Hon Dr Michael Cullen
Deputy Prime Minister, Minister of Finance, Minister of Revenue, Attorney General, Leader of the House

17 August 2005 Speech Notes

Financial Planners and Insurers Association Debate: The pathway to the top quartile of the OECD

Langham Hotel, Symonds St, Auckland

The question up for debate today concerns the pathway that New Zealand must take in order to be in the top quartile of the OECD in terms of economic wealth. But before I give my view on that, it is important to fill out two important pieces of context.

First, while New Zealand has for some time been positioned towards the back of the OECD pack in terms of per capita wealth, we are much better placed on a range of indicators of social wellbeing, including a variety of indicators of health, child poverty, educational achievement and personal security. Indeed we are already in the top half of the OECD on two thirds of the measures where there is comparable data, and we are continuing to climb.

In other words, our quality of life, such as it can be measured, is generally high in OECD terms, and improving. That trend is very relevant to this debate, in that our future economic wellbeing depends to a large degree on keeping skilled New Zealanders at home and attracting the skilled migrants we need. Within the Labour economic strategy, social wellbeing in its various forms is a goose that lays golden eggs for the future of the economy.

The second important piece of context is, of course, that in the last five years we have already been increasing our economic ranking within the OECD. We have posted GDP growth consistently ahead of the OECD average over that period, and as a result have made up considerable lost ground, to the point where we are now starting to reel in the nations immediately ahead of us.

Our economy has expanded by some 20 per cent in the last five years, and household incomes have risen by around 11 per cent on average during that period. This is despite economic conditions that were something of a mixed bag.

On the positive side, we have benefited from some buoyant world commodity prices and from the flow-through effect of the trade liberalisation gains made in the WTO. Immigration flows have been consistently positive, and this has maintained momentum in a very strong domestic economy.

On the other side, the last five years have seen a persistent weakness in the global economy that has been exacerbated by the spectre of global terrorism. That has meant a loss of confidence in some of our key trading partner economies, which has also had a part to play in keeping the New Zealand dollar significantly above what most economists would see as its fair value.

So we have thrived in conditions that were not exactly ideal. Even so there is ample opportunity for us to take a wrong turn and leave our current pathway. In my view, there are three key priorities we need to address to avoid that:

- We need to acknowledge what we have done right in the last five years and ensure that we keep doing those things;

- We need to prepare for the more mountainous terrain ahead, in particular the need to improve our productivity in light of the capacity constraints we are hitting; and

- We need to avoid some obvious potholes.

First, what have we done right in the last five years? As an exporting nation we have continued the process that has in fact been under way for several decades of shifting the balance of our export economy away from commodities with their vulnerability to the volatile cycles of world commodity markets, towards a more diverse range of products and services, and also towards exports with a higher value added component. Thus our tourism industry has been investing in the kind of tourism product that appeals to higher spending tourists and keeps them here for longer.

Similarly, research reported late last year confirmed that, for the first time, value added food and beverage exports represented more than half the value of our total food exports. Value added food and beverage exports increased by 7 per cent from 2002 to 2003, up to 53 per cent of our total food exports.

This kind of change in the structure of our export economy is something New Zealand businesses and governments have been working towards for several decades.

The second thing we have done right is maintaining fiscal strength and stability. This is one of the things that business people are generally aware of only when it is absent. In the last five years we have run a conservative fiscal policy. We have made significant progress in reducing public debt, and, despite what my opponents allege, we have controlled government spending relative to GDP, so that we now spend around 10 per cent less than in 1999. That shrinking of government has been at a time when most OECD countries either held government expenditure steady as a percentage of GDP or increased it slightly.

Our third success is that we have maintained and enhanced one of the advanced world’s most competitive regulatory regimes for business. That includes a tax system which in international terms is a model of simplicity and transparency. I appreciate that this is not a popular view, but it is a view that is confirmed repeatedly by our high placement in comparative international studies by generally conservative bodies such as the OECD and the IMF.

Of course, that is no reason for complacency, and this government has a very good track record in consulting with business on ways to reduce compliance costs and acting quickly on those consultations. Over the course of 2004, the government announced 104 reductions in compliance burdens.

The fact remains we are making good systems better. If we set our tax system, or our planning laws, or our labour laws, alongside those of the remainder of the OECD, I doubt that any New Zealand business owner would opt for a swap.

The fourth thing I believe we have done right is to throw away the fantasy that overtook us in the 1990s that a kind of Darwinian laissez-faire was the only way to approach economic strategy. As the Chinese say, “The peasant must stand on a hillside with his mouth open for a very long time before a roast duck will fly into it.”

In a small economy we simply do not have the time to wait around for market forces to align what is happening in the various parts of the wealth generation process. We inherited a system in which trade promotion, science, higher education and the capital markets were all supposed to respond to market signals and work together. The reality was a lack of focus, dissipated energy and poor coordination.

We have endeavoured to turn that around, not by a return to central planning of any kind, but by creating partnerships with key sectors where we bring into line all of the elements needed to create and sustain growth. That includes coordinating science and industry training, building the capacity of the domestic venture capital market, and promoting better cluster activity amongst complementary businesses, both in New Zealand and in offshore markets.

As you would expect, there is some risk attached to being proactive in this way, and we have accepted that as a necessary evil. However, it is churlish to criticise the occasional failure and overlook the successes. More importantly, these partnerships are creating better information flows to guide the actions of industry leaders, regulatory agencies, tertiary education providers, and investors.

So to keep ourselves on the pathway we need to carry forward the set of policies that is delivering tangible results for New Zealand’s economy. However, there are some major challenges ahead; in particular, as I said, we need to improve our productivity.

That means three things:

- Improving the skills level of our workforce;

- Boosting investment; and

- Creating a world class infrastructure.

These are all long-term endeavours, but they are endeavours in which New Zealand lost the plot during the 1990s. As a result, we are only now starting to get them back on track.

In the last five years the government has virtually reinvented industry training and the apprenticeship scheme. We inherited a skills culture that venerated the chiefs but paid little or no attention to the Indians. The truth is the successful economies emphasize both the high level skills that drive technological advancement and the mid level skills that drive productivity.

We have emphasized both as well. Budget 2005 included $300 million over the next four years to develop quality tertiary education, and an additional $45 million to expand Modern Apprenticeships and Industry Training.

Recently the Prime Minister announced another 5,000 Modern Apprenticeships, taking the total number to 14,000 by 2008. This is part of our broader goal to have 250,000 people participating in structured industry training.

More broadly we have turned around a tertiary education sector that had been growing in a largely unfocused way under a market model where institutions were rewarded for enrolments rather than results. We are reorienting the polytechnics to become the engine room of skills development, rather than having to pursue bums on seats through flighty courses of limited value.

And we are ensuring that tertiary providers are much better hooked into the workforce needs of local and regional industry, and design their programmes around what skills are needed in their local economies. That is why we are introducing higher funding rates for technical and scientific subject areas including science, trades, technical subjects, agriculture and horticulture.

We also announced recently that student loans will be free of interest to students while studying and after graduation, so long as they remain resident in New Zealand. That effectively encourages individuals to invest more in skills than they would otherwise. I have to say this is not a move we would have contemplated prior to this year. It is appropriate now that we have better steering mechanisms for the tertiary sector as a whole to ensure the quality and relevance of courses.

A more skilled workforce needs a higher level of capital investment if it is to meet its full potential. When we came to power, domestic savings and investment was a relatively weak suit, and we have taken measures to improve that.

We have provided direct support to the venture capital market through support for business incubators, Trade NZ’s Escalator programme, and the New Zealand Venture Investment Fund Ltd (VIF), which manages a number of programmes, including the recently announced $40 million Seed Co-investment Fund (SCIF) targeted at SMEs.

And we have provided indirect support through changes to the taxation of venture capital, the recent changes to R&D depreciation and the remedying of several flaws in our investment taxation regime that encouraged investors to chase tax advantages.

We are also acting to improve New Zealand’s domestic savings rate through the KiwiSaver scheme. This scheme will build a wealth management and share owning culture on top of our existing savings culture which is focused largely on residential property. What we know is that domestic savings, when invested under a diversified strategy, exhibit a ‘home bias’. This means that over time we will see an increased pool of savings seeking productive employment within New Zealand.

The third plank of our strategy to increase productivity is infrastructure. It is hard to be productive when you are crawling along the Southern Motorway.

We have reversed the decline in infrastructure spending in the 1990s and are now spending at a rate around 80 per cent higher than our predecessors with the total funds available to the Land Transport Fund over the next 10 years around $23.5 billion, including the various regional packages the government has announced.

We are also investing in the power and water systems that will serve a world class economy, and our telecommunications policy is encouraging investment in broadband technology and increasing competitive pressures so as to lower prices for businesses and ordinary consumers.

These three strategies – skills, investment, infrastructure – constitute the long game in terms of increasing productivity.

The final thing we need to do to stay on the pathway is to watch out for potholes and other hazards, such as crazed spectators running onto the road. Two such hazards spring to mind.

The first is the kind of fiscal loosening that the OECD itself warned about in its Economic Outlook on the New Zealand economy issued earlier this year. They stated that “any additional fiscal stimulus beyond that already planned could put the projected soft landing at risk and would need to be offset by higher interest rates in order to bring the economy back onto a sustainable growth path.”

What this means is that our fiscal options are limited if we are serious about meeting head on the need for future stability. Looking out over the next decade, it is clear that the expenditure risks are all on the upside in areas such as health and education. The risk on New Zealand Superannuation has been brought under control, but only if we continue to build up the Superannuation Fund.

The OECD is making a simple equation: large scale tax cuts or large scale expenditure increases risk destabilising our economy and choking our growth.

The converse risk is that of cutting public services so harshly that we undermine some of the essential supports for our economy, such as biosecurity, or undermine the confidence of ordinary New Zealanders in their quality of life. During the 1990s we went down the route of divisiveness and two-tier health and education. The economic effects of that should be obvious.

It is no coincidence that, in the last five years, alongside restoring the quality of our public services, we have seen a restoration of confidence in our economy. We already enjoy a quality of life that ranks highly in the OECD. And we are firmly on the pathway towards the top quartile in terms of economic wealth.

Thank you.

ENDS

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