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

There is scope for New Zealand to be more connected to the world economy

New Zealand is only moderately well-connected to the world economy, and less well-connected than other small advanced economies:

  • Long-term people flows are relatively high,with a large stock of permanent and long-term immigrants. A sizeable proportion of tertiary students are international students. New Zealand's diaspora is the second largest in the OECD after Ireland in relative terms. Short-term people flows are relatively high and increasing. In net migration, the long-term trend is for small net inflows.
  • There are strong flows of inward direct investment but very low levels of outward direct investment.
  • Export intensity is lower than the level achieved by other small advanced economies even accounting for distance from markets. New Zealand firms do not seem to be well-connected to emerging international production networks.
  • New Zealand’s distance from the main producers of new knowledge and our low levels of business R&D suggest that firms may have difficulty in accessing cutting-edge technological developments.

International connections matter for economic performance…

"During their periods of fast growth, [13 successful economies in the post-war period] all made the most of the global economy. This is their most important shared characteristic and the central lesson of this report. ... To put it very simply, they imported what the rest of the world knew, and exported what it wanted."

…but New Zealand faces particular challenges from its small size and distance from markets

Distance/proximity to markets
Distance/proximity to markets.
Sources: OECD "Going for Growth". Note: Measures the sum of capital-to-capital distances from the country to the world centres of economic activity. The measure is then normalised so the average across countries is equal to 100.

New Zealand is less well-connected with the world than other small economies

Pursuing regional economic integration

New Zealand is only moderately well-connected to the world economy
New Zealand is only moderately well-connected to the world economy.
Source: OECD 2005

New Zealand's longer-term objective could be founded on being an integral part of an Asia-Pacific regional economic market. Flows of trade, capital, ideas and people are already strong with Australia, Asia and the US. But these relationships are likely to increase in importance as the weight of global economic activity increasingly shifts towards Asia. Participation in regional economic integration will be critical for New Zealand's prospects.

To achieve this, government needs a clear strategy for engagement in the Asia-Pacific region, and to promote regional economic integration, both at and behind the border. As part of this wider aim, New Zealand would benefit from continuing moves towards a single economic market with Australia, through ongoing incremental improvements over time.

New Zealand would benefit from being an integral part of an Asia-Pacific regional economic market

Remaining barriers at the border

New Zealand's formal restrictions on international flows are generally low, and other at-the-border policy settings compare reasonably well internationally. On the other hand, New Zealand's distance from markets sharply reduces our connections with the rest of the world. And while imperfect, existing indicators of these policy settings suggest room for policy improvements. Given the importance of international connections to New Zealand, the costs of both inward and outward flows need to be as low as possible, within the constraints of achieving other government objectives.

Further reducing barriers at the border would support greater economic integration

There is scope to further lower at-border costs to advance integration, including the phasing out of remaining trade barriers; the removal of screening of foreign investment - or changes that enhance the level of certainty and implementation of the regime; and addressing barriers in transport and communications links with the rest of the world. High tariffs and other barriers, particularly those facing agricultural exports and higher value-added goods and services, are likely holding back New Zealand's economic development. Continued attention is required to reduce these barriers in multilateral, plurilateral and bilateral forums.

The New Zealand economy is relatively open, but there is still room for improvement
Tariffs on imports 39th / 124 countries World Bank, 2008
Total tariff and non-tariff barriers on imports 18th/ 26 countries OECD, 2008
FDI regulatory restrictiveness 29th / 43 countries OECD, 2008
Investment freedom 18th/ 157 countries Index of Economic Freedom, 2008

Broader domestic policy settings

Policy settings across the board can affect international connections, even those that on face value seem intrinsically domestic. With low obvious policy barriers to deeper integration at the border, these domestic policy choices are likely to be where most gains are possible. Priorities with a strong international dimension include those that facilitate the development of future comparative advantage, ensure New Zealand is a competitive location for people and capital and maximise opportunities to capture economic benefits from our existing resources.

  • Dampening medium-term exchange rate cycles, which are likely to increase uncertainty and impact on investment and productivity growth in the tradeable sector, by reducing the risk of pro-cyclical fiscal policy when the economy is at capacity.
  • Developing a more integrated approach to international flows of people that includes domestic policies as well as at-border controls, and covers emigration and immigration, international students and New Zealanders studying abroad, and links between international researchers and businesses.
  • Reducing barriers faced by New Zealand firms doing business abroad through a more effective offshore presence, and maintaining a well-functioning innovation system that facilitates international knowledge transfer.
  • Allocating natural resources more efficiently to support development and investment in sectors that use water as an input in production, and produce greenhouse gases as a by-product of production.
  • Changing our tax and regulatory settings to encourage entrepreneurial and innovative people and economic activity to be located in New Zealand.

Domestic policy is critical to firms and individuals making the most of New Zealand's international opportunities

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