6. New Zealand, Economic Geography and Public Policy
The orthodox agglomeration arguments (Marshall 1920; Krugman 1991; Glaeser 1998) outlined in sections 4 and 5 appeared to raise serious point of concern for the long-term growth performance of New Zealand. According to these arguments, New Zealand cannot expect to compete internationally on the basis of orthodox urban agglomeration economies across a range of urban sectors, known as urbanisation economies, because the three major urban centres of New Zealand are so small by OECD standards. Although the fact that Auckland in particular is still growing may lead to some urbanisation productivity gains, by international standards the overall national efficiency effects of this will be rather limited. However, the relationship between urban scale and agglomeration economies is rather heterogeneous than this implies, in that it may be possible for the three major urban centres of New Zealand to generate some local agglomeration economies in a small number of specific specialist sectors, usually described as ‘localisation’ economies. Therefore, although the small urban scales of New Zealand will not permit widespread urbanisation economies of agglomeration, a limited number of sectors in which such localisation economies of agglomeration can be sustained does provide the possibility for New Zealand to specialise even further in these sectors and to export competitively. As such, a combination of domestic factor prices which are relatively low by OECD levels, plus some limited localisation economies in the three major urban centres, may provide a small level of protection from international competition for some New Zealand sectors. However, this cannot be expected to be a widespread phenomenon, because the relative ‘thinness’ of New Zealand’s local input markets means that any such localisation effects will only be confined to a small number of sectors. For most other sectors which do not exhibit these localisation effects, New Zealand’s relatively low factor prices will not be able to compensate for geographical peripherality.
The current thinking concerning economic growth and geography therefore largely rules out the benefits of modern agglomeration economies as providing a major source of growth for New Zealand over future decades, in comparison with its major OECD competitors. On the other hand, the alternative models of economic geography and industrial clustering, outlined in section 5, suggest that there may be some ways in which New Zealand may be able to exploit its geographical and cultural characteristics in order to foster its long-term economic growth, even in the face of falling international transactions costs and deregulating markets.
The first alternative argument here relates to that of the industrial complex model. In the case of New Zealand, the extraction and agricultural industries which produce mainly exported outputs most closely correspond to this particular geography-transactions model. The relationships between the producing, supplying and exporting elements of these sectors have been well established within New Zealand over a long period, and the geographical extent of these relationships extends across the whole country. As such, in this particular case, a relatively stable set of transactions and investment patterns are supported by a national, rather than a specifically urban or regional geographical scale. Obviously, the long-term performance of these industrial structures depends primarily on the global pricing trends for primary commodities, and as is well known, standardised primary commodities tend to be both relatively price elastic and income inelastic, the result of which leads to long-term downwards pricing trends. The development of products for niche markets, such as high quality wine for exports, is one way in which New Zealand has responded to these circumstances. However, as far as our discussion here is concerned, there is nothing inherent in this particular pattern and structure of transactions costs relationships which is suggestive of a strong future growth potential for New Zealand. The model is largely neutral on the matter.
It therefore appears that in terms of two out the three major geography-transactions sets of structural relationships outlined in section 5 of this paper, the long-term growth potential of New Zealand appears to be at best rather weak. The reasons for this appear to lie in the recent changes in the relationships between geography and information flows across space. As we have already seen, the nature of inter-firm and interpersonal business information flows appears to have changed substantially over recent years in response to both technological and institutional changes.
The improved ability to communicate has also increased the complexity and sophistication of the types of information which can be rapidly and frequently exchanged between parties in both a formal and informal manner. The result of this is that the geography of such transactions appears to somewhat polarising, in that complex transactions are being increasingly accommodated for by progressive industrial clustering, while standardised transactions are becoming ever easier to undertake over larger distances. For New Zealand, the central issue regarding geography and trade is therefore to understand and promote mechanisms by which a geographically isolated economy with only small urban areas is able to undertake and maintain frequent complex transactions over space.
While the first two types of industry-geography relationships outlined here appear rather pessimistic regarding New Zealand’s long-term performance, the third type, the ‘social network model’, is largely optimistic about New Zealand’s prospects. Importantly, from the perspective of New Zealand, this model is not dependent on the existence of large-scale urban agglomeration economies. Moreover, the insights of the social network model also suggest a possible role for public policy in fostering such growth.
It will be recalled that the social network model is based on the idea that close ‘trust’ based interpersonal networks and ties can often compensate for many of the problems associated with geography. In order to understand how this model can be applied to the case of New Zealand, it is necessary to acknowledge that New Zealand exhibits rather peculiar geographical, economic and demographic characteristics. New Zealand is one of the most highly urbanised societies in the world (United Nations 1997). Yet the small absolute scale of both the national population and the major cities means that even though the major urban centres are relatively dispersed, it is relatively easy to develop and maintain strong personal networks both within and between the cities. This is because inter-personal accessibility built on informal personal networks, becomes relatively easy in small populations, thereby overcoming many of the insider-outsider (Lindbeck and Snower 1989) problems associated with labour markets in large organisation, cities and countries. From the perspective of public policy we must consider how these particular characteristics might be harnessed to the advantage of the New Zealand economy. It will be argued here that appropriate policies can be developed but only as long as they are focussed on the small-firm sector of New Zealand and not with respect to the interests of the large-firm sector.
In order to do this we must first distinguish between the market area and strategic objectives of New Zealand’s large firm sector from that the small firm sector. In particular, we need to acknowledge is that the economic geography of the large-firm and multinational sector within New Zealand is largely beyond the remit or reach of New Zealand’s domestic trade policy. The spatial developments within the multinational sector, in terms of corporate geographical restructuring and investment patterns, are determined by international market forces, which are increasingly growing in their importance. The multinational corporate organisational arrangements are maintained by information networks which extend well beyond national borders.
The result of this is that corporate investment and personnel decisions are undertaken as part of much larger corporate logic, which is generally determined by regional-global conditions, and not domestic regional-national conditions. In the case of New Zealand, such firms are generally part of much larger corporate supplier-customer and investment networks which extend well beyond the reach even of Australasia. Examples here include the major retail banking sector of New Zealand, none of which currently is domestically-owned. Increasingly, the major corporate decisions of these firms are made in much larger urban locations such as Sydney, Hong Kong or even London. These trends therefore imply that a greater spatial division of labour is emerging within much of the large-firm sector, whereby many higher-order activities are being relocated outside of New Zealand, leaving behind rather lower-order activities. This phenomenon is one of the key observations of the new economic geography literature.
From the perspective of New Zealand, such a phenomenon is growth-depressing, because higher value-adding and growth-inducing activities will tend to move elsewhere. Moreover, it is possible that these arguments will progressively apply to most of the firms within the NZSE index. Meanwhile, the relative thinness of New Zealand’s existing markets provides further opportunities for overseas-owned firms to invest in New Zealand in order to service the domestic New Zealand markets. As such, the residual outcome of these various trends will be that an increasing proportion of the activities located in New Zealand by the multinational corporate sector will tend to be located there specifically in order to service primarily the domestic New Zealand market rather than the international markets.
The small-firm sector in New Zealand, on the other hand, faces a completely different set of problems and possibilities to the large-firm and multinational sector. The reasons are firstly, that small firms do not have the information-gathering assets and networks of the large firm sector, and secondly, that a lack of such assets means that they suffer from the problem of ‘distance-deterrence’ (Gordon 1978), whereby the level and quality of information available to them falls rapidly as the geographical distance between themselves and their markets increases. Although the internet has reduced some of the information acquisition costs it does not solve the problem of how to acquire the tacit information generated in other locations. Small firms therefore tend to be highly myopic in terms of their information assets because of the limited resources they have available to them for information gathering and processing. At the same time, this myopia has a direct equivalent in terms of economic geography. Small firms tend to be geographically myopic, in that the spatial extent of the markets of which they have good knowledge tends to be very limited.
Moreover, unless the small firms grow rapidly into medium-sized or large firms, the spatial extents of their markets tends to remain very local. Therefore, on the one hand, we observe the static phenomenon that small market areas generally give rise to small firms, because only small enterprises can be sustained by small markets. However, on the other hand, and even more importantly, we observe the alternative dynamic phenomenon that while firms remain small they tend to service only small markets, whereas as the size of the firm increases the size of the markets served also increases.
In the case of New Zealand, this latter observation can be argued to be crucial. The geographic isolation and small scale of both the national and urban economies of New Zealand, automatically imposes small-market growth constraints on domestic New Zealand firms. Given that the national growth performance in most OECD countries is now dominated by small firm growth (Hart and Oulton 2001), from the perspective of New Zealand policy-makers it is justifiable to consider ways in which these small-market constraints can be lifted from the domestic firms in order to promote exports.
Obviously, firm relocation outside of New Zealand in order to expand market areas, along the lines of the large-firm sector, is not an option for the majority of these small and medium-sized enterprises (SMEs), nor is it desirable from the point of view of the domestic economy. However, there may be alternative ways in which the government can play a role in helping to relax these geographical small-market constraints, as part of a policy of promoting domestic growth. The following discussion concentrated on UK policy, and does not consider the role of Trade New Zealand or related policy initiatives in New Zealand.
The small-firm sector of the UK economy shares some characteristics with New Zealand SME sector, in that the UK is geographically peripheral to its major EU export market areas. Obviously, the spatial extent of geographical peripherality in the UK is not nearly as marked as that of New Zealand, but the cultural and linguistic distance between the UK and its continental neighbours is not at all trivial. For UK SMEs, such cultural distance adds to the information-transactions costs of geography. Therefore, in order to help SMEs overcome the information-transactions costs associated with relative geographical peripherality, the UK government has set up a whole series of programmes, under the various titles of Export Explorer and Market Explorer[4], which are designed specifically to help SME firms make contacts with potential customers in other geographical markets. The definition of an SME used for these programmes corresponds with the EU definition of an SME which is a firm with less than 250 employees. In order to be eligible to take part in these programmes the SME must also export less than 15% of its total sales.
The express logic of these Explorer schemes is to lift the small-market constraints which are imposed on most SMEs, due to the costs involved in acquiring information on other less-peripheral markets export outside of the domestic economy. The Explorer policies are organised around trade visits, or missions, in which the managers of UK SMEs partake in specially organised trips to neighbouring EU markets. The missions are jointly organised by the UK Department of Trade and Industry and UK embassy and consular staff in the destination countries. The participating firms pay a small registration fee plus the costs of their travel and accommodation. As an incentive to the participating firms, these missions receive an indirect tax subsidy which covers the costs associated with arranging the meetings which take place during the visit. Yet, this is not the essential aspect of these visits.
The essential aspect is to ensure that participating UK firms meet the most important potential key overseas customers in their particular market segments. It is this unique level of export networking and information-sharing on the part of the SMEs which is the key set of externalities harnessed by the scheme. Potential customers are identified with the help of consultants in the destination markets, and the embassy and consular officials coordinate the timings and arrangements of the meetings. Importantly, the level of targeting is far more specific than simply the sectoral level, and is determined with respect to the individual firm’s product or service. Prior to the missions, participating firms receive a specially-prepared market report which is tailored to their particular sector, and this provides the firms with most of the technical, legal and business-cultural information required in order to undertake commercial negotiations in the new market.
In addition to this, the firms undergo various briefing sessions about the destination market sectors and the customer firms they are to meet, in order to ensure that they are best prepared for the mission. At the same time, from the perspective of the potential customer firms in the destination markets, the fact that the scheme is backed by the UK government gives the participating firms a level of credibility in the destination economy, such that potential customers are generally very keen to participate in such meetings. Such specifically-targeted Explorer missions, are far more sophisticated in their structure, aims and logic than are the typical types of trade missions organised by either industry associations of chambers of commerce.
The performance of these Explorer programmes over the last four years has been extremely good with participating firms achieving expected returns of the order of twenty-five times their participation costs[5]. Large numbers of participating firms have been able to generate overseas orders for the first time, and in many cases, these orders have developed into long-term business relationships. In each case, these supplier-customer relationships are genuinely new, and as far as the participating firms themselves are concerned, would have been impossible to develop without the public policy assistance.
However, as well as new export orders, the outcomes of these Explorer programmes are threefold. Firstly, the new orders allow the indigenous firms to increase their rates of growth. Secondly, the visits allow the firms to overcome many of the problems of myopia and distance-deterrence which they face by developing long-term business relationships with customers in completely different geographical markets. Thirdly, the visits also provide for a greater level of information-sharing and networking between the participating UK firms themselves. This third aspect is very important, in that the very fact that the firms have chosen to participate in such missions, is itself an indicator of positive selection on their part. Many additional business contacts and contracts are generated between the UK firms, because the cohort of participants see themselves as not only highly entrepreneurial, but also as firms which are keen to engage in what are the internationally-regarded best-practice techniques. As such, a determination to compete in external markets is also seen by the firms as a means of improving their own domestic competitiveness.
The lesson of the Explorer programme is that the expansion of the market areas of the small firms provides for both an expansion in the firms size and also a deepening of the firm’s existing skill-base. These ideas are exactly in accordance with the international competitiveness arguments of Porter (1990), whereby the processes of both external market growth and domestic strengthening are seen to take place simultaneously. In Porter’s arguments, any ways in which the mutual transparency of competitor firms is increased will itself encourage both mutual competition and also mutual cooperation, thereby increasing the overall level of domestic competitiveness.
The link here in the case of the Explorer programme, is the particular way in which the firms are made aware of the competitive ability of other domestic and overseas firms. In the Explorer programme, an acknowledgement of the fact that small firms face enormous information-acquisition difficulties is the spur to encouraging the development of such behaviour. Following the logic of the ‘social network model’ it is also to be expected that the development of such best-practice networks of mutual information exchange will slowly encourage the development of long-term stable business networks within the UK as well as with overseas customers.
To what extent would these particular forms of export promotion policies be successful in the case New Zealand? In New Zealand, while it can be argued that there are many parallels with the UK situation, there are also some differences which a New Zealand policy similar to the Explorer programme may be able to exploit to an even greater extent that the UK. The major issue here is the myopia imposed on New Zealand small businesses because of not only national geographic isolation, but also because of the inter-urban geographic isolation of most small New Zealand businesses.
A New Zealand Explorer-type of policy will help to promote both a national and international business awareness on the part of the NZ small-firm sector, thereby contributing to a relaxation of the severe geographical market area constraints faced by small New Zealand firms. At the same time, the small population scales of New Zealand also readily permit the development of the types of trust relations which become evident in the ‘social network model’. This is because a greater level of mutual accessibility between firms in New Zealand is possible than in much larger countries. Following the arguments of Porter (1990) and Scott (1988) this reduced myopia and increased inter-firm transparency should contribute to a growth in the competitiveness of the domestic economy.
It is important to be clear that this type of policy is not a policy which advocates simply ‘picking winners’ by championing either particular sectors or particular key firms. The firms which partake in these types of schemes are small and come from many different sectors. The only criteria for inclusion is that the firms are willing to undergo a short period of induction and education as to the export market environment and the types of cultural and business issues likely to be faced in entering new markets.
As such, this type of export promotion policy is built on a partnership between the participant firms and the government. Yet it is a policy which explicitly acknowledges the fact that missing markets are endemic in the small-firm sector. Of particular importance here are the limited brokerage or intermediary services available to small firms which are sufficiently targeted to their individual firm exporting needs. The limited availability of such services is primarily due to the coordination problems associated with product heterogeneity, distance deterrence and geographical myopia, which means that from the perspective of a potential intermediary, the costs of setting up such intermediary-network services tend to be inordinate. This is quite different to the case of the large-firm and multinational sectors which are able to employ consultants and brokers to undertake such activities which are specifically tailored to the needs of the individual firm. Therefore, although such comprehensive firm-specific trade support schemes can be provided by the market for the large firm sector, for the SME sector they are generally not provided for by market mechanisms.
As such, this missing-intermediary market phenomenon can be viewed as being largely an externality problem. In the Explorer type of policy, the government institutions explicitly play the role of the market broker or intermediary, and provide both supplier-customer networking and information-provision services. In essence, therefore, the programme is set up specifically in order to facilitate the acquisition of informal and tacit information by the SMEs. These highly-focussed Explorer-type schemes are therefore aimed at expanding the geographical horizons of the small firms by internalising the externalities within the programme. As such, they are designed specifically to compensate for this particular aspect of market failure.
As we have seen, many features of economic geography are related to externalities, and any public policy relating to New Zealand’s trade and economic geography must necessarily attempt to accommodate these issues. In the case of New Zealand’s small firms in particular, we cannot simply assume that the market will provide a solution to their information problems (Stiglitz 2000), thereby precluding any role for public policy. The reason for this is that New Zealand’s particular combination of both severe geographical peripherality and low population scale will progressively impose ever more severe international transactions costs (Rao 2003) on New Zealand’s small firms, which cannot be compensated for by domestic agglomeration effects. Public policy, however, if aimed specifically at relieving the market-area constraints of the SME sector, may be able to help in overcoming some of these problems.
