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Cullen: Auckland Chamber of Commerce

23 February 2005

Speech Notes

Hon Michael Cullen: Auckland Chamber of Commerce Business Breakfast

Carlton Hotel, Mayoral Drive, Auckland

The big economic news of the month is undoubtedly the confirmation that New Zealand now has the lowest rate of unemployment among OECD nations with comparable data. This morning I want to start by looking more closely at that achievement. That is because it both exemplifies what is going right with our economy, and points to the challenge we need to confront if we are to sustain our improved economic performance over the long term.

What the latest figures showed is that in the last quarter employment increased 33,000 (or 1.6 per cent) to 2,056,000. That is an increase of 87,000 new jobs (or 4.4 per cent) over the course of the year, and that means that the economy has added 264,000 new jobs (or an increase of 14.7 per cent) since the start of 2000.

Unemployment decreased to 76,000, which is down 3,000 over the quarter and 18,000 (or 19.1 per cent) over the course of last year. That means our unemployment rate fell to a record low of 3.6 per cent, down from 3.8 per cent the previous quarter and from 4.5 per cent a year ago. This is the lowest unemployment rate of OECD nations with comparable data, and the lowest ever recorded in the 19-year history of Household Labour Force Survey. The last quarter also set records for employment growth (1.6 per cent) and the labour force participation rate (67.7 per cent).

That is a very significant achievement, bringing added prosperity and better long-term prospects to many New Zealand families and communities. The economy has grown almost 20 per cent in the last five years, which translates in real income per person to an increase of 15 per cent.

If we dig into some of the detail we see that we are making progress on some long-standing problems. The number of long-term unemployed people (those who have been unemployed for more than six months) fell in the December 2004 quarter to 14,400, down from 21,600 in December 2003. That is a 30 per cent reduction in a group who are at high risk of long-term benefit dependency and the attendant social problems.

If we look at Mäori unemployment, the rate has either been falling or stable in all but one quarter since the June 1999. And if we look at what has been happening in some of the traditionally depressed regions of the country, we see a jobs renaissance in areas such as the West Coast of the South Island, and in Northland which led the country in terms of percentage increase in employment growth during the September quarter of last year.

This rate of employment growth reflects a domestic economy with an enormous head of steam, and in turn stokes more fuel into that economy through its impact on household incomes. Household consumption was up 6.1 per cent over the September year. And this momentum looks likely to be maintained in the December quarter. House sales data and building consents data for December suggest that the recent signs of a slowdown in the housing sector may be on hold.

There is also strong growth in non-residential consents, pointing to strength in investment intentions by businesses in the quarters ahead. That is confirmed in surveys of business confidence, with the National Bank’s December business outlook finding that a net 27 per cent of companies expect to increase activity over the next 12 months, a net 20.5 per cent plan to invest more and a net 14 per cent expect employment to increase.

Not everything in the economic garden is rosy, however, especially if we look beyond the short to medium term. That is reflected in the headline confidence rate which, although nine points up on November, remained in negative territory. Most forecasters are picking economic growth to remain strong over the short term, before easing to slower rates of growth over much of 2005. The Treasury, for example, expects annual average growth to decline from a forecast 4.7 per cent for the year ending March 2005 to 2.4 per cent for the year ending March 2006.

Our current account deficit saw a sharp increase in the September quarter, through a combination of weak export data, strong imports, and strong investment income payments to foreign investors. On an annual basis, the current account deficit widened to $8.2 billion, or 5.8 per cent of GDP. Further increases are likely over the year ahead.

The exchange rate remains a major concern, driven mainly by the weakness in the US economy. Over January 2005 the exchange rate was 4.6 per cent higher against the US dollar and 5.5 per cent higher against the Australian dollar than in January 2004. Encouragingly, and recent volatility aside, export volumes largely appear to be holding up despite the high level of the exchange rate. However, the lagged effect of the high exchange rate is still expected to affect export growth in the future.

Aside from the short-to-medium term fluctuations, the big issue that is facing our economy is a capacity constraint. Capacity utilisation in the economy remains extremely tight with a record high being recorded on the NZIER’s measure in December. Firms in some industries are also finding it increasingly difficult to find staff. We do not have a reserve army of workers to call on, and being a small isolated country nor do we have a large area of marginal land that can be summoned into production quickly.

Hence the continued inflationary and wage pressure, with the Consumers Price Index increasing 0.9 per cent in the December 2004 quarter, taking annual inflation to 2.7 per cent. That puts us towards the top end of the inflation target, although, after a year of steady rises, the Reserve Bank has left the Official Cash Rate unchanged at 6.5 per cent in January, believing it to be sufficient to achieve inflation between 1 and 3 per cent on average over the medium term.

We need to turn the spotlight on how we deal with the capacity issue in the long term. We are pushing the boundaries of the current workforce envelope, as it were, and we need to ask ourselves how we might extend those boundaries and give ourselves more room to grow.

There are two ways of doing this. The first is labour utilisation, or increasing the size of the workforce and the number of hours they spend on the job. The second is labour productivity, or increasing how much is produced, or how much value is added, for each of those hours.

Growth in per capita GDP from the early 1990s to 2004 came in roughly equal measure from these two sources. However, there is a natural limit to labour utilisation, so looking forward the key determinant of our growth will be how well we can increase labour productivity. The simple fact is that all the OECD countries with higher per capita GDP than New Zealand have higher productivity, while all OECD countries with lower per capita GDP have lower productivity.

We have to think more systematically and with a long-term focus on the skill level of the workforce that we need. That means getting better value from our tertiary education and workplace training systems. It means better focussed immigration policies and practices. And it means reducing the barriers to workforce participation amongst those have young children, but want to maintain a career.

There are no magic wands, of course; as is apparent in the recommendations of the Workplace Productivity Working Group which submitted its final report to in August last year.

The Group’s key proposals were:

raising awareness of the importance of workplace productivity;

sharing information and promoting best practice, via industry and employee networks, and through funding “demonstration cases” of productivity improvements in individual firms;

developing and promulgating diagnostic tools to help firms identify potential workplace productivity improvements;

carrying out research into various aspects of workplace productivity;

improving the relevance and delivery of government support programmes for business; and

reviewing government support for skills training, including expanding support for foundation skills.

Underlying the Group’s work was the important idea that productivity is something that happens mainly within firms, and firms themselves are best placed to make decisions about how to improve their productivity.

However, productivity is more that just what happens on the shop-floor. Indeed, one of the most important shifts we can make in our thinking is to look more broadly and consider the other drivers of productivity, notably the level and structure of capital investment and the level of managerial skill.

New Zealand has relatively low rates of capital investment, compared to Australia and other OECD countries. At the level of individual firms, that means that New Zealand businesses need to increase their investment in plant and machinery.

That leads us in turn to consider how such purchases are financed, and more broadly whether we have capital markets that are as effective as they could be in identifying opportunities to increase value and in sourcing the necessary funds and investment partnerships.

On each of these scores, I think we rate a ‘could-do-better’. There is room for improvement in the scope and sophistication of our capital markets. These are not things to be achieved overnight; however, steady progress is being made in the revitalisation of the New Zealand stock exchange and in joint public-private initiatives such as the VIF funds for developing our venture capital market.

This brings me to my second major theme, which is the link between the rate of domestic savings and the strength of the local capital markets. Stated simply, New Zealand has one of the lowest rates of domestic savings in the OECD. The question is: if we can increase the amount New Zealanders save, what impact will that have on our economy?

I am the first to admit that there are arguments both ways. The US economy has grown spectacularly over the past few decades without particularly high rates of domestic savings. This is because they have been willing to access the savings of others, whether the Japanese, the Chinese, the Arabs or the Europeans, and investors in those nations have been more than happy to oblige.

The opposing argument is that the US experience cannot be automatically replicated elsewhere. It points out that growing economies other than the US, such as much of Western Europe, China and Japan, tend to have higher rates of domestic savings. Indeed the US is starting to realise that there is a limit to how long foreign investors will continue to fund their deficits. Hence the Bush administration’s suite of initiatives to support an ‘ownership society’. Even they seem to be learning that tax cuts are not self-financing.

Partly this is a matter of increasing the size and depth of the domestic capital market. But it is also about the positive side-effects of having a larger proportion of the population with stake in the market, and a stake that extends beyond the housing market.

As David Skilling of the New Zealand Institute has put it:

Asset ownership is increasingly important for meaningful participation in society and the economy. Ownership enhances the ability of people to access opportunities and to invest in the future – by buying a house, financing education and so on – and allows people to cope with shocks. Assets provide greater security, control and independence. A broad distribution of ownership also generates enhanced social cohesion at a national level, and ensures that more New Zealanders obtain the benefits of economic growth.

If we just look narrowly at the Australian experience of compulsory workplace superannuation, there is now a greater level of financial literacy amongst the Australian population, and arguably a greater appreciation of the skills needed to create and manage wealth.

The jury is still out on exactly how all the causal links work:

what type of economy is most likely to benefit from domestic savings?;

how, at an individual level, does saving for a first home or for an education link into retirement savings?; and

to what extent do domestic savers favour the local capital market and have a greater tolerance for risk than they do when investing offshore?

My sense is that there are definite gains to be made, both economic and social, in increasing the savings level of New Zealanders, and in encouraging a diversification in assets away from the residential property market. I think we would benefit from being a nation of shareholders as well as a nation of homeowners.

Achieving this is a matter of shifting our savings culture, creating a better basic infrastructure for saving and ensuring that we have a retail savings industry that delivers good results.

That’s why this year’s budget will see a savings package that is designed to facilitate rather than to coerce and to “be there” through the individual’s full life cycle: through the years in education and training; through the establishment of a family and the acquisition of a first home and, finally, through retirement. But the resources to support these aims will be limited.

A number of things have already been signalled, and the budget will provide more detail:

We believe the workplace is the ideal context in which most New Zealanders can arrange long-term savings, and so you can expect a set of measures aimed at rebuilding strong work-based superannuation schemes. Following on from the recommendations of Peter Harris’s report last year, there will be a number of mechanisms through which the government will encourage participation amongst employees and minimise the transactions costs for employers.

We are moving to resolve the anomalies in the taxation of savings and investment, in light of the recommendations Craig Stobo made in his report released last November.

We introduced a mortgage insurance pilot in September 2004 as a first step toward assisting people into homes. We are looking at further cost-effective ways of assisting home-ownership amongst New Zealanders who would otherwise struggle to get these important first runs on the savings board.

Outside of the budget, as many of you will be aware, the Taskforce on the Regulation of Financial Intermediaries is due to report mid year. This will address many of the concerns raised about the retail savings industry such as problems of conflicts of interest through commission-driven agents, transparency around fees and around the roll up of savings products with insurance products.

Clarifying the situation and taking action if necessary is an important priority, since a corollary of encouraging New Zealanders to save more is ensuring that we have a high quality retail savings industry. That means an industry that provides a range of products suited to local conditions, that operates transparently and applies a high level of expertise while charging competitive fees.

To conclude, I would like to say a few words about the choice New Zealanders will make later in the year at the general election. In my usual restrained manner, I have been trying to tease out the actual economic policies of those on the right of the spectrum. So far all that has emerged is that it is based on a looser fiscal policy through tax cuts in combination with increases in government spending on law and order and several other big ticket items.

If this is accurate, it can only mean one thing: increasing public debt. And how this will assist the economy long term is not at all clear.

To those who argue that the government’s operating surplus creates room for tax cuts and higher spending I can only say: remember your third form accounting and read further down the page.

It is true that the government is running an operating surplus which is forecast to peak this year at $6.5 billion. That will fall to $6.2 billion in 2005-06; $5.3 billion in 2006-07; and $4.9 billion in 2007-08.

However, an operating balance is only the starting point for assessing the health of an enterprise, be it a business or a government. One must then consider strategic options in terms of investments in capital (which for a government involves spending on infrastructure, hospitals, prisons and so on) and in terms of the management of long term liabilities (which for a government include the impact of population ageing and the maintenance of prudent levels of public debt).

What this means for the government’s accounts is that our declining operating surpluses will be almost fully absorbed in contributions to the New Zealand Superannuation Fund and in funding the government’s capital programme.

Once these are taken into account, what remains is the cash position, and the truth is that if one looks at the cash surpluses we have been running, they are relatively modest, and the outlook is for them is weaker. In 2003/2004, for example, we achieved a cash surplus of $520 million. The current forecast for 2004/2005 is for a cash surplus of $1.4 billion. However, this cash build up will be needed to fund capital spending during the next three years, when we are anticipating cash deficits of $705 million in 2006 and around $1.5 billion in 2007 and 2008.

In other words, we should not fool ourselves into thinking we have a large amount of headroom. We do not. Once we take account of capital investments, which are essential for future economic growth, and investments in the New Zealand Superannuation Fund, which are essential for future fiscal stability, what we have left is a thin layer of fat.

What National and others are proposing would involve cutting into the muscle we are trying to build up, weakening our fiscal well-being in the medium term, and threatening our economic well-being in the medium to long term.

I trust that New Zealanders will see through that strategy. A looser fiscal stance would be akin to a dose of one of those party drugs: a good time had by all, followed by a headache in the morning.

That is not what New Zealanders want. We have now had the opportunity to observe first hand the cumulative impact of steady growth, and government policies calibrated towards long-term goals of fiscal stability, strengthening economic fundamentals and quality social services. I believe what New Zealanders are seeking is more of the same.


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