SPEECH NOTES: HON JOHN LUXTON

"On to greener pastures"

Dairy Farmers of New Zealand

Quality Inn Hotel, Wellington

23 June 1999

(check against delivery)

Mark Masters - Chairman Delegates and guests.

Thank you for the invitation to speak to you today.

Dairy farmers are currently facing the biggest change the industry has contemplated in many years. I'm sure that there will be much debate and discussion about this at your conference, so I thought it would be useful if I filled you in on where the Government is at.

The industry has come a long way. From previously having had over 200 dairy processing co-operatives in the Waikato alone, we now have only eight in New Zealand. Costs have come down (as have commodity prices) and on-farm productivity has improved.

But the challenges that the industry faces are only getting bigger. Decreasing commodity prices, unfair trade barriers, increasing vertical integration and an increasing rate of innovation around the world all mean that change is no longer a choice, it's a commercial imperative.

In response to these pressures, your leaders and executives have proposed a far reaching plan which will potentially change the dairy industry as we know it.

It will come as no surprise that I am very much in favour of the direction being taken for most aspects of that plan, but there are still a number of important details which need to be resolved. And there are also some concerns which I will come to shortly.

I am well aware of your organisation's contribution to both the debate and the reform. Many of the shortfalls of the existing structure, as well as proposals for change, have been voiced by Federated Farmers and DFNZ leaders for some time - well before they were publicly acknowledged by 'industry leaders'.

As with similar organisations, there seem to be conflicting views being expressed publicly by your spokespeople but that debate is healthy and I am sure it will continue in the next couple of days. In fact the debate has been occurring for some years now. In 1922 when formation of the Dairy Board's predecessor (the New Zealand Dairy Control Board) was being debated, the New Zealand Dairyman's Leader called the powers "absolute and autocratic ... designed to hand over to the Board the entire handling of the exportable dairy process of New Zealand ....Every Factory will lose its identity and its individuality.. Factory Directors will become non-entities."

A quick review of the New Zealand Dairy Exporter over the last ten years shows how much attitudes have changed as the industry moves to embrace changes which were not thought to be necessary a short time ago.

You know my view that the existing legislation impedes the industry from undertaking some desirable commercial activities which would be in farmers' best interests. Accessing outside capital when needed and enabling more market oriented price signals are just two of the planks of the industry's restructuring proposal which I believe are long overdue.

The Dairy Board's recent independent report from McKinsey's International consultancy has shown very real risks to the New Zealand dairy industry if it does not make change and rapid change in its structures and legislative environment.

Over the last six months, since the Dairy Board responded to the Government's request for a strategic plan, talks between us have gathered momentum. And progress has been good.

There is much agreement between the Government and the industry on the areas of reform. The industry has done a remarkable job explaining the need for reform to farmers in such a short period of time. And I commend them for their efforts.

There are a number of public policy issues that the Government is working through with dairy industry leaders as we seek to accommodate the industry's desire for change.

These include the single seller concept in the current legislation; the competition law issues of a mega co-op; the issue of how farmers can retain their off-farm equity if they decide to leave the mega co-op; the need to protect quota markets for New Zealand farmers and the raising of levies for the public good aspects currently carried out by the Dairy Board while still encouraging innovation. There are also issues in relation to taxation and legislation which require a public policy approach. These are the areas in which the Government has a very legitimate public policy interest in.

One area where there is still some disagreement is the issue of the so-called "single desk". There is still a considerable element within the industry who believe that anything other than a single exporter from New Zealand is undesirable.

Now that the companies have merged and are approaching a mega co-op, things are different. The fear of "undercutting" and loss of "market power" have been ameliorated, not that there is any evidence that they were ever substantial. A mega co-op will lock in a marketing critical mass which the Dairy Board legislation currently provides. The question now is simple. Should we outlaw new investment in the industry by forbidding other companies from freely exporting?

In fact this question is even more relevant now we are facing the possibility of a mega co-op representing over 95% of existing production. This would in effect, give farmers only one organisation that they could effectively sell their milk to. The risks associated with all your eggs in one basket would be even greater. There would be no other New Zealand companies to benchmark performance against.

In effect, if farmers were not able to supply new companies to compete with the mega co-op, the downsides of the existing marketing monopsony would be extended to manufacturing also.

In fact the industry has proposed that the single desk legislation is no longer required if the mega co-op goes ahead. While I welcome that, we need to ensure that the legislated monopoly is not simply replaced by a monopoly in another form.

Currently your shares in the dairy industry could be worth a great deal of money. The success of the Dairy Board as well as the contributions made through retained earnings, mean they are worth a lot more than their $2 nominal value. This needs to be addressed to ensure a proper market price is paid if a new farmer decided to buy in, or if a retiring or disillusioned farmer wanted to opt out.

Changes being made now need to look to ways of protecting farmers equity over time and giving farmers some say over this, based on performance of their company.

I am excited by the concept of a mega co-op competing with the world's giants, but not if it rules out new companies (co-operative or proprietary) starting up in New Zealand. There are incentives on a company's executives and directors to try to retain a monopoly but if it remains, I believe it is you as farmers who will be the losers in the long term.

Much of your efficiency in milk processing has only come about because of previous competition in the manufacturing sector.

The dairy industry has chosen to apply to the Commerce Commission for an authorisation of the merger and I'm pleased with that decision. The Commission has extensive experience in weighing the benefits of competition against other factors like critical mass, and the Government will leave the decisions on merger competition issues up to them.

The challenge to the industry is to meet the normal requirements of competition law in New Zealand for all of its New Zealand activities, but it does not apply at all to the overseas activities of the industry.

The Government cannot direct the Commission in any way, but we are willing to facilitate the Commission's work by issuing a section 26 statement, outlining the Government's views on the changes in the dairy industry's regulatory environment being proposed by the industry to the Commission.

As I said, decisions on merger competition issues are up to the Commission. The Government will not, indeed it cannot, override the Commission's decision regardless of what it is. To do so would undermine New Zealand's entire competition policy and could put us in precarious position in some trade negotiations. I understand your industry leaders believe that they can meet the Commerce Commission's requirements in this regard, and have undertaken to do so.

We have also been doing a lot of work on quota arrangements. Quotas are a Government-to-Government arrangement, so strictly speaking they belong to New Zealand. But this Government is committed to retaining the benefits of dairy quota entitlements for New Zealand dairy farmers.

At the same time, we don't want quota to be abused as an anti-competitive weapon, since whoever holds the rights to access these lucrative quota markets, has an advantage over farmers supplying another company. We are busy trying to reach agreement with industry leaders on a system that will achieve this as well as fulfilling their aims.

There also need to be sufficient safeguards in place to ensure that the industry's impressive record in innovation continues. We have been working constructively with the industry to devise an industry good regime which targets the right areas and does not crowd out private enterprise.

We recognise that many of the industry's activities such as Dairy Research Corporation (DRC) and parts of Livestock Improvement Corporation (LIC) are best funded collectively and an industry organisation is the best way to deal with that. I'll be interested to see how your organisation responds to any such opportunities.

We have also been addressing other issues including tax and the best form for legislation. Our aim is to keep it as simple and effective as possible. We will be following standard Parliamentary process, so look forward to your input at Select Committee.

Make no mistake, in the MMP environment, it will be difficult to get legislation through without too many hitches unless the proposal is sound and well supported by farmers. There are a number of MPs, many in urban areas, who may not respond well to any exemptions or special treatment in new legislation for the dairy industry.

But the challenges the Government faces appear small when you compare them to those that the industry has to work through. Industry leaders and executives have an enormous task ahead in operationalising their proposal. They need to develop a package that best meets your needs as shareholders. And they need to consult with you and get your agreement to it - it's your business after all.

Dairy farmers will need to give detailed and critical thought in deciding on the best commercial actions for the future. And to do that they will need open debate, robust information and unbiased analysis.

There are also a number of commercial issues that the industry has to address, regardless of the merger proposal, and sooner rather than later.

I see the marginal milk 'problem' as containing two issues. The first is bundling of returns on equity in with payment for milk. I believe this gives the wrong price signals and encourages overproduction. As long as supply and shareholding are directly linked, this problem will continue. In the consumer business, the industry's proposal to consider outside capital not related to supply, will partially address this.

The second is the real value of a farmer's milk to the mega co-op which is likely to see greater price variations based on actual costs for things such as seasonality and functionality..

Farmers will also need to ensure that governance and accountability in the mega co-op is of an extremely high quality. Farmers, in fact the country, cannot afford to have a mediocre performer just because we weren't prepared to consider options which increased the responsiveness of managers to our needs. This can't be achieved overnight, but the longer we delay, the greater the potential loss.

You might say that once the legislation and competition issues are resolved, many of the issues relating to structure are none of Government's business - its your industry after all.

How you respond to commercial pressures is up to you as dairy farmers. You own the dairy co-operatives and the Dairy Board. You make the decisions, and you will either reap the benefits or suffer the losses.

Although today I have been concentrating on what has to be done, I cannot overstate the industry's significant progress to date. The dairy industry is New Zealand's largest and most important exporter. Its performance is critical to the New Zealand economy, and that performance to date has been impressive. But there are risks to the industry in spending too long in bringing about change.

Over the past six months or so, the industry has moved a very long way in facing the challenges of the market. Industry leaders have shown great vision and drive. And I am confident that they will continue to bring commercial, market-focused change to the industry.

Over the coming months, the Government will continue to work closely with the industry, and will keep farmers well informed of progress.

Finally I want to talk about the subject of free trade. As farmers you know the importance of access to our markets. You also know the difficulties we face as some countries don't quite practice what they preach - putting up barriers wherever possible. Even if the progress is slow, the government's efforts in reducing these barriers are significant because farmers livelihoods depend on it.

New Zealand has a world-wide reputation of reform - having reduced its import barriers and deregulated its industries over recent years. Too often I hear misguided critics say that our trade partners' reluctance to do the same makes a mockery of New Zealand's policy of opening up its markets faster than they do.

Its important to realise that the reforms we have implemented, both in terms of tariff reductions and deregulation of industry (including that advocated for the Dairy Board for example) should not be seen as part of a trade negotiation. The industry reforms talked about today are being advocated because they are good for farmers. This one to grow your industry to a $40b industry.

Likewise, the reduction of import tariffs has also been good for farmers. It has lowered the costs of your farm inputs be it the $10,000 saved on a new farm ute or the $40 on a new pair of gumboots. I have yet to see such a change that has worked against your interests. Despite Jim Anderton wanting to increase such tariffs again. Likewise dairy farmers can be pleased with a situation that has the lowest interest rates for over 50 years, low inflation and the removal of stamp and death duties. Government has worked hard to improve the New Zealand business environment for our export sector.

If these actions achieve improved market access so much the better but its wrong to judge their effectiveness against that benchmark alone as I have heard some suggest.

Reducing our protection benefits farmers and all New Zealand irrespective of what our trade partners do. As US Federal Reserve Chairman Alan Greenspan, said recently "If trade barriers are lowered by both parties, each clearly benefits, but if one lowers barriers and the other does not, the country that lowered barriers unilaterally would still be better off having done so."

The dairy industry is undertaking some major reforms which have the potential to improve the profitability and competitiveness of New Zealand's most important industry. As I said at the outset, change is no longer a choice it's a commercial imperative. We know that whatever we do we will always face difficult barriers in the international dairy market but I am confident that having grasped the nettle, the industry's future is bright. Thank you.

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