Key: Address to 'Hollowing Out' Symposium
John Key MP
National Party Finance Spokesperson
8 September 2006
Address to ‘Hollowing Out’ Symposium, University of Auckland
Thank you for inviting me here this afternoon to discuss the issue of “hollowing out” in New Zealand.
I guess the first thing to think about is what “hollowing out” actually means. In other countries, hollowing out refers primarily to the decline in manufacturing jobs in an economy, as these jobs apparently migrate to other, lower-wage countries.
Many people in the United States, for example, are concerned about the amount of cheap consumer goods being imported from China, and the effect this apparently has on the manufacturing industry in the US. There are frequent calls for tariffs to protect US manufacturers from this kind of foreign competition.
In New Zealand, where we have full employment and a commitment to trade liberalisation, the concerns about hollowing out are different. As I see it, the concerns about hollowing out in New Zealand are around personal and corporate migration.
In particular, we are concerned about skilled New Zealanders moving overseas, and about head offices of major companies moving overseas, reflecting the changing ownership of those companies.
Such concerns are not new, nor are they unique to New Zealand, but the level of public debate on this issue appears to be rising
So is hollowing out actually happening?
With regard to the migration of skilled New Zealanders, we only have to look at the fact that while we are a country of 4 million people, another 1 million were born here but no longer live here.
One in four of the people who have moved overseas have been to university; 1 in 2 of them now live in Australia. We have a brain drain of around 24% - the worst in the developed world. We run the serious risk of becoming a giant polytech or university for our Australian neighbours.
we cannot afford to be hollowed out of our best and
brightest people, because without doubt the loss of these
people will severely impede New Zealand’s
economic development. These are people who, through their innovation, skill and determination, turn ideas into products and services.
We need to find ways to retain and attract back some of this foreign army of Kiwis.
On the business front, it is clear that New Zealand firms in recent years have been departing our shores. The corporate head office movements and New Zealand Stock Exchange delistings are well known. Perhaps a less understood development in recent times has been the emergence of private equity firms, largely from Australia, snapping up our potential new stocks of mid-size companies before they even reach the New Zealand Stock Exchange.
This creates a number of concerns. Not the least of these is the growing trend of mid-sized New Zealand firms being amalgamated with similar-sized companies in Australia, and on a combined basis then listing on the Australian Stock Exchange, effectively bypassing our market.
Why is this happening?
Primarily it is because of the large pool of investment capital that has been generated by Australia’s compulsory superannuation scheme.
In New Zealand we do not have such a pool of superannuation savings, as New Zealand Superannuation is funded on a ‘pay as you go’ basis through the tax system.
And New Zealanders, as David Skilling has pointed out on numerous occasions, hold the lowest level of financial assets in the developed world - a situation that is unlikely to change in the near future.
In essence, we are a country that lacks homegrown capital, but which has a business community hungry to grow and expand. It is logical - and in fact necessary - that if Kiwis cannot source that capital locally or at a realistic cost, then we should use foreign capital to fill the gap.
Without it, those businesses won’t, and don’t, grow, and that cannot be in anyone’s best interests, least of all our own.
So should we care about this? After all, plenty of economists will argue that capital is a global commodity.
The fact that we attract so much of it just proves we have propositions attractive enough to both investors and businesses to warrant the cost and quantity of that capital. However, there is a danger that overseas owners will seek to move their head offices to their own countries, and will seek to return income to their own countries, if this is beneficial to them.
In particular, this will be the case where overseas jurisdictions have a lower rate of company tax. In this regard we only need to look across at Australia, whose company tax rate of 30% is three percentage points lower than ours.
The issue of imputation credits is also particularly relevant here, and the attachment of Australian franking credits, not New Zealand imputation credits, makes a big difference if you are an Australian investor. After all, capital is provided by investors who demand the highest after-tax return possible, and that, if nothing else, is a driving force behind much of the corporate migration we have observed.
We need to be aware that when we lose a head office or the emerging business, we also lose the associated ancillary activity. Much of this is highly paid work, such as that undertaken by legal, financial and accounting services.
But head offices also create demand for hotel accommodation, restaurants, taxi trips, and so on.
The lasting impression I have about Merrill Lynch’s decision to move part of my business from London to Dublin wasn’t that of the business we established in Ireland, nor the high level of corporate activity we attracted there, but the huge spin-off activity such vibrancy brings with it.
So, in my view, we should and must care. Without that wider business activity, the probability of New Zealand attracting and retaining human capital reduces. This human capital is the vital ingredient for the creation of new and innovative ideas, and the improvement of productivity in our economy.
What can we do?
I think we need to consider at least three things: the amount and quality of our national savings, how we can be more attractive as a country to base operations in, and the attractiveness of New Zealand to high net-worth and entrepreneurial migrants.
I‘m sure there will be much discussion this afternoon about the need to improve our savings rate and therefore the investment in New Zealand by New Zealanders. But if it were as simple as that, one quick solution would be to direct the New Zealand Superannuation Fund to invest a greater proportion of the assets they have under their management onshore. In my opinion this might be a ‘quick fix’, but it is not the long-term solution we are looking for.
If New Zealand was more compelling as a place to do business in, fewer companies would want to migrate.
I will never forget an interview I watched some years ago with Dell Computers’ founder Michael Dell. He made it clear that his company established a significant presence in Ireland not so much on the back of the local tax rate, but on the quantity and quality of graduates the Irish education system produces.
Good policy combined with a world-class infrastructure and skills play an important part. But in some instances this won’t be enough.
I have long argued that New Zealand could encourage the establishment of significant green field operations for a series of industries, such as the provision of offshore financial services, with tax rules conducive to this activity.
Why on Earth wouldn’t New Zealand be prepared to promote a low-tax environment for industries that are high value, new, and provide a genuine pathway for skilled New Zealanders to enter or return to?
I can tell you that as a future Minister of Finance I would much rather have 10% of a lot of revenue, which we currently don’t earn, than 33% of nothing.
I would like to finish by challenging your thinking slightly, in saying to you that New Zealand has to be realistic about the challenges that our size and remoteness from the world’s major markets and populations presents.
In short, we could probably cut our company tax rate to zero and the majority of large multinational head offices would not relocate to New Zealand.
However, we have an advantage that we haven’t always maximised. The world is becoming a more complex and dangerous place. Global terrorism is rife and, in my view, will dominate for some time to come.
Blissfully, New Zealand is largely immune from this, and likely to remain that way. We are a beautiful, peaceful and idyllic place to live, and those who have acquired wealth are increasingly looking to spend more time here.
These individuals are, for the most part, driven and entrepreneurial, and when they come to New Zealand they almost can’t help themselves when it comes to buying assets and creating wealth.
An obvious example is US billionaire Julian Robinson. Few would argue that Julian’s contribution towards developing world class recreational and tourist activities such as Kauri Cliffs and Kidnappers golf resort has been nothing short of dramatic.
These offer large opportunities for employment and for promoting the attractiveness of New Zealand as a tourist destination. Julian is not unique in his desire to undertake business activity in New Zealand, nor do these kinds of individuals need to have the massive wealth that he has attained.
In my time as a Member of Parliament, I have met hundreds of foreigners who have come to New Zealand, individuals who have established businesses and created opportunities. For this type of investor, the decision-making rests with them – they call the shots, not a board located thousands of miles offshore, which sees New Zealand as a small market where risks and management time should be constrained and controlled.
So how can New Zealand become more attractive to these kinds of people? We need to look at what other countries have done to attract them.
In recent times, Australia has developed a set of rules around taxing foreign and Australian-based income, with the aim of attracting well-off migrants who will invest in their country. New Zealand has timidly tried to follow Australia’s lead, but it has been just that – a timid imitation.
New Zealand should, I believe, more carefully explore the options, as indeed the United Kingdom has also done successfully for many years now, and as a result is the home of a huge number of migrant investors. I believe that New Zealand can, and should, do a much better job of attracting such individuals.
By way of example, the recent government changes to New Zealand’s migration rules do not apply to a New Zealander returning, unless they have been out of the country for a minimum of 10 years. Realistically, that is far too long a period to have New Zealanders away. After such a time has elapsed, the probability of them returning reduces dramatically.
Contrast this with Australia, which has taken a far more liberal approach to their rules.
Remaining competitive with those with whom we compete for people and businesses is critical, but what is also important is that we don’t intentionally shoot ourselves in the foot when it comes to making our own laws.
Currently, the Government is in the process of promoting changes governing tax on overseas investments, which in effect means New Zealanders will be taxed on 85% of any capital gains on shares they own in countries outside Australia and New Zealand.
The tax on unrealised gains applies to repatriated funds- so the way the rules are drafted means all the incentives are for capital that is created offshore, for example through a NASDQ float of a New Zealand company to remain offshore.
Not only are we finding it hard to attract people to New Zealand, but we are sending a message to some that they should leave their capital offshore, to become tax exiles, which is crazy.
Surely if we are to grow, then the reinvestment of capital and skills from those who have already been successful is a critical element. Stephen Tindall is living proof of just that. Unless this legislation is redrafted and this issue resolved, New Zealand will, in my view be sending a very inappropriate signal to our homegrown entrepreneurs.
Let me conclude by saying if we are serious about stopping the hollowing out of New Zealand, and I believe we should be, then we need to think about all these possibilities and not rule some out from the beginning through ideology or prejudice.
If we don't, then there is nothing surer than our continued hollowing out and what will remain will be not much more than a picturesque shell.