas by unsustainable spending or equally by unsustainable tax cuts.
We currently enjoy a Standard and Poors credit rating for local currency of AAA/Stable/A-1+. That reflects, among other things, the Fiscal Responsibility Act which requires the government to plan for the longer term when setting fiscal policy, and the fact that government debt and spending, as a proportion of GDP, are low by OECD standards.
Indeed core government operating spending was 32.4 percent of GDP in the 2002/03 fiscal year and is forecast to decline further to 30.8 percent by the end of the current year. Sovereign-issued gross debt was 28.0 percent in 2002/03, and is forecast to decline to 25.3 percent in 2003/04. This is the lowest it has been since the mid 1970s.
These gains are hard won and should not be frittered away. National risked doing this with their 1996 tax cuts which weakened the government’s finances at a time when the dollar was overvalued and export earnings under severe pressure. This time round we have made sure that we have sufficient headroom to provide ourselves with options in the upcoming Budget.
I should also mention superannuation. The Superannuation Fund is an important mechanism for maintaining future financial stability. We remain absolutely firm on our commitment to New Zealanders of all ages to provide a basic income in retirement. We believe that is a fundamental expression of the wishes of New Zealanders to have a fair and inclusive society, rather than one which allows extremes of poverty and wealth amongst the older generations.
Pre-funding this commitment allows us to smooth out the future fiscal cost of the scheme, and reduces the need for sharp increases in taxation when the demographic bulge begins to hit in around 15 years time. This is simple prudence. It is about managing known future contingencies. To fail to take some action would be irresponsible.
Dr Brash has consistently vowed to put an end to pre-funding and to spend the reserves through tax cuts. Since one assumes he would be loath to contemplate tax increases in future to pay for super, his policy has to imply cuts to New Zealand superannuation, either by reducing the level of payment or increasing the age of eligibility or both. On this point he has been very coy, promising to those over 50 that nothing will change, and to those in their twenties that they will be cut loose to fend for themselves. Exactly where his restrictions to super will cut in, and for whom, he won’t say.
What is certain, however, is that he will have to make those cuts and they will have to be severe. And if he expects younger New Zealanders to continue to pay taxes to fund a superannuation scheme that they will be locked out of, he will be inviting some kind of voter revolt.
I come back to the point I started with; that in times of economic difficulty it is important to keep focussed on the future capacity we are creating for our economy. I believe that we have the conditions in this country to return to strong growth after the expected slowdown and to sustain that growth into the long term. What will get us there is a focus on creating value in areas such as skills and infrastructure, and maintaining a foundation of stable macro-economic policies.
However, if we think the game is still about cutting costs, that is where our focus will end up, and I believe we will create long term instability and stagnate as a result.