Prime Minister John Key has said in a speech to a business breakfast hosted by Cullen Law that New Zealand is a third division and unbalanced economy with low productivity growth that risks losing its best and brightest to overseas employers. Among other things, he said New Zealand needed a world class tax system and he was looking closely at what was coming out of Australia's tax review as New Zealand's own Tax Working Group prepared its report for the end of the year. This echoed comments made to us in an interview last week by Bill English. My view The speech is well worth a read to get an idea of what the Prime Minister is thinking. I sense he and English realise they will not narrow the gap with Australia without substantial tax and public sector reform. Their own Treasury Secretary John Whitehead has laid out the types of reforms needed, including a broader, flatter tax system that somehow removes the incentive for property rather than productive investment. I think Key and English are softening up the electorate for an election debate in 2011 about substantial tax and public sector reform. They cannot and will not implement a flat tax or property tax or asset sales in this term. But they might propose it before the election after they've convinced the public, rightly, that the status quo is not enough. Your view? We welcome your comments and insights on the speech below in the comments below.
New Zealand's economic performance is vitally important. This Government wants New Zealanders to have a decent enough wage packet to have real choices in their lives, and a genuine sense of opportunity. As a nation, the income we generate enables us all to enjoy world-class public services "“ like health care and education "“ and to strengthen our national institutions. And in a mobile world, relative differences matter a lot. Skilled people will move to countries where they can earn more. Businesses will locate where conditions are favourable to them. Investors will put their money where it can get a good return. I don't want our talented young people leaving permanently for Australia, the US, Europe, or Asia, because they feel they have to go overseas to better themselves. That's why this Government is focused squarely on improving New Zealand's economic performance. And to be frank, New Zealand's economic performance over a number of years has been disappointing. We have a lot of things going for us, but in the OECD's league of developed countries our economy is now essentially a third-division economy, and our closest comparators are countries like Greece, Korea, and the Czech Republic. Even in the last decade we have slipped down a couple of places in the OECD rankings, despite "Knowledge", "Economic Transformation" and the "Growth and Innovation Framework". In recent times the New Zealand economy has flattered to deceive. Growth in our GDP has been driven by more people joining the workforce and working longer, rather than through an increase in the value of what we produce. Furthermore, our growth has been very unbalanced. It has been built on an increase in consumption, a debt-fuelled housing boom, and large increases in government spending. It has not been built on the more solid foundations of growth and investment in the internationally competitive sectors of the economy. Because of this unbalanced growth, and because of the effects of the global recession, the New Zealand economy is now more vulnerable to future economic shocks. First things first: we are currently dealing with the deepest, most synchronised global recession since the 1930s. What is more, this global slump came on top of our own home-grown recession. The Treasury predicts that over the next three years, the economy will be NZ$50 billion smaller than was expected a year ago in the 2008 Budget. The Treasury also predicts that unemployment will reach a high of eight percent. That is why much of the Government's economic attention over the last eight months has been on managing through the immediate impacts of the recession. We cannot magic away a deep recession; nor can we turn back the tide of rising unemployment. What the Government can do, however, is take the sharpest edges off the recession. That involves a careful balancing act, and we got that balance right in the Budget. The Government maintained all entitlements to income support, and increased spending on front-line public services, particularly in health, education and justice. That support for the economy has helped to maintain activity, support jobs, and give people a degree of security during tough times. At the same time, however, we put in place measures to keep government debt from skyrocketing and we avoided the very real threat of a credit downgrade, which would have pushed up interest rates and cost jobs in the longer term. As far as this recession goes we are not out of the woods yet, but the Government is keeping a careful watch on international developments and is ready to respond accordingly. What I want to focus on today, however, are our longer-term economic objectives and what we are doing to meet them. This Government has three key economic objectives, which together will result in improved and enduring economic growth. These are: increasing New Zealand's productivity growth; maintaining high levels of employment, and reducing New Zealand's vulnerability to adverse events. Increasing our productivity growth basically means getting better at producing goods and services the world wants, and getting paid more for them. At the same time we want to keep employment high, although this will always fluctuate along with the economic cycle. Reducing New Zealand's vulnerability means lessening the risk that another economic shock could severely affect our economy. We will always have better-than-average periods and worse-than-average periods "“ that is the nature of economic cycles "“ but meeting these three objectives will result in an increased long-term growth rate. And meeting these objectives depends on the fundamental strengths and weaknesses of the New Zealand economy. Let's start with our strengths. New Zealand has sound economic foundations, like low levels of corruption, an independent judiciary and strong public watchdogs, an independent central bank, highly-transparent government finances, and a flexible labour market. New Zealanders are amongst the hardest workers in the OECD. We have high rates of employment compared to other developed countries and we work relatively long hours. We have plenty of opportunities. We are closer to the emerging centres of economic growth than we have ever been. We are experts at food production, and the growing middle classes of China and India are increasingly demanding better quality food products. New Zealand has the potential to fill pantries and fridges, not just in Asia but throughout the world, with high-quality, efficiently-farmed products. We are blessed with a beautiful landscape and a unique culture that tourists want to experience. Although we remain the furthest country from world markets, ultra-fast broadband is a breakthrough technology that will give New Zealand firms the ability to reach customers far across the globe. Over the next six months I will take the message about New Zealand's strengths to the rest of the world, as I visit other countries. An important part of my job is to promote New Zealand, to help build commercial networks, and to develop a sense of where our opportunities lie with the rest of the world. But let's not ignore the weaknesses of the New Zealand economy. The most fundamental problem facing the New Zealand economy is poor productivity growth. Our productivity is already low by comparison with other developed countries, and in recent years has been growing much slower than in most other countries. A significant part of the poor productivity growth in New Zealand has been the stagnation of the tradeable sector of the economy. The tradeable sector is made up of those firms that are in competition with the rest of the world "“ that is, they either export to other countries or they compete with imports here in New Zealand. This sector includes agriculture, fisheries, manufacturing, tourism, and forestry "“ the industries that make us money in the world. The sad fact is that the tradeable sector has effectively been in recession for the last five years. During that period, output in the tradeable sector has shrunk by around 10 percent, while the non-tradeable sector of the economy "“ which has lower productivity "“ has grown by 15 percent. That constitutes highly unbalanced growth. As I mentioned earlier, we have had consumption-led growth fuelled by increasing debt and excessive government spending. There has been insufficient growth and investment in the internationally competitive sectors of the economy. We like to think of ourselves as a trading nation, yet we export less as a percentage of GDP than many other small OECD countries. And that percentage has only grown slowly over the last 30 years. Over 90% of our exports come from just under 5% of exporters, and these exports are also very concentrated in a few sectors. Because of our poor export growth, and our reliance on foreign savers to fund much of the investment in New Zealand, our current account deficit has grown unsustainably large. Over time New Zealanders have built up liabilities to foreigners of $177 billion, the vast bulk being household and business liabilities, rather than those of the Government. That total amounts to 98 percent of GDP, which is one of the highest proportions in the OECD, and constitutes a large part of New Zealand's economic vulnerability. Our challenge as a country is therefore to preserve the strengths of the New Zealand economy, while addressing its weaknesses. We need our economy to become more productive through investment in sectors that are internationally competitive. We need a business environment that enables firms to move resources to their best use. We need a public sector which is better-performing and more efficient. In short, we need to reverse the trends of recent years, and get the tradeable sector growing again. Then can we can begin to narrow the income gap with other developed countries. I cannot emphasise enough that there are no quick-fix solutions here. And we must always be conscious that New Zealand's wealth is generated by the private sector "“ by the small firms, the big companies, and the sole traders who generate the jobs, the profits, and the return on investment that drives our economy. But there are things the government can do to further our economic objectives, by providing an environment in which the private sector can thrive. The Government is working on six main policy drivers "“ these are: regulatory reform; investment in infrastructure; better public services; education and skills; innovation and business assistance, and a world-class tax system Regulatory reform The Government's first policy driver is the regulatory environment under which firms operate. Regulation helps ensure we get treated fairly, protect and manage our environment, have a competitive and efficient economy, and so on. But regulation also has its costs. As a recent ANZ publication noted: "The cost of poor regulation is investment that never takes place, jobs never created or income never earned." New Zealand needs to offer a high-quality regulatory environment if we are to overcome the economic disadvantages of our small size and geographical isolation. Other OECD countries have increased the attention they give to regulatory reform and have surpassed us in international measures of regulatory impact and competitiveness. This Government has begun to address that. We have introduced a 90 day probationary period to give smaller businesses the confidence to take on employees. We are undertaking the biggest overhaul of the Resource Management Act since its introduction in 1991. The first phase of our RMA reform programme focused on streamlining and simplifying processes under the Act. A second phase of reform is currently underway. We have repealed Labour's ban on building thermal power stations. We are changing overseas investment regulations to reduce compliance costs for minor investment applications. Bill English will detail these changes and give an update on our Overseas Investment Act review in a speech next week. We have also kicked off a programme of reviewing and reforming regulations including those in the Building Act, electricity and telecommunications rules, and the emissions trading legislation. Rodney Hide, as Minister for Regulatory Reform, has been looking out for what we call "low-hanging fruit". These are the infuriating laws that people often complain about. In an annual Regulatory Reform Bill, there will be a regular opportunity to reduce red tape and make positive changes to regulations. And together with Rodney, we are working on ways to improve the quality of new regulations, and to systematically review existing regulations. Investment in infrastructure The second policy driver is investment in productive infrastructure. A lack of investment over a number of years has resulted in infrastructure deficits that have clogged the arteries of the New Zealand economy. This Government has begun to clear out those arteries. We are investing NZ$7.5 billion over the next five years to build and upgrade schools, roads, housing, hospitals and telecommunications. We announced in February that we were fast-tracking almost NZ$500 million of this investment, and much of this is already underway. This investment is realising some immediate benefits. For example, the start date of the Victoria Park motorway project has been brought forward by a year as a result of the Government's NZ$1 billion boost to state highway spending over the next three years. Later this month, work will begin on the Kopu Bridge, and we have identified an affordable, funded option for the Waterview Connection in Auckland. We have been improving the quality of the state housing stock through a substantial upgrade programme. School building programmes have been brought forward. And we have taken the first steps towards rolling out our $1.5 billion broadband plan. We've also begun to improve the way public sector agencies manage their existing infrastructure assets and plan for future infrastructure needs. In March this year we established two bodies "“ a National Infrastructure Unit to co-ordinate the Government's infrastructure activities, and an Infrastructure Advisory Board, made up of representatives from the private sector and local government, to provide independent advice on investment priorities. These will help lift the level of capital asset management and planning across the public sector. Together they will also develop a National Infrastructure Plan by the end of the year. The challenge for New Zealand is to emerge out of recession with a better stock of infrastructure, with investment decisions better analysed and better regulated, and with the efficiency of commercial disciplines entrenched into decision-making. We are addressing that challenge. Better public services The Government's third policy driver is lifting the performance of the public sector. The wider public sector represents around a quarter of economic activity in New Zealand. Therefore the most direct thing the Government can do to improve the productivity of New Zealand economy is to get its own house in order. The previous government spent a lot of money on the public service without a corresponding increase in actual services to the public. This Government is committed to improving the quality of public spending, by delivering better, smarter services within a limited increase in funding. Our first move was to put a cap on the number of core government administration staff. And our ongoing focus will continue to be on shifting more resources to front line services. We made a good start in this year's Budget. We identified a total of more than $2 billion in spending over the next four years that either did not accord with our priorities, or that had a relatively low value. That money was used to fund other, more valuable, initiatives, including boosting frontline health and education services. That is only a start, however, and we need to make enduring and significant changes in the public sector to improve its performance. This drive for change has been given added impetus by our decision to reduce the allowance for new operating spending in future budgets to a maximum of $1.1 billion. To put that in perspective, that is less than half the new operating spending over the last five Budgets. The expectations of New Zealanders of their public services are rightly high. The restraint I'm talking about is permanent. So delivering better, smarter services with smaller increases will be an ongoing challenge. Looking ahead to Budget 2010, public sector chief executives and Crown entity boards are working with Ministers to find further savings and drive improved performance. I have tasked my Ministers with getting the best possible value out of every taxpayer's dollar. Education and skills The fourth policy driver is education and skills. We are focused on literacy and numeracy at the primary school level, driven by National Standards. National Standards will set clear expectations about what children should have learned at each stage of schooling. Schools will assess students against those standards and convey that information to parents in plain English. National Standards will be in place for Years 1 to 8 at the start of the 2010 school year. The Government wants to introduce National Standards constructively, in a cooperative spirit. We want them to be an aid to better teaching and learning rather than a cause of resentment in the sector. But there should be no doubt about the Government's commitment to National Standards. Parents want them, this Government is going to deliver them, and I am backing the Minister of Education 100 percent. Our second focus is on options for secondary-age students outside the traditional school system. The Ministry of Education has received a number of proposals for Trades Academies, and is looking to get these underway as soon as they can. Trades Academies, based in schools, will give young people wider choices in education and the ability to gain practical, hands-on vocational skills while still at school. The Government is also ensuring that there are options for students outside of the school system. Our Youth Guarantee will focus on 16 and 17 year olds and will allow them to study towards school level qualifications at a polytech, institute of technology, wananga, or private training establishment. We will soon be announcing details of a staged roll-out of the Youth Guarantee, beginning from next year. Innovation and business assistance The Government's fifth policy driver is the investment that both government and business make in research and development, in innovation, and in developing new markets and products. Broadly speaking, the Government's investment in this area, which is considerable, should contribute to either of two goals: helping firms connect with overseas markets, businesses and consumers; helping firms access, or develop, new ideas to create new and higher value products and services. Those two goals will help drive productivity growth and investment in the tradeable sector, and improve our export performance. New Zealand firms that wish to export or operate internationally face twin challenges of distance and size. To help overcome these disadvantages, our trade assistance for exporters needs to be world class. The Government is determined to ensure that our overseas presence helps pursue our wider economic objectives. We are working on ways to best deliver an "NZ Inc" approach on the part of all Government agencies operating offshore. A seamless network amongst these agencies will best support our trade and economic interests overseas, with Government working alongside New Zealand exporters. At a more general level, we are pushing ahead with our efforts to secure free trade agreements, particularly in Asia, alongside our commitment to a multilateral trade agenda. Despite what some people in the Opposition might say, I'll be disappointed if Tim Groser doesn't have a large travel bill in this parliamentary term, because that shows me he is doing his utmost for New Zealand's trade. In terms of innovation, our emphasis is on promoting a stronger interactive relationship between the business sector and our publicly-funded research institutions. Universities and Crown Research Institutes need to be more responsive to the needs of firms. Our innovation system also needs to encourage firms to increase their take-up and application of research. One of our first initiatives in this area has been the Primary Growth Partnership. This will invest in significant research and innovation programmes across the primary and food sectors. When fully up and running, it will see the Government investing $70 million annually in primary sector innovation, matched dollar-for-dollar by industry. Because it is a partnership between the sector and publicly-funded research institutions, the research will be more relevant, take-up will be greater, and it will be more effective. A world-class tax system The final policy driver is the tax system. The primary function of the tax system, not surprisingly, is to collect revenue. In the current environment, when we are facing a decade of budget deficits, we need to make sure we can fund the Government's activities in a sustainable way. But the tax system is also important because it changes the way people behave in the economy. People do things because of the way the tax system is structured, not necessarily because those things represent the most productive use of resources. So we have to ensure that New Zealand maintains a world-class tax system that doesn't get in the way of people working hard, saving, and investing in productive enterprises. This Government has already reduced personal tax rates for a great many taxpayers, in a tax cut package worth $1 billion a year. We have also introduced a $500 million tax assistance package that makes it easier and less expensive for small and medium enterprises to pay their taxes. Together with Victoria University, we have established a Tax Working Group to consider the medium-term tax policy challenges facing New Zealand. The Working Group will be chaired by Professor Bob Buckle and will report at the end of the year. The Government considers that a strategic review of the tax system is very timely at this stage "“ particularly in light of the challenges posed by the current economic and fiscal environment and by our medium-term goal of a 30 percent top personal tax rate. And since our overriding aim is to be competitive with other countries, we can't consider our tax system in isolation. In particular, the Government will be watching closely what comes out of Henry Review of taxation in Australia, which is due to report back at the end of this year. Conclusion The Government has a comprehensive plan, not just for managing through the current recession, but also for improving the fundamentals of the New Zealand economy. The six policy drivers I have outlined will help to create an environment that allows businesses to thrive. I am going to push my Ministers to get as much done as they can, as quickly as they can, inside these policy drivers. But the government cannot itself create prosperity. In the end, New Zealand's economic prosperity relies on the hard work and inventiveness of our businesses and their employees. That's who we have to back. That's the only way we will lift our economic performance.