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Cullen Speech to Hamilton Club ABN AMRO Craigs

Hon Michael Cullen
15 July 2004
Speech Notes

Speech to Hamilton Club ABN AMRO Craigs Economic Breakfast Briefing: NZ’s Path to Growth

Hamilton Club, 21 Grantham St, Hamilton

My topic for today is New Zealand’s Path to Growth. What we need to acknowledge up front is that we are already well and truly on that path, whatever twists and turns may lie ahead. Indeed the most salient feature of the New Zealand economy in the last few quarters has been its capacity to confound the forecasters by outperforming the consensus forecasts for growth.

This is apparent from the latest quarterly gross domestic product results which are at the top end of market expectations and point to the continuing resilience of the New Zealand economy.

They show that GDP growth for the March quarter was 2.3 per cent; the highest result achieved in 18 quarters. That means that growth for the March year was 3.6 per cent.

In per capita terms, GDP growth was 1.9 per cent for the March 2004 year. Terms of trade improvements resulted in higher per capita real gross national disposable income growth of 4 per cent.

Growth over the quarter has been broad-based:

- household spending was up 2.9 per cent;

- exports were up 3.4 per cent;

- business investment rose 4.1 per cent taking the increase for the March year to 12.6 per cent. This is the highest annual growth rate in business investment since 1996. The increase was largely due to a rise in spending on plant, machinery and equipment and non-residential buildings

The figures show increased activity in almost all industry groups. The largest contribution came from the goods-producing industries, particularly manufacturing. Manufacturing production (which excludes food products) rebounded from the flat December 2003 quarter to post a 4.5 per cent increase in the March 2004 quarter. The strong manufacturing activity is consistent with strong export growth and robust domestic demand.

New Zealand’s growth performance continues to outperform the OECD average. New Zealand’s economy grew at over twice the rate of the OECD average in the March 2004 quarter.

These results also mean that in the five years from the March quarter 1999 to this year New Zealand has achieved growth totalling 21.7 per cent. If we consider that population growth over the same period was just 5.6 per cent, what these figures show is that living standards for New Zealanders have increased over that period by around 15 percent in per capita terms.

Looking forward, however, most forecasters continue to expect a slowdown over the coming year. The activity indicators available so far for the June quarter (for example, retail sales, building consents, and house sales) are confirming this, pointing towards slower growth.

A number of factors are driving this slowdown; but one that needs to concern us all is the evidence of a capacity constraint.

We are, if you like, sprinting, and surprising ourselves at how long we have sustained that sprint; but we know we are not in the right shape for a long-distance event. If we continue at this pace we know we will run out of puff sooner or later.

The question, of course, is how we can sustain a strong growth rate over a long period.

To my mind there are two key issues. First, we need to build a more productive workforce and involve the whole population in a culture that values and facilitates growth because of the social and economic benefits it brings.

And second, we need to maintain a sound set of economic fundamentals.

Put simply, growth in per capita GDP is driven by two things:

- What proportion of us are either in work or actively looking for work; and

- How productive each New Zealand worker is.

On the first of these, the advances of the last few years speak for themselves. Our workforce participation rate is the highest it has been for many years. Since we took office there are more people in the labour force, and more of them are employed, leaving fewer unemployed.

I am not claiming that government policies have been the major driver of this development; however, their impact has not been immaterial. We have been putting in place policies that encourage workforce participation (policies such as improved parental leave). And the major set of initiatives in Budget 2004 – the Working for Families package – includes a set of measures that will strengthen these incentives further, by increasing the returns for workforce participation, and ensuring that good quality child care is both available and affordable.

However, there are limits to our ability to increase the size of the workforce by improving participation rates; just as there are limits to our abilities to increase it through immigration. For that reason, productivity is where we now need to focus our efforts.

How can we increase the productivity of our businesses and our workforce?

Unfortunately, the concept of productivity has had a bad press in some sectors. It smacks of teams of consultants with clip-boards and stopwatches, observing the minutiae of business operations in order to identify tiny increments of costs to be saved or additional output to be produced.

In the 1980s and 1990s we did reasonably well at cutting costs and increasing output. However, I would argue that there are fewer and fewer gains to be made in that direction. We need to find ways of adding more value to what we do. We allowed R&D spending to slip in those two decades, and so too investment in plant and investment in workplace skills. We placed the emphasis on becoming efficient producers of volume, rather than smart producers of value.

This is not to say that there were not gains made. Many of our traditional exports, such as lamb and beef, improved their branding and marketing, resulting in higher values from lower volume. But there is a lot more that could be achieved. Currently a New Zealand farmer gets 15 per cent of the value of lamb sold in a UK supermarket; the supermarket gets 60 per cent. We need to ask whether there are opportunities in the value chain to improve the share of the added value that goes to the farmer and to the New Zealand based firms involved in production, marketing and distribution.

Compared to the OECD, New Zealand has low levels of labour productivity, capital per unit of labour, and what is known as multi-factor productivity (that is the increase in output not attributable to an increase in labour or capital). So we need to increase the overall level of skills in the workforce; and we need to increase the investment of capital in New Zealand businesses. The objectives go together. The availability of a skilled workforce means that businesses can invest in capital equipment knowing that it will be well utilised.

The recent growth of labour productivity, capital per unit of labour, and multi-factor productivity has been encouraging. Our labour productivity accelerated from a 0.5 per cent annual rate in the early 1990s to a 1.7 per cent annual rate in the six years to 2002. However, we need to do better to make up for the lost time.

There are some issues around the availability of capital, especially for small to medium sized enterprises. However, the major driver that we need to get better traction on is skills.

This is not just a matter of elite high level skills; indeed the indications suggest the opposite: that our major shortages now and for the foreseeable future are in the mid level skills that provide the backbone to industries like manufacturing, tourism and agriculture.

In this light, the tertiary education sector is one of the key engines of workforce productivity, and hence of economic growth. We have a system that is in many respects world-class, with world-class researchers and world-class teachers. But we need to ask ourselves how well focussed these resources are.

The system we inherited was geared towards increasing the number of enrolments. That may have drawn a greater proportion of New Zealanders into tertiary education; but what is not clear is whether they acquired relevant skills as a result.

One indicator of that may be the fact that 50 per cent of those who first enrolled at a tertiary institution in 1998 had not completed a qualification five years later, in 2003. Getting into tertiary education may be easier; but getting out of it with a useful qualification seems to be difficult for a significant minority.

We are not about to sacrifice the gains made in participation. We are working to make tertiary education more affordable. From next year the government will spend another $110 million on student support, benefiting more than 36,000 students.

Nevertheless, we have established the Tertiary Education Commission with the task of steering the tertiary sector towards a closer alignment with the needs and priorities of the New Zealand economy. They and the tertiary providers need to find ways of reducing the failure rate by better planning throughout the education process; that is, better choices, informed by better information about future skill needs and the performance of individual institutions, and better links to jobs and industries.

We have boosted industry training and been very successful. We are well on track to achieving our target of getting 150,000 New Zealanders learning on the job through industry training and modern apprenticeships by the end of 2005.

It may be time to apply more broadly to the tertiary sector some the features similar to those that make industry training successful, to find ways of getting industry much more closely involved in the tertiary education system. This should not be seen as a threat to academic freedom. This kind of engagement between tertiary institutions could be a standard part of their business, to assist them in identifying the skill needs; ensuring that qualifications match the competencies businesses want; and helping them in the monitoring of quality. Engaged education is without a doubt better education.

We also need to link tertiary research to the priorities of our key industries. Contract funding through the Foundation for Research, Science and Technology is clearly outcomes focussed; but this is less a feature of university research. There are good reasons for this, since we need people engaged in basic research that contributes to our overall understanding of the world. However, it is a matter of finding the right balance. The recent analysis for the Performance Based Research Fund showed that New Zealand academics are world-class in areas such as philosophy and criminology; but we need to ensure that we are world class in biotechnology and the other disciplines that, in the medium to long-term, will pay the bills.

It is time to shift the balance of our tertiary system towards more of an explicit industry-led approach. Beyond industry training itself, the tertiary system needs to take on board the key areas identified in the Growth and Innovation Framework. We need to see tertiary education as part of a larger process of producing an adult population with skills relevant to the New Zealand economy and communities.

Education is of course a long-term exercise. We need also to be able to respond to immediate labour market shortages in key industries. The issues are never simple, but invariably involve some mix of training, immigration and thinking around remuneration and working conditions.

However, complexity should not deter us from action. The tendency in the past has been to throw up our hands in despair and invoke the gods of the market to save us, if they wish. That, I believe, is a dereliction of duty.

Our approach has been, and will be increasingly, to get key industries and the whole government apparatus working together to find solutions to skills shortages. Recent engagements with sectors have illustrated that a government-facilitated process to address sector specific impediments to growth can be an effective economic development tool. This is not something that can be done simultaneously, however, or on a broad front. We need to be strategic.

That is why, through our Growth and Innovation Framework, we will be focussing on the food and beverages sector. The sector is amongst New Zealand's largest and accounts for roughly 10 per cent of GDP. Exports, which represent half of all merchandise exports by value, are $14 billion a year. The sector faces rapid change in international consumer demands, with increasing emphasis on health and well-being, and meal solutions rather than simply ingredients.

The influence of global value chains and increasing competition will threaten New Zealand's level of future market participation unless increased innovation keeps New Zealand exporters at the forefront of market trends.

We are working with key leaders in the food and beverages sector to formulate a whole of government strategy for facilitating growth in this cluster of industries. The strategy is likely to include the design and delivery of business assistance programmes and the development of foundation policies (including regulatory and standard setting policies) that help shape the business environment. It may also extend to areas such as improving the co-ordination of investment in education, training and RS&T, by facilitating the development of networks and linkages between government and the sector, as well as networking between firms themselves.

One less tangible key factor we must not neglect in all this is that increasing productivity and growth is a goal for which the whole community has take some ownership.

The Growth and Innovation Advisory Board recently undertook some research into New Zealanders’ attitudes towards economic growth. The research showed that Kiwis rate quality of life and the natural environment above employment prospects, business opportunities and increasing personal wealth.

There is strong ‘headline’ support for economic growth. Employers and employees also agree on the need for new ideas and ongoing learning. However, New Zealanders do not necessarily buy into traditional growth messages. There is a fear about the negative consequences of growth and ambivalence about big business. Even the term ‘labour productivity’ sounds to many people like something that is done to workers without their knowledge or consent. Or worse, it is regarded as code for cost cutting.

So we still need to win hearts and minds by aligning our growth goals more closely with core Kiwi values. This means changing our language and management styles. For government it means connecting economic growth with social and community goals, such as better health services and a better environment. And for the business community it means connecting business growth with a sense of opportunity for employees to give their best efforts to something worthwhile and purposeful, and to be adequately rewarded both financially and in terms of career satisfaction and opportunities for family and leisure.

Alongside measures aimed directly at increasing productivity, we must never forget the importance of a solid platform of foundational policy settings. If I might stretch the metaphor a little, the engines of growth need to run along a road that is free of potholes and confusing signs and sharp corners.

My government has made this a major emphasis throughout our time in office. I have to say it is quite ironic to see a leader of the National Party – and a former Reserve Bank Governor – giving confusing signals about fiscal policy. Tax cuts for the wealthy, on the one hand, and large and unspecified spending plans on building new prisons to house significant additional inmates, simply do not add up to cogent policy.

We have recognised the importance of clear fiscal signals, even before we became the government. We have kept a tight control of government expenditure through consistent and prudent management. Total core Crown operating expenditure, at $42.2 billion, is around 30 per cent of GDP – down from 35.2 per cent when we took office in 1999 – and even with the new spending announced in the budget this will increase only to 31.6 per cent in 2007/08.

One of our key fiscal objectives has been to keep gross sovereign-issued debt below 30 per cent of GDP on average over the economic cycle. Since taking office we have reduced that indicator from 33.7 per cent of GDP to 24.7 per cent, based on the current June forecast.

Alongside reduction of debt, we are continuing to strengthen the long-term fiscal position through making contributions from our operating surplus into the New Zealand Superannuation Fund. Transfers into the Fund will be $2.1 billion in 2004/05, and in June 2005 the Fund is forecast to total $6.3 billion. Meanwhile the Fund Guardians are moving from a cash portfolio to a fully invested portfolio by the end of this financial year, and, during the first period of investment, have exceeded their target rate of return.

The Fund will contribute to the reduction of net debt, which including the Fund’s assets is forecast to be down to 8.7 per cent of GDP by 30 June 2004. What is more by the end of the forecast period this will fall to zero, as financial assets equal gross debt. This will be the first time in decades that the government has been in the black in net terms.

Meanwhile, we have maintained a consistent monetary policy, aimed at price stability, but have tempered the previous obsession with inflation by requiring the Governor of the Reserve Bank to consider the need for stability in output and employment in setting the official cash rate. We are also providing expanded options for the Bank in taking the edge off currency fluctuations.

Stable macro-economic policy needs to be matched internally by stable micro-economic policy. We have been working at some of our key regulatory issues, notably some important elements of the tax system for business, and the issues around infrastructure.

Two key tax issues where the government is making good progress are depreciation and the taxation of investment.

This week saw the release of an issues paper on the tax rules on depreciation. The rules have not been reviewed since they were introduced in the early 1990s. I have been concerned for some time about whether the present economic depreciation rates accurately reflect the reality of economic life in a world of rapidly advancing technology and the potential disincentive effect this may have on the level of capital investment.

The issues paper considers ways of removing such tax biases and looks at a number of technical depreciation problems that cause practical difficulties for business. For example the treatment of fixed-life intangible property such as patents and providing more flexibility around the process of setting special depreciation rates when unusual circumstances have to be taken into account.

We are also reviewing the taxation of investment. The current rules for taxing investment vary. For example rules are different if the investment is held onshore or offshore and whether it is held directly or indirectly. This inconsistency and complexity can distort investment decisions. Last week I announced the appointment of Craig Stobo to co-ordinate consultation on issues with the taxation of investment and to develop options for reform. Mr Stobo will report back to government by the end of October.

On the regulatory issues around infrastructure, we are maintaining a pragmatic approach to the needs of each sector, rather than committing ourselves to any kind of grand plan. Electricity supply has been a major focus. We established the Electricity Commission, as a means of addressing the issue of short-term supply and reserve generating capacity; and with respect to the longer-term supply question we have recently announced a package of measures to encourage oil and gas exploration.

We are also reviewing the Resource Management Act. Over the past year-and-a-half we have been talking with business, local government, environmental organisations and the broader community about how the RMA is working. Some key problem areas emerged, and our focus is on finding practical solutions to them.

It is easy to make the Act the scapegoat for other barriers to investment, whether technical or cost-related. The fact is that nobody wants to jeopardise the basic functions of the Act, which are to create a fair process for considering resource use proposals.

Nevertheless, there are some aspects of the RMA that are clearly unhelpful. Some of the key processes have become onerous, both in terms of cost and time. And while the Act was originally conceived to prevent the denial of natural justice in major resource decisions, it was not its intention to provide opponents of developments with opportunities for ‘greenmail’ and protracted filibustering. An average period of five to six years to secure resource consent is, I would argue, not conscionable and certainly not necessary for the preservation of democratic rights and processes.

So we are not revisiting the ideas and principles that underpin the RMA, because they are fundamentally sound. Rather, our aim is to get greater certainty and efficiency in the way the RMA operates, and to make it better able to address larger resource issues that are of national, or at least trans-regional, importance.

The review will focus on some areas where we believe there is room for improvement. One example is the need to achieve the right balance of national and local interests. This is particularly important for transport and energy infrastructure where local authorities are increasingly being asked to consider projects that raise issues of national significance using an Act that provides little or no guidance on how competing national benefits and local costs should be weighed. There is no need for the Act to be silent on such matters, and I am confident we can find a way of expressing some straightforward principles in this regard.

The review will also look at improving the consent decision making process, to ensure more consistency between councils; reduce delays and costs; provide greater clarity and certainty for applicants; and largely eliminate opportunities for abuse of the process for personal gain, trade competition, or other vexatious reasons.

We will also be considering measures for building capacity and promoting best practice among the 86 councils who decide approximately 50,000 resource consents each year. While local authority practice has steadily improved, the performance of some councils could still be better.

We will be looking to introduce proposed RMA amendments to the House in September 2004 and those amendments should be passed in this term of Parliament.

So, to sum up, New Zealand is firmly on a path to growth. We should take satisfaction in what has been achieved in recent years, especially since they have been difficult years in many respects. The path ahead has some key challenges, notably around building a higher skilled workforce that is fully conversant with new valued-adding technologies. We know we cannot achieve this instantly, and that we need to plan and invest now to create the workforce that will fully come on stream in five or ten years time.

But what we do have is a much clearer sense of the priorities and strategies, informed by research, and by better engagement between the business sector, the unions, the education sector, and the economic ministries. At the end of the day, that is the only sensible approach to dealing with the many dimensions of growth.

Thank you.

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