Speech – New Zealand Government

I would like to start with a small reflective tribute to the late Sir Frank Holmes, an absolute stalwart of the PECC. This must be the first formal or informal PECC meeting I have attended in the last thirty years without Sir Frank being an integral …

Hon Tim Groser Minister of Trade 20 June 2012

Speech Address to the Pacific Economic Cooperation Council: TPP and New Zealand’s export future

I would like to start with a small reflective tribute to the late Sir Frank Holmes, an absolute stalwart of the PECC. This must be the first formal or informal PECC meeting I have attended in the last thirty years without Sir Frank being an integral part of the discussion.

Sir Frank, who passed away only recently, was a considerable intellectual influence on me and no doubt many people of my generation interested in international trade. Some of the first applied economics papers I read were written by Sir Frank, often in conjunction with Professor Peter Lloyd for the NZ Institute of Economic Research.

Like other international economists of the time – I am thinking of Richard Lipsey, Max Corden and others – Frank and Peter took the theory of the second-best, out of sophisticated game theory literature, and applied it in their case to NZ’s circumstances of the 1960s and 1970s. Put simply, this thinking hugely influenced the design and policy rationale of New Zealand’s first ever genuine FTA – the CER Agreement.

That first comprehensive FTA, finally ratified in 1983, had in turn a huge impact on policy thinking on FTAs around the world. It was literally the ‘gold standard’ of FTAs of its day. To say ‘of its day’ is probably understating its influence; fundamental design principles like progressive liberalisation over many years to deal with sensitivities, comprehensive product coverage, carefully designed review clauses and so forth continue to be valid and to influence Australian and New Zealand negotiating approaches, thirty years on.

Because New Zealand is the legal ‘depository’ or ‘Administrator’ of the TPP negotiation, I had the privilege of announcing yesterday on behalf of NZ, Australia, the United States and all existing TPP members that I had signed a formal letter inviting the Government of Mexico to join the TPP or Trans-Pacific Partnership Agreement. Today, I sent a similar letter to the Canadian Trade Minister.

TPP is deeply influenced by the same political economy thinking underwriting CER. In other words, public policy ideas advanced decades ago by these two intellectuals, Frank Holmes and Peter Lloyd, continue to influence real world events such as this. It is a remarkable testimony to Keynes’ point about the persistent tendency of so-called ‘practical men’ to under-estimate the power of ideas.

Before I elaborate on TPP and the significance of Mexico’s and Canada’s entry into the negotiation, I would like to take some time to restate some basic truths about trade liberalisation, the jobs it creates, the productivity and innovation it leads to and the new markets it opens up.

I started with high level game theory. Now let me go straight to the coal-face to make the same point. Last week I visited a very small NZ export company in Hamilton that has absolutely nothing to do with NZ’s core resource strengths in the primary sector. It is called Proform Plastics. It is an automotive parts company that arose out of the ashes of the old import licensing system and is now overwhelmingly export-oriented, having successfully got itself into the global supply chain of a couple of major international automotive companies.

Proform employs about 120 local people in design, administration and manufacturing. It manufactures everything on site, but often using imported materials, and wins contracts on the quality of its product offering, its service and IP package – it is not just competing on price. As is the case for most successful things NZ does from dairy through to tourism, if it is ‘cheap’ you want, don’t come to NZ. If you want ‘best value’, then come right in.

Proform is constantly innovating its highly specialised product range on a Kaizen, or ‘continuous improvement’ basis – as any company which is involved in exports must. Trade and innovation are joined at the hip. Being a niche player, this company is also proud of its ability to customise its products for the specific needs of its customers. It is in that sense typical of the new generation of export companies that I visit and which give me long term confidence in this country’s future.

Australia is their major market but their people told me that they see major opportunities in three markets – the Thai market, China and intriguingly Mexico. They told me that without the FTAs we have with China and Thailand, it would have been impossible for them to compete in those markets and employ as many people as they do.

Mexico, they said, was a challenge because of an 18% tariff on the components they make. In fact they said that from their company’s point of view, an FTA with Mexico (given automotive assembly there and high tariffs on components) would be more interesting to them than an FTA with the United States. Given the sensitivity of the impending announcement, I was not then in a position to say “well, if an FTA with Mexico is what you want, you have come to the right place!” I could repeat this story with 853 other examples. Why such a precise number? Because MFAT and NZ Trade and Enterprise surveyed 854 New Zealand export companies in late 2009 to assess the impact of FTAs on their companies.

Let me give you the big numbers:

Over 75% of our export companies saw positive increases (some substantial) in their business profitability from the removal of these barriers in several of our trade agreements; just remember this simple reality: the managers who run these export companies do not offer jobs to other people because they want to lose money on their investment of time and capital. They employ more people because they see an opportunity to build a larger and hopefully more profitable business. Profitable NZ export companies means jobs. And usually, jobs in the export sector are better paid jobs. The more foreign exchange our exporters earn, the less money we have to borrow from overseas. If I may make a political aside here: it is extraordinary that the people who complain the loudest about foreign investment are the same people who vociferously oppose trade agreements. It is completely inconsistent.

Other more sophisticated findings from this large survey of 854 exporters include clear evidence that removal of barriers to trade helped these kiwi companies acquire new knowledge and technology. Most intriguingly, 42% of companies surveyed saw the lower prices of inputs in the NZ market as a result of lowering our own barriers was a real benefit to them.

The last point – ie that increased competition in the NZ market helped our exporters – is of course completely unremarkable to the 99% of economists who buy the underlying theory set behind international trade, the theory of ‘comparative advantage’. But we all know this is counter-intuitive to the public of most countries who are in favour of exports and believe imports costs jobs.

So let me approach this from a broader perspective on the basis of an outstanding synthesis of international research produced by the OECD called ‘Policy Priorities for International Trade and Jobs’. This was the centrepiece for this year’s annual OECD Ministerial Meeting in Paris.

Among the numerous findings of this comprehensive study is a range of practical, anecdotal and econometric estimations. For reasons I will not delve into today I am not a great believer in the value of econometric modelling of gains for trade – there is a persistent tendency of such measures to understate the gains from trade. Having said that, it is notable that OECD modelling suggests that a 50% reduction in tariffs and non-tariff measures on an MFN basis for G20 countries would increase New Zealand’s real income by over 8%. Very tidy, even if this is an understatement.

More specifically, I would like to draw attention to one remarkable statistic: the share of imported components in manufactured exports has gone from an average of 20% globally to 40% in only 20 years. As Pascal Lamy, Director General of the WTO said on a panel that I was also on in Paris that figure is almost certainly out of date already and the true figure is probably over 50%.

It turns out that protectionism is even dumber than we thought. The implication is that if you want to remain competitive in world manufacturing exports and be part of the global value chain, you must ensure your manufacturers can access world class inputs at competitive prices. If not, you are going to see your manufacturers fall out of the global value chain. My tiny Hamilton example – Proform Plastics – could never have exported its automotive parts into the global value chain if its imported inputs were still subject to high tariffs and import licensing because an earlier generation of New Zealanders thought we should protect everything in the name of ‘jobs’.

If we want to drill down even deeper we can make the same point with respect to liberalising trade in services. OECD research indicates that a one percentage point higher services import share is associated with a 0.3 per cent higher export share. For high-tech business it is much higher.

The boundaries between being a ‘manufacturer’ or a ‘services’ exporter are increasingly porous. So if you want to help your manufacturing exporters, they need access to the most competitive services which are increasingly deeply enmeshed into their product offering – think again of my guys in Hamilton or numerous other and far larger NZ exporters I could have used to make the point.

This joint piece of work that I am referencing by the OECD, the WTO, UNCTAD, and the ILO is a mine of information about the strong positive links between trade, growth and jobs. It is not just about rich, developed countries. The research suggests, for example, that in Sub-Saharan Africa a 1 percentage point increase in the ratio of trade to GDP is associated with a short run increase in their growth rate of approximately 0.5% per annum which grows to nearly 0.8% after ten years.

And it applies to NZ. That is why we have set this ambitious goal of increasing the ratio of our exports from 30% to 40% of GDP by 2025. We know that for OECD countries this is associated with far stronger productivity growth. On average, an increase of 10 percentage points – the aim of this Government – has historically been associated with an average 4% increase in output per working-age person.

A principal transmission mechanism is productivity. Depending on the country, a 10 percentage increase will lead to an average increase between about 2% and 10% in long-term labour productivity. That is the key to higher wages. Trade also deepens physical and human capital.

The mass of evidence in favour of open trade is so strong that the OECD caustically concludes as follows:

“Despite all the debate about whether openness [on trade] contributes to growth, if the issue were truly one warranting nothing but agnosticism, we should expect at least some of the estimates to be negative…The uniformly positive estimates suggest that the relevant terms of the debate by now should be about the size of the positive influence of openness on growth….rather than about whether increased levels of trade relative to GDP have a positive effect on productivity and growth”.

Increased openness to trade is not some magic wand of course. We still need well-designed safety nets, well designed labour markets, education systems that work for people with low skills and often low expectations. Trade policy cannot solve these problems.

However, even here, trade can help. Although the evidence is not as conclusive as it with respect to growth, the ILO research quoted in the OECD study is quite clear on, for example, the relationship between trade and working conditions. Despite all the allegations around the so-called ‘race to the bottom’, the evidence suggests the opposite: open trade has a positive relationship with working conditions in developing countries. As the study concludes:

“Indeed the positive effect of trade on investment and incomes carries with important implications for reduced child labour, reduced workplace injuries, and informality, while offering new opportunities for female entrepreneurs”

For our country, the last 35 years have seen a struggle to have access to markets, as we have gone through a wrenching adjustment process from an economic mono-culture (we were an offshore farm for Britain) to developing these platforms into the emerging economies.

And we are making progress, ladies and gentlemen. Nearly 50% of NZ exports are now covered by FTAs from our earliest with Australia through to the most recent FTA with Hong Kong. Obviously there are a variety of other factors influencing the rate of growth of our exports than just these FTAs. Nevertheless it is striking that if we just look at the last four years, the cumulative growth of NZ exports to countries that we do not repeat not have an FTA with is a tiny 3% – that is 3% over the four year period, not 3% per annum.

This is not entirely surprising – we went through the worst recession in 70 years in 2009 and many of the major developed economies are a bit below or only a bit above the real GDP levels they enjoyed in 2008. But contrast that anaemic growth of our exports to non-FTA countries with the growth of NZ exports to countries with which we have FTAs. For these countries, our exports in the last four years grew 23%, or nearly 8 times as much as exports to our non-FTA markets. In the case of China the growth of our exports is simply spectacular – 160% – and the growth of imports from NZ is far faster than the growth of imports into China from all sources.

I am as committed to the WTO and the multilateral trading system as any New Zealander – I spent 11 years of my life in Geneva on the GATT and WTO. It remains my firm view that the international community will have to come back to Geneva at some point and find a way forward. It is inconceivable that what was agreed in 1994 at the conclusion of the Uruguay Round – I was our Chief Negotiator – could forever represent the high watermark of political achievement. You cannot have a global supply chain without a vibrant global set of rules and commitments that keep pace with structural change.

But right now, I cannot see a way forward and what a Plan B New Zealand is cooking up through our FTAs and TPP. I will leave aside today a range of other FTAs we are trying to move forward such as Taiwan, India, Russia and Korea and focus on TPP.

TPP has a long period of political gestation. It started life as ‘P2’ – a bilateral FTA between NZ and Singapore with precisely this strategic objective – to act as a bridge to a trans-Pacific Trade Agreement (we envisaged 5 initial countries). Then, just prior to completion of that FTA and at APEC in Auckland 1999 we hammered out in principle agreement to negotiate ‘P3’ (Singapore, NZ, Chile); Brunei joined and the negotiation of what became P4 (or Pacific Four) was completed in 2004 and ratified in 2005.

Since 2010, we have been negotiating the next iteration – TPP – as nine countries. In the near future, this will become eleven, as we move to include Canada and Mexico. Where Japan now goes is suddenly the next frontier issue. And New Zealand, I repeat, is the ‘depository’ of the Agreement – because of this negotiation history.

It is worth pointing out that this slow evolution encompasses three changes in the Election cycle of NZ. Our external trading interests do not change with a change in Government and history shows that a core NZ advantage is that the two major political parties have successfully quarantined trade policy from the normal democratic arm wrestle. It is a huge strategic advantage.

In this very sophisticated international game, the only thing this tiny country of ours has to sell is smart strategy implemented by a team of deeply experienced New Zealanders, each of whom has extraordinary personal networks to draw on.

TPP is now the centrepiece of trade strategy of the United States. Yes, we are in a process of transition of power to the emerging economies, led by China. But the United States is still the pre-eminent power and is using TPP to try to develop a 21st Century, gold-standard trade agreement that can act as a broader template for trade and investment integration in the Asia Pacific.

Reflect for a moment on the phrase ‘integration in the Asia Pacific’. When we look at the relatively poor export performance of New Zealand over the last thirty years and compare this performance with other small developed economies (defined as less than 20 million people), what emerges is quite interesting. There are 20 such countries in the OECD, and only three of them are not located in Europe. Because these 16 countries, all of which perform markedly better than NZ in terms of exports to GDP, are close to large, wealthy markets, it is clear that their close regional integration has, at least up to now, been extremely helpful to their export performance.

Well, we can’t shift our geography, just our mentality, our policies and our performance. And our region is the Asia Pacific. If TPP is the key instrument to closer regional integration, you can see at least intuitively that this has got to be helpful in the long term.

TPP now has enormous momentum. TPP Leaders agreed in Honolulu in November – NZ was led by Deputy Prime Minister Bill English since it was in the middle of our Election campaign – on a set of very high benchmarks, including elimination of all tariffs. There is no point in pretending that you are creating a ‘21st Century, gold-standard trade agreement’ if you do not deal with the detritus of 20th Century trade barriers – tariffs. The market has moved on. It would be like trying to sell a 1997 Palm Pilot to a Californian digital native. You won’t make the sale.

Make no mistake about it. This is going to challenge a number of the participants, especially on their most sensitive agriculture sectors, but if this is not to end as a farce, it is something they are going to have to do. At the same time, since dairy lies at the heart of some of the most politically sensitive issues (the economics are quite another matter), we and Australia have said we can be very, very patient to get to the right place.

Once again, our reference point is the design of CER: slow, progressive liberalisation of the most sensitive areas. Time is not the essential point: it is getting to the right long-term result that actually matters.

Will it work? Well, that depends on the quality of political decision-making in the countries concerned. There are sensitive issues for every country. I can assure you that senior Ministers, led by the Prime Minister, are deeply involved in monitoring the progress of this negotiation. We have professionally identified the key risks, we have risk-management strategies in place and we have among the best negotiators in the world to manage the process.

None of the hard issues have yet filtered up to the political level. Of course I spend a good deal of time batting back constant attempts to destroy the negotiations by anti-trade activists who certainly know what they are doing. They have never seen a trade agreement they have liked and never will.

It won’t work of course. We decided politically thirty years ago as a country that we had to find new markets and there is broad-based political understanding of the importance of this agenda to our country’s future. TPP is a tremendous opportunity for New Zealand and I am confident we can manage the risks professionally. I have no doubt that the deep concern about the Eurozone is feeding into the TPP debate in a positive way. This is the reason Canada and Mexico felt they had to be in the process.

Austerity alone is not politically sustainable. All countries need a growth story too, even though there is widespread understanding amongst the public of the need for prudent economic management. Trade is the engine of growth; the Asia Pacific is going to be the centre of growth and opportunity over the next ten years. I think we are in a good space and with the addition of Mexico and Canada it is getting very, very interesting.

Thank you.

ENDS

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