3 China's impact on New Zealand[44]

New Zealand's exposure to China has been growing over the past decade, but has increased significantly over the past few years. The growing exposure has been caused by China's rapid economic development, growing international integration and the development of bilateral relations, including New Zealand becoming the first OECD country to sign a free trade agreement with China in 2008. New Zealand has had both direct economic benefits from China and indirect benefits through our largest trading partner Australia. This paper concentrates on direct benefits. An accompanying paper (Osborn and Vehbi, 2013) uses an econometric model to quantify both the direct and indirect effects.

The impact on the New Zealand economy has been through a number of channels. Infrastructure investment, particularly in housing as the result of increased urbanisation, has led to increased demand for forestry products for use in the construction industry, boosted by rebuilding following the 2008 Sichuan earthquake. China's urbanisation and growing incomes have led to increased demand for New Zealand dairy products, aided by food quality concerns in the wake of the 2008 melamine scandal. The expansion of China's manufacturing base, combined with low labour costs and an undervalued exchange rate, has made consumer and capital goods available to New Zealand (and the world) at competitive prices.

Combined with the higher prices arising from increased demand from China for New Zealand's export commodities, lower import prices led to New Zealand's terms of trade reaching a 37-year high in 2011, boosting incomes and supporting the value of the New Zealand dollar. While higher prices over the past decade have boosted incomes, most of the trend increase in exports to China has been owing to higher volumes. Cheaper imports and the high value of the New Zealand dollar have helped contain tradables inflation, offset to some degree by higher food prices, particularly for dairy products. These factors have also helped contain rises in the cost of capital goods for firms.

As trade links between China and New Zealand have grown, foreign direct investment between the two countries has also increased. New Zealand's investment in China increased from $160 million in 2007 to $930 million in 2012 and China's investment in New Zealand increased from $890 million to $1,860 million over the same period; these amounts are still quite low with country ranks of 15^th and 13^th respectively. Closer economic ties between New Zealand and China have increased the income and purchasing power of New Zealanders, contributing to higher living standards.

The features of China's growth have had an even greater impact on the Australian economy, particularly China's demand for resource commodities for use in infrastructure investment and to meet growing energy needs. This has led to historical highs in Australia's terms of trade and a high nominal exchange rate, although it eased in mid-2013 as has New Zealand's. Given China's greater importance to the Australian economy,[45] its impact on Australia has been greater than its impact on the New Zealand economy.[46] There has also been an indirect impact on the New Zealand economy from this impact on the Australian economy.[47]

China's expansion has also had an effect on the wider world economy, in particular the relocation of manufacturing from advanced economies to China. Globally, manufacturing's share of GDP has been in decline over the past four decades, falling from 27% in 1970 to 16% in 2010 as demand for services has expanded (Reserve Bank of New Zealand, 2013). This decline has been even more pronounced in advanced economies as production has shifted to developing countries. In line with trends in other developed economies, manufacturing's share of GDP in New Zealand has declined from nearly 19% in the late 1980s to just over 16% in 2000 and less than 13% in 2012. At the same time, imports from China (which are dominated by machinery and textiles) have increased from 0.2% of nominal GDP in the late 1980s to 1.6% in 2000 and 3.7% in 2012.

As in other developed economies, New Zealand manufacturing products have become less competitive on the world market owing to lower labour costs in developing countries, especially China. New Zealand manufacturing has also been impacted by an appreciating exchange rate. This is demonstrated by the ratio of New Zealand non-food manufacturing exports to imports falling from 44% in 2000 to 37% in 2012. At the same time, China's development has led to closer trade and economic relations with the rest of East Asia and New Zealand's trade with that region has increased in line with its trade with China. (See Figures 1.1 and 1.2 above.)

There have been other impacts from China on the New Zealand economy, including labour and capital markets. However, this paper concentrates on the impact on trade as these impacts can be more readily isolated, including in the quantification exercise in Osborn and Vehbi (2013). The timeframe adopted here is from around 2000 onwards, which is when China's impact on New Zealand started to increase, coinciding with China joining the WTO in 2001. The rest of this section explores the channels for the direct impacts of China's growth on New Zealand. We concentrate on the trade channels, especially merchandise exports, but also touch on other channels. This section does not look at the implications of the conclusions for policy, which could be the next step in this area.