Why NZ is poised for further economic success (and winning the World Cup)

Just as the All Blacks have enjoyed a run of real dominance since the last World Cup, the New Zealand economy has also been on a winning streak.

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Networking Luncheon with KEA, Treasury Alumni and MFAT Alumni, New Zealand House, London. 1:00pm, Thursday 27 September 2007

In the light of the Rugby World Cup, you have asked me to talk about New Zealand's prospects of success, in our economy and in the Cup.

At the risk of straining a metaphor, the Rugby World Cup analogy is rather apposite to our economic prospects:

. The days when we last beat the world are a long way in the past - somewhat further back in history for our economy than for our rugby success.

. In the years since we last won, we have knocked ourselves out in the semis a few times.

. We do all the training and preparation at home, but the points have to be scored on the other side of the world. That is, the foundations of economic success are laid in New Zealand, but we will get nowhere unless we can get 'points on the board' as exporters.

. And, most importantly, this time round we have players of scarcely believable flair, dynamic execution on the field, and a crafty coach of steely determination.

I believe we will win.

Just as the All Blacks have enjoyed a run of real dominance since the last World Cup, the New Zealand economy has also been on a winning streak. In fact the economic streak has been a bit longer. We have enjoyed an uninterrupted seven years of growth. The economy has grown by over a quarter since 1999. Our average growth rate over the economic cycle has out-stripped the average of developed countries. It has been faster than the UK, the EU or the US and as fast as Australia's.

Unemployment is at record low levels. There have never been as many New Zealanders in work.

Government finances are strong. We are enjoying structural surpluses and - taking into account the NZ Superannuation Fund - we no longer carry any net debt at all. It is worth underlining this: we have been running some of the strongest government accounts in the developed world. Credit ratings agencies like Standard & Poor's acknowledge this as a key factor in maintaining our rating, and therefore in keeping interest rates lower than they would otherwise be.

Considering the position government finances reached in the eighties, this is a very satisfying state.

Overall, the pace of real economic growth appears to have slowed since the start of the year, broadly in line with our Budget forecasts. But there are also some encouraging signs, such as much higher dairy prices.

According to the ANZ Commodity Price Index, world dairy prices rose by 120 per cent in the last year. Fonterra lifted its forecast payout to $6.40 per kilogram of milk solids - that is 43 per cent higher than the previous season. It will be a very strong economic stimulus. And with the dollar a bit lower, the signs are good that it will rebalance demand away from domestic consumption and towards export growth.

Nevertheless, we are not entirely injury free.

Naturally an economy running at full capacity will show signs of strain, and we are seeing these in a number of ways:

. The current account deficit is around eight and a half per cent of GDP

. Inflationary pressure is persisting in the non-tradeables sector.

. Household debt to income levels are well above their historic averages.

These issues are not critical, but - just as Graeme Henry develops depth to cover contingencies - the prudent thing for our economy is to address the imbalances.

The wisdom of taking a conservative fiscal approach has been highlighted even further in recent weeks by the global credit squeeze.

The shake-up was triggered by so-called sub-prime mortgages in the US, where some lenders found out they had been a little easy with the availability of credit in recent years.

This led to a wider re-pricing of risk, which is no bad thing. It is perfectly healthy for markets to move away from what has been very high-risk activity in recent years to something approaching normality. But the growth of the derivatives industry has done such a good job of spreading risk, it is not entirely clear who is left holding which risks, creating some financial 'mist'. Though the mist is beginning to clear, there will still be some uncertainty and volatility in the short term.

There are some positives to take out of recent events too. The international financial system is in much better shape to cope than it was 10 years ago. And we saw major central banks assisting liquidity where need be.

Back in New Zealand, we don't have the same sub-prime mortgage problems - our banking system is sound. The riskier end of our financial sector is finance companies, where we have seen some troubles in the past year. But they make up a much smaller portion of the overall system than sub-prime mortgages do in the United States and there is no indication of the same sort of systemic issue. Of course, that is no comfort to those who have lost savings, and I do feel for those who have. The government is proposing changes such as mandatory credit ratings to help make the risk/return profile of investments more apparent to investors in the future.

One of the most obvious impacts in New Zealand of a reduced appetite for risk was a sharp drop in the exchange rate. A lower dollar (and continued high interest rates) could reorientate growth towards exports and away from domestic demand.

The global financial developments have emphasised the virtue of several key components of New Zealand's economic strategy:

. First, our strong fiscal strategy.

. And second, our strategy to increase savings and to increase the rate at which our economy can grow.

The government's strategy to lock-in continued economic success for New Zealand is to maintain the foundation of a strong fiscal position. To return to the rugby analogy, our fiscal strength is like the rock-steady scrum that anchors everything else we do.

Second, we are trying to change the mix of growth away from domestic demand toward investment in productivity growth. This might be analogous to Dan Carter's boot, finding field position and knocking over goals that continually keep the scoreboard of growth ticking over.

Third, we have put in place structural incentives to save rather than increase demand through debt. We introduced KiwiSaver, as a landmark workplace retirement savings scheme. It is a bit like a ferocious flanker, tackling every threat in site - from our low savings rate, to better retirement security, to deeper capital pools for our businesses. I will talk more about that shortly.

And, finally, this year the government introduced the most comprehensive package of business tax reform in twenty years - a bit like a flying winger scorching down the touchline. The package was aimed at increasing productivity, innovation and international connections.

The business tax package included $3.4 billion of tax cuts. The headline rate was cut from 33 to 30 cents. International tax changes were introduced that will make it more competitive for kiwi companies to do business overseas. An expanded market development assistance package will grow our connections to the world.

And to increase innovation in our businesses, a new tax credit was introduced for research and development spending.

The business tax package overall was greeted with a headline in the Australian Financial Review saying, "New Zealand is luring businesses across the Tasman." It predicted "R&D investment could flow back across the Tasman."

The government's vision is for a high-skill, high-value, knowledge-led economy, capable of competing successfully in an increasingly globalised world. Our investment in knowledge and innovation goes well beyond the attractive tax package I mentioned.

It has included a heavy emphasis on skills training and reform of the tertiary sector to put a greater emphasis on quality and the needs of industry.

One of the Labour-led government's great achievements since 1999 was to breathe life into skills training with the Modern Apprenticeship Scheme and greatly expand industry training. New Zealand workers want to invest their skills and knowledge on the job, and New Zealand employers want to see the immediate and longer-term benefits of creating a more skilled workforce.

Since its inception in 2000, over three thousand Modern Apprentices have completed their qualifications in crucial industries.

And from next year, a revamped tertiary sector will ensure our tertiary graduates' skills are more aligned with the needs of industry.

Research, science and technology are crucial to transforming New Zealand's economy to a high-skill, high-value, globally-connected economy.

A central feature of our tertiary education reforms is our effort to increase our educational connections internationally.

In August this year, I launched New Zealand's strategy for international education for the next five years, the International Education Agenda. It came with extra funding to support and implement its goals.

This strategy goes well beyond the recruitment of international students. It is aimed at building strong, sustainable education relationships and connections internationally.

These are smart, active policies, designed to improve our ability to compete.

The only way to increase our long term standard of living is to increase our productivity. Productivity improvements come from innovation. The knowledge economy initiatives I have talked about will help to increase levels of innovation.

Productivity and innovation is a major economic issue for New Zealand. The other high priority is to lift our savings rate.

That is why the government introduced KiwiSaver.

New Zealanders as a whole are not very good at putting aside some savings. The Reserve Bank estimates that for every dollar an average household earns, it currently spends about $1.15.

Of the money we do save, we tend to keep most of it in our homes. When Treasury officials looked at the figures, they advised most people still need significant savings in their retirement, in addition to their homes. There will always be NZ Superannuation for your retirement (and that has been made even more secure by the NZ Superannuation Fund). But NZ Super is not going to provide enough income for most people to enjoy in their retirement a standard of living similar to the standard they enjoy while they are working.

And when our savings rate is low, and mostly locked into housing, we don't have enough money for things like our businesses to grow and expand, creating more high quality jobs.

A low savings rate also puts pressure on monetary policy.

If we save more, we will reap long term benefits personally, in a higher standard of living for our own households, and in a higher performing New Zealand economy.

KiwiSaver came into effect on 1 July. Everyone who saves four or eight per cent of their income will get a $1000 contribution from the government into their Kiwisaver accounts to get things kick-started. They could get a $5000 subsidy to help buy their first home - $10,000 for a couple.

The government will provide a tax credit to savers that matches their contributions up to $20 a week. Employers will have to match their employees' contribution and they will receive a tax credit that fully reimburses them for doing so up to $20 a week.

From the savers' point of view, that means someone who manages to put away $20 a week will find their savings boosted to $60 a week.

How might this work in practice? Take a couple we'll call Keri and Mike. Let's say they are both thirty and together earn $75,000 a year - an average income for a two person household.

If they save four per cent of their income, they will have a deposit for their first home in five years - $35,500 in today's dollars. When they retire at age 65 they will have total savings of $390,000. That is enough to generate an income in retirement of $20,000 to $25,000 a year.

KiwiSaver gives us a chance of emulating the success Australia has achieved through its enormous compulsory scheme. Australia's development over the last decade or more has been driven in large part by funds under management through the compulsory superannuation scheme - now worth a trillion dollars.

New Zealand has had no similar scheme.

We have seen the results in the somewhat frequent arrival of Australian private equity firms coming to New Zealand. I welcome the arrival of foreign capital, the technical expertise and marketing opportunities those sales bring. But I also wish it was not a one-way journey and more New Zealand funds were participating in Australian businesses.

Over time Treasury estimates KiwiSaver will grow to around $100 billion in today's dollars after thirty years. That is about sixty per cent of GDP.

It is likely to result in a fundamental shift in our saving landscape. It will substantially deepen capital markets and significantly change the mix of growth from spending to saving and investing.

Unlike a football game, or even a tournament, economic success has no endpoint. There is no final whistle, no point where we can hang up our boots, hit the showers and have a beer. It is a process of continually transforming the economy to meet a changing world.

And, as with the Rugby World Cup, it won't matter in four year's time how well we've done this year. We'll still have to get up again and try to win.

Everything we have seen about the Rugby World Cup tells us we should be confident, but not over-confident about the All Blacks this time round.

And everything we see about the New Zealand economy should reassure you that we have good grounds to be confident of further success for New Zealand. Overall, and combined with our smart, active policies to lift New Zealand's growth rate, KiwiSaver and the government's strong fiscal strategy are positioning our economy very strongly for the future.