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Michael Reddell

Looking for a successful outward-oriented economic strategy 

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The government says it want to increase the export orientation of the New Zealand economy.  Early in their term of office, the previous government adopted an explicit numerical target for lifting exports (as a share of GDP).  Unfortunately, no progress was made towards it.  If anything, foreign trade as a share of GDP were falling, and the pre-election Treasury advice was that, all else equal, the trade shares would continue to shrink.  And all that despite the questionable use of all sorts of subsidies (actual or implicit)  and unpriced externalities (eg water pollution).   

Economies with lots of firms able to profitably produce really good products typically find that those firms are selling a lot of those products abroad.   I’m not aware of any economy that has achieved sustained economic success, catching up to the world leaders, without a significant part of the story involving export success (which also boosts imports).     

As it is, New Zealand has been slowly falling further behind other advanced economies for decades.  And despite all the reforms of the late 1980s and early 1990s, we’ve managed nothing more than to slowing the rate of relative decline. Even then, in the last five years New Zealand has managed no productivity growth at all.

For a time, as New Zealand liberalised, exports and imports as a share of GDP rose.   We stopped doing stupid stuff like assembling TVs or cars in New Zealand, and in the process removed a “tax” on people trying to export from New Zealand.   As a share of GDP, exports got to around 30 per cent in the early 1990s and were briefly even higher than that. But in the most recent year, to June 2017, exports were 26.8 per cent of GDP.  We’ve been going backwards.  Even services exports – doing well in many countries – are now only around the same share of GDP that they first reached in 1995.  

Firms simply haven’t found the profitable opportunities here.  The last bus stop before Antarctica –  and a long way even from the next to last bus stop – just isn’t a great spot for outward-oriented businesses, no matter how skilled New Zealand workers might be, and how innovative and entrepreneurial New Zealand firms might be.   Mostly it is natural-resource based exports that manage to flourish while still remaining based here.

It is also difficult to successfully compete internationally when real interest rates and, in turn, the real cost of capital, for New Zealand investors, have averaged so much higher than those elsewhere.  Those same pressures have given us a persistently high real exchange rate.  As a result, investment in the tradables sector – the bits facing international competition – isn’t often very attractive. 

Unfortunately, it isn’t clear that the new government has any more of a strategy than the outgoing government did for turning around the dismal productivity performance, or for lifting exports (and imports) as a share of our economy.    

In real per capita terms, the tradable sector of our economy is now no larger now than it was in 2000 – two whole governments ago.  The risk is that it will shrink further.  Among the new government’s proposed policies are:

  • measures that will reduce the size of the export education sector. 
  • phasing out government subsidies for irrigation schemes. 
  • of reducing exploration for oil and gas.
  • a more aggressive stance around emissions reductions, including moving towards the inclusion of agriculture in the ETS.
  • moving more aggressively on increasing water quality standards faster,
  • increasing minimum wages –  already high, by international standards, relative to median wages –  quite considerably over the next few years.
  • plans for a major acceleration in housebuilding activity.

Whatever the merits of those measures individually (and some remove subsidies), every single one will put the tradables sector under more pressure, to some extent or other (eg resources being used to build more houses can’t be used for other things).     What will replace them?

If the exchange rate fell a lot, and stayed down, that could help make other outward-oriented industries more attractive.   But how likely is it that?

The exchange rate is now a bit lower than it was before the election, but even at these levels isn’t outside the range it has fluctuated in over the last few years (when the tradables sector has been doing badly).    In fact, the exchange rate is only likely to fall sustainably further if the gap between our interest rates and those abroad shrinks,  And with a somewhat more expansionary fiscal policy (than the previous government was running), plans for a big increase in housebuilding, and a continuation of the high target rate of long-term immigration (despite proposed changes to student visa provisions in particular), it is difficult to see why we should expect any near-term material narrowing in the margin between New Zealand interest rates and those in the rest of the world.  

I hope that the new ministers are going to turn their minds pretty quickly to how they might achieve the sort of reorientation in the economy that their own campaign recognised is needed. Regional development funds aren’t likely to be the answer; in fact, over the last 15 years, “the regions” have generally done better than “the cities”.   Auckland has been the laggard (again in per capita terms). 

There are plenty of things that could be done to lift the competitiveness of the New Zealand economy.  For example, we now have a company tax rate that is above that of the median OECD country.   Lower taxes on the returns to business investment are one of best ways of getting more such investment.   We also already have one of the highest minimum wages rate, relative to median incomes, of any OECD countries.  Reforming our land use and planning laws could markedly lower the cost of housing, and help ensure that people and businesses can locate in the best locations.

But the most important single change we need to make is to end our very unusual immigration policy.  Despite our remote location, and the fact that New Zealanders have been leaving New Zealand in large numbers almost every years for the last 40 years, our policymakers have persisted in driving up the population.  They do that with a target rate of immigration (45000 residence approvals per annum) that is higher, in per capita terms, than those of other OECD countries.  In per capita terms the target is three times the rate the United States has run in recent decades. 

High rates of immigration and quite rapid population growth, in a country with quite modest savings rates, help generate persistently high real interest rates (relative to the rest of the world) and a high average exchange rate.  An immigrant might ease a specific skill shortage in his or her own occupation, but the New Zealand empirical evidence has been clear for decades that each new person accentuates, not eases, overall pressure on resources and domestic demand.  That is because each new person needs new physical capital (houses, offices, road, schools, shops) that together take several years of additional labour.   And resources used to meet those needs can’t be used for other things –  eg growing export industries.  

Defenders of our very high target rate of immigration talk constantly about skill shortages.  But OECD data show that New Zealand workers are already among the most skilled around.  We don’t need more workers – skilled or otherwise.  In fact, because of how difficult it is to base internationally competitive businesses here, there is an almost irreconcilable tension between continuing to drive the population up, wanting to deal with the pressing environmental issues associated with natural resource exports, and still wanting First World living standards.  The best way to square the circle would be to cut back sharply on the target rates of non-citizen immigration. 

There isn’t anything necessarily wrong, in principle, with a growing population.  But successive governments have been putting the cart before the horse – driving the population up in the idle hope that a bigger population might somehow spark higher productivity growth.  In a location that isn’t a natural home to lots of people, that was never very likely.  Instead, we need to focus instead on the able people we already have – and to heed the wisdom of the New Zealanders who’ve been leaving.   Without a change of course, we seem set to slowly drift ever further behind other advanced countries, increasingly unable to offer our people the world-leading living standards we once delivered and could, with the right policies, once again aspire to.