Andrew Gawith: Kiwi expertise can be marketed to the world

Icebreaker has added value to the basic products we generate in New Zealand. Photo / Supplied

The dramatic rise in global commodity prices over the past decade has led to a 20 per cent increase in New Zealand's terms of trade.

That's an impressive boost to our purchasing power; we can buy more imports for a given quantity of exports, or better still, use the additional export revenue to reduce the external deficit and that's basically what we've done.

But to what extent can we rely on commodities to help strengthen a steady lift in New Zealand's standard of living? After all, for the best part of the 25 years up to 2000 the price of New Zealand's commodities fell in nominal terms, and that finally drove former Prime Minister Helen Clark to argue for a transformation of the New Zealand economy away from commodities.

Fortunately for us, Labour, like several governments before it, was unsuccessful at diversifying the economy away from our land-based industries. So we remain pretty reliant on commodities.

Commodity prices have been driven up over the past decade by surging demand out of Asia, and particularly China, on the back of rampant economic growth.

That demand has put real pressure on supplies of primary products, which in some cases had been crunched by weak returns over the 1980s and 90s.

Nobody seriously doubts that China and other large emerging economies will continue to expand rapidly, albeit with the odd hiccup. That implies a further strengthening of demand for food and for higher-cost, protein-rich foods such as dairy and meat products.

Producers should respond to the higher prices by increasing production, but the agricultural sector can be notoriously slow to respond to price signals. It is governed to a large extent by the reproductive cycles of cattle and sheep, and restricted by the availability of suitable land.

The most significant supply response is likely to come from within emerging economies. For example, China has the world's largest sheep flock at about 136 million compared with our shrinking flock of about 35 million sheep.

There's likely to be considerable potential to increase the output of wool and meat from the Chinese flock, which is unlikely to be managed to the standards employed by New Zealand sheep farmers.

In Brazil milk production has been increasing by 6 per cent a year since 2005, roughly twice the pace of New Zealand's vibrant dairy industry. But as we know only too well from our own experience, weather conditions can have a devastating impact on supply.

The Chinese are facing a potentially serious shortfall in wheat production this season unless rains come soon. That would put upward pressure on grain prices and in turn meat prices.

The combination of rising economic wealth, underpinning strong demand for food, with a sluggish supply response, suggests that commodity prices will stay high for a while yet and in some cases may move significantly higher.

The price of New Zealand coarse wool, for instance, is up 50 per cent from a year ago.

Another argument supporting commodity prices at the moment is that low interest rates (relatively loose monetary policy) make it less expensive to build and hold stocks of storable commodities, and make it more financially attractive for farmers to expand flocks and herds (their capital).

Both actions tend to restrain supply, at least in the short term, thus contributing to the lift in commodity prices.

But can we rely on commodities to maintain and ideally enhance our standard of living, or will we live to regret not having done more with the additional income from high commodity prices to transform the economy to higher margin, higher-value products and activities?

How can we take advantage of high commodity prices? We could ramp up production, and that will happen to the degree it's possible at the farm level. The dairy industry has expanded but to some extent could be squeezing out sheep and beef farming.

Rather than simply increase production we could be adding more value to what we produce and reap bigger margins. That strategy has been pushed by successive governments and there are one or two success stories - Icebreaker being perhaps the most impressive.

But generally emerging economies prefer to import commodities in raw form and process them more competitively within their economies. New Zealand finds it difficult to compete against low-cost labour and in many cases far less stringent processing standards.

Investments that might pay bigger dividends over a much longer period include applying our farm management and animal husbandry expertise in developing countries either under contract or preferably by owning farms in these economies.

That's happening with a growing number of New Zealanders investing in dairy farms in South America and Fonterra is looking to do something similar in China. Our farming knowledge and the quality of our animal gene pool are valuable assets - used wisely they could become a high-value service with a huge market in rapidly developing countries.

Chinese investors seem to have a clearer understanding of the value of our expertise than we do.

Another lateral way to leverage sustainable value from the fast growth in demand for food products would be to develop New Zealand's expertise in food safety and certification into a marketable service.

It's clear from food scares in China that food safety standards fall short of what Chinese consumers require and what they will certainly demand as their incomes rise. The same is probably true of other developing markets. This would be a high-value service that could be focused on areas we have expertise in - dairy and meat.

Commodities have made an important contribution to New Zealand's growth over the past decade and look likely to continue to contribute in this decade. However, it would be foolhardy to believe commodity prices will remain high forever - they won't. We need to keep searching for products and services that will keep lifting national income long after this commodity boom fades.

Andrew Gawith is a director of Gareth Morgan Investments, an investment manager, KiwiSaver and superannuation provider.