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Cullen Speech to KPMG Legal Executive Forum

Cullen Speech to KPMG Legal Executive Forum

Good evening. It is a pleasure to be with you today. The terrorist attacks in the United States last year and more recently – and much closer to home – in Bali have reminded us that we can take nothing for granted and that the world is an uncertain place.

In the world economy, we are seeing huge volatility on leading international finance markets with weaker global growth prospects, an ongoing reassessment of corporate earnings and the heightened geopolitical risk all interacting to force new lows in equity and bond markets.

But so far New Zealand is escaping the economic fallout relatively unscathed. Quarterly growth is expected to ease in the second half of this year but it is coming off a high base. The GDP figures for the June quarter showed the New Zealand economy growing on an annualised basis by 4.7 percent.

I gather there are a number of representatives of the tourism industry here today. Let me take this opportunity to acknowledge the increasing contribution of tourism to our economy, and to making New Zealand a more interesting and exciting place to live.

The tourism sector now represents 10 percent of New Zealand’s GDP and employs about 10 percent of the workforce. It is expected to continue growing strongly. In 2001, 1.9 million overseas visitors came here with an estimated spend of $5.2 billion. By 2008, visitor arrivals are projected to reach 2.9 million and the visitor spend to reach $9.7 billion.

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If all sectors of our economy were growing as fast as the tourism sector, the government’s objective of restoring New Zealand to the top half of the OECD league table would be well within our grasp. But the fact is that we have to do more if we are to achieve that goal.

There is broad agreement around the necessary conditions for growth. No economy with persistent inflation, or with chronic imbalances in its public finances, can grow for long. Clearly defined property rights and a well functioning legal system to enforce them are essential. We need administrative systems, in private as well as public organisations, that are transparent and free of corruption. The question is what more is needed.

The growth literature I have seen identifies two other preconditions that are reasonably consistent across most nations: energetic investment in collective goods and a national consensus for growth.

I will start with public investment. This fell away sharply during the 1990s, and the associated short-term savings were essentially dissipated through rounds of tax cuts. There is no evidence that this lifted our sustainable growth rate. There is plenty of evidence that it left the incoming government with a massive bill for deferred maintenance.

We have had to rebuild and re-equip across the spectrum of collective goods: public housing, schools, hospitals, roads, defence force equipment, corrections facilities and the list goes on.

This has put a lot of pressure on our capital budget, and has meant that if we are to keep debt under control we need to run operating surpluses large enough to finance at least a part of the capital spending and/or find other ways of financing the programme. Which is where Public Private Partnerships and other variants on the model come in.

The context for PPPs is what sort of contribution they can make in improving the quality of new infrastructure, in expanding the quantity of infrastructural investment or in bringing forward the timing of that investment.

There is one body of thought that there is nothing new about PPPs. We have always had contractors on public works. Some would see this as a “partnership”.

But the reference to PPP in the current literature and policy debate usually refers to more than conventional contracting. It involves the delivery of assets in an integrated service fashion over some concession period and can engage private sector participation in any combination of design and construction, financing, operations and maintenance and other value adding related services.

Where asset delivery involves private ownership this is generally no longer regarded as a PPP but a BOOT (build, own, operate, toll). There is a continuum. At one end is traditional contracting. At the other there is the BOOT. In between are so-called D&Cs (design and construct) and PPPs.

There are six factors that influence the attractiveness or otherwise of the different procurement options.

First, public acceptance of user fees like tolls. Where public acceptance is low, D&Cs tend to be favoured. Where it is high, BOOTs become more likely.

Secondly, there is the issue of transparency, or certainty of regulation. If it is possible to specify the standard of service level required at a high level, or to regulate clearly, there is not the same risk of cutting corners by lowering standards, and the BOOT/PPP end of the spectrum is more attractive.

Where it is hard to close all loopholes as far as standards are concerned, governments have little option but to own and operate facilities, and hence private participation is restricted to design and construct.

The third variable is stakeholder acceptance. This is not limited to paying user fees and tolls. Acceptance also involves comfort with standards of service that can be expected in the future.

If there is entrenched suspicion about future performance, the D&C is the only effective option open to governments. As acceptance increases, it is possible to move towards the other end of the spectrum. This means that PPPs tend to become more common as experience with them builds. They are not the unknown devils of yesteryear.

It also means that there is a lot of pressure on private participants to make early projects work. If there are perceptions of profit gouging or shoddy service delivery, stakeholder acceptance will grow slowly.

The fourth factor is project size and complexity. If a project is small and straightforward, there is not much to gain by moving away from traditional contracting. The private participant can’t add much value by way of innovative design. There is not the same level of risk to transfer.

The contract size tends to limit how much can realistically be spent on developing the construction, service, and funding contracts, so there is more risk of sloppy performance specification. The prize is not valued so there is less competition in the tender process.

I get very large variations in what advocates of PPPs say is the minimum size to be viable candidates for these new approaches to service delivery. It is not only size, but frequency. A steady stream of smaller projects can be as attractive – from both the government’ and the contractors’ point of view – as one large one.

The fifth factor is the potential for private sector innovation. It also depends a bit on where that potential exists. If it is at the design end the D&C is favoured. If it is in service delivery after construction, we move more towards BOOT type arrangements because the owner will have the greater incentive to search out the innovative opportunities.

Finally, there is the opportunity for risk transfer, over things like construction problems, design variations, level of usage after construction and so on.

The benefits and costs of many infrastructure projects are highly dependent on assumptions made about whether or not the project comes in on time, on budget, encounters limited engineering complications, requires fewer design variations and has the expected use when it is completed. With some projects – like the Sydney harbour tunnel – almost all of these risks were transferred to the private participant in the venture.

I would now like to briefly canvass with you some of the issues I raised last week at the Union-Government Forum around the need to develop a national consensus and the contribution that could make to improving our growth rate.

Let’s not get hung up on the words, social compact, partnership, dialogue, whatever we call it: the evidence is that these sorts of arrangements have helped many small economies such as ours achieve success.

To work they have to be relevant to the institutions, cultures and traditions of the specific countries they operate in. There is no single international standard model.

Secondly, they need to relate to the specific problem or problems that a country is facing at the time they form. They are not just about, for example, wage controls. Third, they need to evolve as circumstances change. Finally, if they are no longer needed, there is no need to try and sustain them. The fact that a compact has been terminated does not mean that it failed. It is just as likely that its work is done.

Many of the high profile compacts emerged during times of economic and social crisis. That tends to concentrate the mind. In New Zealand we are in a relatively benign economic environment. Despite global economic conditions, we are operating with low unemployment, a high labour market participation rate, good fiscal surpluses, modest public debt, low inflation and a lowish balance of payments deficit.

So why change? The reason is that we are trying to reverse nearly half a century of mediocrity. This means that there is a much greater need for greater public awareness about the importance of our mission. In these circumstances, dialogue and explanation become as important as negotiation and compromise.

We do not have a centralised wage fixing system, and I am not aware that any credible economic commentator is arguing that wage inflation is our core problem. Under these conditions, any partnership arrangement is less likely to involve an agreed wages path.

My initial feeling is that what we lack is connectedness. Policies are pursued in their own right. We should not make decisions on – say – the length of the working week or year, without connecting that to decisions about what we are doing to raise productivity. Yet we do.

We have to connect decisions on spending with the need for financing infrastructural investment. We should not on the one hand pay lip service to the need for expanding export markets and on the other try and put excessive restrictions on the terms of any closer economic partnership that we might negotiate.

I don’t have any firm views about how formal any structures that we may use to conduct this discourse need to be or even who should participate. But it does seem that an effective social dialogue must involve all relevant perspectives, and this inevitably means going beyond central government, the unions and the employers to include a wider set of participants, such as local government and voluntary and community organisations.

I have been arguing today that the debate on economic growth has moved on from the search for single solutions and quick fixes. It hasn’t quite settled on the mix of policies that are needed to achieve growth. Indeed, part of the emerging consensus is that there is no settled mix: the things that are needed vary from country to country and change over time.

We are looking for the set of factors that work in this place at this time. We believe that we have identified them – at least at the high level – in the growth and innovation framework. It is now a question of filling in the detail, implementing the programme and building a shared commitment to it.

Everybody has a contribution to make. I look forward to working with all of you as we move forward. Thank you.

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