Dairy prices fell dramatically in 2014 and 2015, prompting the RBNZ to reverse 2014 OCR increases in 2015. Average prices on the GlobalDairyTrade auction fell by 38% in 2014/2015 and 20% in the 2015/2016 to mid-March.
Inconsistent Chinese demand and increased European/US dairy supply causing the perfect storm of plummeting whole milk powder prices. Thankfully, for dairy farmers and the NZ economy dairy prices recovered in late 2016 but can it be maintained into 2017? Here are some reasons why prices may recover:
- EU production is slowing down
- New Zealand production is also likely to fall
- Demand from China is likely to increase
- ASB rural economist Nathan Penny noted three things that would impact the price of milk. One as the fact that milk production was held back before the removal of annual quotas at the end of March 2015 as countries avoided paying penalties associated with producing above quota. Two, after the April removal of quotas, production surged in the EU with April production rising over 3% on a month-by-month basis. Three that post-quota surge has now passed, with production growth slowing, particularly since July, as farmers have struggled with low milk prices.
Once supply is more aligned to demand, global prices are expected to rise again. Europe collectively is the world’s largest dairy exporter, accounting for nearly a third of global export sales. EU exports increased by 6% in milk equivalent last year.
Sources: National Business Review and PWC
With the departure of the UK from the EU there have been many questions asked about the future of UK trade. No longer having the free access to EU markets both with imports and exports does mean increasing costs for consumer and producer.
New Zealand’s Experience
A similar situation arose in 1973 when the UK joined the then called European Economic Community (EEC). As part of the Commonwealth New Zealand had relied on the UK market for many years but after 1973 50% of New Zealand exports had to find a new destination. However with the impending loss of export revenue New Zealand had to make significant changes to its trade policy. In 1973 the EEC took 25% of New Zealand exports and today takes only 3%. Add to this the oil crisis years of 1973 (400% increase) and 1979 (200% increase) and protectionist policies in other countries and the New Zealand economy was really up against it.
What did New Zealand do?
1. It negotiated a transitional deal in 1971 with agreed quotas for New Zealand butter, cheese and lamb over a five-year period, which helped to ease the shift away from Britain.
2. New Zealand was very active in signing trade deals of which Closer Economic Relations with Australia was the most important in 1983. The other significant free trade deal was with China in 2008. Below is a list of New Zealand’s current free trade deals and a graph showing the changing pattern of New Zealand trade:
With brexit around the corner it will be imperative that the UK starts to develop trade links with non-EU countries of which New Zealand might be one. The UK is the second largest foreign investor in New Zealand and its fifth largest bilateral trading partner.
In 2016 Germany recorded the world’s largest current account surplus of €297bn (approx US$315bn) overtaking that of China again to become the world’s largest. The country with the biggest deficit is the USA and head of the National Trade Council Peter Navarro (see earlier blog post) has accused Germany of currency manipulation by having a weaker Euro as compared to the stronger Deutschmark, its previous currency.
As you already maybe aware a weaker currency makes a country’s exports more competitive and imports more expensive. Therefore German cars, tools etc are very competitive on world markets. Trump has indicated that he may put a 35% tariff on imported BMW’s but for America to say that Germany is manipulating its currency is not a winning argument for the following reasons:
1. The Euro is weak as it is more an indication on the Eurozone economy which includes countries which have poor economic conditions – yes if Germany had the Deutschmark again it would be stronger
2. The US is embarking on a policy of expansionary fiscal policy with tax cuts and increased government spending on infrastructure. This will boost jobs but will also increase domestic interest rates which makes the US dollar stronger and thereby reducing export competitiveness of US goods and services but makes imports a lot cheaper.
3. The European Central Bank has cut interest rates to virtually zero and is implemented a policy of quantitative easing (buying back bonds) in order to stimulate the weaker economies in the eurozone.
4. With virtually zero interest rates, German savers are being punished as are German life insurers.
5. Does Navaroo’s allegation hold any creditability when the US is running massive deficits.
The German Problem
In order for German industry to remain competitive employers and trade unions agreed to restrain wage growth – this led to a weakening of the euro. To overcome this imbalances in economies wages should be increasing in Germany as it is a stronger economy and weakening in the poorer countries like Greece and Spain. This means that the latter has a competitive advantage and should attract investment.
Also a ageing population tend not to be big spenders and with the current demographics in Germany, firms are looking abroad to sell their products instead of at home. Ultimately this leads to excess savings which is capital sent abroad
With a current account surplus of 9% GDP the only way this can be reduced is with extreme measures such as:
– Lowering VAT (value-added tax)
– Increasing wages
– Government to increase its spending and run budget deficits
However the surplus is a sign of German’s export prowess and as one German politician said ‘America needs to make better cars”. Only when the German savings are turned into cash will surpluses turn into deficits.
Source: The Economist – Feb 11th 2017
NAFTA took effect in 1994 during the Clinton administration although he had to rely on support from the Republicans in the House – 60% of congressional Democrats voted against NAFTA. NAFTA got rid of tariffs on more than half of its members’ industrial products and by 2009 the deal eliminated tariffs on all industrial and agricultural goods.
Positives of NAFTA
- American corporates believed the deal would cut labour costs and therefore increase efficiency and international competitiveness.
- American consumer would also benefit from lower prices.
- It would raise Mexico’s living standards especially in the north.
- Trade between the USA and Mexico has risen 1.3% in 1994 to 2.5% in 2015
- Mexico’s real income has risen – $10,000 in 1994 to $19000 in 2015
- Less Mexicans are migrating to the USA – 500,000 a year to virtually nothing.
Mexican incomes are no better, as a share of those in the US, than they were in 1994. Americans are slightly better off. NAFTA has caused significant job losses in the manufacturing industry.
However there are some unseen circumstances which have affected the deal.
1. The crisis of the Mexican Peso in 1994-95 – Zapatista rebels launched an uprising in Southern Mexico and the leading presidential candidate was assassinated. Worried about stability, foreign investment began to flee the country. It was eventually brought under control by a loan from the US government.
2. September 11th – this terrorist attack increased the cost of moving goods and people
3. The rapid growth on the Chinese economy which accounted for more than 13% of global exports and 25% of global manufacturing value-added. This puts a lot of pressure on global supply chains.
Have job losses been a result of NAFTA?
Brad DeLong (University of California) estimated that NAFTA could be blamed for only 0.1% of job losses in the US economy. This equates to fewer jobs than the US economy adds in a typical month. But to be realistic job losses would have increased without NAFTA for the following reasons:
1. the advances in technology would see labour being substituted
2. the strong US dollar would make US exports less competitive and thereby making overseas production attractive
3. Transport and communications improvements have made overseas production also attractive
Source: The Economist – 4th February 2017
Below is Paul Krugman on Bloomberg news. He talks of the poor performance of NAFTA for Mexico in that the country hasn’t developed as a whole. Some of the northern states have done well but southern Mexico is still very poor.
Donald Trump appointed Peter Navarro as the head of the newly created National Trade Council – it has been his anti-China stance outlined in his book ‘Death by China’ that has led to his surprise hiring by Trump. The book talks of the economic and military rise of China and the demise of the US manufacturing industry unable to compete with the Chinese sweatshops.
However a lot of the criticisms that Navarro has pointed at China have been quite valid.
1. Currency – the intervention on the foreign exchange market to keep their currency weak so improving the competitiveness of exports.
2. Intellectual property – forcing American firms to hand over intellectual property as a condition of access to the Chinese market.
3. Pollution – Chinese firms pollute the environment and have weak environmental controls on industry.
4. Working conditions – these are far worse than what is the law in most industrialized countries.
5. Export subsidies – government assistance help reduce the cost and ultimately the price of exports from China.
In 2006 he estimated that 41% of China’s competitive advantage over the USA in manufacturing came from unfair practices like those above and when China joined the WTO in 2001 the trade deficit with the USA ballooned at the same time millions of manufacturing jobs disappeared. The deficit though was funded by the Chinese and it was a consequence of the Chinese buying US Treasury bills – to put it simply the Chinese funded US consumers to buy Chinese products. Niall Ferguson refers to the relationship as Chimerica – the two are interdependent in that the USA borrows off the Chinese and then uses that money to buy Chinese products.
Navarro believes that with China adhering to global trade rules the deficit in manufacturing will decrease and manufacturing jobs will return to the US. However when jobs return they are not the same as they were in previous years as it is highly likely that productivity/technology has refined the production process. Research has also suggested that when the trade deficit with China increased (1998-2010) the loss of manufacturing jobs only rose slightly 2.5m to 2.7m. One wonders what Navarro will do in the coming months?
Sources: The Economist, The Ascent of Money by Niall Ferguson.
In the media a lot is spoken of a country’s trade deficit and the concern that it is borrowing from abroad to finance current purchases of goods and services. China’s surpluses have been a big talking point but it is Germany with a current account surplus since 2002 (introduction of the Euro) with a 2105 surplus of 8% of GDP which has taken the limelight – see graph from The Economist.
A lot of students taking the subject for the first time believe that a trade surplus is good and a trade deficit is bad. However, as in a lot of areas of economics, you can’t categorically say they are good or bad. For instance, a deficit might be caused by importing vast amounts of capital goods which will create value in the economy through jobs and goods which can be sold domestically or overseas. The capital goods can also increase the level of productivity and improve competitiveness of such goods. In some respects deficit countries can be better off than surplus countries, as they are consuming more goods that they are producing.
Is a trade surplus good or bad?
For a lot of countries the purpose of exports is to generate revenue so that they can buy imports of goods which they may not produce – or could produce but relatively less efficient. In China a surplus does keep the export sector industries employed but suggests there is a strong presence for saving or weak domestic demand. More balanced trade would increase the level of imported goods into a country and increase real incomes as the value of its currency rises. This will allow for more inflows of foreign capital from abroad stimulating growth in the domestic economy. It would help a sluggish world economy if surplus countries, like China and Germany, were to spend more on imports.
Reasons for Germany’s trade surplus.
There are three main reasons for Germany’s ongoing trade surplus:
- Since the advent of the Euro in 2002 its value has been very weak. This is because the Euro is valued in relation to the entire 19 country eurozone and given the economic condition of the other member states, Germany’s strength in trade is not significant enough to boost the currency. If Germany still had the Deutschemark today it would be no doubt stronger and therefore reduce export competitiveness. It has been calculated that the Euro gives Germany about a 20% price advantage compared to what it would have had if it was still using the Deutschmark and has the largest foreign exchange advantage of any country in the world, with the possible exception of China.
- Another reason is that the German government has been running a very tight fiscal policy and also keeping the wages levels down. In the wake of the worries over the eurozone, Germany slashed its public expenditure with reducing public infrastructure spending and been more focussed on running surpluses. This is all very well but they are taking money out of the system which leads to less demand in the global and European economy.
- The lower cost of imports of oil and gas increased the trade balance in 2015 by around 1.2%. Without the decline in oil and gas prices, the trade surplus would have fallen compared with the previous year.
Germany’s trade surplus is a worry for countries in the EU as well as overseas in that it is importing demand from other countries and reducing output and employment. This is especially prevalent when you consider that monetary policy in a lot countries has become ineffective. When this happens expansionary fiscal policy – dropping taxes and increasing government spending – is way of trying to boost demand but even though the fiscal position of the German economy is very healthy they are doing the opposite and being prudent. Germany is one of the few major economies in a position to easily and cheaply increase demand.
Given the growing importance of tourism to the NZ economy, there is a risk that the latest earthquake could adversely impact visitor arrivals. However, looking at the 2010/11 earthquakes, the long-term impact appears to be limited (see graph from ASB Bank). It is estimated that the impact on visitor arrivals is likely to be small in comparison to the previous quakes, though Wellington through to North Canterbury are likely to see a reduction in visitors. Spare a thought for Kaikoura, the whale-watching capital, which has experienced a lot of damage and currently has no access routes.
Unlike other sectors which produce material goods, tourism encompasses a range of industries and is based on characteristics of the consumer, rather than what is being produced by the producer. Feeder industries into the tourism sector include:
Accommodation – Transport – Retail Trade – Food and Beverages – Car Hire – Tourist Sites
Tourism spending – year ended March 2016
- Domestic = $20,213m ($15,361m spent by households $4,852m spent by business and government)
- International = $14,486m ($2,747m from international students)
Total = $34,699m
One significant point from the data was that tourism revenue surpassed export revenue from dairy products.
Contribution of Tourism to Gross Domestic Product (GDP)
- Direct contribution – $12,873m = 5.6 % of GDP.
- Indirect Contribution (supplying of goods and services to tourism sector) – $9,815m = 4.3% of GDP
- Total contribution = $12,873m + $9,815m = $22,688m = 10% of GDP
Employment – the tourism sector is quite labour intensive, with:
- People employed 188,136 = 7.5 % of total employment.
- People indirectly employed = 144,186 = 5.7% of total employment.
- Total 332,322 = 13.2 % of total employment
Source: Parliamentary Library – Monthly Economic Review November 2016