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Briefing to the Incoming Minister of Finance 2008: Medium-term Economic Challenges

2  Opportunities and challenges facing New Zealand

A number of social and economic trends are changing the world our businesses operate in, including:

  • globalisation
  • international integration
  • technology change
  • natural resources pressures
  • demographic changes and increasing expectations on the state.

These broader trends offer opportunities and challenges for New Zealand. Successfully adapting to them will enable us to narrow the income gap with other countries and attain the living standards we aspire to. Not doing so will likely exacerbate the gap.

Globalisation

Globalisation is likely to continue to change the nature of trade and deepen economic links between countries. While the international situation is likely to increase attention on how flows of capital are managed and how regulation is coordinated, it is unlikely to reverse the longer-term trends. More and more countries are becoming involved in the world economy. Global flows of people, capital, trade and ideas are likely to continue to strengthen.

Globalisation will remain critical to shaping our economy and policy settings…

Globalisation also provides an ever more competitive environment for a wider range of our businesses domestically as well as internationally. Parts of the production chain are increasingly being separated, often across borders, as technology allows companies to coordinate and specialise without being located in the same place. These changes will continue to increase the range of goods and services that can be traded. New Zealand has a range of strengths to build on, including a relatively flexible economy, natural resource advantages and relatively low energy costs to expand and diversify the range of what we trade and exploit new and more specialised markets.

Competition to attract and retain skills and access investment capital is likely to intensify. Greater choice over which countries to work or invest in will prompt stiff competition across tax, regulatory settings and quality of public services. New Zealand will need to offer an attractive business environment and work opportunities if it is to avoid becoming solely an incubator of business ventures and skilled workers that then migrate elsewhere.

Globalisation: Since the 1970s there has been a steady rise in economic links between countries

KOF Index of Globalisation
KOF Index of Globalisation.
Source: Swiss Federal Institute of Technology

…and will increase competition for factors of production

International integration

As economies become ever more integrated, emerging economic problems and their solutions increasingly involve coordination across national borders, greater international rule-making and greater convergence of national rules. As a small external player, New Zealand benefits from greater certainty around the “rules of the game” but also needs to consider the international dimensions and interactions with domestic policy settings. Where our settings differ from those of our trading partners it may create barriers to economic integration. One implication is that significant differentiation of our policy frameworks from our trading partners needs to deliver clear benefits to New Zealand.

Deeper economic integration will see greater integration of the “rules of the game”

Financial systems are a key mechanism through which economies are integrated. Current weaknesses in international financial systems that led to excessive leverage and poor management of risk will take some time to resolve. Without financial market stability, the world economy could experience an extended period of lower growth and a higher cost of capital. International discussions are underway on ways to address the weaknesses that led to the current situation, including poor regulation of the financial system and the build-up of economic imbalances. New Zealand, as a capital importing country that relies heavily on trade, has much to gain from ensuring that any response tackles the underlying weaknesses without significantly increasing the costs or reducing the availability of capital.

Looking more broadly at global demand, shifts in economic weight towards Asia will see changing geopolitical interests and economic relationships. The Asia-Pacific region continues to be the most dynamic and fast-growing part of the world economy. Significant growth within our region provides us with opportunities, increasing demand for the goods and services New Zealand firms produce well, and increasing the pool of skilled people and ideas generated. This regional aspect will need to be reflected in New Zealand's priorities for international engagement and increasingly influence our policy choices.

International integration: Imports of previously untraded services are increasing and manufacturing trade is becoming more integrated across countries

Import of Business Services (eg, includes legal, accounting, engineering)
Import of Business Services (eg, includes legal, accounting, engineering).
Source: Statistics New Zealand
Intra-industry trade (selected OECD countries)
Intra-industry trade (selected OECD countries).
Source: OECD Economic Outlook 2002

China and India have become a significant source of world economic growth since 2000

Contributions to real GDP growth
Contributions to real GDP growth.
Source: IMF 2008 World Economic Outlook

Technology change

Technological advances will continue to underpin long-run economic growth in the leading economies. Emerging economies are also increasing their reliance on innovation as they shift to producing more sophisticated goods and services. Technology will continue to play an important role in driving international integration, allowing previously non-traded sectors to become traded, and reinforcing global economic integration as more parts of the value chain are traded across borders.

Technology change is the ultimate source of economic growth and will offer better prospects for highly- skilled countries

The fast pace of technological change is likely to continue, making knowledge transfer critical. New Zealand's growth potential will be determined in part by how quickly our firms adapt and adopt new technology that is generated offshore. Experience suggests that the greatest gains from globalisation accrue to those countries that can best access, integrate and apply organisational, institutional and technological innovation. Broadly, these gains accrue more quickly to countries that are well integrated with the world economy.

Technological change also plays a significant role in increasing the economic returns to skills. More specifically, countries and people with higher levels of education and skills are well placed to take advantage of the opportunities arising out of globalisation. New Zealand will benefit from these changes provided we are successful in attracting, developing and retaining skilled workers.

Natural resource pressures

Global growth and limits on the availability of natural resources have increased the demand and price for goods and resources in which New Zealand is naturally abundant. These trends have generally strengthened New Zealand terms of trade over the past 10 years. Increased international demand will intensify the need for us to manage our natural resources well. However, continued intensification of land use is further reducing the availability and quality of water in some areas where extraction is already approaching maximum sustainable levels.

Global demand and the structure of New Zealand's production are increasing pressure on natural resources, particularly carbon emissions and water

Emerging global responses to climate change will influence New Zealand’s own commitments to managing climate change. While there is a sense of international momentum in tackling levels of carbon emissions, the pace and strength of the policy responses are uneven across countries. The limited scope for low-cost emissions reductions in New Zealand needs to influence our approach to future commitments. In the longer term, the economic response will be a shift in relative prices that will reduce the carbon and energy intensity of production.

Increasing world commodity prices are contributing to domestic resource pressures

Terms of trade
Terms of trade.
Source: IMF World Economic Outlook

Demographic changes and increasing expectations on the state

New Zealand and many developed countries will see significant demographic change over the coming decades, from an ageing population and immigration. The economic and social impacts of an ageing population are already evident in some countries, and begin to have significant implications for New Zealand from 2010. These changes may also increase international demand and competition for skilled migrants. Effectively managing changes in the structure of the population will require increased attention to policies that facilitate participation in the economy from migrants and older people. More concerted attention is needed to spell out how New Zealand will adapt policy to ensure sustainable finances to underpin the public sector.

New Zealand is facing a permanent increase in the age of our population

Dependency ratios
Dependency ratios.
Source: Statistics New Zealand

Demographic changes will increase demand for skilled migrants, and increase demand for public services and transfers

Within New Zealand, the public sector is also serving a society that is changing. New Zealand is becoming more ethnically diverse and technological improvements and higher incomes are creating greater expectations on the state. Governments are also looking to address a wider range of more complex social and environmental issues. These trends place more complex requirements on the development of education, health, social support and other programmes that will need to be delivered within more constrained expenditure allowances.

Cumulative effect of changes

Taken together these trends will create a very different economic environment in the medium term. They will require substantial changes in the way businesses and government operate. New Zealand's economic growth depends on how well our businesses can adapt to the new world and take advantage of the opportunities it offers. Businesses will need to make changes to their processes, move into new areas of production and service new markets. At the same time, government will need to make some major changes to policy settings and maintain quality institutions.

New Zealand's future economic performance depends on how well our businesses adapt to these trends

Not adapting will see New Zealand's economic position increasingly fall behind that of the countries we compare ourselves with. These countries are unlikely to stand still - they are also in the process of addressing their own constraints to better economic performance. A strategy that relies on marginal adjustment over time to current policies is unlikely to address the significant challenges New Zealand faces.

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