FRESH IDEAS FOR A PRODUCTIVE ECONOMY

Our Presenters...Rhema Viathianathan

Director for the Applied Research Centre in Economics at the University of Auckland and regular economics presenter..

Rick Boven

Rick leads the New Zealand Institute after a career as a strategic management consultant. Director of a number of New Zealand companies.

Geoff Bertram Geoff is an economist and se-nior associate of the Institute of Policy Studies at Victoria University and a seasoned contributer to academic debate on a range of issues including regulation of public utilities, among others.

Selwyn Pellett

Chair, Endace Ltd, CEO, Imarda, Founder, NZ Pro-ductive Economy Council. Sel is an advocate for an sensible and active eco-nomic planning designed to promote a sustainable and productive economy.

John Walley

John is the CEO of the Manufacturers and Export-ers Association and a Director of a number of successful New Zealand businesses.

June McCabe June is a seasoned company director and management consultant. She is Chair of the Capital, Investment and Enterprise work stream for the Maori Economic Taskforce.

Bernard Hickey Bernard is a leading finan-cial journalist and Editor of Interest.co.nz, a news and information site aimed at investor’s and savers in New Zealand.

Gareth Morgan

Gareth is CEO of Gareth Morgan Investments, a director of economics consultancy Infometrics and a well known business and financial columist for the countries leading dailies.

Finlay McDonald

Finlay is a widely respect-ed contributor to various newspapers and a former Editor of the Listener and current Commissioning Editor for Penguin Books.

Facilitated by:

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Turning the NZ tax and benefit system on its head...

Gareth Morgan

The Big Kahuna Gareth Morgan

There are two major changes needed to the tax and benefit regime that currently prevails in New Zealand; one is to the coverage of the tax regime, the other is to the approach we take to welfare andredistribution. Our work looks at the tax and benefit regime in a holistic sense, recognises that the intervention of the State via tax and benefits is about redis-tributing resources from some in society to others.

Do we know what the rationale is for this redistribution? And if so, do we achieve our objectives? These are questions that can only be answered by examining the tax and benefit regime as a whole, an approach that has been eschewed by governments of recent times. Instead, governments have chosen to establish taskforces to look at parts of the tax and benefit system only, confined by quite specific terms of reference that have precluded a ‘whole of system’ assessment. For example, the 2009 Tax Working Group was directed not to consider Working for Families and the 2010 Welfare Working Group was directed not to consider NZ Super in its assessment of welfare. This piecemeal approach undermines so-called independent reviews of the tax and benefit system and has resulted in us losing sight, in large part, of why we

tax in order to redistribute, what extent of redistribution we deem desirable and whether or not we know whether we achieve those, nowadays implicit, objectives.

The first reform we recommend covers an issue that successive tax studies have recommended be addressed by New Zealand governments in order to lift economic efficiency.

It is a comprehensive capital tax (CCT) that all owners of productive capital (land, buildings, structures, plant and equipment, intellectual property) are annually liable for, although it can be offset by those that produce a taxable income return in excess of the minimum required of New Zealand’s productive capital (which we set at 6% pa, a rate that reflects the return available risk free, being the average government bond rate over the past decade).

Hand in hand with the CCT proposal we alter the income tax regime to a single rate on every dollar of income. All income whether cash or in kind is captured for taxation purposes. This is what the CCT does.

The principle of redistribution which loosely accords with the principle of

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vertical equity (wherein the well-off give proportionally more while the poorest receive proportionally the most), has over recent decades been effected through the progressive income tax regime. But the greatest source of means of the well-off is not income, it is wealth, and that has typically remained beyond the reach of the redistributive machinery. Narrowing the tax base in this way results in progressive tax rates that rise more steeply than theyshould, and that brings with it all manner of incentives for taxpayers to avoid being subject to such high rates.

Over the last few decades the redis-tributive goals of our society have been reduced to assistance of last resort akin to an ambulance at the foot of the cliff, which kicks into action only when a person’s lot has fallen so far below what society deems adequate, that humanity and sympathy emerge. This ‘hand up’ approach to redistribution is grossly stigmatising of people so affected and quite at odds with the originalprinciples of redistribution which formed the philosophical foundations of our mixed market/State economy. The thinking behind that model wherein individualism is championed but subject to the constraint of everybody getting a ‘fair go’ was developed during the Age of Enlightenment, kicked off by the early years of the Industrial Revolution and its enslavement of child labour and burgeoning disparity of distribution of benefits.

The result was an ethos that held that everyone has a right to participate in economic progress and for that to be a reality the distribution of wealth has to be such that all can participate, the some are not effectively locked out from birth. This view of the world has been margin-alised over recent decades, in favour of

redistribution on the basis of established need, rather than it being an entitlement for all in a civilised society. We establish a tax and welfare regime that recognises everybody’s entitlement to live in dignity.

The second reform is directed at making quite explicit the redistribution objec-tive of the State by paying every adult an unconditional basic income (UBI). Nobody misses out on this bottom line entitlement. It’s the right to a dignified existence that a modern productive economy can provide. This is quite a different approach to at present where the selective assistance from the is based on the notion that everybody who can, should be in a particular form of work paying work. Aspiring to non-paying work is not recognised in our current welfare system as a legitimate basis for a dignified existence. People who engage in that need to find their own means of support. This rather primitive perspec-tive on the contributions people can make to their society, hasn’t moved much from the rules of a subsistence economy wherein, if one doesn’t produce enough food for the table, one starves.

We can agree that each year our econo-my produces more than enough for us all to eat, be clothed and housed, each year the higher GDP per capita is a measure of the additional surplus gener-ated. This is how far the NZ economy has come since subsistence times where food, shelter and clothing were the sum total of production.

The UBI provides that every adult receive enough to eat, clothe and house themselves unconditionally, this being the universal entitlement to an adequate basic income. The State can underwrite that everybody has this entitlement as

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Dr Gareth Morgan

Gareth Morgan Investments Ltd.

P.O. Box 10068, Wellington, New Zealand

ph. (+64 4) 494-6079 fax (+64 4) 473-0643DDI: (+64 4) 494-6071

email: gareth@garethmorgan.com

a human right. It can raise the required funds from taxes.People then are free to choose to engage in paid or non-paid work knowing their basic living expenses are covered. Unlike today, they are not compelled to seek only paid work, because if they don’t have it, their mere existence is threatened. With a UBI they avoid the stigma of being unemployed if they can’t find paid work, or the loss of respect so-ciety associates with that situation. For example, a person may well choose to care for children, rather than stand be-hind a store counter day after day. Who is to say that society values the store job more? Currently the job of caring for children has to be self-funded. In a soci-ety that produces far more than required for the basic needs of food, clothing and shelter, why shouldn’t a basic income be guaranteed? If nothing else, it’s a signal that the society is sufficiently developed for all to live in dignity.

It is argued that such an income is already guaranteed, at least to those who cannot find paid work, in the form of the unemployment benefit; to those who can’t work in the form of disabil-ity or illness benefits. But what of the person who chooses unpaid rather than paid work? The economy comprises a raft of unpaid occupations: parenting, care of the elderly, volunteer organi-sations such as sports clubs, artists, creatives and so on. None of these can be done by anyone who doesn’t have independent means, an earning spouse, a benefit, or is paid out of their own wealth.

For a society that produces far more than is required to meet basic needs, such a restriction on choice seems back-ward. That the result may be greater out-put of products and services from the non-commercial society and less from

the commercial one, is not an outcome that we should be afraid of. Where is the logic in more and more commercially-based production anyway?The argument that holds we already have this option, that people can opt to withdraw from commercial endeav-our now, ignores the reality that such a choice is only open for those who have independent means; a small subset only of the population, and a very restric-tive one. One of the benefits of being a wealthy society surely must be entitle-ment of every person to some basic level of income, unconditionally.

An effect of this second reform is to deliver a more efficient and equitable approach to redistribution. In theory at least it should make no difference if the State has in place the apparatus to select and monitor those that require a Benefit, or whether the State simply pays every-one a Benefit and claws back from those not in need of it via taxation. Intuitively it would seem the first method would beeasiest and that is what we currently do. But this approach has problems. How do you decide who is deserving, how can you be sure that everyone who is eligible actually gets their dues, how many peo-ple do you employ to administer such a regime? The second method guarantees automatically everybody gets the UBI. It then comes down to whether the taxation regime is efficient and effective at clawing it back from those who don¹t need it. The administrative overhead of monitoring is no longer required.

This is about a revolution in our tax and benefit system, not the next step in an incrementalist journey of patching up the current regime. As such its ideas will both tread on toes and offer new opportunities often simultaneously - to the reader.

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June McCabe Maori Economic Taskforce

June McCabe

Developing science and innovation in the Maori economy June McCabe

Science and innovation will deliver economic growth Science and innovation creates new op-portunities:

• foreconomicgrowth;• improvesourqualityoflife;and• helpsusmakesenseofthe world we live in. For science and innovation to create these opportunities, it is necessary to have a robust science and innovation system that is responsive to national needs and opportunities. Science and innovation are the foundations of New Zealand society. They improve our quality of life, help us understand and manage our environment, and are es-sential to our jobs and pastimes.

Science and innovation are important drivers for of New Zealand’s economic growth. Research improves productiv-ity by creating ground-breaking tech-nologies and new and better ways of doing things – essentially the definition of ‘innovation’. It enables new indus-tries to emerge and existing ones to become more competitive. The World Economic Forum has identified innova-tion and business sophistication as the most important drivers of the income

of advanced economies. Investments in science and innovation have a major impact on the international competitive-ness of a country and the living stand-ards of its people. At the same time, science unlocks understanding and the solutions to many of the global prob-lems all nations face – such as climate change, food and energy security, and an ageing population. The New Zealand science and innovation landscape The Prime Minister has placed science at the heart of the Government’s economic agenda, making clear that the Govern-ment’s objective is a high-performing public science system which supports economic growth, and a wider innova-tion system that encourages firms to increase their investment in, take-up, and application of research. The Government has taken steps to im-prove New Zealand’s science system and direct government support where it can make the most difference. An impor-tant initiative been taken to restructure government funding to clarify priorities and provide a more direct pathway for implementing them. The priority areas are:

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• high-valuemanufacturingand services• biologicalindustries• energyandminerals• hazardsandinfrastructure• environment• healthandsociety

The Government has also increased support for business R&D and intro-duced changes to give business better access to public research. The Ministry of Science and Innova-tion (MSI) is the lead agency charged with driving the science and innovation sector. It is also tasked with directing knowledge and technology transfer from the science and innovation sector to businesses and other research users. It was established on 1 February 2011, as part of a broader Government focus to boost the science and innovation sec-tor’s contribution to economic growth. Government funding within MSI’s Vote stands at $768 million (2010/2011 Budget): this includes funding to Crown Research Institutes (CRIs), oth-er research funders, and business R&D. The eight CRIs play important, distinc-tive and central roles in New Zealand’s science and innovation system, and receive around $480 million of govern-ment funding a year. CRIs perform strategic research that can create oppor-tunities for business and provide infor-mation and technology that contribute to the wellbeing of New Zealanders. CRIs also help meet the Government’s need for research to promote innovation in government services, inform policy development, and provide capacity to unexpected areas of need. Vision Mātauranga MSI’s Vision Mātauranga (VM) is “Unlocking the Innovation Potential of Māori Knowledge, Resources and Peo-

ple to assist New Zealanders to create a better future.” The VM Capability Fund provides specific funding to support for the development of skilled people and organisations undertaking research that encompasses Māori innovation and focuses on four thematic areas:

• contributingtoeconomic growth through distinctive science and innovation

• Taiao:achievingenvironmen tal sustainability through iwi and hapū relationships with land and sea

• Hauora/Oranga:improving health and social wellbeing

• Mātauranga:exploringin digenous knowledge and science and innovation

About $5-6 million per year is funded through the VM Capability fund. Re-cent changes mean that VM is now inte-grated across MSI’s areas of responsibil-ity and priorities. This means that VM it is not only a capability fund, but is now seen as a policy and operational tool to leverage Māori investment as an oppor-tunity for Māori and the Government to work together, to unlock the Māori potential across all the science and inno-vation priority areas. This includes VM being reflected in all CRI Statements of Core Purpose, in which CRIs now deliver outcomes to three core groups – Government, industry and Māori, and amongst other objectives, to “enable the innovation potential of Māori knowl-edge, resources and people.”

The Māori economy and Science and Innovation Significant opportunities exist for Māori

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to be actively involved in the New Zea-land science, research, and innovation system, both in terms of what Māori can offer the system, and in terms of what the system has to offer Māori. Argu-ably, the current system in New Zealand indicates a more passive Māori involve-ment – for example, low participation rates, low educational attainment rates in science, engineering, and technology, and low rates of engagement between the research, science, technology and innovation sector, and Māori organisa-tions and enterprises.

Leveraging Māori investment

There are signs that this is starting to change, and while Māori organisations remain under-represented in the science, research and innovation sector, there is a stronger understanding and awareness of the opportunities. This includes the work that the Māori Economic Task-force commissioned, with the report by BERL on ‘the Māori economy, science and innovation – scenarios of potential, opportunity and value’, released at the Māori Economic Summit.

Of the billions of dollars of assets held by Māori, at least half are estimated to be in the primary sector. There is a great opportunity for these primary sector businesses to step-up and grow, particularly through science, innovation and research and development. Science and new thinking will boost the value of the products firms produce, increase the profitability of production process and, ultimately, create extra value out of the resources Māori already have in the primary sector. BERL science and innovation research The BERL research investigated the

benefits and opportunity costs to Māori and the wider New Zealand economy if investment in science and innovation is better aligned to the needs of the Māori economy. Investigating the science and innovation potential that Māori assets holders can realise is important because:

• scienceandinnovationplaysa critical role in economic development;

• thereisaperceptionthatinno vative knowledge is not flowing between the science community and the Māori economy;

• currentpolicyhasarguably not delivered the investment in science and innova tion necessary to enable the transformation of the Māori economy, and;

• investmentinscienceandin- novation needs to increase and be better aligned to the growth of the Māori economy This growth should be driven by a closer relationship between government policy, funding Māori enterprise and asset owners.

As BERL state, there are potential benefits and opportunity costs for the Māori economy in relation to its effec-tive or ineffective engagement and align-ment with New Zealand’s science and innovation effort. Connecting science and innovation with the Māori econo-my using scenarios modelled by BERL demonstrate the potential benefits (or costs) to the Māori economy, as well as the wider New Zealand economy over the period to 2061.

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The key points generated from the vari-ous scenarios include:• the‘doingnothing’scenario reveals high opportunity costs (in the economic as well as cultural and social sense) and few benefits.

• successineitherproductivity increases or improved export effort yield substantial benefits.

• afocusoninvestmentinscience and innovation that is not matched by the applica tion and/or commercialisation of such effort results in only marginal gains.

• scenariosshowinggainstothe Māori economy also show value to NZ Inc, through gains in national GDP, employment and wider economic benefits.

In summary, based on the scenarios modelled in BERL’s research, success-fully aligning New Zealand’s investment effort in science and innovation with the needs of the Māori economy potentially leads to :

• anadditional$12billionperan num in GDP from the Māori economy by 2060

• 150,000additionaljobsperan num in the NZ economy by 2060

• withover50,000ofthese additional jobs in professional occupations

• andanother30,000ofthese additional jobs in skilled trades occupations

• aboosttoNewZealand’sper capita GDP in the range of $4,800 to $7,500 per annum by 2060

• anexpansionofNewZealand’s export sector by an additional $12 billion per annum by 2060

But a do nothing choice could see:

• 35,000lessjobsperannumin the New Zealand economy by 2060 • GDPfromtheMāorieconomy lowerby$3bnperannumby 2060

Further information detailing BERL’s research is available as part of the Māori Economic Taskforce publications.

Discussion at the Maori Economic Summit 5 May 2011

• Whatarethekeyissuesfacing Māori in capturing the benefits of science and innovation?

• Whatarethestrengths,weak nesses, opportunities and threats for a better alignment between the Māori economy and science and innovation?

• Whatarethebarriers/oppor tunities/issues for engaging with the science, research and innovation system, and what can Māori do to enhance / mitigate these opportunities/ issues or these impacts?

• Howcangovernmentsupport better engagement between Māori, and Crown Research

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Institutes and wider science and re-search community to capture the gains from investment in science and innovation?

• HowcanMāorigainbetterac cess to science, research and innovation funding?

• Whataretheimmediate priorities for action?

• Whatarethelongtermfocus areas for Māori and New Zealand to capture the gains from investment in science and innovation, particularly given the ‘scenarios of potential, opportunity and value’ modelled in BERL’s research?

Towards a productive Maori Econ-omy – key ideas to be presented at the Fabian Seminar

• ShiftingParadigms–risk paradigms and how to create value

• CollaborationandAlign ment – aggregation of assets, role of science and innovation

• Aneco-systemtodrive sutainable, uniquely Maori (brand and enterprise) led export growth – establishing a Financial Intermediary and an Innovation Fund.

• CreatingaMaoricapital market - aligning investors and issuers (Maori asset holders) – i.e. demand and supply of capital for quality deal flow.

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A comprehensive management training programme for SME’s...

International evidence is increasingly pointing to management skills and processes as an important part of the productivitypuzzle.Countriessuchas the US, Japan and Sweden consist-ently score higher on various measures of management skills and techniques whilst New Zealand management scores in the middle to poor range. Indeed, New Zealand managers are strikingly bad at retaining outstanding staff - this, rather than the wage gap might be part of the reason for losing so many people to Australia. The World Bank has been recently running management skills coursesforsmalltomediumsizedfirmsin developing countries and preliminary findings are apparently positive. I propose that New Zealand too devel-ops a comprehensive management train-ing programme for small to medium sizedmanufacturingfirmsandfamilyfarms. We don’t need another knowledge wave The problem for New Zealand’s econo-my is clear – but solutions elusive. Any economistcanalldescribethesizeofthechallenge – and the 2025 taskforce did a very good job of doing that. But good

Management training for dummies...

Rhema Vaithianathan

Rhema Vaithianathan

economists, like good doctors, should offer effective treatment, not just accu-rate diagnosis. The 2025 taskforce offers us a 20th Century cure for a 21st Century ail-ment.Theirprescriptionofprivatization,benefit curtailment and market liber-alizationarefamiliar,oldfashionedandunlikely to work. It might be a solution – but not for the current problems which beset New Zealand.New Zealand’s productivity is low and falling; our gap with Australia is large and rising. We spend more hours at work yet produce less value per hour (Statistics New Zealand, 2010). It is often argued that the reason for New Zealand’s decline is that we are over exposed to commodities – which are exported with little or no value added. Commentators up and down the coun-try are repeating the familiar mantra: we need to diversify our economy and add value. Politicians and business lead-ers form taskforces and working bees, turning their brains to what the next big opportunity for New Zealand might be. Is it the movie industry? Is it the green economy? Is it mining our conservation estate?Knowledge Waves are launched, Reports are released and invitations to policy launches crowd our mantle pieces. What

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invariably follows is bitter disappoint-ment. Most of these attempts are strong on motivational speeches but very weak on specific policy recommendations. In a modern free-market economy such as New Zealand, the sectors in which New Zealand trades are the sectors in which individual firms choose to trade. Wespecializeincommoditiesnotbe-cause Government is directing us to do so but because individual New Zealand-ers – for good or ill –- choose to work as farmers. Entrepreneurs and capital owners choose to invest in forests and to export the raw timber. Unless these busi-ness owners have the skills and capacity to add value, or they see profit in doing so, there is little that Governments can (or ought) to do.

For this Fabian talk, we were asked to eschew Tony Robbins economics, which is based on exhorting New Zealanders to save, add value or capture the knowledge wave. Instead, we were given a more mundane brief: come up with a specific idea or policy for improving New Zea-land’s productivity.

My suggestion is rather modest: to ex-tend any R&D tax credit to management trainingformediumsizedNewZealandfirms. New Zealand managers are poor at managing people My proposal relates to an exciting line of inquiry by Nicholas Bloom and John Van Reenen (Nicholas Bloom and John Van Reenen, 2007) who have unearthed anamazingcorrelationbetweenthede-gree of management skills in a country and the country’s productivity. In cross-country regressions, they have found that countries which score more highly on a specially developed manage-ment survey, have higher productivity.

They report that “management practices can account for up to a third of the dif-ferences in productivity between firms and countries”. (Nicholas Bloom and John Van Reenen, 2007). The link between labour productivity and management practice scores are found to be independent of country and culture (Nick Bloom et al., 2007). The strong positive correlation is striking. Market liberalisation is not the answer for New Zealand Of course, the 2025 taskforce argued that New Zealand’s poor productiv-ity comes down to labour and product market rigidities. In general there is a correlation between free-markets and management scores. There is a posi-tive correlation between a measure of market freedom (the country’s rank in the World Bank’s ease of doing business index) and the country’s overall People Management Score. If you are China, Greece or India, market liberalisation might be a useful avenue to pursue. However, New Zealand already has exceedingly free markets. All those country which scored better in overall management than New Zealand also ranked below New Zealand on ease of doing business.

Having dismissed the idea that improving management scores is associatedwithmarketliberalization,what else could Government do to im-prove managerial competence? AnR&Dtaxcreditfor management skills Management scores are found to be correlated with tertiary qualifica-tions of managers. New Zealand has one of the lowest rates of tertiary

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education of managers in the sample (Roy Green and Renu Agrawal, 2011). One reason for this is the high degree of optimism that New Zealand managers demonstrate about their own compe-tency. Optimism encourages managers and entrepreneurs who have low skill levels to start businesses that they might have little ability to run well. The high level of self-belief also dissuades them from taking up the opportunity to im-prove management skills. Recent work in developing countries suggests that simple measures to upgrade managerial competence can have a major impact on firm productivity (Nicholas Bloom et al., 2011).

My suggestion is that management train-ing be included in a Research and Devel-opment tax credit scheme. The scheme should target only New Zealand firms whicharemediumsize.Firmswhichsend their mid-level managers or owner operators to accredited management training programmes will be eligible for a tax reduction similar to that of an R&D write off. Clearly, if the firm’s profitabil-ity increases in the following years, the tax returns will be higher and the tax rev-enues from the firms will partially fund the intervention.

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New Zealand’s Economic Strategy...

Rick Boven

Rick Boven

The New Zealand Institute’s approach to economic strategy is influenced by its purpose to improve long term outcomes for New Zealand and New Zealand-ers. The Institute is independent and non-partisan and its scope includes economic prosperity, social well-being, environment quality and environment productivity.

New Zealand got rich by exporting com-modities to the high value UK market. Many farmers earning high incomes pro-vided wealth for the small population. When the UK entered the EU the high incomes were no longer available so the economy was diversified and reformed.Small countries export high value goods and services to earn high incomes. New Zealand’s export earnings remain domi-nated by agricultural commodities and tourism.

Both of these export industries have competitors who limit prices and there-fore productivity, because productivity is measured in earnings per hour. They provide export volumes sufficient to limit the current account deficit but pro-ductivity is low, approximately equal to New Zealand’s low overall productivity.When commodity prices rise and fall, the economy responds, reinforcing the

historical belief that agricultural com-modities are now and should be the source of future wealth. Agricultural effi-ciency will remain important as a source of foreign exchange and to provide low cost inputs for value added exports.Now the world’s economy has grown largerelativetothesizeoftheenviron-ment so scarcities, climate change and ecosystem damage have become impor-tant threats to future incomes and well-being. One consequence is that prices for commodities are rising. Earnings from agriculture are likely to continue to increase. However increases sufficient to return New Zealand to high incomes would lead to huge disruption in the world because poor people would be unable to afford food.

New Zealand’s economic challenge is to pursue high quality economic growth, building technological capability and reducing risks by increasing resource use efficiency, protecting and restoring the environment and ensuring supply chain security.

To achieve this New Zealand should do what other small rich countries have done, which is grow exports of high value, differentiated goods and services. A worthwhile start has been made.

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Many of the institutions required to support an innovative economy have been established. The TIN100 largest technology based exporters account for $5 billion of exports each year, around 10% of total goods and services exports. There are over 1,500 non-commodity firms that either export or engage in research and development.

Many New Zealand industries have po-tential for further development includ-ing value-added foods, niche manufac-turing, ICT, scientific and medical, and services. Clean-tech and greening the economy offer potential for high value export growth along with efficiency gains and improved environment out-comes. The challenge now is to turn the rhetoric into action via policies that accelerate the right kinds of economic growth. The foundation for doing that must be to get past the pervasive complacency and pro-vincialism that leads us to think we are doing well. Our best innovators, manag-ers and marketers are very competent but the average performers fall well short of world class. Our commodity history leads us to take a transactional approach to business relationships and there are no centres of excellence for the full-time study of entrepreneurship and international marketing of new products and services.

The response is to downplay the chal-lenge, highlight our progress and celebrate our successes. Despite govern-ment’s prioritisation of the economy there is no sense of mission mobilising the population. Both recognition of the

risk of being consigned to the periphery of the world and strong leadership will be required to build support for change.ThesmallsizeofNewZealand,distancefrom markets and fragmented institu-tions combine to make it difficult to build international businesses. New Zealand does less to help its emerging exporters than competing countries in the mistaken belief that the market will overcome the obstacles to international business success despite institutional inadequacies and macroeconomic im-balances.

Policy responses are required to estab-lish the conditions that will allow high value exporters to grow more rapidly. Specifically:

• Establish at-scale national institutes of excellence building competences in science, engineering, operations, marketing and entrepreneurship throughout New Zealand;

• Ensure tertiary institutions will produce the mix of skills we will need – science, engineering, tech-nologists, international business and entrepreneurs;

• Incentivise investment in high value exports instead of in residential and rural assets;

• Ensure there are sufficient interna-tionally connected capital provid-ing institutions providing funds for growing high value exporters; and

• Assist small growing firms more by providing information, services and

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connections, and by growing clus-ters in New Zealand and colonies overseas.

The easy answer is to say we are doing all these and it is true that some small steps are being taken. But countries that make step changes in economic performance do not do so by taking small steps. They identify where their opportunities are and invest sufficient capital and effort to achieve rapid change. It is not enough to say we are making progress. So are our competitors.

The purpose of this event is to identify what should be done to improve the economy so I should add five broader economic priorities to support the five above that focus on accelerating growth of high value exports:

• Reduce the effect of exchange rate volatility on exporters’ earnings;

• Complete the infrastructure catch-up;

• Balance the government’s books and reduce the aggregate debt;

• Ensure more of our youth are well-prepared to contribute – use e-learn-ing to keep young people engaged at school and ensure successful transi-tions from school to work; and

• Lift the productivity of domestic in-dustries, releasing capital and talent to fuel export growth.

Rick Boven - July 2011

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Issues & Opportunities...

John Walley

John Walley

Recently the Prime Minister stated during a presentation that, “if I could I would have a 50 cent (as opposed to an 80 cent) dollar tomorrow”. If that were really the case, what would be the mac-roeconomic framework? What we have or something else?

The macroeconomic policy settings we have now tend to overvalue the New Zealand dollar which is driven more by the weight of capital flows (some 400x trade flows) rather than any reference to trade flows. That bias has consequences that we can see in the real economy.

A bias towards a high currency favours consumption: the often heard “yes the dollar is high but foreign holidays and imports are cheap”. A bias to a low cur-rency favours producers – we have the balance wrong.

The tendency to overvalue the New Zealand dollar, characterised as inevita-

ble by many, has a serious and long term fallout. Investment is stymied when re-turns are unpredictable and as we trade away the “added value” component all that remains to live on is the commodity base. Is that sufficient?

Instinctively agriculture and tourism are real strengths of the New Zealand’s economy, but looking at the numbers manufacturing makes a larger contribu-tion to the economy. Manufacturing in these numbers includes the added value component associated with processed commodities; increasingly that com-ponent is being traded away by the currency appreciation. The automatic stabilisation claimed to be associated with a floating exchange rate regime (an adverse external demand shock reduces net exports, the falling interest rate will lead to exchange rate depreciation, as a result the balance of trade improves, hence the floating exchange rate blunts the adverse impact and vice versa) oper-ates largely on commodities and not at all on elaborate goods.

 

Sector   GDP($m)   Employment  

GDP  per  person  ($)  

Tourism   6,500   182,400   35,636  

Manufacturing   16,466   248,600   66,235  

Agriculture,  forestry,  fishing  and  Mining  

10,055   157,100   64,004  

Others  (non-­‐traded)   99,646   1,582,500   62,967  

 

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As might be expected the makeup of our economy is reflected in the make-up of our exports, again this emphasises the relatively small part of the economy and exports are subject to the automatic stabiliser mechanism.

Even with the current diversity (it is falling all the time) of exports we find ourselves unwilling or unable to balance our current account, that creates a need to source capital from overseas to make up the difference and that puts upward pressure on the exchange rate. We are doing much worse than other nations in this regard, and clearly we should be focused on expanding the real economy rather than claiming that on-going losses are inevitable.

Current account deficits span decades and governments, this is not a new problem; sooner or later the cumulative impact will see the cost of offshore bor-rowing increase, government spending under pressure, asset sales and ultimately a less attractive and therefore lower value

currency. Sadly by then the damage will be done to the added value sector.

Growth in the real economy requires investment, investment will simply not happen unless returns from exports are more predictable. Other economies demonstrate that currency fluctuations are not entirely inevitable; they are an outcome of macroeconomic policy interacting with the global economy.

Would there be any serious argument which economy, Singapore or New Zealand, has done better economically over the past twenty odd years? As men-tioned earlier an overvalued currency tends to trade away the added value ele-ment sold into a particular market. The difference is commodity prices are set by demand, but added value prices are set

 

 

 

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by competition. Elaborate products are priced into the markets in which they compete; consequently returns in a par-ticular market are intermediated by the exchange rate offset by whatever natural hedge might be in place.

These examples are given to demon-strate that when we are willing to allow an overvalued exchange rate to trade away the added value margin there is no return to be expected from invest-ment in added value, equipment, plant, research and development.

As a result our economy simplifies and regresses to, at best, simply processed commodities. With around NZ$40b of annual exports, a one percent increase in our exchange rate has a net annual cost to exporters of $200 million, this includes the assump-

tion that 50% of sales are sourced in cur-rencies other than the NZ$. The high to low range thus far in 2011 is 20%!Investment in the expansion of the real economy, in volume and complexity, depends on a realistically valued, less volatile currency. Does it matter where that investment goes? Other jurisdic-tions seem to think so; they direct fiscal policy towards what are seen as desir-able activities. Direct comparisons are difficult: military spending and favourable treatment of depreciation in productive assets are common interven-tions; one broad indicator of intent are targeted interventions in the area of research and development. Opportunities#1MonetaryPolicy

When the Reserve Bank Act was intro-duced in 1989 it was designed to control the inflation problems of the 1970s and 80s. It seemed to work for most of the 1990s, but global inflation had subsided by this point in any case. The problem with using the Official Cash Rate (OCR) to curb inflationary pressures has been its ineffectiveness in preventing inflation in the non-traded sector. As the graph below shows non-tradeable inflation has been outside of the target band for most of the last decade.

The price of credit has proven to be an ineffective regulator of domestic de-mand. An increase of say two percent in

  General  Manufacture   Dairy  Farm   Software  Company  

Sales   $10,000,000   $850,000   $1,500,000  

Capital  Employed   $3,000,000   $4,500,000   $50,000  

R&D  Spend   $1,000,000   0   $300,000  

Jobs   80   2.6   6  

Associated  Jobs   5x   5x   Not  many  

Exports   50%  -­‐  95%   90%+   95%  

Natural  Hedge   20  –  50%   some   little  

Volume  Growth  2011   +10%   2.6%   17%    

Revenue  Growth   -­‐ve   ~18%*   -­‐7%  

Footprint   5000  m2   1,350,000m2   100m2  

*2009/10  Year  

 

 

 

 

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the price of mortgage credit is fairly in-significant if house prices are expected to increase between 10 and 20 percent. This has meant that the tradeable sec-tor, which has caused little inflationary pressure, has worn the brunt of OCR hikes through their impact on the exchange rate.

The exchange rate volatility has in-creased over the period since the OCR was introduced. Interest rate differen-tials between New Zealand’s OCR and the official interest rates elsewhere and the bias towards leveraged asset invest-ment have largely driven this volatility. Given that the price of credit has not been effective in reducing non-tradeable inflation, regulatory controls on the supply of or demand for credit are necessary. Controlling the credit supply from overseas through measures such as the Core Funding Ratio that the Reserve Bank has already introduced is one option, but the controls must be much tighter and there needs to be an effort to ensure that the banks do not circumvent the rules. A Loan to Value Ratio would restrict demand for credit by enforcing a minimum percentage of deposit for borrowing. Zero percent deposits have been a major cause of the increase in household borrowing and property bubbles. #2LocalFiscalPolicy

Despite some changes last year to increase GST and reduce personal and corporate tax, New Zealand’s tax system is still unbalanced. Too much of the tax load is carried by personal and corporate tax while capital gains on assets are largely untaxed. It is difficult to understand the rationale

behind this system. Investment in assets produces little for the economy while investment in businesses provides better jobs, higher incomes and more tax for the Government.

The Capital Gains Tax or Land Tax that the Tax Working Group recommended in 2010 is necessary to deal with the tax harbour around property. #3FiscalPolicyresponseto incentives elsewhere.

The only justification for fiscal incen-tives is to level the competitive playing field and match what is offered by New Zealand’s competitors. Overseas we see Research and Development Tax Credits, fast write off for investment, personal tax breaks for early stage business invest-ment and export development loans. These need to be matched here so that our tradeable sector is on an even foot-ing with overseas firms.

Overall, the decision the bias we place on the external of our dollar with our policy framework, towards 50 cents or towards 80 cents, the former gives the real economy a chance and is sustainable in the medium term, the latter feels good for many but will lead to low growth and our continued slide down the OECD rankings as our real economy, robbed of an ability to earn a return from added value, regresses to its commodity base and we are all the poorer for that.

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Prepared for Fabians Seminar: 27-7-2011 Fresh Ideas for a Productive Economy

Don’t Sell... Invest!

Selwyn Pellett

Selwyn Pellett

New Zealand’s economic history is rooted in the success of its agriculture. Abundant and valuable land, in combi-nation with capital and markets provid-ed by the British Empire, and the hard work of a frontier society, made farming a central part of New Zealand’s econom-ic success. New Zealand’s agriculture was, and continues to be, competitive in the global economy because it is able to produce primary goods at a lower cost compared to our competitors. However, theimpactofglobalization,freetradeand technological innovation, has meant that the value of New Zealand exports has remained low and thus failed to keep pace with the value of New Zealand’s imports.

For 40 years New Zealand has focused its efforts on raising the productivity and the yields from farming to grow our economy and to balance our national accounts. Government policy has sup-ported the agricultural sector through tax policy, monetary policy, and access to research and development funds. As a result, agriculture contributes 49% of our exports (Stats NZ) and 15% of our GDP (FedFarmers). Meanwhile, New Zealand’s current account deficit has grown by has swollen from 0.9% of GDP in 1988 to 8.8% of GDP in 2008. Post

the global financial crises, this figure has halved to 4% of GDP but is expected to be a temporary

At the same time, New Zealand’s productivity was falling. As Stats NZ reports, from 2006 through 2009 labour productivity was stagnant at 0%. Mul-tifactor productivity had fallen from 2006 through 2009 and had increased by a mere 0.9% on an annual basis from 1978 to 2009. Unemployment reached its height in 1991 at 11.2% and currently sits at 6.6% in 2011. Our Net Foreign Investment is running at 85% percent of GDP and puts New Zealand in very similar company to the economic PIGS of Portugal, Ireland, Greece and Spain. Some economists will argue why we are different to the PIGS based on the difference between Crown and Private sector debt (ie who owns the debt). But the reality is that the interest bill is born bythecitizensofNewZealandinbothcases, through their taxes, interest pay-ments direct to their banks, or through the cost of goods and service. All these reduce our ability to invest and save.

This is a picture of an economy that has been in steady decline for decades. It isn’t the result of the Global Financial Crisis or even the Christchurch earth-

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quake. It is the end result of an economy that has been fixated with growing our primary industries. We have failed to innovate in order to export higher value goods and services, but have kept bor-rowing to bridge the gap between what we can pay for with primary exports and what we want.

Successive Governments have failed to realizethatagricultureisreachingitsnatural limits, because of the physical constraints of land and water and, more recently, society’s growing unease with water pollution from farm runoff and methane gas emissions from livestock. These emissions alone account for 1/3ofNewZealand’sgreenhousegasemissions. While intensified farming is absolutely possible, it comes at an ever-increasing cost and such expansion needs to be well thought through as an economic strategy. If New Zealand is to gamble our future economic wellbeing on exporting ever-increasing volumes of primary products, then a founda-tion of that strategy must surely be the retention of our land, processing capa-bility and global distribution and brand management in New Zealand hands. Strangely, this isn’t part of the current Government’s policy. It should be. At a minimum, this disconnect of our apparent strategy (food bowl to the world) and land ownership rights (i.e. the ability to sell to anyone), should be a major concern to any New Zealanders who believe farming is our future. How-ever, being a ‘food bowl to the world’ is not a strategy. It is a default ‘business as usual’ outcome that continues in the absence of a strategic economic plan for New Zealand.

However, the Productive Economy

Council remains unconvinced that our future prosperity as a sovereign nation lies with farming. We watch our best and brightest, who we have invested in through our education system, leave our shores, seeking meaningful, high wageemploymenttoutilizetheirskillsand training elsewhere. The economic impact of this loss of talent will be felt in generations to come. Without the innovation our best and brightest would bring to the diversification of our exports, we will have no choice but to lower our standard of living, accept that our children and grandchildren will be living overseas and that our economic environment will progressively degrade.

New Zealand can continue to borrow and to hope that our primary industries can grow to two or three times their cur-rent value, or, as any responsible society would do, we can start working on Plan B.

Plan B: The Productive Economy Coun-cil’s Vision for New Zealand.New Zealand will be the exemplar among small economies, by cohesively building a sustainable, high-wage, high growth, hi-tech economy that benefits allitscitizens,whilefiercelyprotectingits economic sovereignty and ensuring we create new strategic options for the next generation.

Put simply, we must innovate and diver-sify our exports, broaden employment options, own our wealth generation capability (farms and businesses) and leave our children with investment op-portunities, not a debt burden.

To achieve this, New Zealand will need to become an entrepreneurial society, where risk-taking becomes part of the

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national psyche and successful entre-preneurs become national heroes. We will need to develop and implement strategies to create and retain investable hi-tech and elaborately transformed companies, and to deliver well trained entrepreneurs and internationally capa-ble managers to lead them.

By way of example of the potential impact this could have, I will draw on my own experience. Ten years ago I co-founded two companies, Prolificx (later to become Imarda Ltd) and Endace Ltd, withatotalinvestmentcapitalof$360K.In their respective current 12 month trading periods, these two companies will export circa $68 million NZD (normalizedexchangerate,functionalcurrency is USD). They employ circa 180people(1/3offshore)withaverageincomes of over $100,000 per annum and not a cow in sight! In sharp contrast, a farm holding hires, on average, 1.8 people with an average salary of $45,410 (BERL), while the average New Zea-landwage is $47,900 (Stats NZ).

If New Zealand could scale up these achievements to create just 100 such ex-amples then, with a modest investment of$36million,intenyearstimeitcouldcreate nearly $7 billion in additional export earnings per annum, 18,000 new jobs at double the national average wage, and contribute between $500 million and a billion in new tax revenue per year. Is it possible to create 100 new entre-preneurial businesses that replicate this success? Without significant changes to our underlying macroeconomic environ-ment the answer would be a resounding NO! However, we do have the oppor-tunity to change that environment and strategically align our limited resources to achieve this outcome.

To do this (in no particular order) we need to:

• Control the volatility of the New Zealand dollar (Solutions largely contained in initiatives below)

• Expand the scope of the Reserve Bank Act to encompass jobs and exports instead of just a narrow focus on inflation (this will force the development of additional tools so exporters are not used as the hand brake to control non tradable inflation)

• Invest in innovation (R&D tax credits etc)

• Improve savings (compulsory super-annuation)

• Tax capital to remove distortions in the investment profile (CGT)

• Reduce Foreign Debt (reduce de-mand for privately sourced foreign debt to inflate house and farm prices, spend less on imports, earn more from exports)

• Balance the fiscal budget (all income is taxed regardless of source, lift su-per age, remove interest free student loans etc)

• Invest in ourselves to gain economic leverage (Government procurement policies and Super Fund investment criteria, NZX).

• Manage immigration carefully (to avoid stimulating housing inflation and excessive investment in new low yielding infrastructure)

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As New Zealand now has two political parties looking at these problems and developing policies to deal with them, I will park these issues and pretend they are dealt with. So what else is needed? Instead of macroeconomic changes, I will focus on a second order impera-tive – selecting, growing and mentoring entrepreneurial talent, without which all of the above would still not deliver the desired economic returns.

It is our belief that entrepreneurs are born not trained. Students can lose their innate capability through bad experi-ences, but it is difficult, if not impossible to train it into someone with the wrong profile and skills. So courses training a normal sample of students at univer-sity will have very limited success. This means that as a nation we need to screen for entrepreneurial profiles early in the education cycle and help students to develop the required additional tool kit to allow them to embark early on an entrepreneurial career.

The sort of attributes that are essential include a suitable risk profile, an abun-dance of self belief, (ideally supported by a history of achievement to date), superior intellect, hunger for learning and self improvement, and the ability to inspire, communicate and make a differ-ence. Sam Morgan, Rod Drury, Sir Peter Maire and the late Sir Angus Tait are all excellent examples of this sort of profile.

Having screened for these traits, we need to provide supplementary courses at secondary school, largely as teasers foraveryspecializeduniversitydegreethat provides a significant portion of field active work. The scope of this course needs to be developed with a broad range of successful entrepreneurs

and then put into a limited number of universities.

The key role of an entrepreneur is to identify what assets and capabilities they have or have access to (money, net-works, engineering / marketing talent / distributions channels / media etc) and marry that with a market opportunity that has yet to be exploited or could be exploited differently. Again, all of the above entrepreneurs did exactly that. This capability is a mixture of analytical and creative skills, and young entrepre-neurs need to get access to older more seasoned entrepreneurs to refine that skill in relative safety.

There is now the potential to have ap-prentice entrepreneurs, but this would require the buy-in of currently very busy and capable people, willing to invest their time in the next generation of entrepreneurs. Having seen the invest-ment many are already making to help in this regard, we believe there should be capacity to have at least 10 to 20 entrepreneurial apprentices (or pos-sibly even 50 to 100 in a well structured national program) going through such a program each year. The program would havetheapprenticespending3-6monthstints with 4 different entrepreneurs in different technologies or industries. The unique benefit of such a program is that apprentices gain a global insight (i.e. they travel with the entrepreneurs) to see how things are done, and they also create their own network of potential seed funders for their own business while in the programme.

As previously stated, there is much to be done to create a viable Plan B but it

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is possible and it is essential. To gamble the future of the next generation on policies and behaviors that have failed us for decades is patently irresponsible. Farming is literally our cash cow but, as any businessperson knows, you use your cash cows to fund new opportunities with greater growth potential to ensure longevity of your businesses’ success. Every business or economy eventually has commodity characteristics unless you continually invest. Previous genera-tions of New Zealanders invested in this country to create exceptional income per capita and now it’s our turn.

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Summary Points “Fresh Ideas for a Productive Economy”, 27 July 2011

Fresh ideas for a Productive Economy...

Geoff Bertram

Geoff Bertram

High on the agenda for Fresh Ideas in my view are income and wealth distri-bution, employment and real wages, getting momentum into the whanau-ora approach to social policy, fending off US attacks on Pharmac and local software developers under cover of the TPP, moving energy and climate change policy out of the greenwash bog in which they are currently stuck, reviv-ing the ability and the will to regulate effectively, sorting out the role of an offshore-owned banking sector in a small open economy, and addressing the perennial issue of exchange rate over-valuation. Today I’m focusing on the last two of these, but I’ll start with some background points about the wider New Zealand economic scene. Key elements of strength on the sustainability front:

• The freely floating exchange rate.

• A manageable level of net interna-tional indebtedness.

• A long-established position as one of the high-income settler economies of the world with social capital and physical infrastructure to match.

• A strong fiscal position as the fruit of past austerity in the 1990s extending to countercyclical restraint in the 2000s.

• Effectively all the Government’s official international indebtedness is now in NZD, and quite a big slab of private-sector overseas debt is also denominated in NZD.

The areas for dissatisfaction are familiar and long-standing. They include:

• A steady drift towards a low-wage economy.

• Steadily worsening income and wealth distribution.

• Persistent overvaluation of the real and nominal exchange rates.

• The serious weakening of the na-tion’s balance sheet.

• Theexchangerateisoneofthe

keyrelative-pricesdrivingmac-roeconomicstructureandbehav-iourinasmallopeneconomy.Ithastwodimensions:

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The nominal exchange rate (e.g. the TWI) which is an important driver of tradable-goods competitiveness, and changes in which produce capi-tal gains and losses for international investors

The real exchange rate which is the ratio of tradables prices to non-tradables pric-es – in other words, the relative-price incentive to allocate resources between the two sectors.Pervasive and generally unthinking acceptance of neoconservative assump-tions and ideological preferences, has produced a group-think in policy dis-course and the media.This leaves the issue of whether the long-run path of the nominal exchange rate can be influenced, by monetary policy or otherwise, hopefully generat-ing a sustained improvement in the real competitiveness of tradables. A range of options exits:

• Outrightcapitalcontrol• Taxationofcapitalinflows• Sterilisation• Marketsentiment

I list these four not as a fully-worked-through policy package but as sug-gested starting points for more policy discussion. I am not holding my breath in expectation, because the first step to-wards bringing the exchange rate down on a sustained basis is that the political parties, the officials in key ministries (es-pecially Treasury), and a solid number of media commentators, would have to agree at the outset that bringing the rate down is a good idea and make a serious, credible commitment to seek out ways of achieving this. Once there is a will, there will probably be a way – indeed the very emergence

of a will, and of some generally-agreed target exchange rate consistent with an end to overvaluation, might well achieve the required shift in market sentiment and consequent re-valuation of NZD-denominated instruments including the currency.At present, however, the great NZ clob-bering machine lies in wait for anyone in political life venturing down these paths.