The Future Structure of the New Zealand Economy

I was asked by a Spanish journalist the following two questions (particular with attention to a historical perspective):

How likely do you see (if at all) a transition from an economy based on primary products towards an economy where digital services exports might play an important part?

I would also like to ask about the economic relationship with China: how much do you think it is going to suffer because of geopolitical reasons?

The Future External Structure of the New Zealand Economy

The search for product diversification of the external sector began with the first settlements in the 1840s – they needed to find something to export, especially as the quarries, such as whales for oil, began to run out. (Market diversification is dealt with in the second part of this article.) By the end of the nineteenth century, the export sector became very concentrated upon wool and refrigerated meat and dairy (‘processed grass’), where New Zealand had a comparative advantage which was turned into a competitive advantage by innovative scientific technology and sophisticated social organisations based on the family farm and collective post-farm processing.

By the middle of the twentieth century, there were increasing concerns with the long-term viability of this strategy. Suitable farm land was running out. (There was virtually no further land to be broken in from the mid-1950s; water resources were largely fully utilised by the 2010s.) Pastoral farming was not creating enough jobs for the burgeoning population.

New Zealand turned to ‘Import Substituting Industrialisation’ (ISI), as did many other economies. It was realised that would not generate enough jobs by itself and by the 1960s New Zealand was seeking export manufactures – notably, there were tax incentives for exporting manufactures and a free trade agreement with Australia. There was also a recognition of the need to diversify the farm sector – including to forestry, horticulture and wine – given the pastoral price experience New Zealand had during the 1930s Great Depression. Additionally, there were potential exports from the fishing resource (New Zealand has one of the largest EEZs in the world, and better fishing management than most) and from tourism. At that time, service exports were mentioned but, except for tourism, they were not near the centre of the public discussion.

The ISI strategy has fallen over in most affluent countries, including New Zealand, which, like most of them, has experienced a major decline in the share of the manufacturing sector and is now heavily dependent upon imported manufactures. As a gross generalisation, New Zealand manufacturing consists of primary product processing or small localised market supply where importing would be too complicated or costly.

When I was studying this – written up in my Globalisation and the Wealth of Nations – I concluded that New Zealand suffered from the major limitations of location and size.

New Zealand is located far from most other countries, in the middle of nowhere. The direct distance from Auckland to Sydney is similar to the distance from Madrid to Warsaw (and there is only water, not people, in between). International transport costs – and sometimes time – are a considerable burden. One consequence is that New Zealand is rarely in the middle of supply chains, which have been one of the most dynamic developments of manufacturing in recent times. There was a fashion for saying New Zealand should be exporting about 40 percent of its GDP, comparable to many other OECD countries, instead of its current 30 percent. What that overlooked was that most of the additional 10 percent were supply-chain ‘re-exports’, which are not really an option for New Zealand, which is only at the beginning or end of supply chains.

New Zealand is small with only 0.06% of the total world population. It ranks 123rd in the list of countries by population. Its largest city, Auckland, has a population of less than two million, even if Hamilton is included. There are more than 300 cities in the world which are larger on the Wikipedia list.

Urban size is important for the economics of agglomeration which lowers the cost of production and increases economic dynamism by competing multiple suppliers, greater specialisation and thicker labour markets. These are key to high productivity, high rewards manufacturing and services. They were judged to be of such importance that from the late 1990s New Zealand has given special attention to getting Auckland to function as effectively as possible. (Economies of agglomeration are offset by economies of congestion; unfortunately Auckland, located on a narrow isthmus, generates the latter.)

New Zealand’s size makes one pessimistic about there ever being enough agglomeration to make it a major international centre for manufacturing and services. Here are some examples of its strengths and weaknesses.

Fisher and Paykel were an Auckland-based, exceptionally innovative, provider of ovens, electric cooktops, dishwashers, dryers, freezers, ranges, refrigerators and washing machines. Unfortunately, transporting whiteware is expensive. The firm increasingly moved production offshore and eventually was taken over by Haier Group Corporation, a multinational home appliances and consumer electronics company based in China.

An offshoot from the innovation was Fisher and Paykel Healthcare, which designs products for respiratory care, acute care, and the treatment of obstructive sleep apnea. Because their shipment is less expensive, the company is still based in New Zealand, supplying more than 120 countries, with just 1 percent of revenue coming locally. However, since 2010 it has also been manufacturing in Mexico, supplying the United States.

Over a decade ago, I looked into the potential for a major biotechnology, pharmaceuticals and related research industry in New Zealand. I observed that there was no such an industry in the United States, but rather, it existed in about a dozen US cities, because the economics of agglomeration were powerful. All these locations were larger than Auckland, although if nearby Hamilton with its major interests in related animal biotechnology is added the city was near enough to the threshold. There is today a lot of such research activity and some internationally significant findings, but the industry has not taken off as much as one might hope. It may be because there is not the depth in local venture capital.

Xero is a technology company that provides cloud-based accounting software for small and medium-sized businesses, with more than three million subscribers and offices in Australia, Britain, Canada, Hong Kong, New Zealand, Singapore, and South Africa, and the United States. (It also has connections with Infosys in India.)

Sometimes a particular person’s choice of home can create an industry. Thus it is with ‘Wellywood’ because international filmmaker Peter Jackson (best known for The Lord of the Rings trilogy) chooses to live in Wellington. One feature which helps makes the film industry cluster viable, is that it sends its processing to Hollywood via cable. There will always be eccentric reasons for some industry location.

New Zealand has a ‘nice little earner’ in translation services arising from Europeans completing agreements in the evening, cabling them to New Zealand with its 12-hour difference, and having the translated texts available the following morning – the New Zealanders having worked on them while the Europeans were sleeping.

What then are the prospects for New Zealand’s industrial structure? Compared to other affluent economies it will always have a large resource and resource-processing sector. But their growth is constrained by resource availability. Tourism will remain important. New Zealand is likely to have a modest manufacturing sector much like other rich countries. The domestic service sector will be large and there will be service exports (including consulting and educational services). Weightless exports are likely to become a larger proportion of foreign exchange earners, as they will elsewhere.

But I do not expect weightless exports to become a particularly dominant New Zealand activity for two reasons. First, it will be limited by the lack of economies of agglomeration. Second, it is a labour-intensive industry involving skilled professionals. New Zealanders are very internationally mobile; there are even sizeable communities of Māori in Australia. While the country offers some attractive lifestyle choices – a bach at the beach and a hut in the hills near a ski field – there is the real possibility of key personnel migrating.

The Economic Relationship with China

There are two major dimensions to New Zealand’s relationship with China: economic over-dependence and the security tensions in relations between China and the United States and its allies.

New Zealand is haunted by the dangers of economic over-dependence on a single economy. As recently as 60 years ago, around two-thirds of (mainly pastoral product) exports went to Britain. A decade later Britain joined what became the European Community, which at the time was commonly seen something like Mummy running off with a continental gentleman – or rogue.

For the record, the official and informed view was that Britain should join the community providing New Zealand’s special interests were not compromised. New Zealand had been aware of British accession since at least 1961 and had made (successful) efforts to diversify. Between 1965 and 1980, New Zealand exports had shifted from being one of the most concentrated in the OECD by both markets and products to being near the middle.

Today China takes almost a third of New Zealand’s exports of goods and services but it is so deeply interconnected, especially by supply chains, with East and South East Asia, that in total the wider group probably takes near two-thirds of New Zealand’s exports (depending on how it is defined, but including Australia).

The dominance of China in New Zealand’s trade is extraordinary. It is the biggest market for milk products, sheepmeats (for beef it was only second), fish, apples, wine and honey (for kiwifruit it was third). Thirty years earlier, China did not make New Zealand’s top ten export destinations in any of these products. Significantly, each presents particular political problems in the international economy – most notably, widespread barriers to entry for pastoral products. These products make up a significant share of New Zealand’s exports. They can be particularly difficult to manage, as Australia’s recent tensions with China illustrates.

New Zealand has welcomed the opening up of China’s markets which have been important to its recent prosperity. However, the ghost of the British experience remains. New Zealand went through periods of stagnation – notably in the 1920s and 1950s – because the British economy, and hence its imports, stagnated. Chinese economic growth is slowing down; that could well have a similar impact on New Zealand.

New Zealand has vigorously pursued opening up markets elsewhere. Hence the recent trade deals with Britain and with the European Union. Others are on the table, especially with India. (One with the US is an ambition, but hardly on the table given Congress’s attitudes; in any case the political price may be unacceptable to the New Zealand public.) Existing deals are being upgraded. New Zealand has 14 free trade agreements with around three-quarters of its trading partners by value, including one with China and two big open plurilateral agreements: the Comprehensive and Progressive Agreement for Trans-Pacific Partnership  (CPTPP) of 11 countries and the Regional Comprehensive Economic Partnership (RCEP) of 15 countries (including China). They are of varying quality and often involve limitations to the access of key New Zealand export products.

As when Britain joined the EC, the stumbling block has often been dairy product access. Protecting its dairy farmers seems to be a sine qua non of a sovereign nation.

While improved market access will continue to be pursued and may grudgingly happen, the key to reducing over-dependence on particular markets may be new products sold elsewhere.

The other issue is the security tensions between China and the United States and its allies. The horror scenarios for New Zealand would be a collapse of the Chinese economy or a military conflict between China and the US which involved economic sanctions against China. (There are, of course, gradations below either scenario which would be difficult enough.)

The security horror scenario results in the very careful path New Zealand has trod in its relations both with China and the US – ‘tippy toe’, one might call it. It wants to condemn some of China’s actions, but not so forcefully that it will have trading repercussions, as has occurred with Australia. It wants a security relationship with the US which is not too close because of the China dimension – its public would probably not support a formal alliance – but close enough so that were tensions to rise, New Zealand would have its submissions respected, especially if there were trade sanctions on exports important to New Zealand. (The US unwillingness to offer adequate trade access to New Zealand compounds the question of loyalty.)

Lee Kuan Yew once remarked about small nations, that whether elephants make love or war, the grass gets trampled upon; especially true for a country which will continue to depend upon processed grass.