Michael Cullen Speech - Economic Outlook
9 March 2006
Economic outlook – speech to Masterton business breakfast
Copthorne Solway Park
According to Rudyard Kipling, one of the marks of maturity is the ability “to keep your head while all around are losing theirs”. The first couple of months of the year have seen some rather loose talk about recession, and I am very grateful to the growing number of business people and economists who are joining me in pouring cold water on this.
And if we needed a timely reality check we certainly got one on Monday when Australian media giant Fairfax bought on-line auction house Trade Me for $700 million. What a vote of confidence in New Zealand. That should make the doomsayers return to their dark caves. Fairfax would not have wagered that amount of money if the medium to long-term prospects for the economy were not excellent.
It seems that because it has been quite some time since the economy slowed, some of us have forgotten that economies are subject to cycles. It is easy for us to mistake a slowdown for a recession, and for New Zealand, at least in the last twenty five years, recession has always been the signal for unleashing a rash of radical economic policy proposals. In the eighties and nineties we grew used to the idea that there was always a quick fix for a recession.
The truth is we don’t have a recession, and we certainly should not alter our current economic policy settings. History tells us that ill-advised and poorly designed changes can make things worse. The most recent example was surely the late 1990s, when the Asian economic crisis and the unsustainable 1996 tax cuts led to a recession that was deeper and longer than it needed to be.
So, what we face this year and into 2007 is a slowdown in our growth trajectory, which will plateau for a short while at around 1.6 percent. That rate of growth remains very healthy, although most of our trading partners are forecasting growth rates more in the 3 percent range. At worst, in other words, we will forfeit a small part of the gains we have made in recent years in terms of OECD relativity.
What is most interesting about this dip in the economic cycle is that it has taken so long to arrive (having been predicted to come as early as 2004). It also has some rather curious features:
First, it is accompanied by continued strength in the labour market. We currently have 3.6 percent unemployment, which is the lowest rate amongst the OECD countries who use a comparable measure. Treasury forecasts suggest that rate will rise no higher than 4.6% percent at most, a rate which is still below Australia’s current 5.3 percent. In other words, most New Zealanders will work through the downturn, and since labour remains in short supply, there is an expectation that household incomes will continue to rise.
Second, New Zealand households are not expected to suffer a loss of income or wealth during the downturn. Labour shortages will keep wages and salaries up, and house values, which are major component of New Zealanders’ wealth are not expected to fall. In addition, 350,000 households will start to see modest, but very real, increases in take home pay as a result of the family tax changes in the government’s Working for Families package. In other words, the factors underpinning the strong levels of demand in the domestic economy will remain in good health.
Third, the downturn is occurring at a time of strong global economic growth. Anthony Richards, the head of economic analysis at the Reserve Bank of Australia, noted in a speech delivered last week that, “there is every reason to think that the global recovery still has further to run. Most importantly, the world economy still appears to have a fair bit of spare capacity, in terms of both labour and capital. So it is not surprising that global growth forecasts for 2006 and 2007 suggest a continuation of above-average growth.”
The point is illustrated by the fact that higher oil prices do not appear to have had much impact on growth outcomes or forecasts. To some degree this is because those higher prices are not the result of a cut in global supply, as in the two oil shocks of the 1970s, but instead because the demand for oil, as for many other commodities, has been driven up by consistent strength in the world economy.
Finally, as we enter the downturn the exchange rate has at least begun its inevitable slide towards something more like its true value. Forecasters predict that it will continue to ease over the next couple of years, which will mean a very welcome rebalancing of our economy, as our exports become more competitive and higher import costs rein in the domestic economy.
In other words, this is a downturn like no other in recent history. It is not highlighting any major structural problems in the New Zealand economy. Indeed, what it is highlighting is the underlying resilience in our economy, and hence our capacity to bounce back.
There is every sign that regions such as the Wairarapa may fare pretty well. Indeed the strength of regional New Zealand has been one of the key stories of the last six years. Every single region in the country has now been in positive growth mode, year on year, for 25 consecutive quarters. My government's partnership approach to working with the regions has clearly contributed to this consistent growth.
One of the more interesting recent trends has been the strength in world commodity prices, which is forecast to continue for some time. It has been suggested that this buoyancy reflects a deeper shift in the landscape on tradable goods. With the vast manufacturing capacity of emerging economies like China and India, things like laptops and sophisticated manufactured goods are becoming more like commodity products. With so much global capacity and such intense competition it is no longer the case that these products command a health margin.
Conversely, high quality commodities are becoming increasingly less commodified, in large part because markets are starting to appreciate that arable land is a finite resource and modern production techniques are taking us towards the boundaries of what can be feasibly produced.
That all augurs well for an economy like the Wairarapa, with its underpinning of pastoral farming and its steady diversification into niche products, viticulture, olives and tourism. Later this morning I will be visiting the new Matahiwi vineyard just north of the town. This confirms the steady northward expansion of viticulture in the Wairarapa, and represents a very vote of confidence in the future of an important regional industry.
So what are the government’s main areas of focus as the economy takes a breather? Essentially, our focus is on building the productivity of the New Zealand economy to give us an extra gear, or perhaps an extra two, once we return to a higher growth path.
We have seen our economy operating at full throttle in recent years. This has been fascinating to watch; but it has also placed the spotlight on some factors that are placing a ceiling on our ability to grow. My job, and that of my colleagues, is to lift that ceiling, so that we can sustain the next cycle of growth for longer.
There are three important elements to that productivity ceiling: the state of our infrastructure; the skill levels of our workforce; and the liquidity and sophistication of our domestic capital markets.
To begin with infrastructure, when we became the government in 1999 we faced the need for major infrastructure upgrades which should have been initiated during the 1990s. These are five to ten year projects requiring complex consents processes, advanced engineering and long term financing. We had lost considerable momentum and had to work very hard to get infrastructure investment back on track. I am happy to say that our annual public spend on transport capital assets is up something in the region of 90 percent this year on the 1999 level and 100 per cent next year.
The recent announcements by Transit New Zealand of a forecast shortfall in long-term roading revenues illustrate that we are not out of the woods yet. There is no reason to panic, however. In the context of a ten-year programme worth around $12 billion, a $684 million forecast shortfall is serious issue, but by no means an insurmountable one.
Accordingly, we have set up a ministerial advisory group to examine costs and revenues in the roading sector and consider ways of moderating the cost increases. This includes taking a look at whether Transit is over-designing roads and whether its tendering processes are adequate and provide incentives for finding better value for money alternatives.
On the funding side, it is an opportunity to look more closely at options such as infrastructure bonds. This far out, I am very confident that we can maintain our commitment to the roading plan and to the businesses and communities who are depending upon it. That includes the commitments on regional roading priorities.
Infrastructure is also pitching us some curve balls in relation to regulation. In particular, there is a growing sense in the community that the competitive pressures in various network industries are not delivering the results in terms of better prices and a stable environment for long term investment in new capacity.
There is a particular urgency for the telecommunications regime to deliver better results. The information superhighway is becoming a basic infrastructure for business. Broadband is a critical enabler of productivity, growth, and economic transformation, and in the view of my government 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. Our superhighway seems to function with several lanes permanently closed, with inexplicably high tolls and with flashing lights warning users to reduce speed.
In a small market with a population that is spread out along two islands and thousands of kilometres the answers are not easy. However, we are committed to finding the most effective regime that enables New Zealanders to access services comparable with other advanced nations at competitive prices.
The second key factor in building productivity is upskilling the workforce. We now have the lowest unemployment in the OECD, and along with that a historically high labour force participation rate. We are at the limit of our capacity, given current skills and capital investment. All hands are on deck, and the only way we will grow further is if we make give those hands better tools to work with and make them more skillful.
In the last five years the government has virtually reinvented industry training and the apprenticeship scheme. Numbers participating in skills training have doubled, and there'll be a total of 14,000 Modern Apprenticeships by 2008. We continue to work towards the target of 250,000 people in industry training overall
Budget 2005 also included $300 million over the next four years to develop quality tertiary education. What ‘quality’ means in tertiary education is something we are paying close attention to. In the institutes of technology and polytechs sector in particular, quality is not an abstract concept. It is about fitness for purpose, and that purpose is to equip regional economies with the workforce they need. That means a shift in mindset from the goal of filling lecture rooms to include an active role in working with the business community and local authorities to map out future skill needs for a region and work on joint strategies to build those skills. Polytechs are engines of growth; but to function properly they need to be attached firmly to the wheels, the chassis and the steering mechanism. That is a hard task because forecasting skill requirements is always difficult.
Nevertheless, it is not an impossibility. One of the most gratifying things about being Minister for Tertiary Education is seeing real life examples of tertiary institutions working with their business communities to identify future scenarios and strategies.
The third key factor in building productivity is improving access to capital. We are attacking that problem on several fronts. For example, I was in Melbourne recently for the signing of trans-Tasman agreements which will streamline investment flows across the Tasman by mutual recognition of securities offerings and alignment of business law and accounting standards. These measures will make it easier for New Zealand companies to access Australian capital markets.
Last week also saw the introduction of the KiwiSaver legislation into Parliament. This legislation establishes a long-term savings scheme which, while it is not compulsory, tilts the playing field in favour of establishing a long term savings habit.
One of its side effects, of course, is that it will increase the pool of capital in New Zealand that is going searching for worthwhile investment opportunities. In the normal course of events, taking into account factors such as taxation, it is likely that more of that capital will be invested on-shore. This is what known as ‘home-bias’, and it will certainly lead to some degree of net increase in the investment capital available to New Zealand firms. That in turn should decrease our need to borrow off-shore, with all of the additional costs that brings.
A second benefit of KiwiSaver is that a workforce with a higher savings rate and a greater general awareness of the need for financial planning and wealth management is a more productive workforce. When people have a stake in the future, they tend to put more effort into making that future a brighter one. In this sense, KiwiSaver is designed to foster an important mindshift within the New Zealand workforce.
Infrastructure, skills, and savings are key elements in our productivity strategy; but they are by no means the end of the matter. In tax, for instance, you will recall that last year’s Budget included announcements about changes to the rules around R&D and depreciation, and measures to attract overseas equity partners to start up New Zealand companies. Those changes will start to take effect this year.
We are also reviewing business tax to ensure that it provides the right incentives for innovation and investment, without opening the door too wide for the tax planning industry. We will, of course, be looking closely at the Australian reforms and considering what measures may be logical in light of changes there.
You can expect a discussion document on the subject to be issued mid-year, and we are aiming at having any changes in place for the 2008 tax year.
To sum up, many New Zealand businesses are realising that, despite the uncomfortable realities of a short-term slowdown, they need to stay the course on investing in their future capacity. So too the government which is mid-way through crucial investment programmes in infrastructure, skills and savings.
What is abundantly clear is that Rome is not burning, and we are not fiddling. There is every possibility that we will quickly regain our equilibrium and come out of the starting blocks with renewed vigour within the next 18 to 24 months.