Cullen: The Economic Outlook
28 February 2006
The Economic Outlook – speech to Diplomatic Club Luncheon
Tuesday 28 February
Duxton Hotel, Wellington (closed to media)
I always enjoy my discussions with people who, like diplomats, have a close, but slightly detached interest in New Zealand and its economic fortunes. It is easy to get caught up in fierce debates at a national level, and to lose touch with how one is viewed internationally.
For example, last week I was in Melbourne, where I met with business leaders who were somewhat amused at the self-flagellation in the New Zealand business press over the state of our economy.
Their view of us is of a vibrant economy, ranking in size just below those of their largest three states, with a secure economic future due to abundant natural resources, a skilled and motivated workforce, and a regulatory environment that is very friendly to business. It is puzzling for them to hear us complain about economic forecasts that see a brief return to a growth rate of a kind we would have thought quite respectable in the 1990s.
It is rather like those students we can all remember from our university days who normally achieved straight ‘A’s, but threw themselves into paroxysms of weeping at a temporary lapse into the ‘B’s.
I think it is very important to take a more dispassionate view, and to absorb the lessons that are to be learned by looking back on an extended upswing in New Zealand’s economic fortunes. Somehow that is easier to do in an environment such as the Diplomatic Club.
In the last five years New Zealand has posted GDP growth consistently ahead of the OECD average, and as a result have made up considerable lost ground, to the point where we are now starting to reel in the nations immediately ahead of us.
We have achieved over that period a 20 per cent increase in GDP. We have a very high rate of labour force participation and can boast of the lowest rate of unemployment in the OECD, amongst countries who use similar measures.
That is a significant factor for a Labour-led government, since we are concerned not just with the overall quantum of wealth, but also with its distribution. It is relatively easy for economic growth to be captured by a small segment of the population, while everyone else treads water. Indeed, some of our opponents regard this as an essential policy platform to encourage growth.
For us, the labour market is the primary mechanism for turning GDP into household prosperity. It has done that rather well over the last five years as average weekly incomes for individuals have increased by 17 percent in real terms. In addition, we are increasing the benefits of workforce participation for many low to middle income families through the Working for Families programme. This package will boost household incomes by providing targeted assistance to three hundred and fifty thousand working families.
The workplace is also important for us as the setting for encouraging New Zealanders to plan more effectively how to turn their present income into long term security. This week will see the introduction of legislation to implement the new KiwiSaver scheme, which is aimed at increasing the rate of domestic savings. The scheme makes use of the PAYE tax system to create a simple and cost-effective way of encouraging participation in savings schemes and reducing the compliance costs for employees and employers.
Over time this may foster a shift in the level of net debt held by New Zealand households. This has been a cause of concern amongst some commentators over the last few years, and it is certainly a factor in recent decisions regarding student loans.
My own view is that one should not be fixated on the size of the debt carried by a household, so much as whether that debt is supporting sound investments in things like housing and education, rather than supporting consumption habits that are unsustainable. That is a difficult thing to ascertain. My hope is that KiwiSaver will prompt a greater degree of awareness in the community about how wealth is created and how it should be managed over one’s life-cycle.
Our vision for economic development is very much tied in with a vision for social development. It is a matter of great pride to us that economic growth has been accompanied by measurable improvements in a variety of social indicators. New Zealanders in 2006 are wealthier, healthier, more secure from crime, better educated, and better connected to the global economy than in 1999. Within a few years time we hope to add to that list that the average New Zealander has a more tangible stake in the future through active participation in a savings scheme.
So, when we consider the economic outlook at the start of 2006, it is very important to consider what we have achieved and the degree of positive momentum that creates. Contrary to what some sections of the media would like us think, none of this gain is under threat as our economy goes into a soft patch that has long been foreshadowed.
We are facing slowing growth this year, but that reflects cyclical factors rather than a structural change to New Zealand's outlook. This will not be a painless process, as the recent job losses in some sectors confirm.
There are two important factors to bear in mind as we enter this soft patch. The first is that, just as the New Zealand economy has surprised most commentators by its resilience in sustaining above trend growth for five years, so too we should be prepared for the possibility that it will bounce back sooner and stronger than has been the case in previous cyclical downturns.
Indeed, what the consensus forecasts are now starting to show is that the slowdown may not be as severe as in previous cycles. They 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 1.6 percent.
This resilience comes from a number of factors:
- First, as I have mentioned, we have a robust and flexible labour market. While unemployment is expected to rise over the next few years, by historical standards it is expected to remain below 5 percent.
- Second, the relatively tight labour market is expected to contribute to relatively strong wage growth, contributing to reasonable income growth for households. This effect will be underpinned by the Working for Families tax changes, as I have already mentioned.
- Third, New Zealand households have experienced considerable wealth gains over recent years with strong house price growth a significant factor. While house prices are not expected to grow in the medium term, there is little expectation of significant nominal price decline. In other words, our homes will remain a very bankable asset.
- 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. In recent decades, New Zealand’s economy has only gone into recession as a response to weak trading partner growth. The 1997 Asian economic crisis was the most recent trigger. Unless the global outlook suddenly turns sour, the chance of a recession here looks very remote.
- Fifth and finally, we should see some easing in our high exchange rate. When exactly I would not care to say, although most forecasters expect it to occur within the next few years. This will improve our competitiveness and aid export growth. That in turn should lead to a re-balancing of our economic growth profile, and a reduction in the imbalances associated with a high current account deficit.
For these reasons, a prudent observer might conclude that the balance of risk is on the upside. This year’s downturn may not follow the pattern of past downturns. Watch this space.
The second factor to bear in mind is the cumulative effect of a variety of efforts, by both business and government, to improve the productivity of the New Zealand economy. As each month goes by, we start to see the benefits of these investments come on stream. I am referring here to the benefits as broad as improved trade access, the strengthening of the trans-Tasman Single Economic Market, the upskilling of our workforce, and new investments in infrastructure.
As a government, our focus this year is to keep all of these programmes firmly on track.
On trade, we remain firm believers in the value of both the multi-lateral processes, such as the WTO round, and also bi-lateral negotiations. We are very encouraged by the recent progress made in discussions with China, with Singapore and Chile, and with ASEAN more broadly. And of course the careful construction of an Australasian economy with very minimal barriers to the flow of investment, people and trade remains a very high priority.
On training and education, we remain on track towards our goals in industry training, recognising the importance in a modern economy of ensuring that our workforce builds its skills, especially in those export industries where we need to maintain our existing competitive advantage.
I am also coming to grips with my new responsibility for tertiary education. My priorities there are maintaining what I believe is a very strong reputation for quality, while redesigning aspects of the funding system that give rather vague (and sometimes rather unhelpful) signals about where tertiary institutions should focus their efforts.
Infrastructure is certainly a source of some concern, although I believe the current discussion between the government and Transit New Zealand over long term funding is very healthy. It is worth pointing out that the total resources available to the Land Transport Fund over the next 10 years are something in the region of $22 billion, from various sources. A funding shortfall of $684 million is significant in itself, but it needs to be seen in that larger context.
The very purpose of long term planning is to provide us with the capacity to foresee problems and find ways of dealing with them effectively.
The government intends to keep its eyes very firmly on the infrastructure prize. That is:
- an effective road transport system, planned in conjunction with investments in public transport;
- regulatory environments in electricity and telecommunications that ensure real competition on price and service quality, and encourage long term investment; and
- a careful approach to some of the less prominent areas of infrastructure, such as water supply, waste disposal and ports.
There is an important long game to be played in all of these areas. I am very proud of what we have achieved so far, given that we have substantially increased the annual flow of investment into infrastructure after years of underinvestment by the previous National governments.
While these initiatives may not save us from the short-term discomfort of the downturn, they do augur well for our capacity once again to string together several years of strong growth heading towards the second decade of the century.