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Special TopicWeighting Schemes for New Zealand's Trading Partner Growth

New Zealand is a small open economy that is heavily reliant on its external sector. In particular, output and demand shocks - both positive and negative - experienced by our trading partners are likely to materially impact the New Zealand economy through the prices and volumes of traded goods. Accordingly, Treasury regularly calculates a trading partner growth (TPG) rate, which is a summary statistic that broadly informs its assessment of demand from New Zealand's major trading partners.

The TPG rate is constructed as an average of the annual growth rates of real GDP of New Zealand's 16 most important trading partners, who together account for approximately 80 percent of New Zealand's total merchandise exports. Trading partners' growth rates, historical and forecast, are weighted based on their share of merchandise exports. Recent Treasury research examines the extent to which a historical TPG rate is sensitive to different weighting schemes. The first part of this special topic examines the design and effect of alternative weighting schemes. The second part discusses the role of the TPG rate as a driver of output in New Zealand, within the framework of an econometric model.

The country composition of New Zealand's trade continues to shift

The weighting for Treasury's TPG rate is updated on an annual basis in order to capture changing trends in trade. Merchandise exports by country back to 1988 are the basis of the analysis. The country mix of New Zealand's exports has experienced large shifts during this time.

While Asia ex-China's share of merchandise exports has remained relatively steady over this period, China's share has generally trended upwards, consistent with the continued development of China as one of our dominant trading partners. This has generally come at the expense of the developed economies with whom New Zealand trades, such as Australia, the USA and the euro area, whose share has declined approximately equivalently.

Adjustments to the weighting scheme have a relatively small impact on TPG rates
Table 2 shows the ways in which changes were made to the current weighting system. Three additional weighting schemes were constructed, producing three further TPG rate series.

Table 2: Possible TPG weighting schemes
Table 2: Possible TPG weighting schemes   .

These alternatives include the components of New Zealand's international trade not considered by the existing weighting scheme, which are goods imports, services exports and services imports. Together, these other three components amount to approximately two-thirds of total two-way trade with the 16 countries. Hence their exclusion from the existing weighting system could ignore significant developments in New Zealand's international trade.

In Figure 9 all four TPG rate series are plotted. Overall, the differences are relatively small. This suggests that, even though goods imports and services exports and imports make large contributions to the total value of New Zealand's trade, their inclusion does not lead to large changes in the relative importance of the members of the basket of trading partners, either in elapsed quarters or in the future. For example, the ranking of countries to which we export goods is almost identical to that of the countries from which we import goods.

Figure 9: Alternative TPG rates
Figure 9:   Alternative TPG rates   .
SourcesStatistics NZ, IMF, the Treasury

Some insights can be gained from the comparison of TPG rates. For instance, weighting based on goods exports and imports causes an appreciable upwards shift in the TPG rate compared to the existing goods exports only method. Much of this is caused by a redistribution of weight from Australia to China, reflecting the high importance of China as a source of New Zealand's imports, particularly manufactured products. China has recorded high growth rates in recent years (significantly higher than Australia), and thus a rise in China's weight tends to materially raise the resulting TPG rate. Similarly, including services exports sees a decline in the resulting TPG rate, largely owing to a fall in China's weight (as China has a lower share of services exports, reducing its contribution). However, the changes in the TPG rate with different weighting schemes are not significant.

More nuanced weighting schemes make little difference to TPG rates

Beyond simple adjustments to the trade basis for weightings, there are a number of ways that the weightings could be altered in order to generate a TPG rate that is more relevant to New Zealand in terms of growth transmissions. Adopting the former methodology of RBNZ's trade-weighted exchange rate index, a weighting scheme based partially on the relative sizes of trading partners' economies was considered. This method aims to capture the influence that larger economies such as China and the US can have on demand and supply of traded goods. Following RBNZ, we adopted a 50:50 distribution of weights for trade and economic size. Figure 10 plots Treasury's existing TPG rate (Goods Exports) with one “augmented” by GDP.

Figure 10: GDP-augmented TPG
Figure 10: GDP-augmented TPG   .
SourcesStatistics NZ, IMF, the Treasury

Once again, differences are relatively minor. Adopting a partial GDP weighting tends to apply a downwards level shift to the series, mostly due to a skewing of weight away from Australia and China towards the UK, USA and euro area, all of which have grown relatively slowly in recent years compared with our fast-growing (though smaller) Asian trading partners such as Singapore and Hong Kong.

Overall, the exploration of alternative approaches to weighting TPG rates suggests that the relatively simple one-way goods exports measure is as good a proxy for international macroeconomic conditions as more sophisticated measures. This may change over time if the mix of countries New Zealand exports to and imports from changes materially in the future.

Empirical analysis suggests evidence of international growth spillovers to New Zealand

Making adjustments to country weightings is only useful if there is an economic relationship between the growth rates of New Zealand's trading partners and the growth rate in New Zealand. Historically, the TPG rate and growth rate of real GDP in New Zealand have tracked each other moderately closely, as illustrated in Figure 11.

We conducted a simple regression analysis in order to make the relationship more precise. The results suggest that a one percent increase in trading partners' growth rates of per capita real GDP is correlated with a rise in the growth rate of New Zealand's per capita real GDP of around 0.65 percent. Moreover, the relationship is found to be statistically significant.

Figure 11: New Zealand GDP growth and trading partner growth
Figure 11:  New Zealand GDP growth and trading partner  growth   .
SourceStatistics NZ, IMF, the Treasury

Adopting the methodology from the (small) literature on the subject, further analysis considered the impact of other trading partner variables, such as openness, the investment and consumption shares of GDP, and relative income levels. Results indicate that New Zealand benefits from a rise in consumption's share of GDP, which is consistent with the consumable nature of a large part of our exports. The converse is found for investment's share of trading partners' GDP. These findings are particularly timely for New Zealand as the Chinese economy rebalances away from investment towards consumption.

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