What Treasury & RBNZ Should Tell the Finance Min.

25 November 2003

Exchange Rate: What Treasury and the Reserve Bank Should Tell the Minister of Finance

"There is a raft of competitiveness-improving measures which the Treasury and the Reserve Bank should identify in response to Dr Cullen's request for advice on how to reduce exchange-rate pressures on exporters", the executive director of the New Zealand Business Roundtable, Roger Kerr, said today.

"These do not include intervention in the foreign exchange market, as the minister of finance has correctly acknowledged. Nor do they include interest rate cuts, capital controls or, in present circumstances, alternative exchange rate regimes. Such measures would be ineffective and harmful, and the government's advisers should make this clear."

Mr Kerr said that the best thing that the Reserve Bank can do to help exporters is to keep inflation under control. Inevitably, this means cycles in interest rates and exchange rates which firms trading internationally have to manage like any other business risk.

"Nevertheless, maintaining international competitiveness and the health of the export sector is vital for a small, open economy like New Zealand ", Mr Kerr said. "This requires not just a focus on the current value of the dollar but on broader dimensions of price and non-price competitiveness, including productivity, quality and service delivery. Firms must take responsibility for many of these factors.

"But the government also has an important role to play in creating a competitive environment for business. New Zealand has been going backwards in this regard. The 1995 World Economic Forum/IMD World Competitiveness Report found that "New Zealand, in 8th position this year, continues to be impressive with its remarkable comeback from 18th position in 1991", and noted that "New Zealand has an outstanding result in Government (3rd)". Since then, New Zealand has slipped back to 18th position (2003) in the comparable survey, and the quality of government management is also well down."

Recently, the government had announced further reductions on tariffs, which would help exporters as tariffs are a tax on exports. But much more was needed to improve New Zealand's international competitiveness.

Mr Kerr said that the real exchange rate which affects exporters can be expressed as the ratio of international to domestic unit costs. Competitiveness would be improved by measures to enhance efficiency and reduce costs in the domestic sector of the economy. In particular, better fiscal and regulatory policies would help support monetary policy. Key options include

* Lower central and local government spending Most government spending is on domestic goods and services, and increased demand puts pressure on prices and costs. Much public spending is also wasteful, inefficient and poorly targeted. Pre-election spending increases would further undermine competitiveness.

* Reverse galloping state regulation Businesses are being hit with higher compliance costs across the board, and intervention in industries such as telecommunications, electricity and transport is adding to costs and discouraging investment and innovation.

* Improve infrastructure The poor performance of central and local government-dominated industries such as roading and water is creating excessive costs for business. There needs to be greater private sector participation in these industries. Obstacles to investment such as the Resource Management Act and Kyoto Protocol commitments should be tackled.

* Reduce employment restrictions Labour costs represent around half total production costs, on average. Pushing the dollar down - assuming this could be done without increasing inflation and triggering monetary tightening - would be equivalent to cutting real wages. Equally, firms should be taking account of the higher purchasing power of the dollar in wage bargaining. However, the more desirable focus should be on raising productivity. The government's drive to increase unionisation and collective bargaining, and to legislate for more holidays, will simply add to unit costs and reduce productivity.

* Increase competition Monopoly areas of the economy such as accident insurance should be opened up to competition, and there is scope for much greater private sector provision in areas such as health, education and prison services.

* Cut taxes The government is raising excessive amounts of revenue. Tax reductions focused on raising efficiency would take pressure off wages and increase savings. They should include a reversal of the increase in the top tax rate, which increased the cost to firms of internationally mobile employees, as recommended by the McLeod Tax Review.

Such measures would have both short- and longer-term benefits for competitiveness. Skill upgrading through introducing greater choice, competition and autonomy into the government-dominated education sector would have important long-term effects.

"The minister of finance is absolutely right to say that he is "not entirely without options" to assist the export sector and producers more generally", Mr Kerr said.

"The OECD is likely to highlight most of the above options for improving competitiveness and economic growth in its forthcoming report on New Zealand , which will focus on medium-term economic policy.

"The Treasury and the Reserve Bank also have a duty to the taxpaying public to offer independent and professional advice, and any competent response to the minister of finance's request must include such options, as well as others.

"The only real question is: Will the minister of finance accept such advice?", Mr Kerr concluded.

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