Prospects for the Primary Sector

As a small nation with a limited domestic market, New Zealand relies heavily on international trade for the sale of its primary sector products. Accordingly, changes in international demand for and supply of primary sector products, along with changes in trade barriers, will play a critical role in determining the future growth of New Zealand’s primary sector.

Some of the trends that we could expect to see over the next decade include:

Liberalisation of international trade would have significant positive effects.

1. Gradual but continued progress in trade liberalisation. Following recently concluded agreements with Thailand, Singapore, Chile and Brunei, New Zealand is negotiating free trade agreements with China, Malaysia and ASEAN, which are expected to have a positive impact on the primary sector. The progress made in the Doha round[11] of trade liberalisation discussions in 2004 is also expected to have significant benefits for our primary sector, though subsequent progress has been slow. The magnitude and timing of changes to countries’ agricultural protection are still to be determined, so it is difficult to assess the size or timing of the impact on New Zealand. However, modelling by Rae and Strutt (2004) suggests that a scenario based on various proposals and texts presented during the WTO Round could lead to annual gains of around 0.6% of GDP;[12]

International market conditions for our products should be generally favourable.

2. Strong demand for New Zealand’s agricultural exports. The demand for beef, sheep and dairy products is expected to increase as developing countries continue to grow and require protein. The continued emergence of developing countries’ middle classes, with associated urbanisation and Westernisation of diets, should bolster demand for products including meat and cheese. Within developed countries, changes in consumer preferences should continue a relative shift away from red meat and butter and towards poultry and cheese. In combination, these two trends would provide a growing market for the primary sector’s commodities and opportunities to develop markets in higher-end specialist products;[13]
3. Increased supply of most agricultural products. The increasing world demand for agricultural products mentioned above is expected to be met by an expansion of world supply, much of which is expected to come from developing countries. New Zealand producers will remain price takers in world markets and subject to ongoing competition;

Our international climate change obligations may present challenges and opportunities for the sector.

4. Climate change obligations to pose increasing costs. The primary sector plays a critical role in New Zealand’s greenhouse gas emissions profile, with agriculture being a major emitter and forestry providing significant absorptive capacity. Our emissions obligations are likely to be more constraining as time goes on. The international price of greenhouse gas emissions is not being factored into production and investment decisions in the primary sector, as current policy settings – in particular the exemption of methane and nitrous oxide from the carbon tax and the decision not to devolve credits and liabilities associated with forestry – mean that the costs to New Zealand are largely not being passed on to individuals in the primary sector;
5. Increasing biosecurity risks. In line with New Zealand’s growing global interconnectedness, the threat of biosecurity incursions increases. As recent BSE detection in the United States and Canada has demonstrated, the impact on industry can be severe, and recent changes to New Zealand’s biosecurity system demonstrate that this threat is being taken seriously; and
6. Short-term exchange rate and commodity price volatility to continue. There are no signs that the short-term fluctuations in exchange rates and commodity prices, which impact on the profitability of the primary sector, will abate in the near future.

Climate is a key driver of primary sector production…

In addition to international conditions, domestic conditions are the other key determinant of future primary sector growth. Clearly, climatic conditions have a major impact on primary sector production. The National Institute of Water and Atmospheric Research (2001) found that the agricultural component of GDP is negatively correlated with the strength of the southerly airflow over the country; that milkfat production is negatively correlated with annual days of soil moisture deficit and regional summer temperature; and that milkfat production is positively correlated with regional spring and summer rainfall. Buckle et al (2002) show that climate is an important contributor to the overall business cycle, and that it appears to have been the dominant source of domestic shocks over the period 1984-2002.

Other domestic factors such as the institutional setting (including the ease with which business can be done, macroeconomic stability and an effective courts system) have an impact, as well as costs of production, processing and distribution (land, labour, capital, energy and transport). Expected trends in domestic conditions include the following factors:

… and we may be moving to a phase of weather more favourable for pastoral production.

1. The National Institute of Water and Atmospheric Research has suggested that the recent volatility in New Zealand’s weather patterns, including three significant droughts since 1997/98, may be indicative of a shift in the Interdecadal Pacific Oscillation (which lasts for 20 to 30 years) to a cool phase, when it is wetter over summer and autumn, leading to fewer days of soil moisture deficit (and therefore better pasture growth). If this is correct, then New Zealand may be moving into a phase of weather more favourable to pastoral production (Ministry of Agriculture and Forestry, 2003b);

The primary sector’s relationship with the environment will become increasingly important.

2. The impacts of economic growth on the quality of the environment should become more apparent. This is particularly so in relation to water. With the intensification of dairy, sheep and beef farming, the substantial growth in fertiliser use over the last ten years will have an increasing impact on the quality of water. In addition there will be increasingly competing demand for water: for irrigation, power generation, recreational uses and other purposes;
3. The cost of energy is expected to continue to increase, reflecting a continuation of increased domestic and international demand, and the carbon tax that will be effective from 2007; and
4. New Zealand’s macroeconomic stability and generally strong institutions are expected to continue to underpin investment and growth in the primary sector.

Overall, the primary sector is expected to continue to perform strongly in the years to come. As New Zealand sells most of its primary products on world markets, we are clearly dependent on shifts in world demand and supply. Despite considerable variation across sub-sectors of the primary sector, overall these international conditions would appear to be favourable in the short-to-medium term.

This is a necessary but not sufficient condition for a strong performance by the primary sector. New Zealand producers must be in a position to exploit the opportunities provided by world markets. We need to be able to receive appropriate price signals from the markets, produce what consumers require and at a competitive cost, and we must be flexible enough to adapt to changing tastes and demand levels.

The primary sector has performed well in the past…

New Zealand producers have generally met this challenge well. Changes to the way that New Zealand primary sector producers are paid for their production, made largely through the mid-1980s, have exposed them to information on the true value that world markets place on their products.[14] The lack of protection for our primary producers (especially when the protection enjoyed by many overseas producers is considered) gives them sharp incentives to adapt to changing circumstances in product markets. Uncertainty caused by high and volatile inflation through the 1970s and 1980s has been removed. New Zealand producers have used the comparative advantage provided by climate, and have delivered sustained productivity gains – both in production and processing – through innovation, application of new technology and techniques, and consolidation to gain economies of scale.

… and should continue to do well in the future…

New Zealand producers should continue to consolidate, to invest in and apply the results of research and development efforts, to make use of innovations – including those presented by biotechnology – and to develop new products to meet market demand.

This is not to say that the way forward is without risks and challenges. International markets can be fickle and conditions can change quickly, though longer-term trends can in some instances be identified and planned for. Exchange rate volatility can erode or inflate the returns that New Zealand producers make. The very real threat of pest incursions and diseases, and the damage that they can cause to our production and our international reputation, mean that the economy must take biosecurity concerns very seriously.

… though a number of key risks will need to be managed.

The tension between economic growth objectives and increasing environmental concerns, particularly with respect to water quality and availability, will need to be addressed so that future production increases are sustainable. The primary sector cannot rely on ever-increasing inputs to production such as fertiliser and water to drive growth. In this area the government can play an important role through clearly defining property rights and developing planning and allocation tools so that competing objectives can be taken into account. Similarly, an effective long-term response to our climate change objectives will require the participation of the primary sector, and the government can help by designing suitable domestic policy settings to encourage this.