Cullen: Address to Westpac business luncheon
Hon Dr Michael Cullen
Deputy Prime Minister, Minister of Finance, Minister for Tertiary Education, Leader of the House
21 February 2006 Speech Notes
Tuesday Feb 21
Address to Westpac business luncheon
110 William St
Today I would like to give you an update on the New Zealand economy and the medium to long term prospects for Australian investors. In particular I would like to answer the prophecies of doom some of you may have heard in recent weeks emanating from my side of the Tasman.
Whenever an economy comes off the boil, as New Zealand’s economy is at the moment, there are always a few individuals who throw on the sackcloth and roam the streets predicting a return to the dark ages. I have to say it is disconcerting when one of these prophets is a former Governor of the Reserve Bank, but my aim today is to provide you with clear assurances that while these prophets might be full of sound and fury, they lack any connection to the world of facts and hence signify nothing.
The New Zealand economy maintains the set of strong fundamentals it has built up over the last six years. These are not affected by the short term softening we are encountering.
Growth in the New Zealand economy is expected to slow from the strong rates of growth experienced over the last few years. The latest Treasury forecasts suggest that while growth will slow, the trough of the cycle will not be as deep as it has been in the past. According to the Treasury, annual average real GDP growth is expected to trough at around 1.5 percent. The expectation of a mild growth trough is supported by the consensus of independent forecasters.
The slowing in growth reflects cyclical factors rather than a structural change to New Zealand's outlook and reflects the need for several imbalances in the economy to unwind following a sustained period of above trend growth.
A number of factors contribute to the rather benign outlook:
- First, a robust and flexible labour market. New Zealand's unemployment rate, at 3.6 percent, is the lowest in the OECD (for countries with a comparable measure). While unemployment is expected to rise over the next few years, by historical standards it is expected to remain below 5 percent. That compares with Australia's current unemployment rate of 5.3 percent.
- Second, the relatively tight labour market is expected to contribute to relatively strong wage growth, contributing to reasonable income growth for households. In addition the roll out of government's new Working for Families package will boost household incomes by providing targeted assistance to three hundred and fifty thousand families.
- Third, New Zealand households have experienced considerable wealth gains over recent years with strong house price growth a significant factor. While house price growth is expected to ease significantly, house prices are not expected to experience significant nominal price declines.
- Fourth, and very importantly, the growth outlook for our trading partners is good, with consensus forecasts expecting a return to growth of approximately 3.5 percent per annum, consistent with the medium-term trend. Buoyant global growth is likely to mean that while the prices received for a number of our exports (for example, meat and dairy) are likely to fall, they should remain relatively high by historical standards.
- Fifth and finally, the high exchange rate, which has been constraining export growth, is expected to ease over the next few years and this will assist with the competitiveness of our exporters. While a lower exchange rate probably isn’t top of the wish list of overseas investors, it is important to see the long term benefits of a fairer value to the currency, in terms of a more balanced growth profile which is less reliant on domestic demand growth, and a reduction in the imbalances associated with a high current account deficit.
In light of this outlook, what can explain the revival of the prophets of doom? As a recent commentary from First NZ Capital notes, these prophets place heavy reliance on recent negative business and consumer confidence surveys. This reliance is mistaken. As First NZ Capital points out:
- business confidence surveys are at best indicators of current economic conditions, not of future conditions; and
- consumer confidence surveys best predict what has already happened rather than what is ahead (that is they are lagging indicators).
To illustrate this point, one needs only to consider that for the past five years business confidence has averaged a net minus 16 percent, while the economy has averaged 3.7 percent growth, well above economic performance in the nineties. If survey respondents can be that gloomy during the good times, it suggests that one would be foolish to place too much reliance on business confidence as an indicator.
In summary, my major point is that New Zealand remains a strong value proposition for investors, and Australian investors in particular.
Australia is by far the largest foreign investor in New Zealand, with investments of over A$32 billion representing over 40 percent of FDI into New Zealand. New Zealand has traditionally been one of the first offshore markets in which Australian firms expand into. One thinks of NewsCorp and Telstra as early examples.
New Zealand has been a very successful destination for Australian investment. Indeed, by some accounts we are the only country where Australian firms in aggregate have made a return higher than their cost of capital.
The current environment is characterised by an increasing number of firms operating as trans-Tasman companies, and by moves towards increased harmonisation of the respective business environments with the aim of creating a Single Economic Market in the medium term.
The key elements in the value proposition for Australian firms are obvious:
- Both countries operate similar forms of government, and support the free flow of capital, people and goods between them;
- There are strong similarities in terms of culture, lifestyle, language and labour force, as well as our consumer markets and legal and tax systems;
- New Zealand is a low cost producer of a range of agricultural-based commodities, where value can be added through knowledge of market requirements, and through distribution networks into third markets;
- New Zealand demographics replicate those of larger markets and for this reason provide an excellent test bed for new products and services.
The moves towards a Single Economic Market or SEM are making this value proposition even stronger. We can begin to look at a unified Australasian domestic economy, in which New Zealand features as the fourth largest state in terms of GDP, between Queensland and Western Australia. Setting these states alongside each other, there are, I would argue, some strong competitive advantages for investors in New Zealand.
Our GDP growth is driven by a very diversified export sector and a solid domestic economy fuelled by steady population increase. We are, in short, much less vulnerable to external shocks than was the case even in the late 1990s when the Asian crisis hit.
We have a government that has a strong balance sheet and a tight fiscal policy. Crown debt has been steadily sinking as a percentage of GDP to a point where it will soon cease to feature as a significant factor in assessing sovereign risk.
And we come out on top of the World Bank’s regular survey on the ease of doing business. The features that put us there include:
- Lower regulatory imposts on business,
- A non-federal system of government with generally good cooperation between local and central government,
- A flexible workplace environment, and
- A relatively simple tax system.
On the last of these, there are some commentators in New Zealand who continue to lament that our headline company tax rate exceeds that of Australia, despite the fact that the corollary is that we have no payroll tax, no taxation of capital gains and no social security taxes. I remain deeply sceptical at the suggestion that the headline rate scares off investment, when any analysis by a tax accountant will show that the overall tax burden on New Zealand companies is relatively light in comparison with most OECD countries, including Australia.
Despite this, there are some aspects of business tax that are under review which I will refer to later on.
The point I want to make is that all of the above translates into a lower cost environment, particularly for service based industries, and also an environment in which there are fewer impediments to innovation and entrepreneurship. Efficient regulatory and tax systems, and a flexible and adaptable labour force mean that it is easy to do something new in New Zealand.
Against these benefits, the barriers of geography pale into insignificance.
Nevertheless, there are some particular challenges that New Zealand is facing, and that my government is addressing. These include:
- broadband regulation;
- business tax; and
- harmonisation with Australia.
Governments in the 1990s somewhat lost their way on infrastructure investment, choosing to spend their energies bringing regulatory regimes to a state of theoretical perfection which is largely irrelevant to the real world. As a result we are playing catch up in areas such as roading, ports, and power transmission. Even with our construction industry operating to full capacity, it is likely that we will remain in catch up mode for the next five to ten years.
We are facing a particular issue with the regulation of broadband internet services, which is increasingly the key infrastructure for business growth. Broadband is a critical enabler of productivity, growth, and economic transformation, yet our connection speed offerings and standard upload speed are on average still too slow. We are one of the few countries where restrictive data caps have been the norm.
The government will be addressing the policy, legislative, and regulatory settings as a matter of urgency, with a view to creating an environment which encourages investment through enabling adequate rates of return, but ensures stronger and more effective competition than in the past.
On the business taxation front, as I have mentioned, we already have a relative simplified regime; but a further review is under way aimed at encouraging business growth and productivity. I cannot expand too much on what issues are on the agenda, although I would point out that already legislation is before Parliament to allow for accelerated depreciation rates on short life assets.
Lastly, a wide variety of initiatives are being progressed through the SEM agenda. That is the primary reason for my visit to Melbourne. And I want to pay tribute to Treasurer Peter Costello whose drive and energy have given real impetus to the SEM agenda.
My talks with Peter tomorrow are focussed on a range of areas where progress is being made:
- For securities offerings, we are close to finalising plans to mutually recognise documents issued in each other’s jurisdictions. This will reduce barriers to cross border securities offerings and benefit issuers and investors in Australia and New Zealand.
- In business law we will consider a new 5 year work programme that will reduce compliance costs for companies, and improve coordination between Australian and New Zealand financial regulation.
- Regarding accounting standards, we have cross appointments between the relevant Australian and New Zealand bodies, and a work programme designed to consider convergence between the different standards applying in each country.
In addition, for those of you with more arcane interests, we will discuss a proposal made by the Trans Tasman Banking Council to better coordinate the actions of APRA and New Zealand's Reserve Bank, especially in times of financial crisis. This type of cooperation is essential to ensure the rapid recovery of both economies from any such event.
It is important to see how valuable these SEM initiatives are in reshaping the business landscape in Australia and New Zealand. Sometimes the pace of change may seem glacial. Indeed, during the 1990s it seemed at times that the glacier was stalled or in retreat. Now it is making slow but steady progress, and as anyone who has travelled in the South Island of New Zealand can attest, glaciers have the power to permanently rearrange the landscape.
In this case the landscape will be one where investment decisions within Australia and New Zealand will be driven only by the real issues of where value can be created, and will not be unduly affected by the national boundary that lies notionally somewhere in the Tasman sea.