Section 1: Economic Development Context
This section sets out:
- the Government's objective of increasing sustainable economic growth;
- how the Ministry of Economic Development contributes to this objective; and
- the major opportunities and challenges that face the New Zealand economy.
The Government's Objective for Economic Development
If New Zealand is to catch up with other countries, the economy must perform better still, sustaining growth rates at high levels over several decades.
The Government's aim is to achieve a step change in sustainable economic growth. Over the next decade, it intends "working to progress our economic transformation to a high-income, knowledge-based market economy, which is both innovative and creative and provides a unique quality of life to all New Zealanders". The New Zealand economy has performed well over the past decade, halting the long-term slide in its GDP per capita ranking relative to other developed countries. Growth in income per capita has been 2.1 per cent per annum since 1994 - slightly above the average for developed economies.
Despite this good performance, New Zealand still ranks 21st in income per capita at US$23,000, 10 places behind Australia at US$29,600.1 If New Zealand is to catch up with other countries, the economy must perform better still, sustaining growth rates at high levels over several decades (see Graph 1).
This will require high and sustained rates of growth in productivity as evidenced by the number and importance of innovative and globally competitive firms in New Zealand. Achieving this is likely to require continuing and significant change in what is produced in terms of goods and services, and how they are produced, and also in our trading relations with overseas markets.
Role of Government in Economic Development
While firms are central to raising the productivity performance of an economy, the government plays an important role by shaping the business environment to help firms identify innovation opportunities, investing in the capabilities an economy needs in order to innovate, and influencing a wide variety of social and economic factors that underlie changes in how firms operate. Choices made in government's approach to research and development, education, infrastructure and our international linkages can materially impact the pace and direction of economic development. The way government policy influences the business environment, and so productivity growth, is illustrated in the stylised productivity model shown in Figure 1.
Innovation opportunities rarely seem to present themselves to firms in transparent ways. An innovation opportunity often represents a complex interplay between governments (who may be procuring or regulating an innovation), businesses, financial systems and research infrastructures. For example, the idea that mobile telephony was a technological opportunity emerged slowly over many years in Scandinavia as an interplay between state-owned telecom labs, electronics firms, telecom service providers, standards agencies and regional authorities.
Graph 1: Real GDP per Capita (Past and Future Comparison)
Long Description of "Graph 1: Real GDP per Capita (Past and Future Comparison)"
In a small economy, these opportunities will frequently include international linkages. The opportunity for mechanical harvesting of grapes in Australia developed in an interaction between public research organisations, American machinery producers, universities and major incumbent vineyard owners.
Innovation often rests on specific innovation inputs extending beyond R&D, such as design skills, the analysis and assessment of markets, engineering capabilities and software skills. Many of these inputs depend on the capabilities of the education and training system.
Innovation and growth rely on availability of infrastructure services. Infrastructure investment poses special problems for public policy. It usually entails large costs with significant financing burdens, and often calls for construction in an integrated rather than an ad hoc way. Costs and benefits can be spread widely, meaning that normal investment appraisal techniques are often unsuited to investment decisions. These characteristics explain why states have typically played major roles in decisions about infrastructure.
The Ministry of Economic Development assists the Government to develop and implement policies and services that promote growth, including leading work on the Government's economic transformation agenda. This includes encouraging all government agencies to maintain a focus on economic growth.
Sustained economic growth is not an end in itself. Economic growth contributes to the Government's objectives by underpinning the living standards of New Zealanders. Economic growth also supports social cohesion and sound environmental management. The link between economic growth and social cohesion is exemplified by the recent significant decline in unemployment rates to 3.6 per cent, the lowest rate in the OECD. The economy generated 100,000 additional jobs in the last two years.
The following challenges and opportunities have been highlighted here because:
- they are known to be important for growth, productivity and innovation in advanced economies;
- they have particular resonance in a small and open economy; and
- New Zealand stands out from other countries in terms of relatively good or poor performance.
Figure 1: How the Ministry Aims to Enhance Productivity Growth
Long Description of "Figure 1: How the Ministry Aims to Enhance Productivity Growth"
Opportunities and Challenges Facing the New Zealand Economy
The New Zealand economy has a strong emphasis on agriculture, a small manufacturing sector concentrated on low- and medium-technology sectors, and a large service sector.
A key question facing the New Zealand economy and government is the extent to which its industry structure constrains economic growth. However, the above characteristics are shared with such countries as Finland, Sweden, Norway, Denmark, the Netherlands, Canada and Australia, and do not, in themselves, suggest New Zealand is destined to a future of low productivity growth. Several of these countries outstrip the United States in output per worker, and most of them have sustained high growth rates of output and productivity in recent decades.
These countries rested their development paths on resource-based sectors, and out of them developed low- and medium-technology industries that have driven growth. Sweden shifted from iron ore production to iron and steel, to fabricated metal products (most notably cars and trucks), and then to machine tools and electronic systems. Finland went from paper production to chemicals for paper, and then to paper machinery - a major sector in which it is a world leader (see Table 1). The economic transformation of these countries emerged, over a number of years, from a complex interplay between various economic actors - governments, businesses, financial systems and research infrastructures.
Table 1: Historical Industries and Contemporary Specialisations
| Country |
Historical growth industries |
Some contemporary specialisations |
| Norway |
- Fishing
- Timber products
- Marine transport
- Non-ferrous metals
- Hydro power
|
- Fishing and aquaculture
- Marine biotechnology
- Timber products
- Oil
- Marine transport
- Marine electronics (navigation and sub-sea technologies, including sonar and imaging)
- Non-ferrous metals and aluminium
|
| Sweden |
- Timber products
- Iron ore
- Iron and steel
- Marine transport
|
- Timber products
- Engineering products and vehicles
- Telecommunications
- Aerospace (military and civilian)
- Ships and boats
|
| Finland |
- Timber products
- Machinery
- Transport equipment (especially ships)
- Chemicals
|
- Newsprint and high-quality paper
- Machinery (especially for paper industry)
- Chemicals (especially for paper industry)
- Telecommunications equipment
- Ships and boats
|
| Netherlands |
- Agriculture
- Trade and finance
- Machinery
|
- Agriculture (including extension into new products, e.g. flowers)
- Agricultural trading and commodity exchanges
- Electronics
- Finance and banking
|
| Denmark |
|
- High-value agriculture
- Domestic and office furniture
- Architecture and interior design
- Agricultural equipment
- Electronics
- Pharmaceuticals
|
Canada, Sweden, the Netherlands and Finland have also succeeded in creating important electronics and telecommunications sectors. However, in each of these countries, electronics remain a relatively small sector, and prosperity still depends a lot on continuously upgraded traditional industries. Moreover, the Netherlands and Denmark remain heavily agricultural economies, with substantial export earnings from food products.
New Zealand shares the low-tech emphasis and the widely distributed economic structures of these other small economies. Economic development policy for New Zealand cannot simply be based on high-tech sectors, but will need to have an extensive base in the industries that New Zealand actually possesses. However, this cannot be a recipe for complacency or inaction. Critical to improving our economic future will be to technologically upgrade and to innovate, in such sectors as food and beverages, textiles and clothing, printing and publishing, and timber products.
To achieve this process of upgrading and sustain high growth rates, the New Zealand economy faces some significant challenges and opportunities.
New Zealand is one of the smallest advanced economies, with total GDP of US$94 billion;2 it is also distant from the world's major markets and technology leaders. As a result, businesses have to overcome significant hurdles as they try to grow and innovate. For example, discovering information on how the technology frontier is shifting in an industry is harder from a distance. Face-to-face contact is important in getting access to this information for firms.
New Zealand firms have low levels of investment in capital and research and development. Investment in capital has been lower than the OECD median for most of the years from 1987 to 2003, though it has increased rapidly over the last few years. New Zealand businesses invested $677 million in research and development in 2004. If New Zealand businesses invested at the OECD average rate, they would have invested around $2 billion more in R&D. New Zealand businesses are both under-represented in R&D-intensive industries and invest less in R&D in industries that are usually R&D intensive.
As New Zealand's largest city, the performance of Auckland is critical to both innovation and growth. Cities are places where innovations in firms typically occur at disproportionately high rates. Cities with high levels of education have grown faster in recent decades, and human capital has become more concentrated in cities. While Auckland has grown strongly in recent years, much of this growth has been a function of increasing population rather than productivity improvements. Auckland's contribution to growth needs to increase more than proportionately with its population, if it is likely to need to grow in order to compete with other Australasian cities to attract and retain firms and skilled people. The quality of growth is also important, for example, in terms of the provision of infrastructure and other policies to counteract congestion.
As New Zealand's largest city, the performance of Auckland is critical to both innovation and growth.
New Zealand firms have access to an increasingly skilled workforce, and there is an efficient labour market. Participation in tertiary education and investment in on-the-job training have risen substantially. Between 1994 and 2004, the number of people holding a bachelor's degree or higher increased from 195,000 to 413,000 (or 17 per cent of the workforce). Skilled immigration has, on average, exceeded skilled emigration over the last five years.
Even though there has been significant investment in skills and education, the economy is still facing skills shortages, and firms report this as a major constraint to expansion. Whether this is a short-term or long-term issue is hard to ascertain, but it is clear the Government has a significant role in continuing to overcome this constraint. This role relates to government's responsibilities as the major provider and subsidiser of skills and education, labour market regulator and immigration policy maker.
Firms also face the risk that vital infrastructure they need is not available and that this will constrain their growth. The World Economic Forum's Global Competitiveness Report ranks New Zealand 22nd in the world (19th in the OECD) for the overall quality of its infrastructure, while the IMD World Competitiveness Yearbook ranks New Zealand 21st in the OECD for the adequate planning and financing of our infrastructure. Large investments are coming on-stream in land transport, electricity and gas.
More specifically, New Zealand is faced with growing demand for energy, driven by economic and population growth. It also faces increasing pressure on supply, including the need to control greenhouse gas emissions. Risks to energy supply in New Zealand are exacerbated by the dry-year hydro constraint, the run-down in the Maui gas field and the relative lack of investment in the electricity transmission system in recent years. On current projections, significant new sources of generation will be needed by around 2010. A number of projects are being progressed but, as yet, relatively few firm commitments have been made.
Oil supplies are finite and, at some point, world production will peak. Estimates about timing vary widely from around 2010 to around 2040. Mainstream opinion is that, after the "peak", there will be a gradual decline in conventional oil supply. During this period, oil prices will rise and new technologies, previously uneconomic oil resources, and increasing alternatives to oil are likely to come on-stream. The nature and timing of these factors is uncertain. New Zealand government and business leaders need to plan early for the eventual end of "cheap oil" to ensure that the economy is resilient to any transitional problems.
Global trade in goods and services is fundamental to economic growth in New Zealand and the process of upgrading existing industries. World trade as a proportion of world GDP increased from 20 per cent in the early 1970s to about 55 per cent in 2003. As global trade flows have increased, manufacturing production has become more fragmented. There is greater international competition, lower mark-ups available to firms and a reduction in the home bias of production, with a declining share of domestically produced inputs in many countries.3
Exporting is crucial for New Zealand firms and industries to achieve economies of scale and scope. There remains room for improving overall export performance. New Zealand's export growth was slower than that of comparable OECD countries and slower than the world average. As a result, our share of world exports actually shrank from 0.27 per cent in 1990 to 0.21 per cent in 2005, which is indicative of a loss in New Zealand's competitiveness.
On the positive side, New Zealand's exports are less import intensive than other countries (that is, for every dollar of goods we export, they have more domestic value added than in other countries) and the proportion of exports in unprocessed form fell from 27 per cent to 15.5 per cent between 1988 and 2001.
For an advanced economy, New Zealand continues to rely on agricultural commodity production, which often faces significant regulatory trade barriers. The top three export sectors in 2005 were dairy products, meat and wood.
Moreover, the bulk of world trade now takes place within, not between, industries. This reflects the growth of global value chains, with countries specialising in varieties of particular goods rather than industries. This kind of trade tends to occur between close neighbours and amongst rich countries. New Zealand, however, has a low level of within-industry trade in manufacturing.4 In part, this simply reflects New Zealand's isolation from all countries apart from Australia, but explaining the phenomenon does not lessen the importance of finding ways to counteract it. This represents a significant challenge for government and business alike.
Exporting is crucial for New Zealand firms and industries to achieve economies of scale and scope.
Australia is our largest trading partner. Australia enjoyed strong growth in GDP per capita over the last decade, with the longest run of uninterrupted growth in its post-war history. In 2005, New Zealand sent $5.9 billion, or 20 per cent of exports, to Australia. Australia is also the largest source of short-term visitors to New Zealand.
One of the clearest shifts in world trade patterns is the growing importance of emerging Asian countries, which represent an on-going opportunity for New Zealand. New Zealand businesses have been successful in entering the Chinese market. China is now our 4th largest export market, with $1.5 billion of goods exports going there in 2005.
China is also by far the largest source of overseas students in New Zealand. New Zealand is currently negotiating a Free Trade Agreement with China, which presents an opportunity to enhance this relationship further. Geopolitically, as a small economy, New Zealand is also able to play the role of an honest broker, particularly in bridging South-East Asia and the Americas.
As global trade flows have increased, there have been large decreases in transport and information sharing costs and reductions in trade barriers. At face value, this would seem to offer important benefits to New Zealand firms. However, the income people forego when they travel is actually rising as their incomes rise, and better telecommunications do not always substitute for face-to-face meetings. Furthermore, recent analysis of the telecommunications costs New Zealand businesses face indicates prices are higher than in many other countries.5 The overall impact of the reduction in transport and information costs for New Zealand firms remains unclear.
The New Zealand economy is very open and flexible, which makes it relatively easy for entrepreneurs to get started in business. This is reflected in the healthy level of firm entry and exit. There are low barriers to inward trade, with tariffs being on average 3.3 per cent. The regulation of business is generally efficient, and institutions are perceived to be free from corruption. The World Bank has assessed New Zealand as the best place in the world to do business, and our competition policy and its enforcement are also highly ranked. Nevertheless, given New Zealand's particular challenges, we must continue to take opportunities to improve regulation.
China is now our 4th largest export market, with $1.5 billion of goods exports going there in 2005.
Summary
To improve living standards, New Zealand needs to enhance the creation of globally competitive firms. There is a need to:
- foster entrepreneurship and innovation in New Zealand firms;
- improve the international linkages that allow firms to benefit from trade, knowledge transfer and investment;
- improve the quality and reliability of key infrastructure services; and
- strengthen the growth focus in the regulatory environment for business.
The Ministry will lead work across government agencies to meet these challenges and opportunities.
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