Shifts in New Zealand’s External Economic Environment · 2014-06-30 · New Zealand is vulnerable to the global recession because: • The global demand for exports is faltering.

Shifts in New Zealand’s External Economic Environment

Report to the Reserve Bank of New Zealand

June 2009

About NZIER

NZIER is a specialist consulting firm that uses applied economic research and analysis to provide a wide range of strategic advice to clients in the public and private sectors, throughout New Zealand and Australia, and further afield.

NZIER is also known for its long-established Quarterly Survey of Business Opinion and Quarterly Predictions.

Our aim is to be the premier centre of applied economic research in New Zealand. We pride ourselves on our reputation for independence and delivering quality analysis in the right form, and at the right time, for our clients. We ensure quality through teamwork on individual projects, critical review at internal seminars, and by peer review at various stages through a project by a senior staff member otherwise not involved in the project.

NZIER was established in 1958.

Authorship

This report has been prepared at NZIER by Ralph Lattimore and John Yeabsley. The assistance of Victoria Zhang, Tim Ng and John McDermott of the Reserve Bank of New Zealand and Gary Hawke and Jessica Matthewson at NZIER is gratefully acknowledged.

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Contents

1. Introduction ............................................................................................................. 1

2. Background ............................................................................................................. 3

3. My Contacts............................................................................................................. 4

4. Technological Drivers ............................................................................................ 7 4.1 Biased technical change................................................................................. 8 4.2 Economic geography ...................................................................................... 8 4.3 Financial innovation ........................................................................................ 9

5. World Economic Order........................................................................................... 9

6. Emerging Economies ........................................................................................... 10

7. Agricultural Protectionism and the Terms of Trade.......................................... 14

8. The Availability and Price of Foreign Savings to NZ ........................................ 18

9. Migration................................................................................................................ 20

10. The Real Exchange Rate ...................................................................................... 21

11. Conclusions........................................................................................................... 23

Appendices

Appendix A : The My Contacts Opinion Survey .......................................................... 28

Figures

Figure 1 Credit Default Risk Spreads.................................................................................. 1

Figure 2 Striding towards the core of the trade network ................................................... 10

Figure 3 New Zealand’s Terms of Trade........................................................................... 15

Figure 4 Long-run Soft Commodity Price Variation .......................................................... 16

Figure 5 ANZ Commodity Price Index, Meat and Dairy .................................................... 17

Figure 6 ANZ Commodity Price Indices, Horticulture, Forestry, Seafood and Aluminum 18

Figure 7 New Zealand Current Account Deficit................................................................. 19

Figure 8 NZ Country Risk Premium .................................................................................. 20

Figure 9 Population Growth and Permanent Migration..................................................... 21

Figure 10 Exchange Rates................................................................................................ 22

NZIER – Shifts in New Zealand’s External Economic Environment ii

Tables

Table 1 Delphi Opinion Survey: Risk Scores ...................................................................... 6

NZIER – Shifts in New Zealand’s External Economic Environment iii

1. Introduction

I was holidaying in September 2007 with a cousin when two events occurred that would adversely affect the performance of the New Zealand economy. The first was the onset of drought in New Zealand. It was not the usual drought that confined itself to the East coasts of both islands but rather one that encroached on the primary dairying areas of the country. The New Zealand economy headed for recession that was first recorded in the first quarter of 2008.

The second event occurred in the world’s major financial centres. It became clear that many of the largest institutions forming the backbone of the global finance and insurance infrastructure owned large volumes of sophisticated but unsalable assets. Banks increasingly couldn’t trust one another because they didn’t know how many of these toxic products their potential trading partners owned. My cousin was called back to an emergency meeting at Lehman Bros. in London and holiday plans were accordingly truncated.

Figure 1 Credit Default Risk Spreads

0

50

100

150

200

250

300

350

400

450

500

Jan 07 Jul 07 Jan 08 Jul 08 Jan 09

0

50

100

150

200

250

300

350

400

450

500

Australasia

United States

Europe

Basis points

Source: Reserve Bank of New Zealand

The uncertainty created by the existence of these unsalable assets increased counterparty risks in the financial markets. The global banking infrastructure threatened to collapse. One of first indicators of trouble was the cost of insuring against credit default by large corporates, Figure 1. The cost of this insurance rose sharply in August 2007 and it became more volatile. It has continued to rise ever since and remains very high and volatile to date.

The resulting ‘credit crunch’ turned out to be a once in a lifetime event that continues to reverberate across both the real and financial economies around the world. In April, 2009, Pascal Lamy of the WTO reported to the G20 meeting that only US$800 billion of the US$3 trillion of the unsalable (toxic) assets identified so far have been written off. These assets

NZIER – Shifts in New Zealand’s External Economic Environment 1

have to go because they threaten the viability of banks and other institutions that form the backbone of banking infrastructure. Their development represents a financial market failure. Government actions in many countries have been slow and tentative and have probably added to the chaos – many of these actions will probably turn out to be government failures. While there have been many international financial market failures in recent decades, this one will be remembered as one of the most serious.

This essay was commissioned by the Reserve Bank of New Zealand in March 2009 to provide an outsiders view of the likely medium term external (offshore) effects of this credit crunch on the New Zealand economy. It surveys some major shifts in world markets over the recent past and tries to set the scene for the global environment New Zealand faces as the economy works through the global recession.

The approach taken here is to try to look out 5 years or so and try to identify the future trends in financial, real economy and migration effects that are likely to develop. That is, to review the major offshore markets that impinge on New Zealand economic markets. In this sense, the essay is a personal forecasting exercise. In another sense, it is not a forecasting exercise at all. The essay will not attempt to make point forecasts on an annual basis over the next 5 years. That is a futile exercise at the best of times because the probability of any point forecast being right is zero. It is especially futile in the current global economic environment where uncertainty lies at the heart of the financial disorder and forecast standard errors have blown out. The best we can do is to try to describe the dispersion of future values as accurately as possible.

This study is partial in the sense that the analysis largely abstracts from how New Zealand markets and policy might react to the performance of the unfolding global markets. These issues are left for another day but readers interested in this dimension could well begin with Michael Riddell and Cathy Sleeman’s excellent review on that subject, Riddell and Sleeman (2008).

The essay begins with some background on the crisis itself. That is done in the next section covering global and New Zealand issues that have unfolded over the last 18 months. The following section analyses an opinion survey conducted with My Contacts. In this uncertain environment, one person’s view will have very little information content so a survey has been conducted in an attempt to better identify key issues to focus on.

Section four steps back to examine major structural trends in the changing world economic order and the subsequent sections look at likely trends in a range of economic issues and overseas markets that affect the New Zealand economy.


2. Background

It is easy to forget how frequently international financial crises occur, Kindleberger (1996) and Reinhart and Rogoff (2008). Each crisis has its own context and this one is no exception. However, the similarities are important too – counterparty risk increases in the banking system, threatening to cause breakdown in the payments system infrastructure. There is no J.P. Morgan around this time to force banks to agree to deal and the overhang of toxic assets is proving very slow to write-off. Governments have confronted the market failure within the limitations imposed by international negotiations in an environment of current account imbalances that no longer match the governance structures of multi-lateral institutions.

The increased price of risk emanating from the crisis means that households, firms and economies are forced to reassess their debt/equity ratios. This has caused general global recession forecast by the IMF to be greater than anything seen since 1946.

New Zealand is vulnerable to the global recession because:

• The global demand for exports is faltering.

• The supply of foreign savings to fund New Zealand’s 8.9% current account deficit may get more expensive and they are certainly less reliable.

• New Zealand households are heavily indebted.

• House prices are falling.

• The economy is still recovering from the 2007/08 drought, and

• The economy is coming out of a long period of a high real exchange rate.

The New Zealand economy has a number of important strengths to combat the global recession, of course. New Zealand is only one of two countries that Sally (2008) argues has developed a political culture of tolerance for continuous economic reform. This robustness will stand the economy in good stead during a crisis such as this. The vulnerability list above is presented in this one-sided fashion to orient the later discussion on external threats. It is not meant as a commentary on New Zealand’s future prospects.

This crisis is similar to the 1997 recession in New Zealand inasmuch there is a conjunction of domestic drought effects and an international financial crisis. The 2007/08 commodity price boom leading into this global recession is reminiscent of the 1972 agricultural commodity boom and subsequent oil price shock but the underlying causes appear to be quite different.


3. My Contacts

I conducted an informal survey of business and economic researchers that I collaborate with occasionally in order to test my ideas on the various risks that the New Zealand economy faces in the medium term. I selected 25 applied business and economic researchers from My Contacts list overseas and in New Zealand. No professional economic forecasters were involved – they were specialists in both micro and macroeconomic analysis. Most were academics. This group was selected because the Reserve Bank already surveys business groups and it has good information sources through international institutions including other central banks. Economic forecasters are regularly surveyed in Consensus surveys. My Contacts are a somewhat different group. Details on the conduct of the Delphi survey and the participants are given in Appendix 1.

In the two stage survey, the views of participants coalesced around 14 external threats or challenges facing New Zealand over the next five years or so. They ranked each on two metrics – the perceived impact on New Zealand and the probability of occurrence1. These two scores were multiplied together to get a measure of external risk to the New Zealand economy.

The results for the mean scores for all participants and their dispersion (standard deviation) are given in Table 1. The maximum score for each challenge or threat is 80. Given the 2 stage process, it is suggested that the first thirteen issues involve significant risks in the opinions of the group. Some participants saw the possible shift of economic leadership from the US to China as an opportunity or a positive for New Zealand and gave it a negative score. This was outside the permissible range but had it be allowed, the risk score on issue 14 would have been lower than is reported here.

Mean scores of 12 and over might be considered to be the major risks. The other general comment that might be made is that in accordance with economic doctrine, the dispersion of the scores is large relative to the mean!

The challenges identified represent a broad set of issues. For example, participants are concerned about the quality of global or multi-lateral regulation (issue 11) over the next few years. Some are concerned with restrictive and inefficient financial regulation emanating from the credit crunch while many are concerned about climate change policy and its potential to discriminate against New Zealand.

Not surprisingly, the top risk was slow global recovery with a mean score of 33.1 out of a maximum of 80. Half the group scored the impact at the high and very high levels (8 and 16). Clearly, this group of economists is predicting a long global recession rather than a V-shaped recovery. The dispersion of scores is quite high too, with a standard deviation of 25.1.

1 The impact scale is 0,1,2,4,8,16 (low to high) and the probability score comprises the integers 0-5 (low to

high).


Oil price escalation ranks second and like the slow growth recovery issue, the risk scores are very similar for New Zealand and foreign based participants.

The third highest scores are for the risk of resurgence of protectionism against New Zealand (on whatever pretext). Protectionism was described by participants in stage one of the survey in more explicit terms. It included a failure to conclude the Doha Development Agenda at the WTO and protection emanating from ‘food miles’ and international travel ‘carbon footprint’ issues. Protectionism could be the instigator of group thinking under item 11 – also a highly ranked threat. There was considerable concern about the possibility of multilateral climate change policy disadvantaging New Zealand in the future. Worries about inappropriate multilateral financial regulations were part of the response to item 11 but most concern centred on climate change and other real economy policy threats.

The next three issues (5-7) are not in the major risk category except that New Zealand participants are very concerned about reduced people movements. This issue is related to aging in OECD countries and increasing competition for skilled labour as well as restrictions on the inward and outward migration of people to or from New Zealand.


Table 1 Delphi Opinion Survey: Risk Scores Maximum score 80

Iss Ov Overall Foreign ue erall NZ

Me SD Me ean an M an

1 Slo 33. 25. 31. 35.w Global Recovery 1 1 1 7

2 Oil 23.6 17.6 23.0 24.3 price escalation

3 Res 20. 12. 16. 26.urgence of Protectionism (on whatever pretext) 9 9 5 7

4 Slo 13. 11. 14. 11.w Growth in BRIC countries 5 7 9 8

5 Re 11.5 16.7 18.6 3.2 duced People Movements

6 Na 6.9 8.5 9.1 4.3 tural Disasters, Epidemics

7 Maj 7.7 5.5 8.9 6.2 or Global hostilities e.g. terrorism, Taiwan

8 Loseco 15.5 15.0 16.6 14.2 ing agricultural competitiveness to emerging

nomies

9 LosSin 12.2 20.7 7.4 17.7 ing competitiveness to global cities – Sydney,

gapore

10 gikil 9.3 4.3 11.4 6.8 A

sng in OECD countries increasing competition for led labour

11 elim 13.2 10.3 9.4 18.3 D

cteriorating global policies on financial regulation, ate change etc

12 13. 12. 11. 16.Rising country risk premium for NZ 3 8 3 0

13 11. 10. 10. 11.Rising anti-globalisation sentiment 2 1 9 7

14 hi 5.6 5.7 4.7 6.7 S ft of economic leadership from US to China

Source: Author computations

Losing competitiveness in agriculture and to global cities are both major concerns but both issues have high standard errors, especially the latter. Overseas participants are much more concerned about economic geography issues and the importance of global cities as generators of growth and competitiveness.

The two remaining major risks are 11 and 12. Both have high standard errors and both are scored more highly by overseas participants.

Less than half the major challenges in this list are directly related to the credit crunch and the global recession that has resulted. Slower global growth and growth in the BRIC2 countries are two that are. The resurgence of protectionism, reduced people movements, major global hostilities, deteriorating global policies, the rising NZ country risk premium and anti-globalisation sentiment are certainly heightened by the global recession but are challenges at the best of times in New Zealand.

2 Brazil, Russia, India and China.


Natural disasters and epidemics are always with us. It should be borne in mind that this survey was completed before the outbreak of swine flu hit the headlines in April, 2009.

The remaining issues are structural or longer term challenges arising out of the tyranny of distance New Zealand faces but more particularly, they are challenges arising out of the global technological environment that the New Zealand economy faces.

4. Technological Drivers

There are a number of technological drivers that are highly likely to continue affecting the global economy and world trade patterns as demand recovers from the effects of the credit crunch. It will not be ‘business as usual’ in my view because these drivers are very powerful influences on market performance. They involve continuous change.

The technological drivers are expected to continue developing regardless of future demand patterns. Electronics components and final goods have been a major trade driver over the last 20 years but there are no guarantees that will continue to be the case in the long-run, – though electronics growth could easily persist for five years or more. Forecasting future demands at the high elasticity end of the spectrum is difficult but whatever emerges from the laboratories and sells well, is very likely to be produced and marketed using systems based on technology elaborated on the following ideas.

Kaleidoscope comparative advantage

Prior to World War 2, international trade consisted mainly of the exchange of agricultural products and other raw materials for final goods. That has changed radically as new (office, organizational and communications) technology and embodied human skills have enabled firms to increasingly specialize, not just in products, but in tasks and smaller and smaller segments of product supply chains3. Design, production, marketing and after sales services can now be ‘sliced and diced’ at home and across the world in complex ways. Component parts now cross national borders a number of times prior to final assembly. This technological revolution has been very beneficial to OECD countries that develop and control the resulting global supply chains, and to consumers who benefit from the increased variety of goods and lower prices. The result is what Bhagwati has called kaleidoscope comparative advantage – country comparative advantages that refer only to a very small portion of a product’s supply chain4. In other words, as supply chains have been sliced and diced, so has comparative advantage.

These long complex supply chains usually rely on economies of scale to operate efficiently and there are very few products that New Zealand exports that have scale economies in

3 The development of these innovations can be traced in the modern literature from Coase (1937), Arrow

(1962), Vernon (1966) and Grubel and Lloyd (1975) to Krugman (1979) and Helpman (2006). These ideas are brought together in a wider globalization context in, for example, Dicken ( 2003).

4 Bhagwati (2008)


production. Accordingly, New Zealand’s comparative advantages in innovative and niche processes and products are reinforced by the phenomenon of global supply chains.

The other implication of this phenomenon for New Zealand is market volatility. Comparative advantages can be expected to change quickly and regularly as the underpinning technology changes. This has implications for trade adjustment policy at home and abroad. In the current environment where global recession is creating social tensions, foreign trade adjustment programmes have turned protectionist.

Once the global recession has abated global supply chain development can be expected to resume. It provides opportunities for New Zealand through:

• Outward direct investment opportunities.

• Inward direct investment opportunities for New Zealand resources.

• New sources of competitively priced components, goods and services.

• New international trading partners as Vernon product cycles move from China to Vietnam, for example, or Asia to Africa.

4.1 Biased technical change

The second major technological issue facing New Zealand is biased technical change. This is a somewhat longer term issue than this essay encompasses but it is important to bear in mind. Technology is developed mainly in higher income countries where it is developed to suit factor and product market conditions in those countries. Wages are generally high and markets are large in these countries. Technological change that is labour saving suits New Zealand’s aspirations to be a higher wage economy but the focus has to be put on high labour productivity as discussed by Leamer (2007). Moreover, the minimum efficient operating scale of much overseas technology is sometimes too large for New Zealand.

The challenge for New Zealand is to devote sufficient research effort to areas focusing on appropriate technology for New Zealand’s market sizes and other unique conditions.

4.2 Economic geography

There is mounting evidence that some of the technology that has stimulated global supply chain development is producing significant spillovers that lead to economies of scale in human settlement, McCann (2009). At present this technology appears to disadvantage New Zealand quite significantly and unless there are significant elaborations in the underlying technology in the future, economic development favouring global cities are likely to prove a significant obstacle. This challenge is reflected in the opinion survey just discussed.


4.3 Financial innovation

Financial innovation is receiving a good deal of bad press at present. However, the ideas underlying the development of modern financial products are still very useful. In part, recent problems were due to the way these products were packaged and marketed, and in part they are due to the market and regulatory circumstances that have been in play in recent years – product launches in the wrong environment. There will be continuing demand for financial products that help spread and insure against market risk.

5. World Economic Order

The world has lived through an accelerated globalization process over the last 20 years. Global trade relative to world GDP has grown from 30% in 1990 to 51% in 2008. At the same time, the share of world trade of OECD countries has gone down from 73% in 1990 to 61% in 2008. These shifts have led to changes in the structure of the world trade network and, in particular, the role and influence of emerging markets on world trade has increased significantly. In short, the developing world has taken off.

The forecast global recession in 2009 will have major effects on these figures. For example, the global trade/GDP ratio is expected to fall from 51% in 2008 to 45% in 2009 based on the March 2009 IMF forecasts. This is a major fall but it is not expected to last. The effectiveness of global supply chains is so embedded in business organisation (and the degree of openness of emerging economies so great5) that world trade business is expected to keep developing once the recession abates and demand growth resumes. Interestingly, there is recent evidence that the services trade is holding up better than the goods trade in the current environment, Borchert and Mattoo (2009). This is perhaps due to the fact that the large electronics goods trade is based on products that are essentially consumer durables with ongoing production reliant on the demand for variety and novelty – an effect that will dampen when discretionary incomes shrink. Many services may be more essential to maintain economic systems.

Emerging economies have been a major driving force in the rising importance of non-OECD countries just referred to. The six BRIICS economies6 are very prominent in the emerging country group. Their increasing role in world trade can be visualized by examining the deeper role they play in the global trade network. One measure of this is their relative centrality index – the degree to which their trade is a node in the global network. Figure 2 provides centrality indices for the BRIICS economies over the period 1980-2005. The indices are expressed as percentiles of the highest ranked economy which has traditionally been the United States, Germany or Japan. The percentiles are grouped into four categories on the Y-

5 On accession to the WTO, China agreed to the most liberal regime of any new entrant. Shortly thereafter,

Vietnam exceeded China’s accession terms. 6 Brazil, Russia, India, Indonesia, China and South Africa.


axis – C for core (95th to 100th percentile), IP for inner periphery (90 – 95), P for periphery (85-90) and OP for outer periphery (below 85th percentile).

China moved from the outer periphery to the inner periphery in the 5 year period 1980-85 following the initiation of reforms in 1978. It is now near the top of the core group with Germany and the United States. India is close to entering the core and Russia, Brazil and South Africa have the potential to do so7. There are a number of other countries who will likely gain prominence on this measure in the future – Vietnam is a case in point.

Figure 2 Striding towards the core of the trade network Evolution of network centrality indices (1980-2005)

United States China

IndiaSoviet

Union/Russia

Brazil

Indonesia

South Africa

65

70

75

80

85

90

95

100

1980 1985 1990 1995 2000 2004 2005

C

IP

P

O

Source: Reyes, Garcia and Lattimore (2008)

The recent successes of emerging economies in trade have been, in part, the result of business partnerships formed with OECD foreign direct investors. Over 40,000 EU companies, for example, had subsidiaries in China in 2007. Furthermore, the BRIICS and other emerging economies are rapidly creating MNEs themselves that have been investing in OECD and non-OECD countries alike, Safadi and Lattimore (2008).

6. Emerging Economies

The developing trade connections of non-OECD economies is only a part of general economic development programmes in these countries. Economic progress has been uneven but it has been widespread. In many cases like India and China, economic development hasn’t been highly trade dependant either8. Even the continent of Africa was growing at a fast pace up until the credit crunch struck.

7 New Zealand is in the periphery of the trade network but it did break into the inner periphery in 1985, 8 Witness the debate over the last two years concerning decoupling. Of course China, with its trade focus on

final assembly, was coupled to the OECD, but the question could at least be raised.


An insightful statistic produced by the Growth Commission (2008) is that in 1950 only 1 billion people lived in fast growing economies (over 6% real per annum) or in high income countries. In 2007, 4 billion people lived in these two categories of countries. This has important potential ramifications for the demand growth for New Zealand exports. Non-OECD growth has produced an increasingly large middle class especially in Asia but also in other continents. This socio-economic group has relatively high income elasticities of demand for livestock products9. The extent to which this will lead to increased world prices is addressed below.

The expanding middle class is also an important driver of political development, though the time scales involved in political change are likely to be much longer. As Chou En-Lai said, just a couple of decades ago, in answer to a question about the effects of the French revolution, “it’s too soon to tell”.

Non-OECD growth in recent years has also produced a very large increase in the workforce of the integrated world economy. That is, the workforce that has the capacity to respond to labour demands driven by world market influences. This has been, perhaps, the most important driver of recent globalization.

The integration of this huge new workforce into the global economy from non-OECD countries has required correspondingly large capital investments, mostly from domestic sources. Nevertheless, foreign direct investment and business migration has provided valuable complementary inputs to drive Vernon’s product cycles. The credit crunch threatens these FDI flows and may slow down recovery – it is unlikely to turn the clock back. The developing world, from Asia to Africa, has learnt how to build and maintain modern industrial and service networks that can exploit the scale economies of the latest technology. Once the financial crisis is over, this production capacity in goods and services will recover to benefit their own consumers and the global economy generally. This will also keep downward pressure on international inflation rates as China and India have done in recent decades.

The poverty reduction that has accompanied this economic growth is on a very large scale. China alone has drawn hundreds of millions of people out of poverty since 1978. The large, new middle class in the developing world will likely be less tolerant of the disruption caused by the credit crunch and this will keep some pressure on domestic and multilateral stabilisation efforts.

Two recent studies provide specific indicators of the effects of the changing world order on New Zealand. Winters and Yusuf (2007) have broadly analysed the effects of the emergence of India and China on the world economy in their publication Dancing with Giants. This study

9 See for example, Lattimore (1999), Coyle, Gehlhar, Hertel, Wang and Yu (1998), Cranfield, Hertel, Eales and Preckel (1998), Delgardo, Rosegrant, Steinfeld, Ehui and Courbois (1999) and Seale, Regmi and Bernstein (2003).


included a computable general equilibrium analysis of which countries might gain and which might lose, competing with these two giants, Dimararnan, Ianchovichina and Martin (2007). They show that New Zealand is likely to be a large winner in the future based on the complementarities in comparative advantages between New Zealand and the two Asian giants. They implicitly assume that trade and industry policies remain the same as they were before the credit crunch occurred.

The second major study is from the OECD. Rae and Sollie (2008) produce a range of indicators based on an international dataset of over 1000 product categories and 11 services. They ask the question, which OECD countries are most exposed to globalisation pressures? On this question they measure the rank correlation of revealed comparative advantage indices (RCA) between New Zealand and two groups of countries – ‘Dynamic Asia’10 and the BRIC countries11. In both cases the coefficients are around zero – New Zealand is more exposed than the US, Canada, Germany, France, Australia, Finland and the UK but less exposed than Japan, Italy, Korea and new accession countries to the EU. New Zealand is more exposed to globalisation in the sense than New Zealand has an export mix in which its RCA indices are not correlated with the growth rate of the 500 most traded international products. On the other side, New Zealand is amongst the top group of countries where the RCA index is correlated with global product profit margins. New Zealand’s performance is due to its heavy reliance on exports of natural resource based products and a relatively small proportion of high growth products and services like engineering, pharmaceutical products and services.

Rae and Sollie (2008) then compute indices to address the question, which countries are best equipped to cope with globalisation challenges? New Zealand scores reasonably well. Its overall score places it between Japan and the UK – not as high as Sweden, the US and Finland but higher than Germany, Korea, France, Ireland and the Southern and Eastern European countries. The strengths that give rise to this placing are educational attainment, flexible product markets, high labour mobility and low housing transactions costs. The biggest New Zealand weakness on the coping front is relatively low innovation activity.

A final feature of emerging economies that is important in the current context is the global imbalances question. China, in particular, has amassed very large foreign exchange reserves in recent years by running large current account surpluses. This provides the country with a buffer against the global flight from debt and risk to equity.

This current account and reserves position points to some increase in China’s role in global economic leadership. The opinion survey does not rate this issue highly as a threat – in fact some participants rate that eventuality very positively.

10 Comprising China, India, Chinese Taipei, Hong Kong, Indonesia, Malaysia, the Philippines,

Singapore and Thailand. 11 Brazil, Russia, India and China.


Financial markets are well organized to recycle Chinese reserves as they recycle petro-dollars from OPEC members and there do not appear to be major challenges in this area from New Zealand’s perspective. China’s relative position in global financial affairs is small compared to its importance in global real economy supply chains.


7. Agricultural Protectionism and the Terms of Trade

The Dimararnan, Ianchovichina and Martin (2007) World Bank study referred to earlier is an important piece of evidence on New Zealand’s trade prospects but it is not a complete answer because it is, necessarily, based on a series of assumptions which include the political economy of agricultural protection and other factors. What the study does do well is to match the growing demand for agri-food (and other) products with the global supply possibilities. Accordingly, New Zealand’s export competitors are factored into the analysis. Their assumptions about, for example, Brazil’s likely productivity growth in beef and dairy production is uncertain but the model represents some of the best information we have at hand.

The political economy of agricultural protectionism has reached an interesting juncture. Over the last 50 years, developing countries have generally removed policy disincentives against their farm sectors. For example, over the period 1955-59 the relative rate of agricultural assistance (RRA)12 in China was -61%. This means that the farm sector was being taxed at a rate of 61% relative to other tradables. Over the period 2000-2004, the RRA was approximately zero – a level playing field for tradables, Anderson and Martin (2007). The question is: where will China and other developing countries go now, on trade policy? China and Vietnam, for example, have joined the WTO on very liberal grounds13. China has a FTA with New Zealand. These actions point to an increasingly liberal trading regime in China.

On the other hand, China could increase its RRA by pursuing the Korean or Japanese agricultural models. Korea had an RRA of -33% in 1955-59 but it now has an RRA of +167% by essentially subsidizing farming at the expense of other tradables. Korea has amongst the highest agricultural subsidies in the world.

China has a number of agricultural comparative advantages in labour and land intensive horticulture and agriculture but it has many agricultural comparative disadvantages. At the same time China is more self-sufficient in agri-food products (98%) than Korea (87%), Anderson and Martin (2007). Accordingly, the incentive for China to become highly protectionist like Korea in the future, is lower.

The opinion survey highlighted protectionism as a major threat to New Zealand and the non-competition of the Doha Development Agenda is part of that issue. One of the reasons it is so important to complete this WTO Round is to reduce the incentives for China and other emerging economies to deviate from their present trajectories of liberal trade regimes. It is by 12 The relative rate of agriculture assistance is the ratio of the nominal rate of agricultural assistance to the

nominal rate of non-agricultural assistance. A positive RRA reflects a domestic policy bias towards agricultural production. When the ratio is negative it indicates a bias against agricultural production relative to other non-tradables.

13 The most liberal concessions of any new entrant to the WTO family.


no means clear that the Round will be completed – the diversion of policy effort towards macroeconomic stabilization may crowd out this outcome. Nevertheless, increased protectionism makes less and less business sense because global supply chains are very profitable and the current rush to form regional trade agreements (RTAs) could be viewed as an attempt to try to keep up with increasingly complex business arrangements. Nonetheless, RTAs are a threat to the multi-lateral system that treats New Zealand so well, Bhagwati (2008b).

Figure 3 New Zealand’s Terms of Trade Data type

Terms of Trade

708090

100110120130140150160

1920 1930 1940 1950 1960 1970 1980 1990 2000 2010

Index

708090100110120130140150160

Index


New Zealand’s terms of trade has been much less volatile over the last thirty years than it was previously, Figure 3. Furthermore, after trending slowly downwards in the decade after 1990, it has risen sharply in the last decade. The question addressed here concerns its likely medium term trend as the global economy stabilizes over the next 5-10 years. A piecemeal approach is taken here in forecasting the terms of trade because Cashin, McDermott and Scott (2002) have found no conclusive evidence that commodity price movements are inter-related where the products are not part of a supply chain or are otherwise structurally related.

Non-food consumption goods prices are likely to remain constant, or even continue to fall in real terms as global supply chains are reactivated and move to new emerging economy locations in search of cost efficiencies. This can happen fairly quickly as China showed in moving away (relatively) from exports of textiles, clothing and footwear in the decade of the 1990’s towards the final assembly of electronic and electrical goods. Real wages can be expected to rise in the fastest growing emerging economies and stimulate the repositioning of supply bases for production and marketing tasks, and for services. As argued earlier, there are plenty of developing countries who have demonstrated some capacity to develop manufacturing platforms. There is also excess capacity in the BRIICS group of countries to mobilize more workers from regions that, till now, have been somewhat excluded from participating in global supply chains.


China is expected to continue to slowly revalue its currency against the USD in order to reduce the rate of accumulation of foreign exchange reserves and spread the benefits of development more widely. Chinese export prices can, accordingly, be expected to rise over the medium term. On balance, the terms of trade will tend to rise given the weight these goods have in New Zealand’s import bundle.

Capital goods prices are not expected to fall to the same extent as consumption goods prices because New Zealand will tend to import more innovative products with higher IPR costs and they will often need to be sourced from OECD countries including Germany and the US where productivity growth will be more restrained than in emerging economies.

Figure 4 Long-run Soft Commodity Real Price Variation

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New Zealand’s non-food exports have shown some capacity to focus on niche processes, products and markets in the globalised environment over the last 20 years, Lattimore, Kowalski and Hawke (2008). This trend is expected to continue. Some export prices may rise for short periods but overall, the price of non-food manufactures are expected to follow international price trends for competing goods.

Agri-food export prices are expected to trend upwards in real TWI or SDR terms over the next few years but not from the price spikes that occurred in 2007/2008. This is essentially the same projection as that made by Dimaranan, Ianchovichina and Martin (2007). The forecast is based on a number of assumptions. Firstly, as previously argued, global demand patterns are likely to continue changing to include an increasing number of middle income consumers with higher income elasticities of demand for livestock products. Secondly, the rate of technological progress possible for large ruminants is slow and New Zealand already has a strong competitive position in dairy, sheepmeat and beef markets. Thirdly, it has proved difficult to accelerate ruminant (and general economic) expansion quickly in land abundant countries that have the capability to out-compete New Zealand. Fourthly, it is


assumed that protectionist reactions to the current crisis will not be extreme or will be quite temporary.

Figure 5 ANZ Commodity Price Index, Meat and Dairy

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The historic record does point to a trend increase in some New Zealand commodity export prices over the last decade but prior to 2000 many of them were trending downwards. Figure 4 shows the long run trend in two types of agri-food products, wheat and dairy products, both expressed in real USD. Trend wheat prices have declined for over a century because production technology has shifted the supply curve to the right faster than incomes and population have shifted the demand curve. The wheat price spike in January 2008 was a typical short term event caused by drought affected crops coinciding with large ethanol subsidies in the EU and US. However, some commentators think that the downward trend may not continue because crop technological change appears to be slowing and the sector is facing water shortages, soil salination problems and other resource restraints, worldwide.

Livestock products have different sized parameters on both the supply and demand side, as just mentioned. The long term dairy price in Figure 4 is the New Zealand farm payout adjusted for subsidies and stabilization scheme supplements. It is an indicator of the world price in a thin world market dominated by policy effects from a number of countries – especially the EU and US.

There appears to be a downward trend in the world dairy price from 1955 to around 2000 and an upward trend over the last decade. This series ends with the record nominal payout from Fonterra of $7.90/kgm milk solids in 2008 but adding the expected payout of $5.20 for 2009 is unlikely to change that conclusion. The future trend discussed above should be taken from the 1995-2009 trend line, in my view, because like all commodity markets, shocks perturb the dairy market and cause quite high volatility that is largely unrelated to the trend.


Figure 5 and 6 show the same real USD commodity prices but for the ANZ Bank list of New Zealand products. The series finish in March 2009. The meat and dairy series in Figure 5 show the same apparent breakpoint in the trends around 2000. The upward trend for meat appears to be roughly the same as it is for dairy products. Horticultural products and aluminium show the same pattern as dairy and meat. Forestry products appear to trend down after 1990 while seafood shows little trend at all.

Figure 6 ANZ Commodity Price Indices, Horticulture,Forestry, Seafood and Aluminium

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8. The Availability and Price of Foreign Savings to NZ

New Zealand traditionally runs a current account deficit which, prior to the first oil shock, used to average about 1% of GDP, Figure 7. Since that time they have averaged around 5% of GDP. The size and structure of the economy, its trade mix and the volatility of the terms of trade have led to risk premiums being paid for offshore lending by government and firms to finance these deficits. One measure of the country risk premium is the spread between the NZ and US ten year government bond yields.


Figure 7 New Zealand Current Account Deficit

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The current account deficit position in New Zealand exposes the economy in the ‘credit crunch’ to higher offshore borrowing costs and foreign policy interventions that might discriminate against foreign lending. There is no evidence that either of these effects have occurred, yet. Over the period from the end of adjustment to the economic reforms (say 1993) to 2006, the spread was usually positive implying higher risk associated with New Zealand investment. It varied between -0.12% and 2.31%. Just before the credit crunch hit, the spread was 1.47% and it rose to a peak of 2.69% in 2008Q1. It has since fallen to 1.89% in 2009Q1.


Figure 8 NZ Country Risk Premium

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The risk premium for commercial banks and firms can be expected to be higher that this government bond spread. For example, one of the major banks had to pay a premium (over Libor) of around 2.4% in 2009Q1. Nevertheless, these spreads are not unusual.

It was noted earlier that New Zealand now has a culture of tolerance for continuous reform on economic policy matters and as a result government has many degrees of freedom to change policy in response to the unfolding global financial market performance.

9. Migration

Participants ranked the threat of reductions in people movements highly. A key aspect of this concerns the quality and quantity of new immigrants to New Zealand. Prior to 1974 New Zealand operated an open door immigration policy that was restricted to certain countries. There was no immigrant selection involved. The result was that permanent migration to New Zealand fluctuated around 5-7 thousand migrants per year with little year to year variation, Figure 9.


Figure 9 Population Growth and Permanent Migration

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Since the mid-1970’s permanent migration to New Zealand has been influenced by a range of selection criteria. The resulting new trend from that time, under selection policy, has been strongly upwards and the composition of the migrants directly reflects the policies of the day. In other words, New Zealand permanent inward migration has been shown to be policy amenable.

There is an unlimited supply of people, with the full range of characteristics, who can be encouraged to settle in New Zealand. On the other side of the equation, outward migration is quite volatile with growing evidence that immigrants and emigrants are all temporary. In this globalised world a large number of people are very mobile. In this environment, the quality and quantity of net permanent migrantion to New Zealand is not an external threat as much as it is a domestic policy choice.

10. The Real Exchange Rate

The real exchange rate expressed in terms of a basket of currencies like the TWI is normally expected to have no upward or downward trend over time unless there is a very major change in the relative competitiveness of an economy. Such change could occur in New Zealand but it is unlikely to occur quickly. The TWI real exchange rate certainly appears to have followed a constant trend historically, Figure 10, black line.

The first quarter 2009 value of the TWI real exchange rate (RER) appears to be at the trend level.


Figure 10 Exchange Rates

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The RER has had a strong tendency to over and under-shoot the trend in the past. It can be expected to do so again. On this basis, the TWI RER can be expected to depreciate over the next few years or so and to then appreciate for a period of years14. The cycle length appears to be around 8 years

It is very tempting to suggest that the USD RER has been trending upwards since 1950 because the domination of the US economy and the domination of the USD as a global unit of account has gradually weakened. That raises a final issue in this section. While the USD is certainly not the most appropriate basis for estimating the RER, the 5 country TWI may also be too narrow. The RBNZ is using the SDR to measure real international prices and it may also be a more appropriate basis for the RER.

14 Though we thought the depreciation phase of this cycle was beginning in the false dawn of mid-2006 –

such are the dangers of exchange rate forecasting.


11. Conclusions

This essay has surveyed a range of external economic factors likely to affect New Zealand markets over the next few years and beyond the resolution of the current financial crisis. The most important factors identified are not monetary and financial effects. These will likely have important influences in the short-run while the global recession is worked through. However, barring extreme monetary and prudential policy reactions overseas the biggest shifts in New Zealand’s external environment will come from the real economy – but micro economists would say that.

The structure of the world economy has been gradually transformed over the period since World War 2 and the Breton Wood Agreement. Over that time period 13 countries have grown at more than 6% real for periods of 25 years or more – all continents are represented in this star list, even Africa, Growth Commission (2008).

The economic transformation of China needs to be singled out. It is the greatest economic transformation the world has ever seen, both in terms of efficiency improvements and poverty reduction. Furthermore, the importance of its economic feat has spread widely. China has served as a very positive role model across the developing world. Its success to date has encouraged policy makers and business leaders in many other countries to grasp the possibilities on offer from modern technology and international business systems to service consumer wants. The China success has been a multi-lateral effort. The election result in India is probably testimony to the China psychological influence.

A wide range of emerging economies have helped transform world goods and services markets in ways that are likely to lead to a permanent shift in global prosperity. The globalization gains and the poverty reduction associated with this developing environment over the 20 years before 2007 are very likely to be continued after the global recession abates.

The second major shift is a continuous one – technology. Comparative advantages can be expected to move fairly rapidly in future and this puts some pressure on smaller states to maintain their income positions. Innovation is essential and it involves risks, so open tolerant societies will tend to prosper. Infrastructure is crucial to facilitate change with all this implies for productive investments in the education, the health and welfare of people and in hardware.

The structure of global demand appears to have moved in ways that alleviates some pressures on New Zealand in the medium term. The demand for food appears to be more resilient than for some other product lines. The prevalent scale economies in many global production processes leave many gaps for niche players. On both counts, New Zealand is lucky to have its current export mix.


Finally, My Contacts think that the global recession is very likely to be protracted and that raises significant policy risks emanating from abroad. Risks that the international consensus will settle on poor policy solutions in areas that could have important effects on the New Zealand economy.


References

Anderson, Kym and Will Martin (2007). Distortions to Agricultural Incentives in Asia. Agricultural Distortions Working Paper 59, December.

Arrow, Kenneth J. (1962). The economic implications of learning by doing. Review of Economic Studies 29, 155-73.

Bhagwati, Jagdish (2008a). Speech to the Oxford Forum, Oxford University, May.

Bhagwati, Jagdish (2008b). Termites in the Trading System. Oxford: Oxford University Press.

Borchert, Ingo and Aaditya Mattoo (2009). The Crisis-Resilience of Services Trade. Working paper series 4917, The World Bank, Washington D.C.

Cashin, Paul, John McDermott and Alasdair Scott (2002). Booms and bumps in commodity prices. J. Dev. Economics 69, 277-96.

Coase, Ronald (1937). The nature of the firm. Economica NS4, 386-405.

Coyle, William, Mark Gehlhar, Thomas Hertel, Zhi Wang and Wusheng Yu (1998). Understanding the determinants of structural change in world food markets. Amer. J. Ag. Econ. 80(5): 1051-1061.

Cranfield, John, Thomas Hertel, James Eales and Paul Preckel (1998). Changes in the structure of global food demand. Amer. J. Ag. Econ. 80(50: 1042-1050.

Delgardo, Christopher, Mark Rosegrant, Henning Steinfeld, Simeon Ehui and Claude Courbois (1999). Livestock to 2020: The next food revolution. International Food Policy Research Institute, Washington D.C.

Dicken, Peter (2003). Global shift: reshaping the global economic map in the 21st century. London: Sage.

Dimaranan, Betins, Elena Ianchovichina and Will Martin (2007). Competing with giants: who wins and who loses? Chapter 2 in Winters and Yusuk (2007), op cit.

Growth Commission (2008). The Growth Report: Strategies for Sustained Growth and Inclusive Development. Washington D.C.: The World Bank.

Grubel, Hubert and Peter Lloyd (1975). Intra-industry trade. London: McMillan.

Helpman, Elhanan (2006). Trade, FDI and the organisation of firms. J. Econ. Lit. 44 (3), 589-630.


Kindleberger, Charles (1996). Manias, panics and crashes: a history of financial crises. London: MacMillan.

Krugman, Paul (1979) Increasing returns, monopolistic competition and international trade. J. Int. Economics 9, 469-479.

Lattimore, Ralph (1999). Is Livestock a Sunset Industry? Paper presented to the Joint AWAC-ANZCCART Conference (Royal Society of New Zealand), Wellington: 18 November 1999.

Lattimore, Ralph, Przemyslaw Kowalski and Gary Hawke (2008).Forecasting New Zealand’s Patterns of Comparative Advantage. ESAM 2008 conference, Wellington.

Leamer, Edward E. (2007). A Flat World, a Level Playing Field, a Small World After All, or None of the Above? A Review of Thomas L. Friedman’s The World is Flat. J. Econ. Lit. March 83-126.

McCann, Philip (2009). Economic geography, globalization and New Zealand’s productivity paradox. New Zealand Economic Papers, 43 (3), December.

Rae, David and Marte Sollie (2008). Globalisation and the European Union: which countries are best placed to cope?. Economics Department working paper No. 586, OECD, Paris.

Reinhart, Carmen and Kenneth Rogoff (2008). This time is different: a panoramic view of eight centuries of financial crises. Working paper 13882. NBER, Cambridge Mass.

Reyes, Javier, Martina Garcia and Ralph Lattimore (2009). The New International Economic Order and Trade Architecture. Spatial Economic Analysis, volume 4, Issue 1 March, 73 – 102.

Riddell, Michael and Cath Sleeman (2008). Some perspectives on past recessions. Reserve Bank of New Zealand Bulletin 71 (2), 5-21.

Safadi, Raed and Ralph Lattimore, editors (2008). Globalisation and Emerging Economies: Brazil, Russia, India, Indonesia, China and South Africa. Paris: OECD.

Sally, Razeen (2008). Globalisation and the Political Economy of Trade Liberalisation in the BRIICS. Chapter 4 in Safadi, Raed and Ralph Lattimore (op cit).

Seale, James, Anita Regmi and Jason Bernstein (2003). International evidence on food consumption (household goods generally). Tech. bulletin 1904, ERS-USDA, Washington D.C.

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http://www.informaworld.com/smpp/title~content=g909933388~db=all

Winters, Alan and Shahid Yusuf (2007). Dancing with giants: China, India and the global economy. The World Bank, Washington D.C.


Appendix A : The My Contacts Opinion Survey

We selected 25 applied business and economic researchers from My Contacts list. No professional economic forecasters were involved – they were specialists in both micro and macroeconomic analysis. Most were academics. This group was selected because the Reserve Bank already surveys business groups and it has good information sources through international institutions including other central banks.

Nineteen contacts agreed to take part in a two stage Delphi survey and eighteen agreed to have their names published in this report (see below). Nine participants are foreign residents. One New Zealand resident is reclassified as a foreigner because he is a fairly recent arrival in New Zealand.

In the first stage, each contact was asked to nominate their top six external economic threats to the New Zealand economy over the next 5 years or so. No background material or references were supplied. Respondents had to rely on their own knowledge of the relationships between the Global and New Zealand economies. They were asked to score each threat on two metrics (0-5) with 5 being the highest. The first metric was the impact the threat would be likely to have on the economy and the second metric was the probability of occurrence of the threat.

There was a great deal of overlap in the choice of threats made by respondents. The threats were ranked by their frequency by the author. This was not a clear cut exercise because similar ideas were expressed in different ways. However, some participants went to some trouble to explain their responses in detail, making the job easier. Fourteen threats were selected in this way (Table 1) and participants were then asked to score these fourteen on the two metrics using the same scales. They could add very, very important threats that were not on the list. Failure of the Doha Development Round at the WTO was the only issue added. The two metrics were multiplied together to get a measure of the risk of the threat to New Zealand.

Once the second stage results were submitted the impact scale was arbitrarily changed to try to prevent ‘averaging out’. The impacts identified are considered more important than the probabilities assigned. Secondly, most participants are specialists in particular areas and where they think the impact of a challenge or threat is very high, we want to give that adequate weight. The impact weights were changed from integers 0-5 to 0, 1, 2, 4, 8, 16.

It is recognized that this ex post change may bias the results and the reader is welcome to request the unaltered scores.

Both stages of the survey were completed before the concern regarding swine flu in Mexico hit the headlines.


The members of my email ‘my contacts’ list who graciously agreed to participate in the survey are:

• Professor Rick Barichello, Canada

• Professor Antonio Brandao, Brazil

• Professor Novella Bottini, Italy

• Professor Ross Cullen, New Zealand

• Professor Paul Dalziel, New Zealand

• Professor Gary Hawke, New Zealand

• Dr Brent Layton, New Zealand

• Professor Peter Lloyd, Australia

• Professor Philip McCann, New Zealand and UK

• Mr Rory O’Malley, Australia

• Professor Javier Reyes, Mexico and United States

• Professor Martin Richardson, Australia

• Dr Raed Safadi, Dubai and United States

• Dr Adolf Stroombergen, New Zealand

• Dr Chris Wheatley, New Zealand

• Professor Glenn Withers, Australia

• Dr John Yeabsley, New Zealand

• Professor Tony Zwart, New Zealand


Shifts in New Zealand’s External Economic Environment · 2014-06-30 · New Zealand is vulnerable to the global recession because: • The global demand for exports is faltering.

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