The long term economic and social challenge

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Michael Cullen's overview of NZ economy 2007, as presented to Waikato Chamber of Commerce

Friday, February 23rd 2007, 12:45PM

There are significant economic events on the horizon affecting the business sector generally and I would like to outline the government's approach to them.

The Business Tax Review is coming up, with announcements to be made in the budget, and KiwiSaver will begin from 1 July this year.

Initiatives like these fit into an overall context of the government's efforts to prepare New Zealand for the future.

The challenges are not just about the next two or three years, but about achieving our vision over the next ten to twenty years.

It's a vision of a fair society and a strong economy.

As we look out at our long term challenges, we need to harness the potential of all our people.

We need a consensus for the direction of economic growth and if the benefits of growth are not shared equitably, we will undermine that consensus.

Our challenge is to create a sustainable economy built on innovation and quality, producing the kinds of products the rest of the world will pay a premium for.

We need to be saving more and investing more.

We need to foster participation and promote skills training at all levels and stages of life.

And we need to take advantage of our place in the world, by seeing climate change as an opportunity rather than a risk, and by tapping into the rising Asian powerhouses in our neighbourhood.

To set the economy up for the future, we need to start making these changes now.

We have already come a long way towards building a stronger, fairer economy.

The early years of this century were the longest period of sustained growth in the last thirty years.

The New Zealand economy is a quarter larger today than it was in 1999.

Even with the current slowdown, our economy has been growing faster than the average of developed countries.

From the end of 1999, when the Labour-led government came to office, we have been growing at an average annual rate of 3%.

Faster than Europe, Japan, the US and the UK and as fast as Australia.

While gains have been enjoyed across the economy, our business sector has particularly prospered.

According to company tax returns, profit growth averaged over 20% a year in 2003, 2004 and 2005.

By comparison the average for the previous eight years was profit growth of 5% to 7% a year.

If we think back to just a year ago, doomsayers were forecasting recession.

Indeed a slow down was inevitable after such a long period of strong growth. I have never pretended to have discovered how to abolish the economic cycle, something only ever achieved by parties in Opposition.

But the downturn seems to have bottomed out. The Waikato region in particular has hardly paused for breath, being the fastest growing region last year according to National Bank's latest regional trends survey with 3.5% growth. The lift in Fonterra's forecast payout announced this week will no doubt further underpin the regional economy.

Across the country we are certainly emerging, with some encouraging signs.

Indeed, the Reserve Bank has expressed its concern the economy is bouncing back somewhat faster than it is comfortable with.

GDP is continuing to grow at close to 2%. Compared with our past cyclical downturns, this is very mild. Business confidence is the highest since mid-2003.

Our economy is not only larger, but stronger and better positioned for the long haul.

• More Kiwis than ever - 2.1 million of us - are in jobs and our unemployment rate is lower than at any time in the last twenty-five years.
• Our public finances are sound. Gross debt is approaching 20% of GDP and we no longer carry any net debt at all, counting pre-funding of New Zealand superannuation. New Zealand has better public finances than nearly all other OECD countries.
• We have begun to address the infrastructure deficit that built up through the nineties. We have started the largest road building programme this country has ever seen, at least since the nineteenth century. Waikato in particular is seeing the benefits of that. We are also making crucial progress in telecommunications and security of electricity supply.

So what's left to do?

Our current account deficit is nearly 10% of GDP. That tells us in fairly stark terms that the mix of growth is still excessively dominated by domestic demand.

We are neither saving enough nor exporting enough.

We have one of the lowest rates of research and development in the OECD. Exports as a percent of GDP have barely moved in the last thirty years despite all the economic reforms.

We are certainly highly inventive and adaptive people. We have one of the highest rates of firms starting up. The problem is that not enough of them kick on to be reasonably sized and globally connected.

The May 2006 DHL Export Barometer found that only two in five of the exporters surveyed had introduced new technologies in the past year and only one in four had a physical presence in export markets.

We simply have to do better at producing the high value products the rest of the world wants to buy.

We're working actively with our exporting sectors through agencies such as New Zealand Trade & Enterprise to increase our global connections.

Harnessing greater research and development and upskilling the workforce are key.

We have taken great strides to resuscitate skills training with the Modern Apprenticeship Scheme and industry training programmes.

Next month I hope to congratulate the 3000th Modern Apprentice to have completed his or her training in one of the crucial industries that has benefitted from the scheme. In Waikato alone, some 800 young workers are undertaking Modern Apprentice training, another 10,000 are in industry training. This progress is one reason skills shortages are at seven year lows according to a recent Labour Department survey.

As Finance Minister and Tertiary Education Minister I also want to see a sharper focus on quality, relevance and value for the $2.6 billion we invest in the sector every year.

From 2008, the government will be investing in priority areas of tertiary education, and shifting resources to education and training that better matches skill and learning needs. You, as employers, will have a greater role in defining the competencies that graduates need to have. Tertiary institutions will concentrate on their distinctive contributions – there will be less competition and duplication.

While the government is investing in skills, we are also working through the Business Tax Review on other measures that will improve productivity and competitiveness.

Specific announcements around the outome of the review will be unveiled in this year's budget on 17 May.

These will involve the headline corporate rate; a much more favourable and well understood international tax regime; and assistance, through the tax system, to drivers of growth.

Proposed tax credits for R&D and export market development are cases where I think the government can make a difference, where getting our hands slightly dirty is better than relying on the the invisible hand of the market.

These advances will come on top of considerable effort that's already been put into simplification and areas which are designed to lift investment over the long term, such as depreciation.

Complementing these moves are efforts to increase savings.

New Zealand's savings levels by international comparisons are very low.

The results are felt across the economy - in weaker economic infrastructure, a shallower pool of local capital for development, excessive domestic demand pressures in the economy, our chronic balance of payments deficit and in inadequate savings in far too many of our households.

Savings schemes provide further opportunities to build the wealth of New Zealanders and help build the pool of assets needed for business investment.

There is little point in complaining about increasing foreign ownership of the New Zealand economy if we are continually saving far less than our investment needs.

I particularly want to encourage savings by those of modest means, difficult though that is for many. Inequalities in income translate into much greater inequalities in wealth over time, as we have seen in most developed countries over the last quarter of a century.

If we want to make sure we own more of our own businesses, we need to save more.

If we want to have deeper capital markets that provide the oil for a well-functioning business sector, we need to save more.

If we want to have a better standard of living in retirement than NZ Superannuation alone, we need to save more.

The government has been active across a broad range of policies to increase our savings.

The New Zealand Superannuation Fund is a very significant initiative set up to provide better long-term stability to superannuation by partially pre-funding it.

By setting aside some of the future cost of superannuation, New Zealand will be better placed to meet the cost pressures that are ahead as more of us retire.

For all the contribution New Zealand Superannuation makes - and it's substantial - it will only help fund the cost of providing the basic pension.

Most New Zealanders will want their own retirement savings as well and workplace savings schemes are a key tool.

The government showed leadership by introducing the State Sector Retirement Savings Scheme.

It is a voluntary savings scheme aimed specifically at state sector employees.

But, fortunately, most New Zealanders are not employed in the state sector.

On July 1 we are taking the biggest step forward in a generation to help New Zealanders secure the lifestyle they desire when they retire. It's called KiwiSaver, a voluntary workplace scheme available to everyone between 18 and 64. It is designed to be simple, easy-to-access and low cost for employers.

To kickstart the scheme, everyone who signs up will immediately receive a $1000 up-front contribution from the government. On top of that, a subsidy of up to $5000 will be available for a deposit on a first home for each saver provided they have a total household income below the income cap. The cap has yet to be set.

The incentives are very strong for young people to join as they start out in the workforce. They can choose to contribute 4% or 8% of their wage or salary and new employees will be automatically enrolled.

I am hoping the automatic enrolment provision will be a real catalyst for the scheme, especially with around 700,000 people starting new jobs every year. The point is, if your contribution starts straight away, you are less inclined to miss the money. The immediate pain is much less, the gain over time much more.

And, as we know, the younger a person starts saving the more benefits multiply later in life.

By making employer contributions tax exempt we are making it even more attractive for you to help your workers save. Their balances will grow much quicker with a helping hand from you.

The exemption effectively gives you more choices when it comes to remunerating your workers.

It's worth explaining this. A worker who joins the scheme will put aside a minimum of 4% of their income.

It will be possible to put aside as much as 8%.

Some will struggle to set aside that amount, so KiwiSaver has been designed so employer contributions can count towards the minimum contribution.

Let me outline an example of how this might work.

Take a hypothetical firm called Farmwidgets Inc, with a staff of fifteen.

When management sits down with staff to negotiate wages and conditions, staff present a claim for an increase of, say, 4% (half the firm's average profit increase over the last several years.)

Farmwidgets Inc managers are aware of the Reserve Bank's warnings about wage settlements needing to be non-inflationary. But they also know there is strong demand for skilled labour, they value their staff and want to hang on to them - and they want to recruit new staff for a new export line of farm widgets soon to go into production.

This firm might offer a wage settlement of 2% cash and 2% as a matching KiwiSaver contribution.

The employers' contribution is tax exempt.

It allows the employer to make a higher offer than would otherwise be possible to retain staff and attract new talent.

The government's contributions increase the value of the offer for the employee. In the first year, a staff member paid $50,000 a year, who puts aside $1000 of their own cash (2% of their income, or twenty dollars a week), will also get $1000 cash from the government and $1000 from their employer.

The inflationary effect of the settlement is minimised, taking pressure off interest rates, which also helps Farmwidgets inc (along with every New Zealand business.)

And it increases the pool of investment capital available to growing New Zealand businesses.

Employers who embrace this opportunity, I believe, will see greater job satisfaction, loyalty and retention.

I believe we will see employers competing for staff by offering superior superannuation contributions through Kiwisaver.

I am heartened some of our toughest critics in the business world have applauded the changes to the scheme as a win win for workers and employers.

Indeed, Fletcher Building - with eight thousand employees - was the first company to say it will make a contribution towards each worker's KiwiSaver scheme. It announced it would chip in a 2% contribution for some of its workers.

As with any new scheme there will be a learning curve for employers, of course, and Inland Revenue is about to begin a major campaign to provide you with information.

You will receive a detailed "how to" guide in May and before that Inland Revenue will be running information seminars organised through this chamber of commerce.

A public information campaign and a financial literacy campaign run by the Retirement Commission will also assist employers understanding.

Your responsibilities will include giving an info pack to new staff when they come on board and giving Inland Revenue the details of new staff and existing staff who want to join. Then you'll deduct contributions from before-tax pay and send it in along with their PAYE. These requirements will not add significantly to employers' existing requirements.

You are not expected to be financial advisers, though you can choose a KiwiSaver scheme for employees to join if you want to.

And as KiwiSaver beds in over time, I believe employers and their staff will see its role as very positive for them individually as well as for New Zealand as a whole.

KiwiSaver is a key part of the sustainable economic strategy we have which aims to better position New Zealand for the long haul.

It's vital to keep a focus on the future and keep responding to the challenges we know lie ahead.

Climate change is another example, and one with particular relevance to the Waikato because of the exposure of the local economy to agriculture, and thus to climate.

We are the most agriculturally dependent developed nation in the world, by far. We are also the most remote developed country. Our products travel further than most to market, so we are more exposed than anyone to spurious arguments about 'food miles' and 'wood miles'.

But vexatious as those arguments are, they highlight why there will be opportunities and demand for sustainably produced goods and services.

New Zealand is well placed to grab these opportunities. But they can't all be resolved easily with slogans and easy options. Some way or other the cost of carbon will have to be reflected in the workings of the economy.

To sum up, we are recognising frankly the economic challenges we face and addressing them with an active programme and effective policies.

I'm very proud of the gains we have made already.

I'm proud of the plans we have to create a stronger economy and a fairer New Zealand...proud of the reductions in unemployment and poverty this government is achieving... proud of the fact that by a margin of nearly two to one New Zealanders approve of this government’s economic management.

And as we move through the initiatives coming into effect this year, I hope I have persuaded you they fit into our vision for a New Zealand we will continue to be proud of long into the future.

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