Section 1: Economic Overview
The Government's economic objective is to increase New Zealand's growth rate, so per capita income returns to the top half of the OECD and stays there.
This section outlines the challenges New Zealand must overcome to improve economic performance in this way. It discusses current trends in the economy, the importance of productivity as a driver of growth, and how government can influence productivity in New Zealand.
Finally, it describes how the Ministry leads development and implementation of the Government's economic development agenda.
The Economic Objective: Sustainable Growth
In its Growth and Innovation Framework (GIF), the Government set the economic objective of increasing New Zealand's rate of growth so that our per capita income returns to the top half of the OECD and stays there. To achieve this, our economic growth must exceed the OECD average for a prolonged period.
Income growth is important because it underpins the general well-being of New Zealanders. Other key factors promoting well-being include social cohesion and sound environmental management. The Government's broad vision, articulated in the GIF, is to create:
- a land where diversity is valued and reflected in our national identity;
- a great place to live, learn, work and do business;
- a birthplace of world-changing people and ideas; and
- a place where people invest in the future.
Together, the GIF economic objective and vision reflect the Government's integrated approach to improving New Zealanders' well-being.
Economic Performance in New Zealand
Trends in New Zealand's Growth Rate
New Zealand's economic fortunes declined steadily for much of the latter half of last century. In 1950 New Zealanders enjoyed the third highest level of per capita income in the world. By the turn of the millennium New Zealand ranked 20th of the 30 OECD countries.
Despite this relatively poor ranking, New Zealand's growth trend is improving. An average annual growth rate of 3.7 per cent since 1992 means New Zealand has been one of the OECD's strongest performers. New Zealand's average income per person increased by around 2.5 per cent over the same period, just above the OECD average. These improvements were driven by increased employment rates and, more recently, improved labour productivity growth. The economy has also become more resilient, rebounding quickly from the effects of the Asian financial crisis and periods of drought, and maintaining a robust pace of expansion even during the recent global downturn.
But New Zealand must do better. Other OECD countries are constantly improving their economic policy to boost national economic performance. As their incomes rise, they will become increasingly strong magnets for the talented people that New Zealand needs to enhance its own growth performance. If New Zealand falls too far behind its OECD counterparts in the growth stakes, it risks losing the ability to catch up with the leaders. Unless it can generate the innovation that will help quicken the pace of growth, New Zealand risks permanently trailing the field.
Policy makers need to understand the factors underlying New Zealand's improved economic performance , so that successful policies can be retained and strengthened, and opportunities for further improvement identified.
Higher Productivity Drives Income Growth
The most direct causes of growth in income per capita are:
- increased employment (especially skilled labour);
- improvements in the price of exports relative to imports (terms of trade); and
- increased output per hour worked (productivity).
These factors have all underpinned New Zealand's relatively good performance in recent years. Increases in labour participation were particularly important for growth in incomes over the five years from 1993. Over the 1990s, the terms of trade stabilised after a long period of volatility, and have even improved a little over the last five years. However, since New Zealand is now approaching full employment, the key to sustained future growth is increasing productivity.
Businesses become more productive by investing in skills and equipment, seeking out market opportunities, and developing new and innovative products and work practices. The most successful firms specialise in goods and services that consumers want and that the firms themselves are best at providing. They organise production and marketing to deliver their products and services at competitive prices.
Firms that do this most effectively tend to grow, attracting resources and customers from other firms, competing successfully in international markets, and driving less successful firms out of the market. The growth of successful businesses thus results in more productive use of the nation's resources. Successful firms can afford to pay higher wages necessary to attract the workers they need to grow, so incomes and employment both increase.
Within sectors there has been very rapid growth in exports of some niche products. For example, by 2002 over $1 billion of New Zealand's exports from sectors that the OECD classifies as "high" and "medium-high" technology had been growing by at least 10 per cent per annum for the previous decade. Many of these exports build on New Zealand's natural resource advantages. They include food and beverages and non-food commodities, and also high and medium technology products that have developed out of a specialisation in the primary sector (for instance, insecticides, fungicides and herbicides; and harvesting and grading machinery). Tourism and the export of education services have also grown rapidly.
The easier it is for firms to set up, attract resources and grow, the faster the economy can seize new opportunities. Data on firm births and deaths, job creation and destruction, and innovation suggest that New Zealand has a healthy, flexible, continually adapting economy more likely to deliver high rates of productivity growth.
The OECD's 2003 Economic Survey of New Zealand concluded that the country's improved economic performance has been underpinned "…by the programme of reforms that began almost 20 years ago. Those reforms have provided the economy with several important strengths: a sound macroeconomic framework; low inflation and a fiscal surplus; a flexible labour market; high-quality public administration and regulation; and an education system that delivers top-class overall results for the majority." These foundations enable the economy to respond flexibly and innovatively to changing conditions and opportunities.
Future Challenges to Improving Economic Performance
The world is becoming a global economic village. Over the past 25 years, trade and immigration have intensified, and the cost of transport and telecommunications has fallen dramatically. These trends will continue to quicken. New Zealand must compete globally for the skills and talent needed for it to be among the most productive countries. As a small country, remote from most of its major markets, it needs to at least match the incomes and quality of life offered by other countries competing for the same talent.
New Zealand's working-age population is aging, so improving productivity rather than labour participation will be the key to maintaining recent gains in per capita income. Raising productivity will hence become an even stronger imperative in the years ahead.
New Zealand's very small economy and distance from technology leaders means it is harder to keep up with world-leading technologies. It also means New Zealand firms serving the domestic market are small by world standards. Small firms face a daunting challenge in bearing the fixed costs of developing markets and moving into exporting. Scaling up production to meet the volumes demanded for entry to international markets is also challenging.
While there is no direct measure of technology adoption, local research and development (R&D) effort is an important element in facilitating technology transfer. New Zealand's private and public expenditure on R&D has grown rapidly over the last decade, but this has been from a very low base. Exports of high and medium-high technology manufactures - another indirect measure of technology adoption - have also grown rapidly from a low base.
Exporting is crucial for a small economy to achieve economies of scale in areas it is good at. Export receipts help fund the purchase from abroad of an ever-wider variety of goods and services that it is uneconomic to produce domestically. New Zealand's export growth since 1992 was faster than that in the previous two decades, but it was slower than that of comparable OECD countries, and slower than the world average.
New Zealand's share of world exports actually shrank over this period. However, the import content of New Zealand's exports is low relative to most developed countries and, once this is taken into account, New Zealand's export growth performance over the 10 years to 2001 is more in line with other OECD and developed countries for which data is available.
Growth in services exports (the import content of which is low) has been faster than the world average. Also positive is New Zealand's growing volume of processed exports. This reflects a more productive use of domestic inputs and also reduces New Zealand's exposure to movements in raw commodity prices. The volume of elaborately transformed manufactures increased by approximately 170 per cent between 1988 and 2001, while the proportion of merchandise exports in essentially unprocessed form fell from 27 to 15.5 per cent.
Agriculture has long been described as the backbone of the New Zealand economy. It remains true that there is a much higher concentration in agriculture, and the export of primary produce and manufactures based on it, than in most OECD economies. Future export success in this area will be influenced by:
- rising incomes in China and India, which will increase demand for New Zealand goods;
- competition, particularly from South America;
- New Zealand's ability to guarantee produce that is free from diseases such as foot and mouth and BSE;
- accession to the EU of countries with large agricultural sectors; and
- the outcome of the Doha trade round and New Zealand's ability to access distribution networks increasingly dominated by a few global companies.
More generally, the New Zealand economy will need to adapt to meet the challenge and opportunities of China's rise as a centre of low-cost manufacturing, and as an increasingly strong player in research and innovation - a challenge intensified by the expected completion of a Free Trade Agreement (FTA) between the two countries.
An FTA will provide New Zealand with better access to a large and fast-growing market, where rising incomes and rapid development are fuelling demand for some products in which New Zealand has a competitive advantage. Greater exposure to lower cost manufactures will put further pressure on some domestic sectors. An FTA may also provide opportunities for collaboration in areas of R&D - biotechnology in particular - that are likely to play a significant role in New Zealand's future economic performance.
New Zealand's economic performance and development will remain closely tied to that of Australia. Development of a Single Economic Market will help New Zealand to reap the benefits of growth in the Australian economy, and will provide New Zealand businesses with opportunities to capture economies of scope and scale. These international issues are critical to New Zealand's future economic performance.
Other factors likely to be influential are new information and communications technologies, which enable international outsourcing of production and increased productivity across the economy, and the rise of regulatory responses to climate change, which will stimulate technological change. This will require government to focus on using the instruments at its disposal to ensure New Zealand makes the most of these opportunities. This is the focus of the International Linkages Strategic Priority.
Conclusion
New Zealand's economic performance has improved markedly since 1992, reflecting greater adaptability and resilience, and underpinned by the economic reforms commenced 20 years ago. New Zealand continues to face urgent challenges due to international competition for skills and talent, its small size, and its distance from technology leaders. The continuing heavy concentration in primary products and manufacturing based on them, means that New Zealand's economic performance is likely to be affected by a different mix of external factors than higher income OECD countries. New Zealand needs to foster development of internationally competitive businesses able to take advantage of the opportunities created for increased trade. These issues provide a particular focus for the Ministry's strategic priorities.
Achieving the Government's Economic Objective
The Impact of Government on Productivity
Improvements in productivity are driven by changes in the ways firms and industries operate. How businesses operate is shaped by the business environment. Government policy shapes much of this environment and influences a wide variety of economic and social factors that underlie changes in how firms operate.
Government is a funder and provider of services directly impacting on businesses - such as education and training, and research and development. It can create incentives for entrepreneurial behaviour and remove obstacles that impede it. It can ensure that regulations impacting on business are well designed and easy to comply with. Similarly, it can ensure that key infrastructure - such as transport, energy and communications - is effective and low cost and hence helps firms operate efficiently and effectively.
These connections between government policy, the business environment and the immediate causes of productivity growth, are illustrated in the stylised productivity model shown in Figure 1.
Figure 1: How the Ministry Aims to Enhance Productivity Growth
→ Long Description of Figure 1
Implementing Policies that Work
Foundation Policies
Governments and international agencies broadly agree on the range of "economic foundation" policies that promote a business environment conducive to economic growth.
Many commentators consider that New Zealand's policies are generally sound in these areas. However, on-going examination and adjustment of policy settings may yield significant further growth improvement. Policies must also be adapted in response to changes in the economic environment, and to match evolving world best practice.
Small adjustments to regulation, for example, can have important effects across the economy. Surveys of New Zealand businesses identify employment, occupational safety and health, environmental and ACC legislation as the areas of greatest concern. The proposed changes to the Resource Management Act (RMA) are an example of government responding to these concerns. Other areas of regulation are being reviewed to improve international regulatory co-ordination with New Zealand's key trading partners, particularly Australia, to ensure New Zealand regulation reflects best practice and facilitates trade and investment. Promoting regulation that works is the focus of the Ministry's Regulatory Environment Strategic Priority.
Provision of high-quality and well-chosen infrastructure can influence firms' investment decisions, productivity and economic growth. There has been a review of infrastructure provision and regulation, and several initiatives are underway. These include the Transpower upgrade, the search for new supply sources for electricity and a new regulatory regime for the electricity sector. Changes to the RMA are also in train - partly to improve its effect on infrastructure supply - and climate change regulation is being introduced. The Ministry's Infrastructure Strategic Priority focuses on these areas.
Facilitative Policies
In addition to getting these economic foundations right, most countries that have shown exceptional rates of growth have adopted some combination of facilitative policies to promote it.
These often aim to:
- foster the concentration and specialisation of economic activity;
- attract foreign investment;
- improve firms' capability to enter and service export markets; and
- increase private sector R&D.
As recognised in the GIF, government strongly influences the conditions affecting entrepreneurship and innovation through its regulation of all economic activity, and through the funding and provision of important inputs in the productive economy - such as education and training; research, science and technology; and infrastructure. It can also address co-ordination issues, particularly between public and private investment in these areas, and provide incentives for innovative activity so that net benefits to the economy can be increased.
Because of their small size and remoteness, New Zealand firms face particular challenges in keeping abreast of new technologies. Domestic policies therefore need to focus on facilitating inward technology flows, and on assisting potentially high-growth export firms to surmount the barriers caused by small size
Some small economies - such as Ireland and Finland - have improved their OECD rankings by investing significantly and on a sustained basis in their capability to innovate and to adapt and create new technologies. Each country has adopted strategies that reflect their particular circumstances and opportunities. Finland, for instance, has worked hard to establish technological centres of excellence that link firms with public sector providers of research and education. It has also developed institutions to undertake periodic industry-specific scans of emerging technology. Ireland has invested heavily in upgrading educational qualifications in areas of technology that have become increasingly important as its economy has grown.
While trade access agendas evolve over time in response to new opportunities, this area of effort is well established and understood. A challenge is to find ways of maximising New Zealand's gains from access to key international markets by assisting firms to identify and develop new opportunities.
New Zealand needs to continually evaluate and upgrade its investment in policy, regulatory and budgetary instruments, whilst recognising that the private sector is the driving force behind innovation.
To succeed economically, New Zealand needs to maximise what it is good at producing and adapt rapidly to changing export markets and international competition. But firms may be overly reluctant to take risks in pursuing new directions. Well-targeted facilitative policies that encourage more experimentation (through lowering risks and costs to innovative firms) should foster additional productivity growth.
Fast growing and rapidly changing sectors are the most likely to experience problems with responsiveness of government-funded or government-provided goods or services. Government needs to work closely with these sectors to overcome such difficulties and to tailor generic policies to fit changing circumstances.
Many countries with poor growth records have also pursued facilitative policies, which emphasises the difficulty in implementing them successfully. While potentially valuable, they are generally more complex to implement and more context-dependent than "foundation" policies. They also require considerable judgement about where to apply resources. So facilitative policies must be carefully selected to reduce the risk of large, sunk investments. They also must be appropriate for the New Zealand context and address the constraints experienced by New Zealand firms. Accordingly, they must be regularly and rigorously evaluated, to ascertain whether the policies are producing results.
The Ministry's Innovation Strategic Priority is aimed at addressing these issues and identifying and implementing policies that stimulate increased innovation in the economy.
The Role of the Ministry of Economic Development
The Ministry of Economic Development leads development and implementation of the Government's economic development agenda. This includes co-ordinating work on the Growth and Innovation Framework across departments and other Crown agencies.
The Ministry incorporates the Ministry of Consumer Affairs and the Ministry of Tourism, and advises Ministers on a wide range of policies designed to promote economic growth and development. These policies are largely implemented by Crown entities, with the Ministry's role being to monitor delivery and assess effectiveness. The Ministry also provides services direct to business through the Companies Office, the Intellectual Property Office and other business units.
Government does not create income growth but it can have a major influence on the environment and conditions in which growth can occur. Given the importance of income growth to the well-being of New Zealanders, and the Ministry's sphere of influence and operation, we seek to ensure that:
the business environment promotes a higher rate of sustainable income growth for New Zealanders
This is the major outcome we strive for. We therefore apply a growth focus to all our work. We assist the Government to develop and implement policies and services that promote sustainable economic growth. The Ministry cannot achieve its major outcome unaided. We encourage all government agencies to maintain a focus on income growth, and seek to ensure that policies aimed at achieving non-economic objectives assist - or at least do not detract from - efforts to improve income growth.
Conversely, the Ministry collaborates and consults with other agencies to ensure that its work assists the pursuit of other economic, social and environmental outcomes. This work with other agencies is the focus of our Leadership Strategic Priority. We also tailor our approach to the needs and characteristics of particular sectors, so that policies are as effective as possible in contributing to growth.
For example, some of our work also contributes to Te Puni Kōkiri's outcome of Māori succeeding as Māori, and to the Ministry of Pacific Island Affairs' overall outcome that Pacific peoples achieve full social and economic participation in New Zealand society. The Ministry's work hence contributes to other agencies' population-based economic objectives, in addition to the Government's social objective of reducing inequalities.
Focusing on the Priorities
The Ministry's diverse activities impact on the business environment in many ways. While we need to work across a wide front, to be most effective we must focus our effort on those policies that will make the biggest improvements to the business environment. The best policies for growth are not always immediately obvious, because the economy is complex and there can be long time delays and uncertain connections between implementing policy and subsequent change in the growth rate. To set priorities we hence need to exercise critical judgement.
In doing so, we take into account our knowledge of the structure and operation of New Zealand's economy, plus insights from the business community, international experience, and domestically-focused research.
The next section sets out the five key strategic priorities we have identified and our rationale for selecting them.
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