Matt Nolan says our small size and export reliance on homogenous goods actually makes us resilient to global economic shocks

Matt Nolan says our small size and export reliance on homogenous goods actually makes us resilient to global economic shocks
Small perhaps, but an out-performer and resilient, says Matt Nolan

By Matthew Nolan*

New Zealand is a small country.

As the Global Financial Crisis has shown, the whims, fancies, and mistakes of the large economies in our globalised world have a significant impact on New Zealand.

However, as New Zealand has outperformed most of the world over recent years, and looks set to keep outperforming, I have learnt that it can be good to be small !

The benefits of specialisation

Focusing on what we are relatively good at, instead of trying to do everything, is a simple principle that holds at every level of human interaction.

In economics, and when talking about international trade, this idea is called comparative advantage.

This implies that by focusing on what we are relatively good at, we can trade and expand the number and type of goods and services available to us – relative to autarky (a situation of self-sufficiency).

But this is not just a story of the benefits of New Zealand specialising – in fact we want other countries to specialise as well.

According to theory, data, and the practice of recent decades the massive productivity improvements in China have been a massive boon to the living standards and incomes of New Zealanders as well as for the Chinese themselves.

I know that this doesn’t get mentioned nearly as much as it should, but the massive improvement in productivity and lower costs associated with production in China has made incredibly cheap manufactured goods available to New Zealanders.

New Zealanders haven’t had to sell as much in terms of tourism services, milk, meat, wool, and IT services in order to buy televisions, computers, vacuum cleaners and cars.

Having China develop its own economy and concentrate on its areas of comparative advantage is not a bad thing for New Zealand – it is a great thing for us !

Diversifying risk by diversifying markets

Now these benefits from specialisation might seem sort of obvious, and the crisis did nothing to make them seem any more apparent.

If anything, they highlighted the risk to New Zealand from having a set of businesses and households that were too dependent on certain kinds of production – namely the concern that as a society we are in some way not diversified.  My colleague touched on the idea of diversification here.

This issue becomes even more important when we start to think of the growing integration of supply chains across countries, and the fact that specialisation involves products becoming more and more heterogeneous (different).

But this is actually where New Zealand is in an amazingly strong position rather than a weak one.

With fertile land, excellent knowledge and technology, and a sparse population, New Zealand is relatively good at making food.  54% of New Zealand’s merchandise exports are in food and animal exports.  And yet, New Zealand’s production of food and related products accounts for only the tiniest sliver of total world production.

Milk, meat, wool, no matter how much we talk about our great produce these products are relatively “homogenous” (similar).

In that context when one country decides they really don’t want to buy any more, exporters can more easily switch where they sell these products somewhere else – compared to firms that sell speciality computer chips, or other manufactured parts. 

One of the recent examples of this was the rapid shift in dairy product sales to Venezuela.  The fact dairy exports to Venezuela slumped 56% in the past year has been in the news recently.

However, what the news stories forgot to point out is that dairy exports to Venezuela are incredibly volatile – doubling and halving on a regular basis.  Dairy exporters are able to look around the world, including Venezuela, and trade on the basis of market conditions in these countries – selling to the places which are willing to offer the most attractive price for dairy produce.

The fact that New Zealand exporters, and our nation’s comparative advantage, tends to be in a product that can be quickly shifted and sold in different countries helps these exporters deal with the risk associated with a slowdown or shift in demand in an individual country.

This wasn’t always the case – while the products were similar, New Zealand used to rely strongly on sales to Britain until they entered the European Economic Community.  The fact that New Zealand has been able to quickly shift its sales of commodities and products between nations in the face of a massive global economic slump has shown how much our primary product producers have matured and learnt to take advantage of this homogeneity over recent decades.

New Zealand’s small size and exporters reliance on homogenous goods actually makes the country relatively resilient to global economic shocks – an important point to keep in mind when demanding that the government interfere to “restructure” or “rebalance” the economy.

Terms of trade and insurance

While what I have discussed a lot of benefits from being a small trading nation, some that are too often glossed over, I would be remiss to ignore potential costs. The intuition that being small and exposed comes with risks is true.

These risks can be seen as akin to an issue that has been discussed widely by economists in the past with regards to New Zealand’s rising terms of trade, the issue of “Dutch Disease”. This focuses on the impact on the economy from a rise, then fall, in commodity prices.

I’ll be honest that I do not like the name, in truth this is the “Dutch Issue” – disease suggests only costs, while issue indicates to us that we are facing a situation with winners and losers, risk and reward, and given that we should be trying to understand what these risks are to see if we can somehow insure against them at a reasonable cost.

It is evidently not true that a jump in the price New Zealander’s are receiving for exports is a bad thing – the data does not suggest that the “Dutch Issue” hits growth (further explanation here), the assumed costs in terms of misallocated investment presumes that government knows how and where to invest better than the firms investing (dubious at best), and even a temporary lift in prices will be an income boon to those inside New Zealand who are exposed to it.

There are two policy relevant ways to think about how a resource boom impacts upon the economy:

1. Distributional (explained in terms of question here): 
The increase in the price of certain commodities (say milk) also leads to a shift in wealth within the country, from those endowed with milk (and those who work with them) and away from those who compete with milk in some way (eg milk consumers). 

2. Variability and risk
Given the size and scale of dairy exports as a proportion of our economy, sudden shifts in dairy prices have a sizable impact on economic outcomes.  Given that these shifts are unforeseeable, monetary and fiscal policy in of themselves may not be able to react sufficiently – the fact we know there is risk combined with a view that this risk is not being taken into account provides scope for social insurance.

Norway is one country that has responded on the basis of this type of issue – leading to the introduction of the Norwegian oil fund.  In this way the choice of the Norwegian government can be seen as a form of social insurance, and if we think that people within society are unable to insure themselves then this can be seen as a self-evidently good thing.

Note that the Australian superannuation fund, and Cullen fund in New Zealand, have also been justified on this basis even if they were not the main reasons given – and they were not funded in a way that is fully consistent with this idea.

A key point to keep in mind if we do want to think about terms of trade movements in this way is that it requires that individuals in society are, for some reason, unable to insure themselves against the risk associated with price variability.  If we cannot make this argument, then the concern about variability and risk also melts away – as it becomes the choice of the individuals involved.

All in all this implies that, being small is grand – as a nation we just need to be honest about what being small means, and the risks that do exist.

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Matt Nolan is a senior economist at Infometrics. You can contact him here »

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Matt,
It's good always to cover the conomic principles of where we are, and while I would support your prime thesis (that being good at making food, and in particularly dairy, is a good thing), and that buying other products off global specialists like China is also a good thing, but I would still challenge a couple of your other points.
My understanding of  Dutch Disease is broader than just the rise and fall of commodity prices- so managing in our case for dairy prices to drop materially at some stage- but relates to the crowding out by the success of dairy of other trading industries subject to global pricing in some way.
Like you I would not try and counter this by blocking dairy in any way (apart from managing possible environmental risks), nor in the government generally trying to pick winners (other than some support for plausible start ups, or trade facilitation, as I believe they do now).  
Where your article is silent, and where I would strongly advocate some government action, either through the Reserve Bank or Treasury management, is in concentrating on the current account, and in particular on the exchange rate. If and when the current account is in balance, or even the shock and horror of a small surplus for a change, then the economy would seem to me well enough balanced.
You rightly enough champion Norway which has a current account surplus of 13% of GDP. NZ, despite the best terms of trade for fifty years?, has a deficit of 5%. So in my view the government should be either controlling capital flows in such that the exchange rate is correctly positioned, or failing that, matching the Norwegians in investing out to match, with the same exchange rate effect. At the very least the government should not be exacerbating the problem itself by selling assets offshore, or borrowing offshore.
Then with a correctly positioned exchange rate, let the market decide the winners with the comparative advantage.

I agree. Matt ignores the finance issues. I suppose that's what economists are trained to do. We have Dutch Disease, the crowding out of productive industry, but it is crowded out by the finance sector. The finance sector is too large - too many bankers, economists, real estate agents, life insurance salesmen, the list goes on. This is why the current account is negative - we spend more than we earn on financial services - interest and insurance and fees and legal costs.

Stephen,
What both you and the author neglect to take into account is the role that governments have played in facilitating the "comparative advantage" enjoyed by the dairy industry in New Zealand and manufacturing in China. Without the publicly funded infrastructed which has been built over the years by the New Zealand government, the dairy processing industry wouldn't have gained the economies of scale which enables Fonterra of  being one of the leading producers and traders of milk products in the world. After all Fonterra is essentially a creation of the government being an amalgamation between the old Dairy Board and two of the largest dairy processing cooperatives, which arguably wouldn't exist without government provided infrastructure. 
 
And China has a neo-mercantalist policy regime that has encouraged export oriented growth and has facilited this by favoring development in the coastal regions which have access to South East Asian trade routes over rural regions . This state of affairs have caused an economic imbalance which ensures that the interior and northwestern provinces lag far behind the coastal industrial regions in terms of spending power and job opportunities, which grants the manufacturing industries access to an abundant supply of cheap migrant labour. They also provided numerous inducements to foreign direct investment, subsidised infrastructure, cheap credit, energy subsidies etc to facilitate international trade. 
 
http://newleftreview.org/II/60/ho-fung-hung-america-s-head-servant
 
 

Excellent article.  One thing we are good at is indeed food.
We can also think about some of the other excellent industries we have and some we have lost.
Look at Scott Technology.  It's great for New Zealand and New Zealanders for every reason.  No real reason for it to be where it is, or indeed be in New Zealand.  It's here because it started here and largely owned and managed here.  But if ownership changed then we should worry that it will move. We need to pay a lot of attention I believe to maintaining ownership locally within the country.
TV documentary maker Natural History.  Another excellent outfit.  But owned in recent years by Fox and laterly from Australia.  Great for us and to ensure it remains so, some attention to regaining local ownership would be useful.
From the 19th centrury Mr McSkimming made toilet bowls in Balclutha.  A series of ownership changes led manufacturing from Balclutha to Dunedin to Auckland to Australia and I have now lost track. I don't agree with the cost of manufacturing cause.
Look at the excellent, and cheap tech items made in Italy, a high income country.  Because the companies are usually family owned. 
We need to think local ownership.   Including for farms actually.    

I think that a part of what gave us resiliance during the last economic/ financial shock was the fact that we had high interest rates...   and we had very low levels of Govt debt.
In 2007 the OCR was 8.25%..
The drop to 2.5% ...leading to much lower lending rates has had a Profound effect in regards to our so called resiliance.  ( ie. our capacity to borrow ...leading to GDP growth )
Govt debt is now about $70 billion...  from $30 billion in 2008
these 2 shock absorbers are now deplenished ....and  the next time we have a shock we might  see just how resiliant we are, in regards to the  "real economy".
The above are all "financial" points of view ....which just goes to show how pervasive and dominant the financial sector is in our small economy.... how reliant we are on debt.
Our Current acct deficit will never go away....