Michael Cullen Address: Deutsche Bank Lunch, London

Thank you for coming here today. My intention in these introductory comments is to give you some feel for the state of the New Zealand economy and for the subtle pressures that are emerging in it. In historical terms, my message is unusual. Typically, a small, trade dependent economy followed the international business cycle. If the larger northern hemisphere economies were slowing, the New Zealand economy was depressed: if they were depressed, we were in dire straights.

During the last three years, I have moved through the various international finance ministerial fora - IMF, World Bank, Commonwealth Finance Ministers, APEC Finance Ministers – in a state of surreal tranquility. The fact of the matter is that our economy has quite atypically not been impacted by international uncertainty and stagnation. Not only has performance been much more stable than that in most other countries, but it has been stable at the upper end of relative international economic performance.

The New Zealand economy is in good heart. It has been one of the best performing economies in the OECD in recent years. The headline numbers tell the story. The economy grew by 4.3 per cent in the year to March 2003. Employment has grown in each of the last twelve consecutive quarters, so we now have an unemployment rate of 4.7 per cent, which is the lowest since 1987 and is very low by OECD standards. To give you a benchmark, the unemployment rate was 6.3 per cent when this government took office at the end of 1999. Inflation is well under control. Consumer prices rose by a very modest 1.5 per cent in the year to June.

This strong performance has not been a result of any fiscal stimulus. We are running strong surpluses, and spending and debt are falling as a percentage of GDP. In the 1999 fiscal year spending in the core Crown sector was 33.8 per cent of GDP. In the current financial year it is expected to be 31.1 per cent. Gross debt was 33.8 per cent of GDP. This year it is forecast to fall to 25.7 per cent.

These amounts do not take account of the financial assets that are accumulating in the New Zealand Superannuation Fund: a fund that has been set up to help cover part of the pension costs associated with a transition to an older population structure. Those assets are expected to be close to 3 per cent of GDP by the end of the current financial year.

Our economy – like any trading economy – has always been vulnerable to divergence: either the domestic economy moving ahead when the tradeables sectors are under pressure or vice versa. In the period between 1999 and last year, our export sectors experienced very strong income growth as a result of a coincidence of supporting influences: a depreciating exchange rate, strong commodity prices and good climatic conditions.

In 2002 the exchange rate started to appreciate quite strongly – and this has continued into 2003, although at a slightly slower rate. The effect on the export sector has been slow to emerge, partly because many export contracts were expressed in New Zealand dollars, partly because an appreciating currency lowered input costs, and partly because exporters held currency hedge contracts. Those factors are now fading and export incomes have come off their peaks by about 5 per cent. I stress come off their peaks, because their growth in the previous three years was very strong and they are still high by historical standards.

While the export sector has shifted from an accelerant to economic activity to a brake on it, the domestic economy has picked up and remains buoyant. A large part of that is due to the strong turn around in net migration, driven by fewer New Zealanders leaving, more returning from abroad and more foreigners seeing New Zealand as an attractive destination for study, work and living.

I should perhaps comment on the monetary policy stance that has emerged as a result of these trends. The central bank in New Zealand enjoys full autonomy in its operations in controlling inflation, but it excercises that autonomy under the terms of a Policy Targets Agreement between the Governor of the Reserve Bank and the Minister of Finance. This agreement changed when I became Minister of Finance and changed again when the previous Bank Governor left office and a new Governor was appointed.

The current PTA sets a target of keeping future inflation between 1 and 3 per cent on average over the medium term. In pursuing that objective, the Bank is required to avoid unnecessary instability in output, interest rates and the exchange rate.

The most recent statement from the Bank, notes that the exchange rate has been the least stable of those three indicators. Under those circumstances, there may be an expectation that interest rates would fall to stabilise exchange rate pressures but the Bank warns that a move like that could accentuate the divergence between the domestic and export sectors.

At the moment, our interest rates, both short and long term, are below historical averages – at least compared with the last ten years. But international interest rates are even further below international historical experiences.

The net effect is that we have relatively low interest rates by domestic standards but relatively high rates by international comparison. These are particularly attractive conditions for international investors, whether from the perspective of investing in financial assets or directly in productive activity. It is a good time to invest in New Zealand.

I must comment that this interest rate differential is not an unstable element of macroeconomic settings: we have good growth, low unemployment, low inflation and strong public finances – all strong foundations that should reinforce the attractiveness of the investment destination.

Looking forward, we do expect the economy to slow in the year to March 2004. It has hit a soft spot as a result of the combination of a number of temporary factors. These temporary factors include the dry weather conditions that impacted on some parts of the agricultural sector and on electricity generation, the slowdown in tourism and export education that accompanied the SARS outbreak, weaker dairy product prices and of course continued uncertainty and sluggishness in the global economy.

Our best estimate is that these are in fact temporary, and current indicators are that they are abating. The net effect is that we expect growth to slow to between 2.25 and 2.5 per cent before picking up again in the 2005 financial year.

Indeed, every time a new forecast comes out the downside risks arising from these temporary factors recede and the estimate of their short-term impact is reduced. Even the world economy seems to be lifting, although results are patchy and it is dangerous to draw too many firm conclusions on its prospects just yet.

As I have said before, whenever I come to meetings like this, I comment on how relaxed I am about the performance and prospects of the New Zealand economy, compared with my more anxious counterparts in Finance Ministries in other countries.

But I am quick to add that while our performance is good, we can and must do better. New Zealand slipped behind developed world growth rates in the latter part of the last century, and if we do not regain some of that lost ground we will struggle to attract and retain skilled and productive workers who might otherwise prefer to take their chances in higher per capita income environments.

The government has therefore constructed a framework within which we can pursue higher sustainable growth through an emphasis on innovation.

This growth and innovation framework has three core elements.

Firstly, we want to strengthen the foundations that are the necessary conditions for successful economic performance in an uncertain and ever-changing world. This means we need sound government finances, a competitive economy, a cohesive society, a healthy and skilled population, sound environmental management, a strong research base and a globally connected economy.

I think that you will find that even on existing foundations, New Zealand is a very attractive inward investment destination. We have a very stable macroeconomic environment, clear and relatively light handed regulation, a foreign investment friendly inwards investment framework, a skilled, hard working and by international standards cost effective workforce and last but by no means least, a safe domestic security climate.

We will build on that.

The second element of the framework is that we will build more effective innovation, through a mix of attracting and developing talent, creating new venture investment funds, making better linkages between tertiary institutions, industry and communities and by increasing global connectedness. Finally, we are developing areas where our natural advantages and aptitudes give us scope to boost growth and innovation. These are biotechnology, information and communications technology and the creative industries. These sector level competencies have applications across a range of industries.

These comments are somewhat technical, and I appreciate that investors like to get a feel for the political aspects that sit behind policies and programmes and that are likely to drive a government when it faces hard decisions.

I will therefore try and give you a flavour for the style and philosophy that guides our government.

There are seven pillars.

The first is leadership and partnership. We have rejected highly intrusive regulation, protection and subsidy, but we do not leave either the economy or society to the fortunes of the market. We believe in as much market as possible and as much government as necessary, but we go beyond that Clintonite expression of the role of the state. We feel that the government is uniquely placed in terms of responsibility and authority to take certain initiatives and to carry certain risks. This leadership and partnership role is expressed in our industry and regional economic development programmes.

Second, we are pro growth and pro innovation. We don’t want to restrict our vision to a redistribution of an existing economic cake. We recognise that many of our basic economic strengths have emerged from our natural and national capacities and advantages, and that they are the foundations of a brighter future. We see no problem with applying biotechnologies to traditional land based industries and seeing ourselves as a great centre for fashion and film making: both are natural components of an innovative and growing New Zealand.

Three: equity. We have a strong tradition in fairness and security for all and make no apology for keeping that at the forefront of all of the decisions we make. We are encouraged by the emerging research and analysis that concludes that a cohesive and inclusive society is not only valuable in itself but improves the performance of the economy by improving the effectiveness of networks, reducing litigation, and lowering transaction costs.

The fourth pillar is opportunity. Opportunity exists at many levels and can be unleashed from many sources. Creating opportunity improves skills, increases flexibility and adaptability and releases the incredibly inventive nature that resides deep down in the New Zealand psyche. Individuals, as well as regions and industries, must be given the opportunity to develop their potential and to follow their destinies.

The fifth pillar is a strong public service. One of the global lessons of recent years, from the smallest state to the largest corporate, is that strong ethics and good governance matter, are easily taken for granted, and take a long time and a lot of money to repair if they fall from grace.

Next, we will build a confident nation. Confidence is infectious and uplifting. For us, confidence is deserved. We are a small country a long way from the power centres of the world but we have led in many fields of human endeavour, from democracy to peace, from environmental respect to the forefront of scientific achievement.

Finally, we must respect our deserved reputation for being clean, green and sustainable. That means that some of the hard decisions on matters that we sometimes take for granted - like things we do on global warming – can not be put off or watered down.

If I run my finger over that list, it is a list that makes me comfortable within myself, but it is also a list that spells out where the world wants to go.

My message is that we are not resting on our laurels or leaving our fate to the whims of economic fortune. The trouble is that we, like you, face an uncertain future.

As we face an uncertain future, it is very important to take comfort in the fact that we have significant policy headroom and a range of policy options. This is not simply fiscal headroom. The monetary authorities have room in which to move. Our interest rates are relatively high compared with those in the rest of the developed world. Fiscally, there is scope to respond on both capital and operating fronts.

If the economy does slow, we enter a slowdown with much more scope to absorb the labour market downside than we have had since the start of restructuring in the late 1980s. Corporate, farm and household balance sheets are in a reasonably healthy state. We have taken steps to expand trade opportunities, to plug some of the gaps in the venture capital market, to upgrade our training programmes, to align immigration policy more closely with skill needs and to rebuild the infrastructure: all factors that will make it easier for New Zealand firms to find their way in troubled times.

We can approach the immediate future with a lot more confidence than many other OECD countries, and I think that you can look at New Zealand as offering sound and attractive investment opportunities in a number of spheres.

I am happy to take your questions.

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