Q+A interview with Gareth Morgan & Sir Paul Callaghan

Sunday 2nd October, 2011

Q+A interview with Gareth Morgan & Sir Paul Callaghan.

The interview has been transcribed below. The full length video interviews and panel discussions from this morning’s Q+A can be watched on tvnz.co.nz at, http://tvnz.co.nz/q-and-a-news

Q+A , 9-10am Sundays on TV ONE. Repeats at 9.10pm Sundays, 9:05am and 1:05pm Mondays on TVNZ 7

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GARETH MORGAN & SIR PAUL CALLAGHAN interviewed by GUYON ESPINER

PAUL The Finance Minister, Bill English, says the double downgrade doesn’t mean our economy is weakening, but rather reflects global concern about our levels of foreign debt. Is that the case? Are we at the mercy of foreign governments at the moment? Is there anything we can do? Our next two guests think there is. New Zealander of the Year and renowned scientist Professor Sir Paul Callaghan joins us from Cambridge in the United Kingdom; and Gareth Morgan, director of Gareth Morgan Investments and the author of the Big Kahuna, a book about tax and welfare, he’s in Wellington, and they’re both with Guyon, who’s in Auckland – work that out.

GUYON Thanks, Paul, and thank you, gentlemen, for joining us. Can I start with you, Gareth Morgan? What is the scale of this problem internationally with Europe and America ? How big are we talking in terms of an economic crisis here?

GARETH MORGAN – Financial Analyst
Oh, I think it’s very big, actually, Guyon. I tend to think of it as the second leg of recession after the grand financial crisis. New Zealand’s been in pretty sweet spot, actually, because during the first leg while America and Europe slowed down, China kept going full steam, so all those commodity-producing countries – New Zealand, Australia, Canada, Brazil – they sort of could defy gravity, and we say that reflected in our currency. We’ve seen it reflected in the price of our commodities. I mean, record prices for milk. All the crayfish we make now gets not sold to Japanese – it actually gets sold to Chinese. So, you know, we’re very dependent on China , but China is starting to slow now because China ’s growth has been driven by government investments – state and local government investments in China . And you can only do that for so long, you know, build roads to nowhere and three times as many airports as you need. And so China , on the other hand, is finding that its assets – its foreign assets offshore – are starting to have questionable value because the debt of these countries that it lends to – it’s the lender – are looking increasingly vulnerable. So the whole thing’s starting to impact, and that’s, I think, why the credit agencies have hit New Zealand . It’s because we actually haven’t undergone enough structural reform in this economy to handle a situation where the world comes off. I mean, you know, our balance of payments – deficit’s 3% of GDP at the moment, so it’s come down a long way, but that’s against record terms of trade and a domestic economy and therefore imports that are on their back. So, you know, what’s going to happen – as soon as those terms of trade start falling away, if China slows, you know, this balance of payments and deficit’s going to blow. This external debt’s going to blow. That’s our problem.

GUYON Sir Paul Callaghan, do you think from where you sit that New Zealand is too reliant on China and they simply can’t be the saviours this time?

PROF SIR PAUL CALLAGHAN – Victoria University
I think we’re obviously extremely fortunate to have China as a major market, particularly for our primary products, but there’s no doubt that Gareth’s right. This is an extremely worrying situation. I mean, there are opportunities for New Zealand at a time like this, perhaps to, you know, recruit some of the refugees and talented people from the rest of the world, but I think what we really need is a long-term strategy to address the issue of the balance of payment. And we’ve got to have a strategy that’s aimed at growth of exports – export-led growth – and it’s got to be in the highly productive sector of the economy. And the problem is that the most productive sector of our economy that dominates our exports is dairy, and fabulous as it is, we really can’t grow it, because of environmental limitations. So we’ve suddenly become a country a bit more like, say, Singapore or Japan, where you’ve got to start to think of developing exports based on knowledge and not on using our resources.

GUYON You say, don’t you, that it’s manufacturing that we often miss and this is actually one of our greatest and strongest opportunities, yet some see it as a sunset industry.

PAUL Well, it’s a curious thing, isn’t it, because if you look at New Zealand ’s profile of our exports, manufacturing represents our largest single sector. It’s about 11 billion a year, which is more than dairy, at 10 billion. And about six billion of 11 billion is elaborately transformed. A lot of it is quite high-technology stuff. If you look at something like the TIN100 list – the Technology Investment Network report that comes out every year – we’ve got something like a $5 billion a year export in the very high-tech sector. And unlike the rest of the economy, that’s been growing a lot faster. The average rate of growth of that over the last five or six years has been something like 6% or 7%. And if you look at the highest technology aspect of that, which is something the World Bank reports on, which is a smaller component of that manufacturing, the growth’s been something like 11% over the last 20 years. And that’s much faster than the economy as a whole. And so the problem is it’s invisible to most New Zealanders, it’s invisible to the politicians, but we’re very good at it. We just need to grow it by a factor of 10.

GUYON So, Gareth Morgan, I guess this plays into what you’ve been saying recently in terms of getting our investment out of the residential and property sector and into the more productive side of the economy. You see a capital gains tax as a major plank in that transformation, don’t you?

GARETH Well, I don’t, actually. I see a comprehensive capital tax, which is a tax on all income from capital, whether it’s cash or whether it’s imputed income. But the issue is New Zealand ’s got an external debt in the private sector. How has that come about? It’s come about by the banks borrowing money offshore and lending into the property sector here. And the property sector’s the best way to have made money in New Zealand . I mean, if I want to make money without paying tax, I’d just go and buy half a dozen mansions and wait for the rest to you to speculate their price up. I mean, it’s pathetic, really. And that’s the structural reform that New Zealand needs to undertake. We’ve had two extremely irresponsible governors of the Reserve Bank over the last decade who on the one hand have publicly worn their heart on their sleeve, bemoaned the rise in property prices, and on the other, have directed the banks to give preference to lending on mortgage. It’s just unbelievably incompetent.

GUYON Do you think Labour’s plan of a capital gains tax which excludes the family home is going to make any difference to this?

GARETH No, I don’t. I think it’s a waste of breath. But from a political point of view, it’s a start down the road, so that’s why I would congratulate them for that. But the biggest problem we’ve got is overinvestment in residential property. You know, you hear Paul talk about what’s happening in all these— in the transformation of products, and services is another one. New Zealand has got the brain quotient. We cannot get the capital, either equity or debt, into that sector, and it’s because it’s being diverted to the property sector. We have this ridiculous behaviour by the central bank compounded by the tax problem that investment in those sectors is tax-free, so I would put the charge straight back for the last 20, 30 years of this nonsense on both the Reserve Bank and holes in our tax system, absolutely.

GUYON Sir Paul Callaghan, you are— and we’re talking about incentives – I guess, tax incentives – to either encourage or discourage people to do certain things. How do we get the sort of investment in research and development which is woeful in New Zealand by international standards? Does it require research-and-development tax credits or some sort of incentives? Or is the market going to step up and do this on its own?

PAUL Look, I personally do favour an R & D tax credit. I think it’s a judicious use of government funds can really make a difference here. And one of the things we have to do is to favour those industries which have high knowledge content by effectively lowering their tax rate. And I think this is one of the most effective ways of getting industry to invest more in R & D through a tax break. It’s what industry wants. I think it’s really what Treasury’s recommended. Unfortunately, because the previous government did it, the present ones seem to think it’s politically unpalatable, but I think there’s no doubt it’s the most efficient way to go. Gareth’s absolutely right. I mean, what we need is more private investment in this sector. There’s good money to be made here, and people who are investing in this can do quite well, indeed. The growth rate, as I said, is very good in these businesses. But there’s a lack of understanding about how this works. We often get carried away with fads in New Zealand and we think that we have to play to our strengths, whether it’s, as it was 10 years ago, buyer technology or the latest one might be clean technology, because these things sound fashionable. But the truth is if you analyse what we’re good at, it’s quite a diverse range of activities. And rather than being prescriptive about this, we’ve got to look to where the talent really lies and put our investment there. And mostly this is driven by brilliant entrepreneurship and business understanding of where there are international market opportunities – the science and the technology capabilities there.

GUYON Gareth Morgan, if I can bring this back to the sort of the ‘person at home’ level, I guess, would you expect to see interest rates, mortgage rates rise as a result of this credit rating downgrade that we’ve received on Friday?

GARETH I think they won’t be as low as they otherwise would’ve been, but I’d expect the currency to continue to fall. You know, it’s fallen from whatever – 87 down to 76.

GUYON And that’s a good thing?

GARETH Well, it’s a sign of a weaker economy, actually, or a more vulnerable economy. And in the second leg of this world recession, New Zealand ’s absolutely more vulnerable. But to me, I’m not in favour of subsidies into those sectors. What I’m in favour of is levelling that tax field, Guyon, so that you don’t basically tax favour investment in property speculation. I mean, I was just in Blenheim this week. In the Marlborough Express, you know, the headline is ‘30% fall’ – fall – ‘in QV values in Blenheim town’. And it’s led by this woman saying, ‘I was told that property could only go up, and now I’m in the crap because it’s actually going down.’ That’s the learning curve that New Zealanders are going to have to go up over the next 10 years.

GUYON And, Gareth Morgan, can I just ask you finally what you perceive the permanency of this situation going to be? I mean, is this just a temporary debt crisis or do we move to a world where it’s no longer possible for people to borrow five times their annual income and buy a house?

GARETH Definitely it’s more permanent. We’re going to pay now for the sins of the last 20, 30 years since the financial deregulation where we’re basically overdosed on debt. For the Europeans, they’re going to have to forgive – the lenders are going to have to forgive the debts of Greece , Ireland and Portugal . And the market has already moved past that now. It’s looking at Spain and Italy . This is actually extremely serious and has the potential to be a major slump.

GUYON Sir Paul Callaghan, if I can finish with you, if there was one policy that you could convince the government to pursue right now that they’re not doing, what would that be?

PAUL Look to a long-term strategy of innovation in New Zealand and make New Zealand a place where talent wants to live so that we’ve got all the capability to drive that ahead. We’ve proven we can do it; we just need to grow it a great deal more.

GUYON Sir Paul Callaghan and Gareth Morgan, thank you very much for your time. We appreciate it.

GARETH Thank you.