Here are some charts and commentary from the BNZ which are particularly useful for New Zealand Trade and the potential growth of the agricultural sector.
NZ’s most significant exports to China are dairy products (39% of total), forestry (24%), tourism (12%), and meat (10%). With the possible exception of forestry, all of these sectors stand to benefit from ongoing urbanisation in China, the continued rise of the middle class, and rising household income and consumption levels. Not only is Chinese demand expected to strengthen further, but domestic production in many cases will fall well short of consumption. Exports from NZ will have a big opportunity in helping make up the shortfall.
Chinese protein demand soaring
There is a strong and well proven link between rising incomes and changes in diet (see chart below). The gradual westernisation of the Chinese diet has seen per- capita consumption of protein soar over the past decade or so. In contrast, per capita consumption of traditional foods such as rice is in decline.
Urbanisation has further stepped up Chinese demand for protein. Compared with the less diversified diets of rural communities, city dwellers have a varied diet richer in animal proteins and fats, and characterised by higher consumption of meat, poultry, milk and other dairy products.
Data from the Chinese National Bureau of Statistics shows per capita consumption of dairy products (excluding butter) has climbed from 7kg/person in 1992 to 20kg/person in 2012. Meat consumption has risen from 13kg/person to 23kg/person over the same period.
Per capita protein consumption for urban households is roughly three times that of rural households.
The BNZ Markets Outlook reported an annualised increase in net immigration by 33,000 the highest since 2003. The boost mainly comes from the fall in migrant departures. This will impact on aggregate demand and the RBNZ have talked in monetary policy statements about increases in potential growth (like the housing market) and the impact it will have on a tightening of monetary policy later next year – remember also the Christchurch rebuild.
It is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question.
Indicators that you might want to mention are below. Notice how low global interest rates are as economic conditions have warranted greater borrowing and spending in the world economy.
The New Zealand Economy
New Zealand’s GDP expanded by 0.2 percent in the June quarter. The result was consistent with consensus forecasts, although some forecasters were expecting a decline in economic activity (due to the flow-on effects of the drought experienced earlier in the year). On an annual average basis the economy expanded by 2.7 percent over the year to the June quarter. The current account deficit totaled $9,099 million in the year ended 30 June 2013, equivalent to 4.3 percent of gross domestic product. Strong economic growth has been forecast for the second half of 2013 as the economy recovers from the drought conditions experienced earlier in the year. The annual rate of inflation is forecast to rise from its current low level back within the Reserve Bank’s medium term inflation target band of 1 – 3 percent over the coming year. The Bank is expected to commence tightening monetary policy (increase interest rates) next year as a result.
The Global Economy
The global economy continues to at very low levels. However most of the economies of the European Union remain in recession (two consecutive quarters of negative GDP). US growth has increased to 2.5% which indicates that the job market is now picking up and demand is more prevalent. Even considering the recent issue with the debt ceiling the US dollar (what is seen as the world reserve currency) has remained relatively stable – in fact it strengthened after agreement was made in Congress.
However the major emerging markets face slower growth and will take longer to come out of the downward cycle. Meanwhile, global financial markets have faced considerable volatility, owing to prospective changes in US monetary policy, a new policy in Japan, and instability in China’s banking system.
Bayleys Real Estate Country magazine included an article on the outlook for New Zealand’s agricultural sector which was written by NZX Agrifax.
With regard to the Dairy Industry the effect of the drought in the latter part of 2012/13 season slowed production. This was also the case with other countries as the domestic market seems to have absorbed their output. So this lack of supply combined with a steady growth on demand has resulted in high dairy prices for a sustained period of time. With prices remaining high there is now the chance that milk production will increase especially in the US where their elasticity of supply of milk is fairly elastic. New Zealand is forecast to have a good milk production season as pastures have recovered from the drought. See graph below for forecasted milk prices.
The recovery in lamb prices has mainly been down to the increasing demand from the Chinese market. During the first 10 months of the season, over 80,000 tonnes of lamb was exported there which accounts for 29% of NZ’s total lamb exports. That’s up from 44,000 tonnes over the same period last year. There has been in particular an increase in demand for higher value items such as legs and shoulders. This led to an increase in price as supplies to traditional markets was now reduced.
New Zealand households have gone through a period of deleveraging since the GFC in 2007 in which borrowing against the house has dropped significantly. Consequently household savings has gone up. However the increase in household debt from 2000 to 2007 was rapid and is forecast to increase further especially with house price inflation on the rise. But this house inflation doesn’t correlate to the economic conditions of the country and RBNZ Governor can be justified in saying that house prices are over-valued. Graph below from the BNZ Economy Watch.
Here is some introductory information and another image from the book Inequality: A New Zealand Crisis by Max Rashbrooke.
* New Zealand now has the widest income gaps since detailed records began in the early 1980s.
* From the mid-1980s to the mid-2000s, the gap between the rich and the rest has widened faster in New Zealand than in any other developed country.
* The average household in the top 10 per cent of New Zealand has nine times the income of one in the bottom 10 per cent.
* The top 1 per cent of adults own 16 per cent of the country’s total wealth, while the bottom half put together have just over 5 per cent.
- 35% of New Zealand’s GDP was generated in the Auckland region – see graph below
- 14.2% was generated by Wellington
- 78% of GDP was generated by the North Island
- Taranaki had the highest GDP per person – $73,223 – forestry, fishing, mining, electricity, gas, water and waste services industry contributes almost 41% towards the Taranaki region’s economy, versus 6.7% nationally
- Wellington region ($55,791 per person), and the Auckland region ($45,709 per person)
- The lowest GDP per person was in Gisborne region – $30,450 per person. National average – $43,660 per person
A move by the European Union to slash subsidies to farmers isn’t as big a deal as it sounds. The EU has announced cut to the subsidies it pays industrial scale farmers of up to 30% – this is part of the Common Agricultural Policy (CAP) which costs the EU tax payers 50bn a year and is 40% of the whole EU budget. This will be of little benefit to NZ farmers as they will still be denied access through tariffs and quotas on sheep, butter, cheese etc.
Objectives of CAP
At the outset of the EU, one of the main objectives was the system of intervention in agricultural markets and protection of the farming sector has been known as the common agricultural policy – CAP. The CAP was established under Article Thirty Nine of the Treaty of Rome, and its objectives – the justification for the CAP – are as follows:
1. Raise and maintain farm incomes, through the establishment of high prices for food. Such prices are often in excess of the free market equilibrium. This necessarily means support buying of surpluses and raising tariffs on cheaper imported food to give domestic preference.
2. To reduce the wide flutuations that often occur in the price of agriculutural products due to uncertain supplies.
3. To increase the mobility of resources in farming and to increase the efficiency of all units. To reduce the number of farms and farmers especially in monoculturalistic agriculture.
4. To stimulate increased production to achieve European self sufficiency to satisfy the consumption of food from our own resources.
5. To protect consumers from violent price changes and to guarantee a wide choice in the shop, without shortages.
CAP Intervention Price
An intervention price is the price at which the CAP would be ready to come into the market and to buy the surpluses, thus preventing the price from falling below the intervention price. This is illustrated below in Figure 1. Here the European supply of lamb drives the price down to the equilibrium 0Pfm – the free market price, where supply and demand curves intersect and quantity demanded and quantity supplied equal 0Qm. However, the intervention price (0Pint) is located above the equilibrium and it has the following effects:
1. It encourages an increase in European production. Consequently, output is raised to 0Qs1.
2. At intervention price, there is a production surplus equal to the horizontal distance AB which is the excess of supply above demand at the intervention price.
3. In buying the surplus, the intervention agency incurs costs equal to the area ABCD. It will then incur the cost of storing the surplus or of destroying it.
4. There is a contraction in domestic consumption to 0Qd1
Consumers pay a higher price to the extent that the intervention price exceeds the notional free market price.
The increase in farmers’ incomes following intervention is shown also: as has been noted, one of the objectives of price support policy is to raise farmers’ incomes. The shaded area EBCFG indicates the increase in the incomes of the suppliers of lamb.
Throughout most of its four decades of existence, the CAP has had a very poor public relations image. It is extremely unpopular among consumers, and on a number of occasions it has all but bankrupted the EU.
A new book entitled Inequality: A New Zealand Crisis by Max Rashbrooke was recently launched and it traces New Zealand from being one of the most equal to unequal societies. Since 1982 real GDP has grown by about 35% but about 50% of that extra income has been acquired by the top 10% of income earners – their average incomes increased from $56,300 to $100,200. The lowest 10% of earners saw their incomes grow from $9,700 to $11,000 – see graph – Source Inequality: A New Zealand Crisis. The lost share of the national income with the lower income groups is indicative of economic conditions in the early 1990‘s and the 1991 Employment Contracts Act which acted as a catalyst to the loss of union power. The top 1% earn approximately 18% of New Zealand’s net wealth whilst the bottom 50% earn approximately 5% – see graph below for distribution of income – Source Inequality: A New Zealand Crisis
Rashbrooke does mention a quote of the late Margaret Thatcher in which she said that “It is our job to glory in inequality and to see that talents and abilities are given vent and expression for the benefit of us all.” However in the long run it is how much inequality that we feel is acceptable. According to New Zealander Robert Wade (LSE) inequality in the US caused the GFC and that after a certain level of inequality the economy enters into a bubble phase. As bank balances become greater they take more risks and lend to consumers who realistically cannot afford a mortgage but like to feel that they are catching up with the higher income groups. Ultimately it is about power and you only have to look at the lobby groups in the US to see the influence that they have over policy. In order to have a more equal society there must be a policy of integration and all citizens must have a pathway to follow whether this is access to education, healthcare and social assistance.
Here is a quote from Development Economist – Hernando De Soto from the PBS series ‘Commanding Heights’.
Oliver Twist has come to town, and he’s poor, and he’s got a TV set, and he’s able to see how you live as compared to how he lives, and he’s going to get very angry. So either you show him a capitalist route to do it and integrate him, or he’s going to find another ideology. And the fact that today there is no more Kremlin that is organizing a revolt doesn’t mean that they’re not going to find another capital, because when these things happen, when people are unhappy and rebel against a system, they’ll find another locus of power very, very quickly.
Lower interest rates has a positive effect on debt servicing costs. As a % of exports foreign debt servicing has fallen from 20.8% in 2007 to 10.6% at the start of 2013. However there is concern about the longer term effects of lower interest rates and the impact it will have on the housing market in NZ. If the CPI is pushes up towards the 3% the RBNZ may be forced to increase interest rates which influences the strength of the NZD and debt servicing. Furthermore, because net debt continues to increase indefinitely in the historic trends scenario, financing costs also increase exponentially. Below are graphs showing NZ’s debt servicing costs and explaining the debt spiral.
Brian Gaynor in the NZ Herald recently stated why there could be a sustained period of low inflation. He came up with the following reasons. You will notice that most refer to the supply curve shifting to the right. The last one relates to a reduction in demand.
• Labour-saving technologies have reduced costs.
• Union militancy has dissipated, particularly as far as wage increases are concerned.
• There has been a massive increase in the production of goods and services and this has led to some oversupply.
• More competitive marketplaces have made it difficult for suppliers to raise prices.
• The mass production of cheap consumer goods in China and other Asian countries has kept a lid on prices.
• Technological advances have seen the price of some products, particularly telecommunications and electronics, drop sharply.
• A significant reduction in import duties and tariffs has created more import competition and put pressure on high-cost domestic producers.
• Strong currencies, particularly the New Zealand and Australian dollars, have also helped put downwards pressure on prices.
• Better price discovery, mainly through the internet, has enabled consumers to identify the cheapest products.
• High house prices in New Zealand have meant that a high percentage of income is committed to meeting interest payments instead of being available for consumption.
On New Zealand’s TVONE last night the current affairs programme “Sunday” ran a segment on the booming property market in Auckland. There were some interesting interviews with real estate people plus economists – namely BNZ Chief Economist Tony Alexander and New Zealand Institute of Economic Research (NZIER) Principal Economist Shamubeel Eaqub. The economists were a lot more rational in their thoughts as to buying a house – for example:
* Have you actually done the sums?
* Can you afford to repay the mortgage if there is a 3% interest rate increase?
* We could see a US style housing collapse.
* Auctions are a good example of buying on emotion with all the hype.
Loads of behavioural economics in the programme. You should be able to see the following:
Herding – People tend to follow the herd, especially information is uncertain, incomplete, and asymmetric (some people are more informed than others).
Relative Positioning – is a concern people have regarding their own economic and social status relative to other people.
Overconfidence – is a belief, fed by emotions, that you can predict movements better than you actually can. When you’re overconfident, you’re not as smart as you think you are.
Institutional Failure – Investment decisions that can be bad for society but good for the individual can be a product of the institutional environment. If decision makers face little or no downside risk when making very risky decisions, they’ll take those risks.
Here is the link to the programme – “Sunday – Going, Going, Going”
The BNZ publish a report entitled “NZ at a Glance” which summarises the current state of the NZ economy. Here are some of the main points:
GDP – Construction is the main driver of growth over the next couple of years – mainly residential. Net exports is likely to take a hit as import penetration starts to build with as the economy recovers. GDP is forecast to increase to 3.6% in 2014 from 2.9% in 2013.
Unemployment – the current rate is 6.2% and the labour market is tightening with the increase in economic activity. Forecast to fall to 5.2% by March 2015. Tighter labour market will mean higher wage growth but also because of higher inflationary expectations as the economy recovers.
Inflation - quite subdued and the annual rate has been 1% or less over the last four quarters. A strong NZD, weakening commodity prices and low inflation globally are conspiring to offset domestic-demand driven price increases. Low inflation also becomes self-fulfilling to the extent that it moderates inflation expectations and price-setting behaviour elsewhere.
Current Account - The current account deficit appears to be stabilising in a 4.0% to 5.0% of GDP range. This is thanks largely to a resurgence in the commodity prices of the goods that New Zealand exports. This is a welcome development to the extent that it may appease nervous rating agencies for a year or so.
The New Zealand economic expansion is gaining in momentum. The rebuild of Christchurch is now building up a head of steam and this is supporting increasingly widespread confidence. Very low interest rates and a booming housing market are playing their part too. Eventually this will necessitate a response from the central bank but while annual inflation remains below 1.0% (and set to stay there for a while) it suggests that any such response might be some time in coming. Meanwhile, the NZD remains supported by money printing elsewhere and the relative strength of the economy here.
In the year ended March 2013, New Zealand’s merchandise exports totalled $46,182 million. The breakdown is as follows:
Australia $9,738 million
China $7,414 million
USA $4,338 million
Japan $3,143 million
Exports to the top ten destination countries accounted for approximately two-thirds of New Zealand’s merchandise exports by value. See chart below for percentages. With regard to the composition of exports the breakdown is as follows:
Milk power, butter and cheese products are $11,434 million
Meat and edible offal $5,287 million
Logs, wood, and wood articles $3,274 million
Crude oil $1,767 million
The top ten export commodities accounted for 64 percent of export value in the March 2013 year. With regard what destination it was sent from we can see the following:
34% of are sent from the Port of Tauranga
11% exported from the Ports of Auckland and Lyttleton Port
10% exported from Auckland International Airport
In theory, an advantage of a floating exchange rate is that it will automatically correct any tendency for the balance of payments to move into surplus or deficit. The following sequence of events shows how this automatic correction is supposed to work.
• Assume the NZ balance of payments is initially in equilibrium.
• Assume now that export values remain unchanged, but an increased demand for $ tends to move the NZ B of P into a deficit.
• This increased demand for imports will increase the supply of dollars in the foreign exchange market.
• The external value of the dollar will fall and this will make exports cheaper and imports dearer.
• The changes in the relative prices of exports and imports will increase the volume of exports and reduce the volume of imports and the B of P will be brought back into equilibrium.
In practice it may not work out like this because the supplies of exports and imports may be slow to adjust to the price changes. For example, if the prices of exports fall, it may take considerable time before the increased quantities demanded can be supplied. There are also problems associated with the elasticities of demand for exports and imports. A 10% fall in the prices of exports will not increase the amount of foreign currency earned unless the quantities demanded increase by more than 10%. A further problem is that a depreciation of the pound increases import prices and, since New Zealand imports a large amount of raw materials and manufactures, this has the effect of raising the cost of living and the costs of production in many industries.
A disadvantage of the system of floating exchange rates is the fact that greatly increases the risks and uncertainties in international trade.
For example, an Auckland manufacturer of cotton cloth may be quoted a firm US$ price by his American supplier, payment due, say, in 3 months. He will still not be certain of the costs of his cotton because he does not know what the US$-NZ$ exchange rate will be when he comes to make payment.
If he is quoted US$500 for a bale of cotton and the exchange rate stands at:
NZ$1 = US$0.56, a bale of cotton will cost him NZ$892.86.
If, however, by the time he comes to make payment, the exchange rate has moved to:
NZ$1 = US$0.53, a bale of cotton will cost him NZ$943.40.
Speculators remove some of this uncertainty by operating a forward exchange market where they guarantee to supply foreign currency at some future date at a price agreed now.
A perfectly free market in foreign currency is not likely to be found in the real world. Even when currencies are said to be floating, governments tend to intervene in the market to smooth out undesirable fluctuations. The central bank (Reserve Bank in NZ) is responsible for this type of intervention and the way it operates is explained in the next section.
Advantages of a Strong Dollar
• A high NZ$ leads to lower import prices – this boosts the real living standards of consumers at least in the short run – for example an increase in the real purchasing power of NZ residents when traveling overseas
• When the NZ$ is strong, it is cheaper to import raw materials, components and capital inputs – good news for businesses that rely on imported components or who are wishing to increase their investment of new technology from overseas countries. A fall in import prices has the effect of causing an outward shift in the short run aggregate supply curve
• A strong exchange rate helps to control inflation because domestic producers face stiffer international competition from cheaper imports and will look to cut their costs accordingly. Cheaper prices of imported foodstuffs and beverages will also have a negative effect on the rate of consumer price inflation.
Disadvantages of a Strong Dollar
• Cheaper imports leads to rising import penetration and a larger trade deficit e.g. the increasing deficit in goods in the NZ balance of payments in 2011
• Exporters lose price competitiveness and market share – this can damage profits and employment in some sectors. Manufacturing industry suffered a steep recession in 2011 partly because of the continued strength of the NZ$, leading to many job losses and a sharp contraction in real capital investment spending and the lowest profit margins in manufacturing industry for over a decade
• If exports fall, this has a negative impact on economic growth. Some regions of the economy are affected by this more than others. The rural areas are affected by a strong dollar in that our produce becomes more expensive to overseas buyers.
Here is a graph from the BNZ which paints a rosy picture for the NZ economy – looking at a 3% increase in GDP this year followed by 3.7% in 2014. Investment is probably the reason for the forecasted growth – with the construction industry especially in Christchurch. However trade will most likely be subdued as demand for imports has been on the increase at the same time the dry summer has affected primary exports. Nevertheless by international standards New Zealand is in reasonably good shape when you consider the problems in Europe and the USA.
I picked some interesting statistics from Reserve Bank Governor Graeme Wheeler’s recent talk to the NZ Manufacturers and Exporters Association.
Importance of manufacturing
* share of global GDP fell from 27% in 1970 to 16% in 2010.
* USA 26% in 1970 – 9% in 2008
* Manufacturing employment 62m in 2000 as compared to 45m in 2010
Reasons for the above:
* Global transfer of capital, investment, and technologies
* Competition from Developing Economies – export processing zones with lower taxes and cheap labour.
This trend of relative decline has been common despite differences in economic structures, size and geography, commodity endowments, and exchange rate arrangements and behaviour. For example, since 2000 the real effective exchange rate of the United States has depreciated by 14 percent and manufacturing employment fell by 31 percent.
In New Zealand manufacturing’s share of GDP has trended down:
1980’s = 25%
2012 = 12%
2013 has seen the primary sector of New Zealand continuing at a dual speed. On the one hand dairy and beef prices are up, but sheep and wools prices are making it a real struggle for those farmers. The weather hasn’t helped matters and the North Island is currently very dry but for those in the South Island there has been enough moisture in the soil to maintain reasonable grass growth which ultimately keeps farmers happy.
Dairy Farmers have coped well with the mixed weather and the discovery of DCD in milk. Milk powder has increased in price by 9.8%. With the REINZ farm price index showed farm prices fell 14% from January to August 2012 Fonterra had initially forecast a substantially lower payout for the new season. However interest in farm conversions is still strong.
Sheep Farmers haven’t done as well. World lamb prices have been downward mainly because of the increase in lamb exports from Australia – increase in supply. Like New Zealand, Australia is predominately pasture-based and less affected by higher feed costs. Furthermore favourable seasonal conditions in Australia has resulted in extra stocking and it is estimated that lamb production will increase by 15% in 2013.
You may have heard Stephen Topliss of the BNZ in the media this morning talking about the inconsistent employment data that was recently published. In 2012 30,00 people lost their jobs and there was drop in the number of participants in the labour force by 48,000 as people gave up looking for work – see diagram below for Composition of Labour Force. There are some conflicting pieces of data:
1. The unemployment rate fell from 7.3% to 6.9% over the last quarter but this most probably is due to the fact that the participation rate has fallen.
2. The number of people employed fell by 1.4% for 2012 but the Quarterly Employment Survey suggests that employment grew by around 1.5% over the last year.
3. Business intentions and actions are inconsistent – survey indicate that they expect to hire more labour but ultimately they don’t
4. In surveys consumer confidence is high with the backdrop of so many losing their jobs
5. Housing market usually reflects the state of the labour market – today employment market poor
It begs the question how accurate is the employment data. Lies, damn lies and statistics.