A problem awaiting the new government

Whichever party, or group of parties, gets to form the next government will face the same facts about our disappointing economic performance.  As I noted a few weeks ago, based on the recent PREFU projections, not even Treasury seemed to rate very highly the chances of meeting the National-led government’s export objective.

Here is the share of exports in GDP, showing actuals for the last decade or so, and Treasury’s projections for the next few years.

x to gdp

By the end of that forecast period, there will only be four more years until the goal of a much-increased export share of GDP was to be met.  On these numbers, exports as a share of GDP would by then be at their lowest since 1989, 32 years earlier.  So much for a more open globalising economy.

One of the indicators I like to use is a rather rough and ready decomposition of real GDP into its tradable and non-tradable components, first developed by an IMF staffer looking at New Zealand a decade or so ago.    It assigns the primary sector and the manufacturing sector components of real production GDP, and the exports of services component of expenditure GDP, to the tradables sector –  the bits where New Zealand firms are competing with the rest of the world.  The rest of GDP is classed as non-tradable.    It isn’t a precise delineation by any means: some local manufacturing isn’t really tradable (due to high weight and low value, and thus transport costs) and, for example, the electricity generated for Comalco is, in effect, tradable.   But, broadly speaking, it seems to capture something meaningful about the New Zealand economy.  In the early days of the National government, then Minister of Finance Bill English was quite keen on it.

All economies need firms in both tradables and non-tradables sectors.  So one sector isn’t inherently better or worse than the other.  But countries that are catching up with the world-leading economies tend to be ones in which the tradables sector (exports and import-competers) lead the way.  In such economies, firms are finding more and better, more lucrative, ways to tap the much larger global market.  Of course, we also gain when the non-tradables sector is becoming more productive –  both directly as consumers, and as a reduction in the input costs of tradables sector firms.    But there is a limit to how many cafe meals we can serve each other.  There isn’t really a technical limit on, say, how many smart ideas, translated into appealing products, that firms in a small country could sell to the rest of the big world.

As well as dividing real GDP into tradables and non-tradables components, I’ve also expressed both components in per capita terms.    Over long periods of time, most real economic series trend upwards, and actually it is something like per capita production or value-added that matters most in looking at gains in material well-being.   Here is the latest version of my chart, updated for last week’s GDP release.

t and nt components to jun 17

The series do bob around a bit.  The tradables sector, for example, had a very good June quarter on the back of a couple of tourism one-offs (the World Masters’ Games and the Lions tour) but then it had had a poor year last year.   But what I try to draw attention to is that (a) the peak in the tradables series was as long ago as 2004, and (b) real per capita tradables sector output is now no higher than it was at the end of 2000, almost 17 years ago.  Across the whole terms of two governments, one National-led and one Labour-led, there has been almost no growth at all in the real per capita GDP of the tradables sector. None.

Some economists really don’t like the chart.  So lets look instead at each of the components that make up the tradables sector measure.

tradables components 2

Services exports, in real per capita terms, did very well in the 1990s, growing quite strongly until around 2002.  But, overall, almost no growth since.   The mining sector briefly did very well around 2007/08 when a new oil well came on stream.   And, in per capita terms, the agriculture, forestry and fishing component of production GDP, and the manufacturing component, have gone almost nowhere over 25 years, again in real per capita terms.

What changed 15 years ago?  Well, one of the things that has changed a great deal is the real exchange rate.  Here is a chart of the Reserve Bank’s index, showing an average for the last 15 years (as well as one for the previous few years).

rer to july 17

It is unlikely –  all but inconceivable in fact –  that if we keep on doing what we’ve been doing for the last 15 years or more, in terms of economic policy settings, that we’ll see any sustained per capita growth in our tradables sectors.  It is that old line about a definition of insanity being doing the same stuff over again and expecting a different result.

Even to sustain those sectors at the sort of flat levels –  no growth at all – we’ve had over the last 15 years or more has involved the significant subsidies of (a) unpriced pollution externalities especially around water, (b) significant direct subsidies (to, most notably, the film industry) and (c) significant effective subsidies to the export education industry (by offering a bundled product where students can pay for an education –  in some cases an “education” –  and get preferred access to work and residence visa entitlements too –  that benefit being provided free to the providers by the New Zealand government).

I’d be very happy for a new government, of whatever stripe, to deal directly to any or all of those distortions.  But they, and their advisers, need to bear in mind that exchange rate chart.   Unless the real exchange rate falls quite materially, it is difficult to envisage much growth in other tradables industries to replace the shrinkage in the subsidised industries.  (It was exactly the same issues policy advisers faced when we started liberalising, and stripping away earlier subsidies, in 1984.)   Real exchange rates can’t be managed directly, but they can be materially influenced by removing the sorts of other policy distortions that put intense pressure on domestic resources, and drive up the prices of non-tradables relative to tradables, skewing the economy away from the tradables sector.

I’m not optimistic about prospects, but the good thing about pessimism is that one can, just occasionally, be pleasantly surprised.


30 thoughts on “A problem awaiting the new government

  1. I have said this before – it is self-evident – if we keep importing migrants into NZ without ensuring the productive component of the influx is directed into the tradeable sector then the tradeable share of GDP must decrease – it has to – the mathematics tell you


    • NZD is the 11th most traded currency in the world next to China on the 10th most traded currency. The NZD value has nothing to do with migrants because the traded value is supported by speculative traders around the world.


  2. This echos something I read recently about a small ‘rust belt’ town in the USA where the author said he grew up in a town surrounded by factories that made things but since 1990 no new factory had opened but plenty of shopping malls have been built around his town. Now job opportunities are in low paid retail. Similarly since arriving in Auckland 15 years ago many green fields are now shopping malls but new factories have been shy to announce their presence.

    A young Kiwi is usually happy to work in a job where they have international travel with various perks so the skills and motivation should be there. Maybe with fewer young Kiwis starting families they are less attached to NZ by family and the usually superior environment for bringing up kids so they just move to a foreign city to look for a career. So partial solution would be (a) Australia and Europe to be less accommodating to skilled young Kiwis (b) financial incentives for children [remember universal child benefit – remember how having children stirs up ambition] (c) encourage investment in industry by dissuading investment in property?


    • Bob

      On your possible solutions:
      – Australia is already less welcoming to NZers than it was (not just the current cyclical weakness, but the progressive tightening of rules/entitlements
      – we don’t have too many houses (given the number of people) but, if anything, too few.

      The answer seems unlikely to be having even more people (even if they are NZers not leaving). It isn’t that NZers aren’t entrepreneurial, just that – outside the non-tradables sector – there don’t seem to be many opportunities in this remote location (which we can’t change) at these sorts of real exchange rates (which we can influence, by doing less to drive up the population growth rate.

      The outflow of NZers to Australian that really began in the mid 70s was, largely, “a good thing”. It was a bit sad, for individuals and perhaps even for towns, but it was better than the alternative (staying where the opportunities no longer were). But the NZ psyche is (understandably) very reluctant to grasp that point or (perhaps expressed in a more balanced way) see things that way.


      • By ‘accommodating’ I meant ‘obliging’ not literally. The unstated point being it is out of our hands – it is likely the absolute academic cream will always move but it is probable other countries will increase restrictions for unexceptionally skilled Kiwis.

        Presumably the productivity lifters are a small subset of dynamic and highly curious self-confident individuals. Not necessarily strongly academic but certainly happy to travel.

        Your point about exchange rate is well taken – my job for the last 7 years was contract programming for a business selling aircraft parts – almost entirely export and almost entirely sold in US$ and the owner kept waiting for the exchange rate to get below 0.6; with 10,000 international suppliers of aircraft parts it was competitive. They closed down earlier this year.

        Looking for the next Apple, Samsung, Nokia, Lego, etc is day-dreaming but small businesses selling say cheese, fruit liquors, ax handles, flax weaving, yachts, etc could export successfully based on NZ’s reputation (surprisingly good) and our low wages. PNG was full of Kiwi accountants; they were liked because they interacted well, were competent without trying to protect their job but mainly they were cheaper than Poms and Aussies.

        If NZ sinks much farther economically compared to other countries then almost all our young talent will leave.


      • This is where I disagree. The next Apple, Samsung, Nokia is not beyond New Zealanders. It really boils down to the depth of our Capital Markets. Leadership to build those and entities to encourage those entities to grow to that size does require either the depth of capital markets or the subsidies that the government is prepared to spend to assist in the incubation of such large entities.

        Government backed and supported entities are huge. Look at the old tech companies like Telecom or Air NZ or our batch our power companies. All of which require substantial investment by the government. There is no reason why we cannot build a equivalent Samsung in NZ.


      • Rocket Lab CEO Peter Beck revealed the company plans to build a rocket and launch into space every week.

        CEO Peter Beck told Newstalk ZB’s Early Edition the company had six rockets in various stages of production in New Zealand and Los Angeles and the goal was to get production time down to a week.


        Here you go. Our very own Samsung opportunity. Space the final frontier. We have a technology adge. Now it boils down to how significant do we want this new budding opportunity and how large a company pretty much is dependent on access to capital.


      • Yes, good stuff. I wish them all the best, but by all accounts it is an incredibly competitive industry. I’m afraid it still reminds me of all the individual initial success stories people have fixated on for at least 40 years, few of which in the end amounted to very much here. Some did of course.


      • In a similar sort of initial investment in Air NZ, tha government could become the incubator or angel funder launching Space NZ offering commercial flights in competition with Elon Musk’s Space X. It boils down to how much we are prepared to dream it and to risk it.without the depth of our capital markets to provide the risk capital, the government has to provide the leadership and the capital to launch such businesses. Samsung was created from the subsidies provided by the Korean government in the form of direct annual subsidies plus favourable tax breaks.


  3. Self-deluded Self-sabotage

    Don’t care how you dress it up … this is hilarious

    “not even Treasury seemed to rate very highly the chances of meeting the National-led government’s export objective”

    Nobody is prepared to say it as it really is – a huge fail


  4. A history lesson … During the 1980’s a number of high flying businesses originated in NZ reached a size where they could no longer achieve growth in NZ so they established operations into Australia. Brierley Corporation, Industrial Equity, Alan Hawkins Equiticorp, Bruce Judge and Judge Corporation and later Ariadne. Unfortunately the skills they possessed did not translate successfully overseas. They all imploded. Then in late 1970’s Fletcher Group amalgamated with Challenge Corpn and morphed into Fletcher Challenge. Fletcher challenge decided it had to become internationally competitive and began a drive of rationalisation and divesting itself of any labour intensive activities or any business if could not be the biggest fish in the pond. It branched out overseas. Again the dominance it had established locally did not translate overseas at all well and most of the group as we knew it then has gone. On the Australian front exactly the same problem exists. Whenever a company ventures north is doesn’t end well. BHP failed with Magna Copper in Brazil. NAB (National Australia Bank) has had 2 massive failures in its ventures into UK and USA. Funnily enough most Australian intrusions into New Zealand are successful. Banking and Insurance are 2 examples


    • As an aside, Fletcher Challenge was a partner in the initial Tiwai Point aluminium smelter exploratory evaluations with Comalco – in the final analysis they waved it away as the capital commitment was to large and a failure would wipe the whole group out


      • I was part of the internationalisation at FCL (not involved in anything to do with Tiwai). According to Hugh Fletcher there were negotiations to participate in Tiwai Point


    • I was with Fletcher Challenge Property Division and at the time undertook the acquisition of all the major shopping malls in Auckland, Chartwell Square in Hamilton and also shopping malls and commercial buildings in Wellington under a CEO headhunted from Singapore, Paul Chaston.

      If I recall, the main issue with Fletcher Challenge was its gearing ratio which was predominantly 40% debt funded acquisition. The capital markets did not have sufficient depth to fund its continual growth as the population was far too small given its dominant size. It was also a period when interest rates was rising affecting the groups profitability. The Fletcher Challenge Board took fright of the increasing pressure of high interest rates and started an asset sell down after firing Paul Chaston and his replacement was Mark Binns.


      • If the Fletcher Challenge Board did not panic and sacked a highly skilled Singapore property investor and developer and replaced him with a not so skilled just out of University lawyer to run that business Fletcher Challenge would still have owned all the major shopping malls in Auckland, Hamilton, Christchurch and Wellington.


  5. In the case of the UK, a 20%-ish fall in the GBP hasn’t resulted in an export boom yet. Do you see that as down to Brexit worries, or are there macro factors at play?


  6. It is only a year (and in NZ at least standard assumptions about lags from the exch rate to exports are more like 18-24 months), but more importantly the fall is partly about genuine and huge uncertainty about the future regulatory environment. I can’t imagine businesses are keen to invest much to take advantage of a lower exchange rate until that is much more resolved.

    (A bit as it might be if, say, we clamped down on water pollution and agric methane emissions, and then somehow managed to get the exchange rate down. One would offset the other, but one wouldn’t expect to see an overall lift in exports).


    • It is interesting to speculate as to what the economy would look like if say savings rose miraculously and the NZD fell 20%. Would Delegat’s, Fisher & Paykel, Rakon and Sanford get much bigger? My own view is that you would see a new generation of startups come through that actually make things, perhaps artisanal furniture, cheeses, jewelry and the like.


      • I think it would be a mix of things. I suspect we’d see increased capital intensity in agriculture (see Hollad), some growth in the existing businesses (including tourism, which might require more congestion pricing etc), more retention of the firms that now gravitate offshore or are taken over and offshore quite quickly, as well perhaps as some of the sorts of new products you talk of.


      • I think you also saw that fantastic NatGeo article on Dutch agriculture. I have been speaking with a number of companies involved in “Internet of Things” tech to optimise use of water, herbicide, fertiliser etc and the opportunities there are almost boundless.

        Xero has proved SaaS can work in NZ, and I think even manufacturing can work, provided it’s sufficiently integrated with contract manufacturers in Asia.


  7. Time will tell with Xero. It still hasn’t made any money (fair enough and not surprising at this point) and the open question is whether if/when looks like doing so it won’t be more valuable based abroad and/or primarily owned abroad. If it isn’t, and really can reach world levels of profitability here that would be telling.

    I’m more sceptical on the manufacturing side of things. What will change that will mean it will happen now when not for the last 50 years? A sustained lower exchange rate would certainly shift the economics for some, but it sounds a stretch for more than a few. I don’t think there are many such firms operating even in western Wales or northern Scotland, which are a lot closer to major markets and value chains than we are.


  8. What has changed is that you can now get most things contract manufactured in Asia at quite low production runs and can be shipped from Asia to the target market. This is not the same as outsourcing, as the design and prototyping is still done locally, as well as other high-value activities like marketing. If the product is sophisticated it will be cloud-connected and reliant on regular firmware updates, so the threat of copying is less relevant. In many cases tech firms are able to sell their product as a service, as Rocket Lab is successful doing with its Electron rocket.

    As far as I am aware, small teams of engineers in NZ are still competitive with more expensive teams in Silicon Valley. Furthermore, large corporates seems to struggle with product development relative to startups (e.g. witness EDMI’s failure to design a good small smart meter). Something like a car or a smartphone could never come out of NZ (because there is just too much coding and design) but a specialised device like a water meter or a robotic milker could. The hard part, in my experience is getting to the point where contract manufacturing becomes possible, because until that point you are dependent on low production runs and a patchy local manufacturing skill base, so your price is totally uncompetitive. That is why successful founders have to have maniacal self belief.


    • OK, I see what you mean. I guess the (empirical) question is whether it is the bits that would still happen in NZ that might be some of the bits most prone to the apparently increasingly importance of personal contacts/connnections/ closeness to supporting top-notch research institutes etc.


      • Lack of face-to-face connection is a huge disadvantage, I don’t doubt it. However, there are advantages in having a rather unusual culture and geography and a high per-capita endowment of dreamers, inventors and enthusiasts. My feeling would be that if we removed the macro obstacles holding us back we would end up somewhere short of a Boston or a San Francisco metro area but we should still be able to beat a Slovakia or a Slovenia.

        Liked by 1 person

  9. I’d probably be a bit more optimistic (at least on one dimension). With all the skills of our people etc I think we could muatch material living standards almost anywhere in the advanced world, so long as we don’t overdo the number of people. Reykjavik does. (And actually Australia does)


  10. ….still get stuck on why foreign capital flows in if there is no productivity: higher real interest rates backed by a lack of productivity seems an unusual situation? (in theory); And I recall an argument that the OCR should have been cut further to allow domestic / non-tradeable inflation to run higher to hit 2% given downward pressure on tradeable prices – but that would suggest a higher real FX based on above? perhaps I am mixing messages and real vs. nominal developments….any help appreciated (!!).


    • re your first sentence: yes, a very unusual situation, and yet it is just what we’ve seen in NZ for decades. It is a measure of how badly unbalanced our economy has become. But it can happen when you get persistent demand pressures, unrelated to productivity, in a climate with a modest savings rate: big increases in govt spending would do the same, but here the demand pressures have mostly come from the rapid population growth (all that capital stock that needs accumulating for each new person). Doesn’t happen in Singapore because, thru some mix of coercion and private choice, they have high private savings.

      On your second point, the important distinction is cyclical vs trend. Yes, I’ve argued that the RB shld have cut the OCR earlier/more because inflation is below target, but that is just about the current state of the cycle. On average over 25 years tho, they’ve basically delivered average inflation not too far from target – and over those horizons therefore it is real forces, not mon pol choices, that are driving the real exchange rate.


      • …ok, thanks heaps; though re demand pressure, per post the other day, investment has been relatively weak given population growth (like chasing shadows..); anyway, will go back to the eco 101 class! (mind you, the RBNZ paper by Bernard Hodgetts “Household saving and wealth” helped on the modest savings observation..); cheers


    • Higher interest rates does encourage more bank deposit savings. More bank deposit savings does not equate to higher investments in the productive sector or in higher productivity. Nothing really about higher real interest rates is a driver for productivity because it is the opportunity returns that determine where investments are made. Therefore your economist theory is already fundamentally wrong.


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