Address to the Ralph Hanan Memorial Lecture

Let me first acknowledge and thank my colleague and friend, the Attorney-General Chris Finlayson, for inviting me to deliver the annual Ralph Hanan memorial lecture.

As you know, this annual lecture is a celebration of the Liberal tradition of the National Party. It honours one of the Party’s greatest liberal minds and practitioners, the Rt Hon Ralph Hanan. I am not the first to observe in this series of lectures that Chris is perhaps the most obvious inheritor of that proud Liberal tradition.

Ralph Hanan, for his part, is forever remembered as the National Party Minister who politically steered through Cabinet and Parliament the abolition of capital punishment, one of the great Liberal causes of the twentieth Century.

I do want to acknowledge Chris and the work he is doing as Attorney General, as Minister of Arts, Culture and Heritage and as the Minister in Charge of Treaty Settlements. His professional qualifications and personal commitment to each of these portfolios are unquestionable.

My abiding interest lies in a different set of issues that are part of the same Liberal agenda: the pursuit of liberal trade policies. Like Chris, I spent decades of my professional life on these issues prior to going into politics and feel deeply privileged to the New Zealand Minister responsible for this portfolio.

I also want to foreshadow that I am using this lecture to announce what I consider to be a most interesting new development for New Zealand on trade. If we can bring this initiative home it will strengthen yet further our determination to pursue export-led growth and our links with the emerging economies.

The Case For Liberal Trade

To me, the case for liberal trade policies, particularly given New Zealand’s economic history, is simply overwhelming. I came to this view decades ago in part through simple observation of the realities facing New Zealand and in part because of the influence of some great teachers. A key figure here for me, as for a number of New Zealanders of my generation, was Sir Frank Holmes, who passed away in the weekend. Frank’s research and advice on international trade, particularly on regional trade agreements, continues to influence what I do today.

Trade is about specialization. Specialization is the heart and soul of productivity growth, which in turn is the key to the elimination of absolute poverty.

Trade in its first manifestations would have been intensely local: largely within tribes in Asia, Europe, the Americas or wherever and then after the invention of agriculture some 10,000 years ago, between villages.

The deeply local nature of these early traders was imposed by limitations around available technology and most particularly high information and transport costs. When trade first became ‘international’, it would have involved only either unique goods and services or very high value goods and services. It is not a coincidence that early exchanges between Europe and Asia involved highly expensive items like silk, gold, silver and spices. Only highly valued goods could justify the extraordinarily high transaction costs.

The Rise of the Global Supply Chain

Let us leap across millennia and centuries to where we are today in the 21st Century. The things that drive us as human beings have not changed; we are just better organized. More and more people and communities on the planet have discovered that the competition for resources does not need to involve war, but is better organized through mutually profitable exchange, buttressed by the rule of law, both domestic and international.

What has changed is not human nature, but technology. Because of technology, the opportunities for trade are now extraordinary. It is rapidly falling transport and communication costs that have created the phenomenon of the global supply chain.

If only decades ago the dominant mode of trade was to exchange finished manufactured goods for other finished manufactured goods, at the beginning of the 21st Century this seems almost quaint. The industrial model of vertically integrated production – you try to make everything – is almost certainly the wrong model. “100% made in New Zealand”, while a crowd pleaser as a slogan, is absolutely the wrong slogan for higher real wages and a prosperous future.

There will be honourable exceptions – goods that are from top to bottom nearly 100% NZ value added and yet remain internationally competitive in the process. Further, given our extraordinary primary resource strengths, there may be rather more such successful examples in New Zealand’s future than would be the case in most developed countries. But by and large, we need to move beyond this idea of “100% made in New Zealand” to embrace the extraordinary opportunities of the global supply chain.

It requires a big mental shift for people to ‘get it’, because in too many quarters thinking is stuck in the outmoded earlier mindset and the policies that supported that model. It is only some twenty years ago that we left that policy framework behind. No wonder, attitudes have not yet caught up in all corners of the political debate.

Let me examine the proposition from the perspective of a high-end manufacturing product: can we build airplanes and export them? At the top end of the technology scale, stand large-scale civil aircraft. Can we build and export them? Literally – no, but in a wider sense, yes we can and we do.

Altitude, an offshoot from Air NZ is a small but brilliant engineering and increasingly bespoke manufacturing company. They manufacture ‘bits’ of Boeing aircraft and have entered what may be the most sophisticated supply chain in the world. Good market to be in too: civil aircraft is the number one export item of the United States and, like our whole trading economy, deeply linked to the Asian and emerging economy success story.

So could we build and export small aircraft? I give you the same answer, but the other way round: ‘Literally yes, but in a wider sense no, we cannot build and export small aircraft by ourselves. Pacific Aerospace has exported well over 600 small aircraft over several decades – I think each is worth around $2-3 million. But it’s not “100% kiwi”. The engines are Pratt & Whitney; the avionics are American, the highly specialized aluminium is also imported. They too are part of the global supply chain – at the designer and final assembler stage in the global supply chain.

This is where New Zealand needs to position itself – as a small, diverse and sophisticated producer of ‘bits’ in the global supply chain. Trade in intermediate goods is now some 60% of world trade; trade in intermediate services is even higher, according to OECD definitions.

Many New Zealanders, particularly New Zealanders of my generation, have difficulty believing that New Zealand can be an exporter of manufactured goods. “How can we compete with China, when their wage rates are one tenth of ours?” is the way it is usually put.

Well, leaving aside the fact that wages in Shenzhen, Shanghai and other important centres of the Southern Chinese export machine are actually increasing at rates around 15% per annum, the best answer is to say ‘we are not trying to compete with China in that sense’. We are trying to produce bits of the global supply chain and China does ‘other bits’.

Rakon, which has just opened a second China manufacturing facility in Chengdu, Western China (partly because of rapidly rising costs in their first facility in Shenzhen), produces relatively low cost, but high quality, simple chips and oscillators in China in their millions. The ultra high-end, high cost oscillators will, as I understand their strategy, continue to be made in Auckland at their Auckland facility. Can’t compete with China? Nonsense. It is a matter of working out what we can do smarter and better than others and our extraordinarily positive relationship with China is a huge strategic asset for New Zealand.

In fact, far from the investment in factories in Chengdu and Shenzhen ‘costing New Zealand jobs’, exactly the opposite is the case. As the company has recently made it clear, the expansion of production in China gives them a world leading cost base to ensure they can profitably compete in their main market while simultaneously allowing their NZ based business to continue a transition to manufacture a broader range of top-end products for the Telecom market and high value GPS applications. This is exactly the strategy that we need for NZ inc to follow if we want to lift our game in the global supply chain.

The Transformation of New Zealand Trade

In terms of economic adjustment, what I am describing is light years from where we were as a country, even a generation ago. When I was born, 90% of all our exports went to one country, the United Kingdom, and almost all our exports were agriculture commodities – an economic mono-culture, one could say.

There are dangers in mono-cultures – they inherently have less resistance to a change in the environment in which they have thrived. Recall here the essence of Darwinism: it is not literally the ‘fittest’ in a given environment who survive; it is those who can adapt who survive a radical change in the environment. Like all mono-cultures, the NZ trading economy of the 1970s, and the utterly hopeless trade and industry policies that supported it, our trading structures had no built-in genetic resistance to environmental change, albeit change of a policy-induced nature.

When the environment did change – and change radically with the decision of the UK to join the then unreformed Common Agriculture Policy of the EEC – it exposed all of New Zealand’s structural weaknesses. It was always going to be ugly. The adjustment was always going to take time.

The manufacturing we did do at the time of that fundamental shift in the external environment was the polar opposite of what I have just described as necessary to compete in the global supply chain. We had a policy framework that was the very antithesis of the global supply chain. Through rigid import licensing and massive tariff barriers, we force-fed vertically integrated production in New Zealand for the domestic market. I remember that when we started to scope out the CER negotiation, our exports of manufactured goods were some pitifully small percentage of total NZ exports.

If we could not make it 100% in New Zealand, we had a simple solution: we sent officials and business people to Tokyo or Detroit and said: “pull your TV, Sony-san, to bits and export the bits to New Zealand where we will re-assemble them. And while you are at it, Mitsubishi-san and Mr Ford, send us bits of your cars so we can re-assemble them here in NZ”.

It was a money-go-round and subsidy racket made possible only by having a highly successful mono-cultural agricultural export economy with unlimited access to the middle class of what had been the most powerful country in the world – Great Britain. The moment the UK joined the then EEC, the skids were under us. It was the start of a massive challenge to NZ to build new political, business and trade policy platforms.

If you sit down and ask yourself why have we not made a faster adjustment to this new trading world, and why all those OECD comparative charts have us flat-lining from the mid 1970s you may be underestimating the gulf between the reality of NZ trade strategy yesterday and today.

But ladies and gentlemen, don’t throw in the towel yet on this small but fascinating country of ours. We have engineered a revolution, if you are allowed to use that term to describe something that has required a quarter of a century. And this lies at the heart of my deep belief, that New Zealand is now poised to enter a new period of highly successful wealth creation over the next quarter of a century.

As with our earlier success, if we make it happen, it will be based around superior export performance, and again to the middle class of the world’s most important economies as it was in the early 20th Century. It is just that the power has shifted and we have needed to shift with it.

New Zealand Trade Looking Ahead: The Case for Rational Optimism

All the ingredients are there and we just need to put them together, piece by piece. I have concentrated tonight on our future as a niche manufacturing and services exporter, not agriculture. Nothing alters my view that agriculture is going to play as large a part in our future as it has in our past and our relationship with the emerging economies lies at the heart of that judgment. I think Sir Graeme Harrison, Chairman and founder of ANZCO, is absolutely right with his metaphor: agriculture is New Zealand’s Silicon Valley. The choice was never agriculture or non-agriculture. We need superior exporting performance from all sides of our economy to build our future.

Of course we need to see our way through this current deeply difficult international situation in the developed world, and we will. And of course we will need consistently sophisticated leadership from our political, business, farming and technology leaders to build successfully on this new trading platform. These leaders need to be looking through the front windscreen to where we are going as a country, not the rear-vision mirror at where we have been.

Central to this new trading platform are our trading relationships with the emerging economies. The bedrock here is our relationship with Australia, the CER and the wider economic relationship around the CER.

I have so much enjoyed the theatrics around the Wallabies and the All Blacks during the World Rugby Cup – think of the mixed Australia/NZ sporting DNAs of some of the key personalities – Robbie Deans, Quade Cooper, Sonny Bill, and Brad Thorn – this great athlete even played international rugby league for Australia, for heaven’s sake. Australia – that marvellous and deeply successful country – is by far our number one export market and is increasingly our partner in this new chapter of engagement with the emerging economies.

Second to Australia in terms of our trading relationships is of course China. China today takes some 11% of our exports – about half the level of our exports to Australia. But China has the capacity to be transformational in our trading future, without ever running the risk of the same level of dependence we had decades ago on one market.

New Zealand and the Greater China Economy

We are uniquely well placed to build that economic relationship, because we are the only developed country in the world to have a comprehensive FTA with the world’s second largest economy.

But we also, intriguingly, are the only country in the world to have a matching comprehensive FTA with the second element in the wider Chinese economic area – our FTA with Hong Kong, which we signed in 2009. And tonight I am delighted by the news that we have initiated the first step that may lead us in a year or so being the first economy in the world, other than China itself of course, to join the three points in the Chinese economic triangle together.

Tonight I have issued a brief press statement welcoming a sparsely worded press release from the New Zealand Commerce and Industry Office in Taipei (NZCIO) and the Taipei Economic and Cultural Office in Wellington announcing that they had agreed to explore the feasibility of an economic cooperation agreement between New Zealand and the Separate Customs Territory of Taiwan, Penghu, Kinmen and Matsu (Chinese Taipei).

To use its WTO nomenclature, Chinese Taipei is an important trading partner for New Zealand and even after its WTO accession maintains a number of high barriers to our exports.

New Zealand signed a FTA with China in 2008 and a Closer Economic Partnership with Hong Kong in 2009. The FTA with China has been spectacularly successful.

I am hopeful that any eventual economic cooperation agreement with Chinese Taipei will see substantial growth in exports to this important economy. It is not just important for our goods exporters. It is an important source of tourists, students and investment as well.

We are highly complementary economies. I am confident that the proposed independent studies will demonstrate that an economic cooperation agreement will benefit both economies.

The negotiation of the Economic Cooperation Framework Agreement (ECFA), plus the opening of direct air and shipping links across the Taiwan Strait have accelerated economic integration in this dynamic area. An economic agreement with Chinese Taipei coupled with our existing agreements with China and Hong Kong would assist New Zealand companies in becoming more closely involved in this exciting development.

This announcement is completely consistent with our long-standing one-China policy, strongly supported by successive New Zealand Governments since 1972. That policy always permitted us to develop economic and cultural links with economies on both sides of the Taiwan Strait. In the absence of formal Government to Government relations, non-government offices were established many years ago in Taipei and Wellington to advance those links.

The formal process NZCIO has agreed on is complicated. The steps are important but the end point we hope for is an ‘Economic Cooperation Agreement’ between our two economies.

I have, as you would expect, fully briefed the Opposition, given the strong bipartisan support for our long-standing ‘one China’ policy. Whichever Party or Parties form the Government after the Election, it will be the next New Zealand Government that will oversee the next phase: a joint study by the two non-government offices of the feasibility of an Economic Cooperation Agreement. A subsequent decision to negotiate is something for the new Government in Wellington to take.

Where might this lead? Here I can give only my personal views.

• First, I think this complicated agreed negotiating process is a smart solution to a complicated scenario.

• Second, as I have mentioned, our two economies are highly complementary and I consider it most unlikely that the two non-government offices will reach any conclusion other than it makes excellent sense to recommend to their respective authorities to agree to their negotiating an ECA.

• Third, it is my strong expectation from the detailed consultations that have preceded this initiative that an ECA will involve comprehensive liberalization of all items of trade interest to both economies. The authorities in Taipei know that New Zealand Governments do not enter into agreements that exclude key items of trade interest to New Zealand, no matter how sensitive they may be. We fully understand the need to handle sensitivities and we are always reasonable on transition pathways.

If the above personal judgments prove to be correct, then we may have a most interesting scenario in front of us.

If we succeed in establishing an Economic Cooperation Agreement with Taiwan based on the assumptions I have outlined above, New Zealand, and uniquely New Zealand, would be the only country in the world to have economic cooperation arrangements in place with these three customs territories.

One other country is close: Singapore. However, Singapore, as far as I know, has not started discussions with Hong Kong, but it too has an FTA with China and is the second economy, other than New Zealand, now discussing an ECA with Chinese Taipei.

Singapore, I suppose, is a special case – it is the world’s greatest entrepot port with an astonishing ratio of exports to GDP (over 200%) to show for it. Obviously, its links with China and the huge Chinese Diaspora are unique. For New Zealand to position itself in this same space is, I think, remarkable. Let us step back and try to understand what is happening in the broader scheme of things.

First, it is manifestly clear that we are seeing a massive transference of relative power to the emerging economies, led by China in particular, but with India now also experiencing China-type growth rates. You will also be aware that the Prime Minister launched only last week the first of our planned ‘NZ inc country strategies’ on India.

That transference of power to these developing country giants, already rapid, will be turbo-charged by the difficulties facing the developed world. It is essential therefore that New Zealand position itself with both and we think a more collaborative, NZ inc, strategy will prove a superior strategy for our small country. Competition can still be intense, but we need to ‘think’ and act more collaboratively on the frameworks and leverage our core common strengths. There is an obvious analogy to NZ’s great success at the World Rugby Cup where intense competition and collaboration were the essential ingredients. Competition and collaboration are not binary choices – it is a matter of integrating them strategically.

Second, within the Chinese economic space, deep integration is occurring. Some 40% of the exports originating in Chinese Taipei now go to the mainland and to Hong Kong – way ahead of the United States which used to be their dominant export market. Some 16% of their imports come from the mainland. The mainland’s imports from Chinese Taipei have reached US$84billion, an increase of 27%. So the growth rate is rapid.

Given the past, the people to people links are if anything, even more important. Here too we can see extraordinary progress. According to official statistics, over 3 million mainland Chinese tourists have visited the island of Taiwan since the two sides agreed to raise the daily quota in July 2008. In August – that is, two months ago – the number of direct cross-straits flights was increased from 370 to 558 per week. I read a few weeks ago in the Financial Times people are already complaining about lack of capacity.

Hundreds of thousands of Taiwanese businesspeople live on the mainland.

Ladies and Gentlemen, I will not labour the point. Integration is taking place and this initiative, building on the earlier agreements with China and Hong Kong, has the potential to place us in a unique position.

Assuming a future New Zealand Government and the authorities in Taipei give the green light to their respective civic offices to negotiate a binding Economic Cooperation Agreement, is success a done thing? No, of course not. I have never participated in a trade negotiation that was easy.

But look at New Zealand’s formidable track record here. With almost no leverage other than the coherence of our trade policy strategy, the product of a New Zealand Inc approach at the political level, New Zealand has had astonishing success in creating new trading platforms. I wouldn’t bet a dollar against our succeeding again.

All I can say is that on the basis of my discussions and consultations, I believe both sides, in Taipei and in Wellington, are highly motivated to make this work. But it will require work and sophisticated management of the obvious sensitivities to get us over the line.

Ladies and Gentlemen, our future does not just depend on greater China, important though it is. We and Australia have concluded a comprehensive FTA with the whole of South East Asia. We are still building on the CER through the Single Economic Market initiative. We are the first country in the world to have persuaded Russia to engage in an FTA. We have other negotiations underway with Korea, India and of course TPP. And I assure you that we have not given up on the WTO – but there is no political space there yet to advance that I can see.

The platform for sustained growth in exports, and the higher paid, more productive jobs associated with superior export growth, has been laid. For the immediate future, we need to chart the New Zealand ship through the deeply turbulent waters now facing most of the developed world’s economies. But looking longer-term and considering the meagre choices we faced thirty years ago as a trading nation, our trading future looks good to me and it is going to get better.

Thank you.