Thursday 26 May 2005

Cullen Address to Manawatu Chamber of Commerce

Vision Manawatu, Square Centre, Palmerston North

My aim today is to talk about the medium to long term outlook for the New Zealand economy, and to link that to the economic strategies of the government and particularly those contained in last week’s Budget.

The budget has been criticised for delivering too much in the future and not enough in the present. Those who make such statements clearly have not read the text, since it contains a great deal in terms of assistance to business and improved public services, both of which will come on stream as soon as is feasible.

The first thing to note is that annual GDP growth for the next two years is forecast to be around 2.5 per cent. Were this still the New Zealand of the 1990s, or if we were in almost any other country in the OECD, this would be cause for wild celebration.

Neither of those is the case, of course. Coming off a five year period of sustained growth at over 4 per cent per annum, these forecasts have the look and feel of a downturn.

We need to be careful not to miss the larger picture. In particular, we need to beware the temptation to make radical changes in economic policy simply because of a soft landing, especially when that soft landing merely brings us back towards the OECD average.

The important question is, or ought to be: what was it that enabled us to sustain growth at around 4 per cent for so long, and how can we build on that obvious resilience? In other words, how do we play the long game?

My response is three-fold:

Stable fiscal policy based on maintaining prudent levels of debt;

Increasing productivity through investing in relevant skills, physical capital and intellectual capital; and

Overcoming our disadvantages in the global marketplace by better collaboration, improving our capacity to innovate and freeing up world trade.

The budget has a great deal to say about each of these.

On fiscal policy, I fear I am becoming something of a Cassandra figure when I point out that a credible regime of future stability is fundamental to maintaining a positive business environment today.

In recent years we have reduced the perceptions of long term risk in the New Zealand economy by working hard at bringing down public debt.

Gross sovereign-issued debt has fallen from 35 per cent of GDP in June 1999 to an estimated 22.6 per cent at the end of June this year. Alongside this, the accumulated assets in the New Zealand Superannuation Fund will stand at around $6.5 billion. The programme of future transfers into this Fund neutralise the impact of one of the most significant aspects of long term risk: how to meet the needs of an ageing population.

Gross debt is forecast to move to about 20 per cent of GDP by the end of the forecast period, and to remain around that figure over the ten year projection period beyond that. Any proposal to increase that debt track, be it a significant cut in tax rates or a significant increase in baseline expenditure, will inevitably increase the likelihood of sudden and disruptive tax increases in the years ahead. That will have an impact on how the international financial markets and credit rating agencies view New Zealand and this will immediately be built into interest rates.

That does not mean we should lock in the detail of current fiscal settings in perpetuity; only that we need a very clear rationale for changing it. Cutting taxes in response to a large surplus one year, when forecasts show that surplus diminishing in the ensuring years, and indeed becoming a deficit in cash terms, is mere folly in anyone’s book.

That is where I want to turn the focus to increasing productivity. For an economy like ours this is the only game in town, and it is one in which our options are becoming focused around improving skills, and investing in technology. We do not have a large hinterland to bring into production. By and large our natural resources are already being tapped to something near capacity.

Our long term success depends upon getting better value per hectare of productive land or seabed, a better return per tourist, and a greater proportion of our income derived from intellectual property.

That means increasing the average level of skills in our workforce by a combination of targeted immigration, social policies that assist those with small children to continue their careers, workplace training and changes to our education system so that it continues to produce excellence at the top end, but solves the problem of the long ‘tail’ of under-achievement.

Hence the budget’s tertiary education package which provides close to $300 million over the next four years to develop quality tertiary education that is highly relevant to the skills needed in the economy. It includes higher funding rates for technical and scientific subject areas including science, trades, technical subjects, agriculture and horticulture.

There will also be an additional $45 million to expand Modern Apprenticeships and Industry Training.

Previous budgets have included measures to increase workplace participation amongst those caring for children, and have also recast our immigration policies around the notion of active recruitment of the kind of talent New Zealand businesses need.

Budget 2005 adds another element to the mix, in the form of a temporary tax exemption of five years on foreign income for people who are recruited to New Zealand to work, be they foreigners or New Zealanders who have been living abroad for ten years or more.

Productivity is also the driving consideration behind the other aspects of the budget’s business tax package. This is aimed at ensuring a more productive use of capital and improving New Zealand's access to worldwide capital, skills and labour. Beyond the tax exemption on foreign income, the key elements of the package are:

Changing tax depreciation rates to reflect better how assets decline in value. Depreciation rates for short-lived plant and equipment will increase and rates on buildings will reduce.

Raising the low-value asset threshold from $200 to $500, thereby reducing compliance costs from having to maintain fixed asset registers;

Better access to tax deductions for R&D expenditure for companies who bring in new equity investors, so as to match the growth cycle of technology companies.

Finally, a range of tax simplification measures including alignment of payment dates for provisional tax and GST and changes to FBT.

The cost of these and other tax measures in the budget will be an estimated $1.86 billion over the forecast period. This will be partially offset by revenue from the new carbon charge of around $720 million over the same period. However, we are talking of a net reduction in revenues of over $1.1 billion from these measures.

The third aspect of the long game for the New Zealand economy is overcoming our disadvantages in the global marketplace by better collaboration, improving our capacity to innovate and freeing up world trade.

Since coming to power in 1999, the government has sought to collaborate with the business community in addressing this need, and the result is the Growth and Innovation Framework which Budget 2005 continues to support with fresh investment. This involves:

$31 million to increase the gains from international economic partnerships;

$49 million to implement the digital strategy announced earlier this week;

$72 million to increase support for business research and development; and

$118 million to increase capability in scientific research.

These are investments in programmes that are already working for New Zealand businesses, boosting our productivity and expanding our capacity and the return on our skills.

So in summary, Budget 2005 is unashamedly future focused. While some of the lead times are longer than many would wish, we need to take a responsible approach whether we are implementing a change to tax rules or making a strategic investment in education or science. I do not need to remind you that in government as much as in business those things that are done with care are the things that have the greatest long term effect.

Thank you.

ENDS

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