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Dr Roderick Deane - 1 May 2007 To Whither or Wither? To Whither or Wither ? To Whither or Wither ? Observations on the State of the Economy Roderick Deane* An address to the Treasury Group Lecture Series, Wellington 1 May 2007 *Dr Roderick

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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

Roderick Deane*

An address to the Treasury Group Lecture Series, Wellington 1 May 2007

*Dr Roderick Deane is Chairman of Fletcher Building Ltd and the NZ Seed Fund, and a Director of Woolworths Ltd in Sydney. He is also Patron and Chairman of the IHC Foundation. Until 30 June 2006 he was Chairman of ANZ National Bank, Telecom Corporation of NZ Ltd, Te Papa Tongarewa (The Museum of NZ), City Gallery Wellington Foundation, and a Director of the ANZ Banking Group Ltd in Melbourne. Dr Deane is very appreciative of the assistance he was given in preparing this material by the Economics Group of the ANZ National Bank and by Bryce Wilkinson and Roger Kerr.

Observations on the State of the Economy

To Whither or Wither ? To Whither or Wither ?

2

A long-run perspective on New Zealand’s economic growth

$0 $5,000 $10,000 $15,000 $20,000 $25,000 $30,000 $35,000 1866 1886 1906 1926 1946 1966 1986 2006 $, 1995/96 prices, March yrs 50 100 150 200 1900 1920 1940 1960 1980 2000 Index 1 6 11 16 21 1820 1870 1913 1950 1973 1990 1998 2005 OECD rank in terms of GDP per capita

  • 15
  • 10
  • 5

5 1955 1965 1975 1985 1995 2005 % of GDP, March yrs

GDP per Capita ( 1 8 6 6 -2 0 0 6 ) Real Com m odity Prices ( 1 9 0 0 -2 0 0 6 ) The rise and fall of NZ’s relative place in the w orld: ( 1 8 2 0 -2 0 0 5 ) NZ’s Current Account History ( 1 9 5 5 -2 0 0 6 )

Sources: Statistics NZ; IMF; ANZ National Bank; OECD (Luxembourg and Iceland are excluded due to lack of data).

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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

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Current macroeconomic settings have improved significantly

  • 6
  • 4
  • 2

2 4 6 1966 1971 1976 1981 1986 1991 1996 2001 2006 Ann % chg (March yrs)

  • 5

5 10 15 20 1966 1971 1976 1981 1986 1991 1996 2001 2006 Annual % change

  • 8
  • 6
  • 4
  • 2

2 4 6 8 1971 1976 1981 1986 1991 1996 2001 2006 % of GDP, June yrs

GDP Grow th per Capita ( 1 9 6 6 -2 0 0 6 ) Consum er Price I nflation ( 1 9 6 6 -2 0 0 7 ) Fiscal Balance ( 1 9 7 2 -2 0 0 6 ) Unem ploym ent Rate ( 1 9 6 6 -2 0 0 6 )

Sources: Statistics NZ; Treasury; ANZ National Bank. 2 4 6 8 10 12 1966 1971 1976 1981 1986 1991 1996 2001 2006 %

4

Terms of trade, productivity

700 900 1100 1300 1500 1966 1971 1976 1981 1986 1991 1996 2001 2006 Index

  • 4
  • 2

2 4 6 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 % (growth, 3 yr average)

  • 4
  • 2

2 4 6 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 % (growth, 3 yr average)

Term s of Trade ( 1 9 6 6 -2 0 0 6 ) Productivity – Labour ( 1 9 9 1 -2 0 0 6 March yrs) Productivity – Capital ( 1 9 9 1 -2 0 0 6 March yrs) Productivity – Multifactor ( 1 9 9 1 -2 0 0 6 March yrs)

Sources: Statistics NZ; ANZ National Bank.

  • 4
  • 2

2 4 6 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 % (growth, 3 yr average)

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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

5

Multifactor Productivity

Trend Average Annual Growth Rate

2.0 2.3 0.7 0.0 0.2 0.4 0.6 0.8 1.0 1.2 1.4 1.6 1.8 2.0 2.2 2.4 2.6 1988-2000 1992-2000 2000-2006 After the Employment Contracts Act and 1991 Budget Years ended March Percent Clark-Cullen During "The 'Failed' Policies of the Past"

Sources: Statistics NZ; Capital Economics

6

Consequently, NZ has transformed itself from a below average performer to an above average performer

0.9 1.1 1.2 1.3 1.5 1.6 1.7 1.8 1.9 2.0 2.2 2.3 2.4 2.5

NZ 1977-1986 0.8% NZ 1998-2006 2.1%

Density estimate GDP growth per capita (%)

NZ 1970-1976 1.9% NZ 1987-1996 0.7% Distribution of per capita grow th rates for advanced countries, 1 8 7 0 -1 9 9 8

Sources: Angus Maddison, The World Economy: a millennial perspective, OECD, 2001. Statistics NZ.

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7

We benefited from the mid-80’s to mid-90’s reforms

A rem inder on the Reform s

  • Monetary and fiscal policy vastly improved
  • Dollar floated
  • Low inflation achieved
  • Labour market transformed
  • Internal regulatory structures dismantled
  • Income taxes reduced
  • Size of government scaled back
  • Government offshore debt eliminated
  • Budget moved to surplus
  • Corporatisation/ privatisation delivered
  • Exchange controls/ import licensing abolished
  • Tariffs greatly reduced
  • Price, wage and dividend controls abolished

Outcom e: Business sector adaptability hugely increased 8

The decline has been arrested

5,000 10,000 15,000 20,000 25,000 30,000 1970 1975 1980 1985 1990 1995 2000 2005 GDP per capita (US$) OECD NZ 1970-2005: OECD average growth = 2.0% per annum NZ average growth = 1.3% per annum Sources: OECD; ANZ National Bank.

GDP per capita

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But closing the gap requires something a lot more

5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 1970 1975 1980 1985 1990 1995 2000 2005 2010 2015 2020 2025 GDP per capita (US$) OECD NZ For NZ to catch up by 2025 requires: OECD average growth = 2.0% per annum NZ average growth = 2.7% per annum For NZ to catch up by 2015 requires NZ average growth of 3.4% per annum

I t took us 2 0 years to fall dow n the ladder. Assum ing OECD real GDP per capita grow th of 2 .0 percent, NZ needs to grow at 2 .7 percent to close the gap by 2 0 2 5

Sources: OECD; ANZ National Bank.

10

We are here, but we need to be there…

0.9 1.1 1.2 1.3 1.5 1.6 1.7 1.8 1.9 2.0 2.2 2.3 2.4 2.5

NZ 1998-2006 2.1%

Density estimate GDP growth per capita (%)

Distribution of real per capita grow th rates for advanced countries, 1 8 7 0 -1 9 9 8

Sources: Angus Maddison, The World Economy: a millennial perspective, OECD, 2001. Statistics NZ.

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11 GDP per capita level

Source: OECD OECD

Population and Participation Productivity

10 20 30 40 50 60 70 80 90 10 11 12 13 14 15 16 17 18 19 20

United States Australia

GDP / hours worked ($) Hours worked per capita per week

Austria Belgium Canada Denmark Finland France Germany Greece Iceland Ireland Italy Japan Luxembourg Netherlands New Zealand Norway Portugal Spain Sweden Switzerland Turkey UK

Work harder or work smarter

12

We continue to rank lowly in the OECD stakes

OECD Nation Rankings Richest nation: Luxem bourg High incom e: Norw ay, USA, I reland, Sw itzerland Middle/ high incom e: 1 4 nations including Australia, UK, Canada, France, Japan Low / m iddle incom e: New Zealand, Spain, Greece, Korea, Portugal Low est incom e: Turkey Rankings based on purchasing power, taking into account the cost of 3000 items, from a litre of milk to building a house

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13

Are we in fact starting to go backwards?

4 5 6 7 8 9 1970 1975 1980 1985 1990 1995 2000 2004

Index

New Zealand

20000 40000 60000 80000 100000 120000 1991 1993 1995 1997 1999 2001 2003 2005 Person days of work lost

Econom ic Freedom I ndex ( 1 9 7 0 -2 0 0 4 ) W ork Stoppages ( 1 9 9 1 -2 0 0 6 )

Sources: Statistics NZ; ANZ National Bank; Economic Freedom Annual Report 2006 (The Fraser Institute). 1 2 3 4 5 '88-'90 '90-'95 '95-'00 '00-'06 Compound annual average growth rate

Labour Productivity

1 2 3 '88-'90 '90-'95 '95-'00 '00-'06 Compound annual average growth rate

Multifactor Productivity 14

Core public service employment growth

  • 2.6
  • 2.5

4.1 2.7 1.9 2.8

  • 3
  • 2
  • 1

1 2 3 4 5 1990-1995 1995-2000 2000-2006 Calendar years Percent Government Administration and Defence All other sectors

Source: Statistics NZ; ANZ National Bank.

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Working less but wanting more

37.5 38.0 38.5 39.0 39.5 40.0 40.5 1986 1991 1996 2001 2006 Hours (s.a.) 28 29 30 31 32 33 34 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 % of GDP Forecasts 50 100 150 200 1980 1984 1988 1992 1996 2000 2004 (000) Sickness and invalid Beneficiaries Unemployed

Hours w orked per full tim e em ployee ( 1 9 8 6 -2 0 0 6 ) Core crow n spending ( 1 9 9 7 -2 0 1 1 June yrs) Unem ployed and beneficiary num bers ( 1 9 8 0 -2 0 0 6 June yrs) Current Account Deficit ( 1 9 8 0 -2 0 0 6 )

Sources: Statistics NZ; Treasury; Ministry of Social Development, ANZ National Bank.

  • 10
  • 8
  • 6
  • 4
  • 2

1980 1984 1988 1992 1996 2000 2004 % of GDP

16

Household borrowing sky-rocketing

50 70 90 110 130 150 170 1991 1994 1997 2000 2003 2006 % of disposable income 10 20 30 40 50 60 1992 1994 1996 1998 2000 2002 2004 2006 20 40 60 80 100 120 140 160 % Index (92Q1=100)

Proport ion of weekly wage required t o service mort gage(LHS) House price- t o- income adjust ed for int erest rat es (RHS)

Household debt Housing affordability Bank & NBFI lending to households

Sources: Reserve Bank of NZ; ANZ National Bank. 5 10 15 1991 1994 1997 2000 2003 2006 % of disposable income

I nterest servicing

20 40 60 80 100 120 140 160 1998 2000 2002 2004 2006 2 4 6 8 10 12 14 16 18 NZ$ billion NZ$ billion Tot al lending t o households (LHS) NBFI s (RHS) Banks (LHS)

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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

17

NZ’s current account deficit is unsustainable

  • 25
  • 20
  • 15
  • 10
  • 5

5 10 15 20 25 Iceland Greece New Zealand Spain Portugal Turkey Hungary United States Slovak Republic Australia Czech Republic United Kingdom Italy Poland France Ireland Mexico Korea Canada Denmark Belgium1 Austria Japan Germany Finland Sweden Netherlands Luxembourg Switzerland Norway % of GDP

Source: OECD Economic Outlook, December 2006.

Current Account Balances of OECD nations 18

1.5 2.0 2.5 3.0 87 90 93 96 99 02 05 Utilities as % of GDP

Infrastructure investment is a key issue

  • 30
  • 20
  • 10

10 20 30 90 92 94 96 98 00 02 04 06

  • 40
  • 30
  • 20
  • 10

10 20 30 40 % (ann avg) Investment intentions (fwd 4 qtrs, right scale) Private Non-residential Investment (left scale) Net % of respondents 2.6 2.8 3.0 3.2 3.4 3.6 3.8 4.0 72 76 80 84 88 92 96 00 04 K stock to GDP

Capital stock to GDP ( 1 9 7 2 -2 0 0 6 March yrs) Transport spending as % of GDP ( 1 9 9 2 -2 0 1 1 June yrs)

Sources: Statistics NZ; Treasury; NZIER; ANZ National Bank.

Utilities GDP vs econom y-w ide GDP ( 1 9 8 7 -2 0 0 6 )

0.7 0.8 0.9 1.0 1.1 1.2 1.3 1.4 92 94 96 98 00 02 04 06 08 10 % Forecasts

I nvestm ent ( ex-buildings) and QSBO I nvestm ent I ntentions ( 1 9 9 0 -2 0 0 6 )

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Uncertainty is impacting negatively on investment

3.0 3.1 3.2 3.3 3.4 3.5 3.6 3.7 94 95 96 97 98 99 00 01 02 03 04 05 06 07 10 20 30 40 50 60 70

K stock/GDP (left scale) Business uncertainty (inverse, right scale) K stock to GDP Business uncertainty (gap between buisness confidence and firms own activity expectations)

Capital stock to GDP and business uncertainty

Sources: Statistics NZ; National Bank Business Outlook; ANZ National Bank.

More uncertain Less uncertain 20

At a time when more investment is needed because capacity utilisation is near historical high

0.83 0.84 0.85 0.86 0.87 0.88 0.89 0.90 0.91 0.92 0.93 0.94 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 CUBO (percent)

Historical average

Capacity Utilisation at near all tim e highs despite econom ic slow dow n over past year

Sources: NZIER; ANZ National Bank; OECD.

NZ’s capital stock grow th lagging behind

3.9 4.0 OECD 4.1 3.2 Australia 3.8 2.7 NZ 1995- 2004 1985- 1994 Annual average growth (% )

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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

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The biggest problem facing small business...

5 10 15 20 Lack of Skilled Employees Regulation Tax Burden Competition Turnover Exchange Rates Other Cashflow Interest Rates Rate of Pay Rent Management Supply Shortages Access to Finance Inflation Percentage of respondents (300 respondents)

Biggest problem facing sm all business ( 2 0 0 5 )

Source: ANZ National Bank.

22

Main findings of Business New Zealand – KPMG Com pliance Cost Survey: Septem ber 2 0 0 6

  • In 2006 compliance costs increased for four of the six company

categories.

  • Tax is still the top compliance concern, followed by employment

law issues.

  • Business people perceive compliance costs to have increased in all

areas, especially regarding the Holidays Act.

… and businesses in general

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23

Tax rates

Source: NZ Treasury Briefing to the Incoming Government 2005.

Corporate Tax Rate 24

Tax rates

Marginal Personal Tax Rate

Source: NZ Treasury Briefing to the Incoming Government 2005.

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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

25

Number of Pages of New Primary Legislation by Decade

1900s to 2000s

5,000 10,000 15,000 20,000 25,000 30,000 35,000 1900s 1910s 1920s 1930s 1940s 1950s 1960s 1970s 1980s 1990s 2000s

The regulatory creep

Source: Parliamentary Library.

26

Of more recent years …

Economic Negatives and Regulatory Interventions

  • Increase in top tax rate to

39c

  • Restoration of ACC monopoly
  • Employment Relations Act
  • Tariff freeze
  • Re-nationalisation of Air NZ,

Kiwibank, rail

  • Takeover regulation
  • Commerce Act more

restrictive

  • Re-regulation of

telecommunications

  • Re-regulation of electricity
  • Energy efficiency regulation
  • More central control of health

and education

  • More lenient welfare rules
  • Kyoto Protocol shambles
  • Re-regulation of banking
  • Privy Council appeals

scrapped

  • Resource Management Act
  • Local authorities legislation
  • Securities legislation
  • Accounting standards
  • Corporate governance
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Capital Markets

  • Lack of depth & breadth says RBNZ Governor
  • This limits economic growth
  • Raises vulnerability to crises
  • NZX small and declining in relative importance
  • Agrees regulation needs improvement
  • Private equity becoming dominant
  • Yet all this pointed out to RBNZ & Government
  • Ironically been huge increase in regulation and compliance costs

in NZ capital markets

28

Employment Relations

  • Numerous re-litigations of legislation
  • Harassment cases a nightmare for employers
  • Work/ life balance imbalance
  • Fixed term contracts
  • Union meetings and site visits at will
  • Holidays Act … unintended consequences
  • Days off in lieu at will
  • Discretionary payments double dipping
  • Workplace stress
  • Inequality of power
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Kyoto and All That

  • Original estimate of credits $300 million
  • 2006 estimate $609 debits
  • Error $900 million
  • Treasury reported tax would be ineffective
  • Carbon tax policy & NGA’s abandoned
  • 30 months of negotiations wasted
  • Australia did not sign Kyoto but are further ahead than us
  • Another new Government policy announced Dec 2006

30

Banking Regulation

  • RBNZ requires “standalone capability”, particularly when under

stress

  • Major systems to be relocated to New Zealand
  • Huge cost and inefficiency
  • Harsh reactions to any reservations
  • All third party contracts to be renegotiated/ separated
  • All direct reports to CEO require RBNZ approval
  • No analysis that benefits of all this might exceed costs
  • Individual director attestations
  • Initial aim standalone capability under future stress situations
  • Yet, RBNZ reiterates this is “light handed” regulation
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31

Telecommunications

  • Once the fastest growing industry
  • Regulator over-ruled by Govt.
  • Unbundling cost/ benefit analysis ignored
  • Regulation wiped $3 billion off Telecom value
  • No compensation for Telecom shareholders
  • Regulation now all encompassing, even over Telecom
  • rganizational structure
  • Following same route as failed electricity reforms
  • Competitors predicting losses despite regulation
  • Yellow Pages sale a short term palliative

32

Electricity Regulation

  • Much regulation, numerous changes
  • Industry largely Government owned
  • Seriously conflicting regulatory objectives
  • Conflicting regulators (Govt & CC & EC)
  • Major transmission outages
  • Lack of security of supply
  • Uncertainty & underinvestment
  • A disaster waiting to happen
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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

33

Research Study on Regulation

  • ANZ Bank study December 2006 shows poor regulation hinders

economic performance

  • Study found evidence of distortionary effects of regulation
  • Recommended need for five policy changes
  • 1. Quantitative cost/ benefit analysis
  • 2. Done by independent body
  • 3. Articulate goals better
  • 4. Ex post reviews essential
  • 5. Negative impact of uncertainty needs policymakers attention

34

Business adaptability is being rapidly eroded

Regulatory Dilem m as

  • Regulation begets regulation
  • Regulation overrides commercial solutions
  • Regulation and changes induce uncertainty
  • It imposes high transactions costs
  • Diverts energy into rent seeking behaviour
  • And away from focussing on winning in the market
  • Regulation always has unintended consequences
  • It concentrates on past issues rather than future growth
  • Success ironically attracts regulation
  • Regulation reduces flexibility
  • It ultimately impedes the competition it pretends to promote
  • Reduces attractiveness of New Zealand for foreign direct

investment

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35

Scorecard

Positives

  • Monetary policy (but softening eg inflation rising)
  • Overall stance of fiscal policy
  • Forex non-intervention (so far)
  • Favourable terms of trade (thanks to global commodity boom)

Negatives

  • Intrusive widespread re-regulation
  • Growing size of Government (big spending increases)
  • Higher taxes
  • Infrastructure mess (roads, energy, telecommunications)
  • Social policy (health, education, welfare)
  • Constitutional issues (MMP, appeal rights )
  • Shrinking domestic capital market (cf, role of private equity)

36

In summary

  • Decade of good econom ic grow th, but econom y now slow ing
  • Given lags, this arose from
  • World expansion
  • Commodity prices
  • Domestic productivity
  • Productivity grow th based on
  • Deregulation (promoted flexibility & competitiveness)
  • Stable macro policy (low inflation)
  • Reducing size of Government (since Government

redistributes but does not itself generate growth)

  • Labour market conditions and the relative price of capital

to labour

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Dr Roderick Deane - 1 May 2007 To Whither or Wither?

37

In summary (continued)

But, in recent years

  • Increasing size of Government
  • Extensive regulatory interventions
  • Poor Government sector management
  • Who believes health, education, or welfare are well managed ?
  • Sharply slowing productivity growth
  • Huge external imbalance
  • Inflationary pressures re-emerging
  • So where do NZ’s comparative advantages now come from?

38

Some Solutions

  • More respect for property rights
  • Greater certainty in the application of the law
  • More certainty in enforceability of contracts
  • Less intrusive regulation and fewer changes in the rules
  • Insist on cost/ benefit analysis for new & old regulations
  • Ex post reviews of regulations
  • Smaller Government
  • Lower taxes