Address to Institute of Directors Auckland Branch Dinner
Thank you for your welcome, and may I also congratulate the recipients of the Distinguished Fellow Awards. It is true of
business as of any other human endeavour that we stand on the shoulders of the giants, and that we often do not pay
sufficient homage to those who have laboured to create what we now take for granted.
This is a useful stepping off point for what I want to say tonight about the challenges that are ahead of us in 2003;
challenges that business leaders and political leaders must face head on.
It is said that the good is often the enemy of the best. The task of leadership involves sifting through a range of
options, all of which have some appeal, make some people happy, and promise to impact positively on some indicator or
other. Of course, these options often have hidden costs or add to future risks. Choosing the best option out of a range
of arguably good ones is never an easy task.
It is here that a breadth of vision and a long-term perspective becomes essential. This is where we look to an
experienced Board to provide leadership, and – in the context of economic management – this is the standard we must
apply to political decision making on matters that affect the economy.
During my time as Minister of Finance I have been frequently accused of long-termism. I am happy to be found guilty of
this.
As the year draws to a close, I would like to reflect on the implications of a long-term focus for economic policy,
considering in turn the strategy for economic growth, long-term fiscal management, and the long-term deepening of our
capital markets.
During this year our economy has managed to sidestep the worst effects of global turbulence post-September 11. The
flow-through effects of high export prices and volumes have sustained an exceptionally strong level of economic activity
in the first half of the year.
Indeed, the recent OECD report put the annualised growth rate for the period at more than 4.5 percent. This is the
growth rate that, if sustained over a 5 to 10 year period, would more than likely return New Zealand to the top half of
the OECD.
However, there are some potholes in the road ahead, and we will need to keep a firm grip on the steering wheel. Export
prices have already declined, with dairy being particularly hard hit. The exchange rate provided a temporary cushion by
staying below its long-run trend; but that effect is now diminishing. Consumption growth is projected to slow
significantly in the current quarter.
Moreover, the cold spring weather in the South Island, and some localised catastrophic weather events in the Hawkes Bay
and Nelson/Marlborough, suggest a lean year ahead for some parts of the primary sector. The benefits to the Auckland
economy of the America’s Cup regatta will also come to an end early next year.
Meanwhile, we cannot expect any immediate help from the global economy, which faces the challenges of sluggish
performance in the US and parts of Asia, and of course the uncertainty of the situation in Iraq and the threat of
destabilisation by international terrorism.
Nevertheless, the rough patch in the road is likely to be relatively short. Forecasters are predicting that our export
volumes will follow the global trade cycle and pick up towards the middle of 2003. GDP should also follow this pattern,
slackening in the second half of 2002, and opening up some excess supply. This will set the scene for the
re-establishment of robust, and non-inflationary, growth in mid to late 2003.
This is reflected in the latest National Bank Outlook which shows business confidence improving for a fourth consecutive
month. The headline confidence figure is now up to 0.1 percent negative. I am convinced that before Christmas we can
find the one more optimist we need to put us into plus territory.
I was especially encouraged by the all-important own activity index, where there has been an 8 point jump from last
month to net 31 percent positive. The rebound is echoed in a strong increase in profit expectations over the same
period, while other indicators – such as investment and employment – remain buoyant.
A robust medium term outlook is a helpful platform for working towards expanding our long term economic capacity. The
Government’s growth strategy is aimed at that longer timeframe, and is about increasing our capacity for growth and
innovation. We are still a small and geographically isolated nation attempting to box above its weight.
Therefore our vision has to involve achieving by intelligence, innovation and coordination what other economies achieve
by virtue of their size, concentration and proximity to markets. This means:
Attracting and keeping a highly skilled labour force;
Earning a greater proportion of our income through our intellectual property;
Using high-speed internet technology to make our exporters ‘virtually’ present to their markets;
Finding ways of overcoming the 'thinning' of our capital markets;
Stimulating an entrepreneurial ‘infrastructure’ connecting ideas and innovations with structures and processes that will
grow them into successful businesses; and
Streamlining our regulatory processes, without losing sight of their function.
Clearly this has to be a joint effort between business and government, both central and local. I believe that in the
last three years we have won the intellectual debate on the question of the legitimate role of government in nurturing
economic growth. Prudent fiscal management and monetary policy settings aimed at low inflation are necessary, but not
sufficient, conditions for growth. I do not think there is any further argument to be had over whether Government also
has a role in improving coordination amongst the productive sector and in making strategic investments in skills and
public infrastructure. It does have a role to play, although how that is played out in detail is a matter for
experimentation, debate and refinement. The key planks of our growth strategy remain the same:
Partnerships with business in the key areas of biotechnology, information and communications technology and creative
industries, aimed at better coordination and the attraction of investment capital into those sectors;
A skills strategy based on a better focussed tertiary education system that is responsive to the skill requirements of
New Zealand businesses;
A complementary immigration policy, aimed at attracting skilled migrants with the ability to fill the immediate and
longer term skill gaps;
Investment in infrastructure – in particular in the area of roading – as one of the essential pillars of productivity
growth;
Investment in those public services – health care, education, policing, environmental protection and others – which make
New Zealand an attractive place for people with skills and ideas to live; and
Promoting free trade amongst our major trading partners.
2003 should see advances on all these fronts, all of them aimed at securing the conditions for long term sustainable
growth.
Turning to the question of the government’s financial management, this year’s Budget announced a very important shift in
our long term fiscal objectives. Sadly, the shift has not received the attention it deserves. Up until Budget 2002,
fiscal objectives had focussed almost exclusively on the operating balance. We can, of course, run slightly larger or
small surpluses, or even dip into the red from time to time without having any material impact on the financial health
of the government.
What really matters is that when our debts fall due, we can refinance them. That is the real bottom line. It wasn’t an
operating deficit that provoked the financial crises in Argentina, Poland, Mexico et al during the last twenty years. It
was when they couldn’t refinance their debts that the bailiffs knocked on the door.
At one level, if the operating balance is positive, debt should not rise, so a focus on the operating balance might be
sufficient. This is only true if we assess fiscal pressures over the short term. If we take a longer term view, we must
acknowledge that – in strictly fiscal terms – the population structure will turn for the worse. The working age
population will shrink relative to the retired population, a demographic shift that will be difficult to manage
economically and socially unless we have reserves to draw upon and increases in the productivity of our workforce. Hence
we must start to invest to anticipate and partially pre-fund that demographic transition.
In the longer term, we also need to spend on capital to keep our asset base robust, relevant and reliable. This is not
only roads. It also means modernising schools and hospitals, re-equipping the defence forces, having sufficient
electricity generating and transmission capacity to keep the lights on and so forth.
Operating revenue must cover operating expense on average, over the business cycle, but it also needs to make some
contribution to meeting our capital spend and leave enough left over to partially pre-fund the demographic change.
It was this realisation that led us to make debt the primary focus of our long-term fiscal objectives. There is no
rocket science here. It is a judgement call as to what level of debt is sustainable in the longer term. We have put a
stake in the ground at around 30 percent of GDP on average, over the business cycle as a prudent long term goal.
We are committed to managing operating expenditure, Superannuation Fund transfers and our investment programme (whether
funded by capital spending or borrowing) so that overall debt remains on track to meeting that long term 30 percent
target.
That is a quantum leap away from the annual obsession with the operating balance. Managing for the longer term does,
though, raises big issues when short term trends deviate from the long term goal. It is clear from the periodic reports
on the Crown’s finances that revenue receipts are running well ahead of those forecast at the time of the May Budget.
Under these conditions (and all other things being equal) debt would be lower than forecast. The exact extent of the
revision to forecast will be revealed when the Budget Policy Statement is published on 19 December.
This raises the question of what a government that manages to the longer term should do when the numbers look a lot
better than forecast. The answer is that it responds as any large and complex business would respond: with caution. Past
experience suggests that a number of things can happen. Some of the revenue boost may turn out to be associated with
timing: taxpayers paying early to avoid penalty interest. These early payments will reverse out in due course. Equally,
some of the forecasts – especially in the outyears – may overstate emerging surpluses as a result of the technical
assumptions that are used in making them. Some of the extra money may be a result of cyclical factors: at the end of a
longish period of economic expansion the public finances are better than average. And some may reflect structural
changes. It may just be possible that we are starting to see a lift in the trend rate of economic growth.
To be frank, at this point in time, we simply do not know what is driving the numbers. We do know that relatively small,
but strategic, changes in underlying economic conditions – the exchange rate, commodity prices, trade flows, immigration
etc – can have both large and rapid impacts on the revenue. Caution advises that we should keep some fiscal insurance in
place during these times of intense global uncertainty. Caution also advises that, at this early stage, we should
respond very carefully to any indication that the extra revenue may be of a more permanent or structural type. It is
simply too early to move with confidence to a substantially higher spending track, because our experience is that these
structural shifts in spending are very difficult to claw back if later evidence suggests that we need to.
What I can say with confidence is that we must avoid the temptation to spend the cyclical element of emerging surpluses.
In the 1990s, fiscal policy was decidedly pro-cyclical. The government of the day tended to dissipate emerging fiscal
surpluses through tax cuts. This gave a short term stimulus to activity, eventually requiring the Reserve Bank to apply
the monetary brakes. When drought and the Asian crisis slowed the economy and the revenue flow, the response was to cut
spending, thereby deepening the contraction.
In 2000, the new government made it clear that it was abandoning this approach. It declared an intention to look through
the economic cycle and to allow the economic stabilisers to work. It is absolutely essential, both for the sake of sound
fiscal management and for establishing credibility, that they be allowed to work on the upside, not only on the
downside. In fact it is probably fortuitous that the first time we really let the economic stabilisers work, it is in
good times rather than bad.
Fiscal cynics would say that everybody wants the fiscal stabilisers to work – but only during depressions! We want the
best of both worlds: to go to the well in a drought, and also to draw off surplus water in the wet years. Fiscally, if
we allow the balance to automatically contract when the economy does, to moderate the contraction, but do not bank the
surpluses in an expansion, debt simply ratchets up. Banking fiscal windfalls will be a big test of the political will of
this government.
We are also managing to the longer term with Crown financial assets. The government does have large financial portfolios
in the Government Superannuation Fund and Natural Disaster Fund. Both are around the $3.5 billion mark. The New Zealand
Superannuation Fund will have around $2 billion in it by the end of this financial year, rising by about that amount
each year after that for some considerable time.
It is important that these funds are managed well, to maximise the returns we get from them, subject to the appropriate
spread of risk. The overwhelming evidence of history is that a better return, with very limited risk, comes from a
diversified fund, with a mix of bonds and equities, foreign and domestic. That is why we have made the decision to
diversify the Crown financial portfolio, with the diversification overseen by experienced professionals, not
politicians.
In such a fund, there will be good years and bad years, and different parts of the portfolio will experience different
rates of return in any year. These funds are there for the long term. The NDF is there to cover some of the costs of a
natural disaster. We don’t know when it will be needed. We do know that the GSF will be drawn down over many decades. We
have actually passed a law stopping any withdrawals from the NZSF before 2020.
All of these funds are managed in terms of detailed statements of investment principles and policies, and they are
reviewed annually. It is legitimate to question the judgement behind the principles and policies and the asset
allocations that have been developed as a result. That is informed debate around long term objectives.
It is ludicrous to judge the financial performance of only parts of the portfolio of the funds, over periods as short as
three months. And yet try as we may to lift discussion to a more rational plane, that is precisely where it is conducted
in the political and popular media arenas.
If I could turn this around and look at some criticism that I hear from time to time, it is also important to take the
longer term view of the impact of diversification of these funds on New Zealand capital markets. I hear suggestions that
all, or a very large portion of these funds should be locked in to domestic securities.
I must stress that the primary purpose of diversification is to get the best return on our assets, consistent with a
prudent management of risk. However, I have always thought that an inevitable and welcome by-product of diversification
is that it will deepen our capital markets.
This will happen over time. It is the long term impact that we must focus on. There will be limits to the amount and
pace of what our capital markets can absorb without creating an asset bubble. Each fund will make its own asset
allocation decisions, and these will change over time as investment performance is reviewed. As an example, though,
consider the GSF. It has set a long-term target of having 14 percent of its assets in New Zealand bonds and one eighth
of its portfolio in New Zealand equities. That is over $400 million of new equity into our stock market. If the NZSF
follows a similar asset allocation, new equity of around $250 million will be injected each year. So there will be a not
inconsiderable deepening of our capital markets, but as always, we need to keep the focus on the longer term.
As John Maynard Keynes pointed out, “in the long-run we are all dead”. As with many of the great axioms of economics,
Keynes’ statement is self-evidently true. However, it should not be taken as an encouragement to take a short term
approach to encouraging economic growth or to managing public finances. Prior to our own long-run demise we of the
baby-boom generation hope to enjoy a lengthy and comfortably Keynesian retirement. To achieve that we need to plan for
the long term, both individually and collectively.
Moreover, although we will be gone in the long-run, our children will still be here. They will be living with the legacy
of today’s economic leadership, and I would hope that that legacy would comprise a strong capital base and healthy
skills-based industries. I would hope that their judgement will be that we served their long term interests in a
distinguished manner.
Thank you.