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SEP 16

Thirty Years of Manufacturing New Zealand

Thirty Years of Manufacturing New Zealand

See presentation here: 


New Zealand was the first country to embrace inflation targeting, along with a raft of other polices that have come to be known as the broad neoliberal policy approach. In contrast to the northern hemisphere in New Zealand many of these changes were championed by the left of politics, and has become the entrenched position, for the most part, across our political spectrum for the past thirty odd years. Has this period of political thought delivered the promised well balanced improvements in our economic wellbeing, and what has been the outcome for the productive sectors of our economy?

What happened to Manufacturing?

New Zealand, along with most of the Anglo Saxon world, has offshored a significant amount of manufacturing activity since 1985. This accelerated when import tariffs were abandoned for most manufactured and agricultural goods. What manufacturing activity existed prior to the 1985 was targeted at rural support and infrastructure: road, rail and power generation plus some consumer durable manufacturing that could only function behind significant licencing and import tariff barriers.

Some types of pre 1985 activity, particularly that could be mass produced was quickly replaced by imports, and in the longer term more and more activity moved to low-cost countries. In a small economy local supply chains have found it hard to sustain themselves as volume fell through the 1990s, and as volume falls skills, capability and competitiveness become increasingly hard to sustain.

Many manufacturers in New Zealand did, and still do, have supply chain positions within the domestic market, even for goods that are finally exported. This dependence means that the loss of capability early in a supply chain can have a broader impact on the ability to compete via downstream effects on the manufacturing ecosystem – one more recent example of this was the loss of local manufacturing capability related to the rail industry in Dunedin.

There are pockets of success with some specialised products where New Zealand producers of elaborate goods do well in global niche markets but these successes cannot fully offset the decline in well-paid employment and elaborate product export revenue. New entrants are more likely to produce offshore, often not by choice: design, development, prototyping and early production can and do happen in New Zealand but the loss of any such local activity generally happens at some point.

Weekly incomes in manufacturing are higher than all industries both in average and median termsii.

Manufacturing valued added as a percentage of GDP in New Zealand has fallen significantly in the past 30 years, sitting at 27% in 1982, compared to 11.9% in 2012. Employment in manufacturing has fallen in terms of full time equivalent employees – from 224,600 at the end of 1989, to 175,100 in the second quarter of 2016. Since 2009, employment has been more stable around this 170,000 level i.

Had New Zealand had maintained manufacturing activity closer to 30% of GDP, much like Germany managed over the same period, average incomes would now be substantially higher. Employment has increased in some sectors with lower earnings, such as tourism.
How have high value elaborately transformed exports, exports performed?

In real terms since the mid 1980s exports, as a percentage of GDP, have been largely static at around 30% of GDP. Perhaps holding your own in a competitive world such a headline looks more than reasonable, in comparative terms. In the last decade, this has been due to particular success in processed primary exports, boosted by the Free Trade Agreement with China, but high-value simply and elaborately transformed goods have not shown the same growthiii.

An intent to grow exports in relation to GDP has been voiced by government after government, from both sides of politics, but not much changes. Most recently National’s target of raising exports to 40% of GDP by 2025 looks to many to be just as unattainable. Generally, not much more than wishful thinking, lacking the necessary investment and macroeconomic policy focus to encourage the structural changes on the ground that would contribute to that goal.

Looking more into the detail and breaking out the performance of the tradeable and non-tradeable sectors we can see the two sectors grow together into the mid 2000 since then tradeable growth has stalled or even slipped a little. While the non-traded sector has continued to grow at historical trend rates i.

The implications for economic growth?

Different types of production activities require different levels of skill and capability, from simple stuff easily replicated and subject to low cost of entry competition to complex stuff that requires years of experience and deep supply chains with hard won capability. The measure of economic complexity indicates the ability and capacity to make things that are hard to make or are new, speaking to the ability of an economy to grow value in the future. When breaking up exports into different types of production according to the level of processing, it is clear that as a primary and processed primary producer (milk, meat, wood, fish) expansion in real terms has been achieved. However, in terms of simple or elaborately transformed goods, the news is less encouraging . The implication is that the New Zealand economy is evaporating complexity, and with it the capability and capacity to make complex new things and compete in value markets.

The Economic Complexity Index (ECI) assesses economic complexity the higher the value, the more complex the country is in terms of economic activity. As examples, activities which contribute the most to economic complexity are Machinery (2.54 ECI), Chemicals and Health (2.52 ECI) and Electronics (2.25 ECI), whereas the industries that have the lowest values are Cotton, Rice, Soy and Others (-2.3 ECI) and Oil (-2.1 ECI).

On the ECI scale (2014), New Zealand is ranked 39th with an ECI of 0.70. When we compare New Zealand value with countries who are biased toward added value, we score much lower: Japan (2.25 ECI), Germany (2.05 ECI) and Switzerland (2.10 ECI). This is important because complex enterprises have positive flow on effects to the economy which goes on to build further network effects. This means having access to all the business activities and services required to provide all the products and services needed to support differentiated supply chains, manufacturing activities and production processes.

The US sits at 1.8 ECI, due to their large technology sector; military, pharmaceuticals, space, auto and aviation, while Australia is much lower at 0.30 ECI, due to their reliance on the mining sector. New Zealand has experienced an increase in ECI since 2010, likely due to the significant increase in process primary exports and some success with newer tech companies. Between 2000 and 2010 New Zealand’s ECI ranged between 0.1 and 0.35 .

Those countries with a focus on the real economy tend to higher complexity and better, more competitive economic performance.

It also clear that the long term decline in the economic complexity is associated with those economies that have embraced the finance and real estate and offshored activity, abandoned any industrial, monetary and fiscal policy efforts that would encourages the industrial base to focus domestic efforts on challenging complex activities.

The threats associated with falling complexity?

Growth only in primary and processed primary activities concentrates risks, such growth has clear limits in terms of environmental sustainability along with the ups and downs, currently a very down period, associated with competition rich commodity markets. At the extreme end of risk to agricultural commodity products is the inevitable progress in biochemistry that threaten to supply of laboratory sourced meat and milk products.

Right now the threat agricultural commodities are persistent low prices. The future could see wholesale substitution low cost laboratory sources. Add in the decline in real terms of simple and elaborately transformed export categories our strategic weakness is clear.

What are the problems of scale?

The operating environment associated with a small economy, the absence of local scale, creates a major structural challenge for niche operators. The limited local market means that specialty firms, and their associated supply chains, must export early in their growth cycle. It is not unusual for firms employing 30 people to earn more than half their revenue from exports. As a result, significant currency risk comes early for New Zealand firms. It is worth noting that fewer than 1000 firms have export revenues more than NZ$5m.

This means that policy settings that influence the exchange rate, important to exporters in large economies, are crucial for New Zealand’s exporters. Sadly the Governments Policy Targets Agreement with the Reserve Bank of New Zealand and our tax framework act to elevate the exchange rate in the long term, and falling earnings challenge savings. The absence of capital gains tax, and the inflation targeting paradigm so ingrained that forecast inflation, that never happens, still needs to be targeted. By all means lament what happens to the currency and ever increasing house prices but never do anything that is really effective about either.

The upshot is a long run overvalued currency. Since 2004 the exchange rate has been systemically higher than the previous decade by around 13%, a wealth transfer to the domestic financial economy . This is no small difference, and represents huge pressure on real economy margins, profitability, reinvestment and competitiveness, for exporters and for those competing in the domestic market against imports made even cheaper by the currency. The knock on to employment and median wages is manifest in social outcomes. The loss of skills, capability and investment makes for ever greater recovery challenges in the future.

For an economy like New Zealand that lacks the natural resilience of scale, industrial policy is all the more vital, we have to move past the days of “just let it happen”, when large economies like the UK start to see the light in this regard there is hope. That said we need to avoid the picking winners trap, better to support winning behaviours in general. Even small economies are far too complex to pick winners but is possible to help with activity based support, for example tax credits on research and development and general tax policy that encourages investment in the real economy as opposed to real estate, and of course better management of the exchange rate.

Globalisation and New Zealand?

Putting aside the scale issues that have some specific implications. The loss of capability, the absent capacity and polarisation of earnings in New Zealand is not unique, the benefits of globalisation can be real but are diffuse. The problems are focused and clearly visible around the world, the rust belt in the USA, the North of England, those same problems are here in New Zealand. Popular sentiment has demonstrated we have not done enough to address the needs of those communities who feel the downside. More insidious is the loss of activity when new ideas are not rooted in the community that helps generate them, it is hard to measure the loss of activity that establishes and grows somewhere else.

Trickle down has failed; austerity is seen to hit those who depend on state spending. Governments fixated on surplus cutting spending and the same time as private debt burdens reduce aggregate demand translates into low growth or recession. The politics of deflation differ significantly from what we have now: private debt stunting growth and the inability to inflate away the burden of debt will need new solutions.

Where to now?

A move away from a policy framework that relies on “wealth” generated from asset rents, or more broadly the financial economy; to wealth based on providing well-paid demanding employment, supplying real things that customers value, an economy that invests in infrastructure, a real economy that works for more people will drive tomorrows politics.
Despite the experience of the last 30 years, there is a future for manufacturing, producing things that are hard to make, as demonstrated by those countries who report increasing ECI and continue to build capability. This requires a change in broad policy bias: in education, industry, science, fiscal and monetary policy all have a role to play.

i - Statistics New Zealand – InfoshareQES Survey - Full-Time Equivalent Employees by Industry (ANZSIC06) and Sex (Qrtly-Mar/Jun/Sep/Dec)
ii - Statistics New Zealand – NZ.Stat - Earnings from main wage and salary job by industry (ANZSIC2006), sex, and broad age groups (2009 onwards)
ii - Tradable Vs Non-Tradable Graph, original Source NZ Treasury, Exports by Level of Processing, Source Statistics New Zealand - http://www.nzmea.org.nz/documents/1331-manufacturing_in_new_zealand.pdf 

iii - http://atlas.cid.harvard.edu/rankings/

ECI Tables - http://www.johnwalley.co.nz/253-policy_and_prosperity.aspx - Tradable Vs Non-Tradable Graph, original Source NZ Treasury - http://www.nzmea.org.nz/documents/1331-manufacturing_in_new_zealand.pdf

v https://croakingcassandra.com/category/exchange-rate/

tags: manufacturing, exchange rate, currency, policy, debt, exports, complexity, value
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