Development Strategies for the Eighties

Address to the Electrical Supply Authorities Association conference in Christchurch on 22 September; published in the ‘New Zealand Monthly Review, November 1980. It was also published in “Straight Furrow”.

While there can be little dispute that the structure of the New Zealand economy will be very different in 1990 from what it is today, there is considerable room for debate on what that structure will be. For today we face real choices about the future structure of our economy, and the strategies we might pursue.

I want to simplify this range of choices by examining two basic development strategies. We might summarize one strategy as the “Small is Beautiful” strategy, using the phrase of E. F. Schumaker. The alternative strategy might be called “Think Big”. Here I shamelessly use the slogan of Mr George Chapman, President of the National Party.

Before I describe the two strategies to you, let me point out that they have some areas of common agreement. Both see our future in an economic structure very different from the past. Undoubtedly traditional sheep and dairy farming will continue to be of great importance in our economy, but they will not have the role of the leading sector in development as they had in the past.

The second point of agreement is that New Zealand must, in some sense, specialize. We cannot imitate the industrial nations of the world in Japan, Europe, North America, or even Australia. Our economy is too small. We cannot reap the economies of scale which are so crucial for their development. If we try to imitate such economies we will have a lower standard of living, and lose our highly skilled labour force to those countries which through economies of scale have higher productivity and pay higher wages than we can. Just as we did in the past as a specialist supplier of high quality animal food and fibres to the rest of the world, in the future we will also have to find a specialist role, although possibly a different one.

So much for the agreements. The disagreements are more substantial, so let’s look at each strategy in turn.

The “Think Big” strategy

As publicly presented the “Think Big” strategy centres on a few crucial industrial sectors. The most typical and vaunted are energy and chemical projects based upon the Maui gas field. These include electricity, ammonia-urea, methanol, synthetic petrol and petro-chemicals. Another big sector is metal smelters supplied from electricity produced from hydro stations in the Upper Clutha Valley and coal from the Waikato. In addition, there are similar “Think Big” proposals in forestry (although the main thrust here will be after 1990), in some mineral mining, and to a lesser degree in fishing and tourism.

The “Think Big” strategy is characterized by taking some of our raw materials, such as Maui gas, coal, hydro electricity, and forests, and processing them for export. The processing plants are large, and capita- intensive, so they employ little labour compared to the value of output. Characteristically the plants are owned by multinational firms, or consortiums of a large New Zealand enterprise and a multinational.

Few employment opportunities created

It has been correctly pointed out that the “Think Big” projects will not directly generate enough employment opportunities. Let us recall the magnitude of our employment problem. Today we are around 100,000 jobs short; by that I mean that the actual level of unemployment is 100,000 New Zealanders. In addition we have to find an extra 20,000 jobs a year to deal with the labour force increase, in addition to those jobs that will be destroyed by technological and economic change. At the very least we are concerned about creating an extra 300,000 jobs over the next ten years, and the true figure may be closer to 500,000 if we allow for job destruction. Some of these jobs will develop naturally in the government and service sectors, but perhaps a half will have to be created in the primary and secondary sectors, including transport and construction. Thus we have a formidable job creation task before us.

Compared to these figures the big projects create very few jobs. For instance, the most ambitious use of Maui gas giving us 80 per cent self-sufficiency in liquid fuels creates 3,000 permanent jobs, with a construction force rising to a mere 7,050 at its peak.

However, these employment figures are for direct employment only. What is crucial about many of these “Think Big” projects is that net export earnings per worker are intended to be high. Of course they may not be, if for instance we oversubsidize the firms, or most of the surplus accrues to the overseas investors. But if things go well, we could make substantial gains in foreign earnings. For instance, with regard to that use of Maui gas, the expected estimated net annual foreign earnings is $880m or around $290,000 per permanent worker.

Such very substantial gains would enable us to expand the economy and this would create jobs and employment. Thus the employment generation mechanism of the “Think Big” strategy is more aimed at improving our balance of payments and thereby creating the jobs we require.

Problems with “Thinking Big”

There are a number of major problems with the “Think Big” strategy. First there is the question of whether the projects will be as socially profitable as the advocates claim. Quite frankly, I am somewhat sceptical about the social profitability of many of the projects. A number of them seem to require government subsidies, rather than standing on their own two feet.

The second difficulty is that no one has calculated whether these big projects will create enough jobs directly and indirectly. We could find ourselves in the mid-1980s with only enough projects to earn, say, foreign exchange for half the jobs we require.

Third, even if we have enough foreign exchange, there is no mechanism to ensure that the rest of the economy creates the right jobs. It is quite easy to envisage the development of a low-productivity manufacturing sector which sops up unemployment but does not really contribute to national production.

You will also notice that the strategy does not say much about what happens before the projects start earning the foreign exchange in the mid 1980s. Part of the answer is that there will be interim employment opportunities in the construction of the plant, financed by overseas borrowing, but, alas, unemployment will remain. Moreover, the overseas borrowing will, of course, reduce the social profitability of the projects.

A fifth point is the regional impact. There is little in these projects for the north of the South Island, and most of the North Island. Characteristically the expenditures and employment will be intense in localities but there will not be widespread benefits.

A sixth point is the question of ownership and social control. It is not merely that most of this development is based on large corporations. The plants they run are ideal for very militant unions. You need only to look at Kinleith and Kawerau for evidence of the consequences of labour relations in capital intensive industries. Historically our labour relations have been best in small businesses and farms. Our national aspirations are that we want to be self-employed rather than corporate managers. If we go for these big plants we are going to have to pay a lot of attention to the issues of social control of the large corporation and the powerful union.

Faced with these problems the Big Thinker would argue that they are not insurmountable, and in any case you can’t make an omelette without breaking eggs. If there was no alternative development strategy, the case for thinking big rather than doing nothing would be unbeatable.

The “Small is Beautiful” strategy

Thus, at the very least, the “Small is Beautiful” strategy provides a test of the viability of “Think Big”. However, it is more difficult to describe. Its essence is to see our farms and, to a lesser extent, forests, fisheries, mines and hydro stations, producing a wide variety of raw materials which we process with a highly skilled labour force into a wide variety of products for export or substitutes for imports. Typically these processing firms will be small scale and in international terms of output of a particular product may be small. But collectively they would add up to a substantial foreign exchange earner.

Let me give you some examples. The food industry has evolved this way for a number of years now. Instead of carcases and a few bulk dairy products we are diversifying into food preparations; honey, horticultural products, wine, feed stuffs, and deer and goat products. Today we scour about half of our wool, and we aim to increase that proportion and to process the grease which the scouring extracts. Moreover, we fully process only 8 per cent of our wool. We can build up exports of woollen yarns, carpets, and fashion wear. Instead of exporting pulp and paper from capital intensive plant, our comparative advantage is to export the more labour-intensive solid wood products, including furniture. Wood chips can be used in small stills throughout the country to produce ethanol as a substitute for petrol. We can export skills, in terms of international contracting and consulting. This is just the beginning of a list of a myriad possibilities which the “Small is Beautiful” advocates see.

You will notice that the products I have mentioned usually require a highly skilled work force. There is no future in our attempting to compete with the lower skilled work forces, say, of South East Asia. That would mean we would have to pay low wage rates, which would result in outmigration to high wage countries.

The “Small is Beautiful” strategy meets some of the problems of the “Think Big” strategy. Since the strategy is land-based, there is a natural regional balance. The typical firms will be New Zealand-owned and managed, with a size that gives a chance for good labour relations. The strategy directly creates jobs, but as the new firms will also create and conserve foreign exchange there will also be indirect creation of jobs. And the jobs will be created throughout the 1980s including the first half when the big projects are yet to come on stream.

Problems with “Small is Beautiful”

Nonetheless there are some difficulties with the “Small is Beautiful” strategy. Where is the investment capital for the developments to come from, although the requirement is not as acute as in the case of “Think Big” since the strategy is less capital intensive? Again we cannot be sure that the strategy will create enough jobs, although we might surmise there are enough potential opportunities. But can we convert these potentialities into actualities?

Therein lies the central problem of the “Small is Beautiful” strategy. It is easy enough to think big, and to initiate big projects. You advertise you have so much electricity, gas, or whatever, and invite proposals from corporations. Then it becomes simply a matter of pitching the government terms, prices, and subsidies at a level which will make it worthwhile for the corporation to initiate the project. Thereafter the corporation takes over.

In contrast, the initiation of “Small is Beautiful” projects is less direct. For instance, we might observe that there are opportunities for the export of a wide range of pharmaceuticals and cosmetics based on natural products that our farmers can grow. How does the government go about converting these opportunities into real live exports?

The answer is a lame one. The role of the government is to create an economic environment where private initiatives can do the conversion for us. Such an environment includes a good infrastructure, a well trained labour force, a vigorous research programme_ and sufficient business services. In addition the price and taxation structure has to be favourable. For instance, the current practice of capital subsidies encourages the capital-intensive technologies, which “Think Big” supports, while penalising the more labour intensive industries which the “Small is Beautiful” strategy supports and generates unemployment.

Indeed the curious paradox is that so-called private enterprise supporters advocate a form of development which is deeply dependent upon state involvement. The big projects invariably involve a very direct partnership between the corporations and the state. We must distiguish between corporate enterprise, including state corporate enterprise, and private enterprise. In contrast the “Small is Beautiful” camp has an almost naive faith that, given the right economic environment, private enterprise in the form of small and medium businesses, the self-employed, will grasp the initiative  and flourish. The big thinkers have far less confidence in the efficacy of multinational private enterprise. Ironically the so-called private enterprise lobby has the lesser faith in private enterprise.

The “crowd out” effect

The natural question the onlooker to the debate will raise is whether we can have both strategies. Indeed the proponents of each strategy will claim that there is room in their strategy for the best elements of the opposition strategy. Undoubtedly we are going to have a bit of both, but in reaching this conclusion we must not ignore what economists call the “crowd out” effect. Its essence is that the initiation of one project can prevent the initiation of a second; that is, it can crowd it out.

To illustrate this phenomenon let me take the recently published 1980 Energy Plan and the contentious issue of metal smelters base on electricity. Unfortunely the plan is a bit cryptic, but if I read the relevant part correctly it goes like this.

The government has contracted to supply to a number of metal smelters, of which the aluminium potlines are the most notorious, a total of up to 5,000 gigawatt hours a year. This requires construction of a number of power generation plants over the next fifteen years. The energy plan mentions stations on the Upper Clutha at Clyde, Lugate, Queensberry, and Gibbston, geothermal stations at Ohaki and an unspecified site, a new coal-fired station in the Waikato plus the conversion of part of the Marsden B oilfired power station near Whangarei into coal-firing. It would appear that only part of the installations at Clyde are for domestic power; other domestic increases over the fifteen-year span can be met from the completion of the Upper Waitaki system and the station at Huntly. Thus all the other new stations I have mentioned are necessary to supply power to the metal smelters. In addition the plan says we will have to burn fuel oil and distillate in the late 1980s to meet the smelters’ requirements.

The plan itself expresses doubts as to its feasibility. The exact words are “the plan contains measures which have yet to be confirmed as feasible”. The planning schedule appears tight, even if it is feasible. If one new power station’s commissioning is delayed we would be faced with a power shortage leading to the burning of even more of the expensive fuel oil, or to power cuts. One cannot help but look to the current industrial dispute at Huntly, and wonder what would be happening if we needed the Huntly station urgently.

Leaving aside the questions of engineering feasibility and scheduling, we have to ask whether the schedule is economically viable. You will already be aware of the public debate over the social profitability of the aluminium smelters. To make a trivial but fundamental point, much debate arises out of a lack of agreement as to the rules of the game. For instance, some evaluations are based on the national interest irrespective of which part of the nation benefits. If the investing corporation may make a large profit and the rest of the country make a smaller loss, some assessments conclude the project is viable since the total benefit to the country is positive. Other assessments concentrate only on the benefit to the non-corporate part of the economy and, faced with the same facts, argue that the project is not viable. Their conclusion is that the government subsidies to the corporations are too high.

Another disagreement arises in terms of the alternatives. If we compare aluminium smelting to doing nothing, then the project may well be viable. If we compare it to a number of other projects which cannot go ahead if the smelter and electricity power stations are built, we may well get a different conclusion. Clearly this second approach is the essence of the “crowd out” argument.

Will the smelters prevent other projects? Let me instance three ways in which they can crowd out.

Higher electricity prices

The first is that associated with the smelters is the vast power station construction programme I mentioned. It looks as though the construction programme will cost $1,200 million (in today’s prices), or an extra $80 million a year. All this finance will not come from revenue for electricity sales to the smelters. It is clear from the announced selling prices that the electricity account will be in deficit throughout the 1980s because the outgoings in investment and fuel costs will exceed the revenue. It is not until the 1990s, at the earliest, that the smelters will start paying their way.

There is nothing wrong with this in principle; it is a standard development strategy to invest now to get a return in the future. However, we need to ask who is going to provide the extra savings in the 1980s for the investment. Given that we are referring to the government’s power-station construction programme we can predict, I think with confidence, that the extra construction cost to provide for the metal smelters will have to be financed from higher domestic electricity prices than would otherwise be necessary.

Some will escape these higher prices by switching to cheaper gas, which will put up the price of electricity to the rest of us, particularly those in the South Island, East Cape, and Northland who are not on the natural gas pipelines. The higher electricity prices will push up firms’ energy costs and, in that they feed into labour costs through higher consumer prices, the firms’ overall costs. Some firms which will have been viable under a low electricity cost regime will not be viable under the higher price due to the smelter regime. This “crowd out” effect may be marginal for a particular firm, perhaps preventing an extension into exporting or import substitution. Aggregated across all firms the “crowd out” effect may be more substantial.

Crowding out irrigation schemes

There is a second “crowd out” effect from the alternative deployment of the resources we use for the construction works. In the case of hydroelectric power stations the alternative civil works are improving the transport network, land development, and irrigation schemes. The bulldozer driver on the Clyde dam cannot be building irrigation works.

There is an interesting story attached to irrigation. The government tells us in its Growth Opportunities catalogue that there is the potential for another 200,000 hectares of large scale border dyke irrigation schemes in Canterbury alone. Commissioned, they would generate an extra $100 million of export earnings, and the internal rate of return is at least 12 per cent. But total works expenditure on irrigation this year is a miserable $6.3 million in the whole of the South Island (compared to $68 million on South Island hydro power works), and there are no irrigation projects going on at all in the Waitaki area where the main hydro power works are under way.

If this is not sufficient evidence that the electricity power station construction programme is not crowding out irrigation schemes, let me go a step further. The government uses a standard discount rate for evaluating projects of 10 per cent p.a. That means roughly that government requires a 10 per cent social profit on capital investment. There are two exceptions. On irrigation projects the required return is 15 per cent p.a.; that means they have to be one and a half times as socially productive as the standard government project. Thus irrigation projects with a return in the 10 to 15 per cent range are being held back. The other exception is on energy projects, where the discount rate appears to be only 6 per cent p.a. or two-fifths below the standard rate, and less than half the return required from irrigation works.

So one cost of the smelters is delaying the irrigation works programme, and that means less farm production for processing and export.

Nuclear power stations?

There is a third “crowd out” effect by the smelters of a longer term nature. As is clear from the energy plan, we are going to have to use most of the Upper Clutha, our best geothermal sites, and much of a coalfield to supply the smelters. For domestic needs in the 1990s we are going to be left with the lower Waitaki, the lower Clutha, and perhaps very little else. Long-term power supplies for the South Island look reasonably secure until after the turn of the century, but what about the North Island? The concern is compounded by the rising energy demands of the forestry programme after the 1990s. How are these going to be supplied?

One response might be to commission a second platform at Maui, although this would have the effect of halving the life of the Maui gas field. It will be expensive and I shall not be surprised if such a commission is added to the power plan in 1981 in order to avoid the feasibility and scheduling problems.

Even so, it is difficult not to interpret the energy plan to imply that by the end of this decade we will be seriously discussing whether to build a nuclear power station in the North Island, probably close to Auckland. Like you, I had thought the issue of nuclear power in my lifetime had been settled by the Royal Commission. If we go ahead with the smelters the issue must once again be raised.

A policy of moderation

While the smelters and associated power stations may be profitable, particularly to the corporations rather than the rest of the country, if there is nothing else to do, the evidence is that they will crowd out a number of viable projects which will create jobs and improve our balance of payments. Nobody has demonstrated that the smelter projects are better than these alternatives. All the available evidence points to the contrary, that in economic terms we will make large economic losses by not proceeding with the alternatives that the smelters will crowd out.

That is the trouble with the Big Thinkers. Because some of the big projects they propose are economical1y viable, it does not follow that all the projects are viable. On the contrary. some are clearly not, but we have committed ourselves to them through an attack of megalomania. The costs of these ill-conceived projects could be high — literally hundreds of millions of dollars.

Such a view does not automatically conclude that the “Small is Beautiful” strategy is 100 per cent correct. Undoubtedly it has its defects, undoubtedly  some of the big projects should go ahead —it would be crazy to leave the Maui gas in the ground. However, it seems me that the Big Thinkers are too dominant in terms of our current economic strategy.

What we need is moderation, and greater faith in the ability of New Zealanders to seize initiatives if the economic environment is right. If we had that faith, I believe New Zealand will finish the 1980s as a prosperous and varied social democracy. If we do not pursue a policy of moderation the best we may expect is in 1990 the economic and social problems that will confront us—those of us who are left—will be worse than they are today.