The Economy in Transition

Notes for speech to the Wellington Chamber of Commerce’s “Beehive to Business” breakfast meeting.

16 October 2018

Thank you for having me here today.

This month marks the first anniversary of this coalition Government.

We came to office promising to rebalance the economy away from its excessive reliance on speculation and immigration towards productive investment.

In the words of the deputy prime minister, to reject the notion that the modified status quo would do.

And we are on the way.

Today I want to take this opportunity to recap the measures we have put in place and draw together the strands of our plan for a more sustainable, productive and inclusive economy

When I asked the Prime Minister for the Economic Development and Environment roles I was not simply choosing

the areas that interest me. Though of course they are fascinating. I chose them because I thought we can and will make a difference to improve the lives of New Zealanders.

Together with my Trade and Export Growth portfolio they are areas that must work together to bring about some of the key changes we want to see in New Zealand.

Changes that will make our economy more productive.

Changes that will ensure economic growth is within environmental limits.

Changes that are inclusive, benefitting all New Zealanders.

Changes that will speed the transition from volume to value and boost the creation of higher paid jobs.

Let’s begin with what’s going well. Then move on to the international economic challenges we face. And finally I’ll set out some of my thoughts on how we can respond to those challenges, linking

up across government to make a Just Transition to the future for New Zealand we want to see. 

Much about our economy is going well

So, to begin, I’m pleased to say that our economy today enjoys many strengths.

On traditional measures, the key macro indicators are good.

Inflation remains low and steady.

Economic growth forecasts are solid, averaging around 3% and the June quarter came in at 1 per cent.

Unemployment is low, at 4.5%, and projected to fall further towards 4%.

There are signs that real wages are improving.

Government debt as a proportion of our economy is among the lowest of any developed country, at close to our 20 per cent of GDP target, and coming down thanks to our ongoing surpluses.

Interest rates are low and set to stay low for some time.

We are boosting infrastructure spending, injecting $1 billion a year into the regions through the Provincial Growth Fund and in our first budget we announced the $5.5bn Families Package targeted at low-income New Zealanders.

Together those measures will lift consumer spending and stimulate the real economy.

We are planning for our future, having restarted contributions to the Super Fund.

To help businesses invest and innovate we have introduced the R and D tax credit and have set money aside for a Green Investment Fund and we are in the midst of important tax review by the expert group led by Sir Michael Cullen.

There has been a lot of attention from the Opposition on headline business confidence surveys that frankly do not reflect the economic reality.

It is what Prime Minister Jacinda Ardern has described as the “business confidence paradox”. Most commentators have noted the political dimension of them as have a number of economists. They reflect “sadness” of some of those disappointed about the outcome. They hold a mirror up to the political leanings of respondents rather than the economic reality.

They are proven to be a very poor predictor of the actual performance of the economy, as most economic commentators also acknowledge.

As the Prime Minister puts it: When you line up business confidence with key economic performance measures over the last two governments there appears to be an inverse relationship between business confidence and the actual performance of the economy.

For instance, average business confidence scores under the Clark/Cullen Government were much lower than the Key/English Government, despite Clark and Cullen delivering higher average growth, lower unemployment, lower debt, larger surpluses and stronger wage growth than their successors.

Since World War II growth rates have on average been higher under Labour. And for those with a long memory, Mr Muldoon was not from Labour.

The Prime Minister has put the low confidence surveys down to “uncertainty” and has moved to address those through a clear statement on workplace reforms and the appointment of a Business Advisory Council to complement the consultations we are undertaking with small and medium sized businesses.

The current macro indicators I have already mentioned point towards a positive picture. As Reserve Bank governor Adrian Orr said in August, “all signals are green for business investment”.

And as Sky City Chair Rob Campbell said recently said: “This is a great place to open and operate a business. Negativity is for those who stand on the side lines watching and commentating.”

 

And we have a good platform for future growth.

We enjoy strong institutions, clear legislation and effective regulation. That underpins long-term economic success by ensuring fairness and ease of doing business. In February, we were once again named the least corrupt country in the world by Berlin-based Transparency International. Our democracy is vibrant and our civil society is strong. In the longer term these are key to adherence to the rule of law, including contractual certainty, investment and property rights.

Our neighbours in the Asia-Pacific region have some of the fastest growing economies in the world, and we are growing strong trading links with them. Technological advances including in e-commerce are beginning to overcome some of the challenges of New Zealand’s distance from key markets – as we move further into ‘weightless’ areas where distance is no object. Look at the success of Xero and Weta Digital, for example.

And, what’s more, New Zealand has laid down the foundations of future economic growth.

We have backed some of the key technologies that underpin a modern economy, structural separation of Telcos by the last Labour Government plus broadband roll-out by Steven Joyce are a case in point. Investment has flowed to the Telco sector, which is a prerequisite to success for a modern economy.

We are fully committed to respond to the opportunities and challenges of our changing world. We are investing in innovation – in areas like robotics, sensors and Artificial Intelligence.  For example the recently announced Endeavour Fund round put substantial efforts into automation in orchards, vineyards, medical imaging, drug development, superconducting magnetic materials, smart sensors and a host of other research with strong economic potential.

The innovation cycle has improved hugely since the Knowledge Wave conference but is held back by gaps in the capital cycle – an issue I will return to on another day.

There are domestic economic challenges

But for all these strengths, of course we have challenges too. Let’s look first at some that are domestic.

Firstly, productivity and productivity growth are low by international standards. Our economic growth has been too dependent on high levels of net migration and house price inflation driving consumption and demand for extra infrastructure.  And too much of our capital has been skewed towards speculative asset classes, like rental property, rather than growing new points of comparative advantage.

Paul Conway at the Productivity Commission correctly notes that these factors have contributed to low per capita capital density in our productive sectors. This in turn is a root cause of poor technology transfer and low economic complexity. While some progress has been made, our exports remain focused on too few products and too few markets.

Low capital density in our productive sector is one of the reasons exports fell from 30 per cent to 27 per cent of GDP from 2008 to 2017 despite the last government’s stated ambition to lift them to 40 per cent of GDP.

Secondly, some of our growth has brought growing environmental and social impacts. Polluted rivers and pressured infrastructure are not sustainable. Agriculture and tourism are vital parts of our economy, but business-as-usual growth in these areas is now reaching natural and social limits.

Thirdly, even though our economy has grown overall, per capita growth has been modest and some New Zealanders have been left behind. There are disparities in growth across regions and between groups in society. Many of our people are unable to buy a house or participate fully in the life of their communities. Home ownership is the lowest since the 1950s rents have increased markedly relative to income and there is the shame of homelessness. 

There are international economic challenges.

Of course the job of Government is never finished.

It’s not just in New Zealand itself where we face challenges. There are global challenges too.

In the aftermath of the Global Financial Crisis, a decade of aberrant monetary policy in some countries has produced unusual consequences. Negative interest rates, asset price inflation, and growing inequality.

Discontent about growing inequality, multi-national tax avoidance, limited employment opportunities and, higher housing costs are causing political instability. A number of democracies are electing anti-trade governments. A rising tide of protectionism is bringing with it emerging trade wars, creating risks for our exporters. In many countries there is growing public scepticism about trade. The very system of rules-based world trade is facing serious challenges.

Traditional industries are being disrupted by new digital technologies, creating uncertainty for those whose jobs are disrupted. The nature of work is being affected by Artificial Intelligence, machine learning and automation. New plant-based alternatives to milk and synthetic meat technology are advancing all the time, and consumer preferences are changing.

In the manufacturing sector, patterns of production are changing, with offshoring and now reshoring in some cases.

Growing global action on climate change means that carbon-intensive industries, including agriculture and long-haul tourist travel, may face significant challenges in the future if we do not innovate.

 

We are adjusting course

So, in the face of all these challenges, domestic and international, we need to adjust our course.

The changes we are already making are addressing these challenges and creating real opportunities for New Zealand. Through levers that only government can pull, we are stimulating the productive economy.

It’s a tremendously exciting time, as the confluence of computing power, sensors, robotics, positioning systems, big data and the internet of things mean we are in the midst of the fourth industrial revolution.

I believe we have the vision and talent - both in the current coalition government and in society - to position our country for the future.

While Rocket Lab’s Peter Beck may disagree it’s not rocket science. There is no new principle of economics. At one level it is simple. To grow points of comparative advantage we need to invest money and commit people to the task. And as the saying goes, people follow the money. To succeed we need to increase investment in those sectors. We can’t magic up the money. To succeed we need to re-orient incentives so that investment goes into productive rather than speculative asset classes. Investing more – in both physical assets and knowledge – will help to boost productivity. More innovation will help us to develop more world-leading technologies that will compete in the global market place and improve competition of existing sectors. We will build on existing successes, and extend those into other areas.

The race is on. Exponential growth in the commercialisation of new ideas from the fourth industrial revolution will turn into the law of diminishing returns. It is the duty of business and government to maximise our share of these opportunities, now.

Some, like Rocket Lab, will arise from the brilliance and drive of a few individuals.

New Zealand’s offering of goods and services need a higher degree of economic complexity, so that they can better compete in the global marketplace. We also need modern trade agreements to lower barriers and maximise our access into global value chains.

Responding to the challenge of climate change will both help cure the environmental ill and create opportunities as we advance.

And success will not be measured by GDP alone. Human, social and environmental outcomes also matter. Which is why we are moving towards a wider ‘wellbeing budget’ approach. We are building an economy that is more productive, sustainable and inclusive.

And of course we are not starting from scratch.

The underlying competencies needed for the economy we want exist here today. We have had close to two decades of good telecommunications policy. We have an export IT industry, high-tech manufacturers, investment in engineered wood products, the beginnings of an encouraging response to the Kiwibuild challenge in terms of factory house production, a nascent space industry, a thriving film industry, and nearly all the new off-farm investment in food and beverage is in adding value.

But we want more. There are four main parts to our plan for growth.

Firstly, we need to strengthen the foundations of our future success, including developing new points of comparative advantage.

Secondly, in the largest areas of our export economy today, we need to add more value to volume. We also want businesses to reduce their adverse impact on the environment. We believe this will also add value via both efficiency improvements and enhance the brand we rely on for premium prices.

Thirdly, we need to leverage new opportunities - many of which are adjacent to our existing key sectors. That’s important to lift productivity and exports, and to enabling higher-value land use in New Zealand.

Fourthly, we need to back the industries of the future, positioning New Zealand as a hub for world-leading innovation, linked into global value chains

I will now take each of those four points in turn. 

We need to strengthen the foundations of our future success

Firstly, strengthening the foundations of our future success.

On innovation, we aim to lift investment in Research and Development from today’s patently inadequate figure of just 1.3% of our economy, to at least 2% in 10 years. That’s a 50 per cent increase - a real challenge to achieve but worth it to lift productivity. Part of that will be delivered directly through government investment. But the key lift needed is more R and D investment by the private sector. This will be stimulated by our new R and D tax credit.

Its  main elements are:

  • A tax credit rate of 15 per cent.
  • A $120 million per year cap on eligible expenditure
  • A minimum R&D expenditure threshold of $50,000 per year.
  • A broad set of eligibility criteria applied to all private sector entities plus State-Owned Enterprises, industry research cooperatives (including levy bodies) and minority-owned subsidiaries of Crown Research Institutes, Tertiary Education Organisations and District Health Boards.
  • A definition of R&D that ensures the credit can be accessed more easily across all sectors, including the technology sector.
  • We are also looking at allowing refunds to start-ups that are not yet profitable. 

The R and D tax credit is a tax cut for businesses that invest in R and D. It totals more than $1bn over four years. It’s a major initiative.

We are also establishing a new Green Investment Fund to make investments that both reduce greenhouse gas emissions and provide a financial return. The Fund will receive a $100m capital injection from Government and will operate independently.

Further, I am keen to ensure our early stage capital markets are strong enough to support the growth of our innovative firms. We will not, and would not want to stop, all globalising companies selling down or selling out to overseas investors. But our ambition is to support our capital market so that they are not driven to those outcomes or driven to exit too early by the inadequacy of our early stage capital markets.

On skills, we will better match education and training to the changing needs of the economy. We want everyone to have access to further and higher education. Not just for school leavers, but also for mid-career re-training. This is an important part of the social contract as we face the digitalisation of so many jobs. We have already made a start, with no fees in the first year for everyone starting tertiary education or training for the first time and two years for apprenticeships. Firms need access to high-level skills, including management and entrepreneurship, to thrive in a competitive world. So we are adjusting our immigration policy to better target the skills we need, while trimming some of the immigration which we do not think has been in New Zealand’s best interests. Treasury analysis shows some immigration has adversely affected wages in lower paid sectors, adding to inequality.

And the work programme of the Tripartite Future of Work Forum includes a Review of Vocational Education and Training; improving the quality of careers advice at the school and post-school level; collective action on the Skills Shift in Manufacturing initiative; and implementing the Digital Skills for a Digital Nation report.

On infrastructure, Cabinet has approved a new 10-year plan for transport. This makes record investment in the roads, rail and public transport for our growing regions and cities. That will help people get to work, improve supply chains and reduce costs, supporting businesses to expand.

On ease of doing business, New Zealand already has an outstandingly business-friendly environment. We will build on that, and support it with effective regulation. Some of it seems mundane like enabling e-invoicing, but has important efficiency gains for business. We designed regulation that helps, rather than hinders - like regulating but not smothering the space industry. This has enabled a new industry.

As a small, innovative country, we have helped Rocket Lab gain first-mover advantage, to operate the world's first private orbital launch facility in Mahia, right here in New Zealand. We will continue to develop proportionate regulation to support the growth of disruptive technologies, like that, as they emerge.

We are promoting growing international links in our science and innovation systems, especially with other small advanced economies. We are working to attract more high-quality inward investment, for the likes of forestry and forest processing, at the same time as in our the first phase of our revision of Overseas Investment rules we banned foreign buyers to ensure our housing market for existing homes is a New Zealand market, not an international one. That change takes effect new week.

Today I am announcing the second chapter in our rewrite of the Overseas Investment Act.

Our aim is reduce complexity, improve investor certainty and cut unnecessary red tape, while ensuring investments are consistent with New Zealand’s national interest.

We know that more can be done to simplify the Act for those making productive investments in our economy, while adequately protecting our most sensitive assets, including our pristine land which is the envy of the world. 

Capital is globally mobile and competition for investment is fierce. This review will ensure New Zealand remains an attractive destination for beneficial, long-term foreign direct investment.

But it will also examine ways to ensure prospective foreign investments are consistent with New Zealand’s national interest.

Many of our closest allies have the ability to block investments that are inconsistent with their national or security interests in a way that we cannot.

In a time where the international rules based order is coming under pressure, we must test the appropriateness of our arrangements and whether more should be done to protect the interests of all New Zealanders.

The Government will consult widely on options for reform. Public consultation will take place in the first half of 2019 and legislative reform is expected to be completed by mid-2020.

Our Trade for All policy is now being implemented in consultation with the public. I see that as a crucial element in our push back against the anti-globalisation sentiments which are feeding protectionism abroad.

Diversifying our export markets and improving our export earnings requires market access, and we have a very active programme negotiating new – and upgrading existing – trade deals: the CPTPP, the EU, RCEP, Britain after Brexit, the Singapore and China upgrades and the Pacific Alliance.

We are confident that these initiatives will help the private sector succeed economically for the benefit of business, owners, employees and the country. 

We need to add value to volume in our biggest existing sectors

Secondly, we need to build on our existing economic strengths.

That means adding value to volume in key sectors like agriculture and tourism. We will work with businesses and the trade unions to tackle barriers to growth while operating within environmental limits. For example, that means continuing to extend our primary production into higher-value food, beverage and timber products while also moving towards more sustainable land use to protect our rivers and to protect our brand. Already, in 2017, exports of processed food were valued at $4.7bn, with year-on-year growth of 12%. Exports of infant formula alone grew by more than 59% in the year to June 2018 to reach $1.24 billion.

 

Our actions in this area will include helping businesses to invest in R&D and ensuring that our trade policy objectives promote high-value exports. The new $40 million a year Sustainable Food and Fibre Futures Fund, launched in August, will help the sector move from volume to value. The Free Trade Agreement under negotiation with the European Union offers a major opportunity to get more of our high-value goods and services into one of our key markets. We are continuing to promote New Zealand around the world as a high-value destination for travel. The new Visitor Levy will ensure that tourists make a fair contribution to the cost of the infrastructure they use.

 

We need to open up opportunities in adjacent areas

Thirdly, we will leverage opportunities adjacent to some of today’s key sectors.

We will work with businesses and innovators to identify opportunities in areas linked to our existing strengths. That will include the emerging areas of precision agriculture, sensor technology and on-farm robotics.

These are important examples of where New Zealand can lead, in ‘Industry 4.0’, the growing trend towards automation and data exchange should be harnessed, not avoided. We are working with the Manufacturers’ Network on initiatives that will support our wider manufacturing sector to adopt new and emerging technologies and to grow the skills base within the sector. 

Our current biological economy could be the basis for future specialisations in plant-based foods, as well as nutraceuticals and pharmaceuticals. Our excellent base of health research could extend our small but fast-growing and high-value medical technology sector. Our world-class data assets, such as integrated data infrastructure, could enable us to become a world hub for advanced social research. Our already large renewable energy sector could be a platform for clean energy specialties.

In these areas, your Government will work with businesses and labour to improve growth. We will make use of multiple policy levers - including tailored domestic regulation, the right incentives to invest, trade policy and funding. Our initiatives reach beyond cities to unlock the potential in our provinces. Over three years, the $3bn Provincial Growth will enhance these sorts of economic development opportunities in regional New Zealand.

 

We need to support the growth areas of the future

Fourthly, we will move quickly to capitalise on the creativity of our entrepreneurs.

Of course, we can’t expect a country of New Zealand’s size to be at the forefront in all new technologies. But to use Sir Paul Callaghan’s phrase, some of our key strengths could lie in the ‘weird stuff’ – important niches where there is not yet any other obvious global frontrunner, and where we have a bit of a head start. Digital film services, satellite launch services and medical devices are cases in point.

We will work with, businesses and science leaders to identify the sectors where New Zealand’s unique features position us well for new and disruptive technologies. Then we will reach out to innovators and start-ups in New Zealand and overseas. Call it an example of cluster theory if you like. To us it is pragmatism.

We will connect policy makers across agencies with transformative technologies and emerging sectors. We will offer fast-paced, responsive government engagement in the most promising of these market-led opportunities. Support for these ‘pathfinders’ will include agile regulation, funding and, where appropriate, greater willingness to trial new technologies within the government’s own systems. 

Conclusion

So, in summary, we are implementing our vision to move New Zealand’s economy from its reliance on property speculation and immigration by encouraging productive investment to grow our points of comparative advantage. While our economic foundations are sound, we and the rest of the world face significant challenges.  We always will. We also have exciting opportunities. By moving from volume to value and building on our comparative advantages, we aim to build an economy that is more productive, more sustainable and more inclusive.  Only by achieving all three will we be able to ensure that growth benefits everyone.

I have outlined some specific initiatives that we have implemented and will continue to develop.  We all know that to be a successful nation, government, business owners, workers and regions all need to work together.

We have a fine leader, who is drawing New Zealanders together and making us proud of our place in the world.

Her campaign slogan was “let’s do this”. We have started. With your help we can do even better.

Thank you.