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MAY 14

Moving up the value chain

One of the keys to New Zealand’s future success will be our ability to move from a producer of low value bulk commodities, to add value and produce elaborately transformed products and associated services. Generally, due in no small part to our policy framework, we have been trending towards less added value and have seen growth in bulk primary products; changing this trend requires significant policy change.

In the above graph, you can see some negative trends in real terms over the past 10 years. The top two lines are processed and unprocessed primary products, essentially bulk commodity goods. These have seen growth over this time, largely because of the growth of the dairy industry and the sale of logs. Conversely, the sectors which add value, elaborately and simply transformed manufacturers have been more or less stagnant over the last 10 years, falling since 2009.

There are many reasons for this difference in growth, but policy settings are the most critical, these are a matter of political choice and can be changed to make a difference.
One of the drivers of this difference is the absence of a Capital Gains Tax. This means investment is incentivised towards asset heavy low revenue enterprises, which are generally in the primary sector. This tax imbalance takes investment capital away from added value activity, which tends to be high revenue, but lower in assets. Equally in times when there is hot money in the global economy it tends to find its way into asset markets, chasing higher interest rates and lifting exchange rates, sandbagging returns to those exporters not betting on capital gains to make the enterprise worthwhile.

Why should we all care about this?

The high value added sectors, the simply and elaborately transformed products and attendant services are important for a number of reasons. The sector provides well paid jobs, including many that are demanding and highly skilled. This is important for earning a living in the world economy, improving living standards and perhaps keeping people who might otherwise seek employment overseas.

This type of activity also has high flow on effects in supply chains and the broader economy in terms of the skills, innovation and IP it creates, as well as the high number of jobs it supports elsewhere in the economy, particularly in the service sector.

Allowing the trend we can see in the graph to continue will have negative effects on our economic future. This trend would see us rely more and more on low value commodity goods to pay our way in the world. Does it make sense to rely only on shipping raw materials offshore, failing to foster growth in New Zealand based on the skills of the people here? Perhaps some of those skills would rub off to further transform materials produced here so a higher value product can be exported.

Growth in simply and elaborately transformed manufacturers increases the diversity of our exports, improving long term resilience and generally lifting the skills in our communities. It is not a good idea to put all our economic eggs in one basket – milk power and logs to China. 

What policy settings could promote more high value added activity?

Fix the tax hole which allows tax free capital gain on land and property. Currently this oversight overloads corporate, personal and other taxes; furthermore it lifts interest and exchange rates and starves productive activities of investment.

Research and development is risky and costly, but an undeniable part of added value products and associated services, particularly for those in high value added businesses. Here much of the added value comes in the form of IP, which supports higher margins. Research and development tax credits would be a policy choice to support and promote this activity; tax credits have a broader reach and better fit the structure and scale of industry in New Zealand; much more effective than winner picking grant systems. Accelerated depreciation on manufacturing equipment would encourage more firms to keep up with rapidly changing technologies, a vital part of staying competitive. It is worth noting this does not change the tax take, only the timing of tax payments.

An overvalued exchange rate acts as a barrier for exporters and import competing industries. While this has the immediate effect of reducing their margins, this will over time affect their investment decisions. If a reasonable return on investment is threatened by currency appreciation; investment falls and with it future competitiveness. The development and maintenance of skills and innovation will also be damaged. While this is not overly visible, it is a concern that warrants a policy response if we are to increase our high value added content in our exports.

tags: exchange rate, accelerate depreciation, exports, manufacturing, wiki nz, value
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