Cullen's catch 22

By BRIAN FALLOW

Finance Minister Michael Cullen worries - as do many business people - that the Reserve Bank may be too slow to recognise an improvement in the economy's sustainable growth.

And if the bank gets it wrong we may never know, because it will not let growth exceed what it thinks is the sustainable rate for long enough to show it was wrong.

"There is a possibility that the bank's view [of the sustainable growth rate] could be self-fulfilling. That's why the bank needs to keep under review changes in productivity," Cullen told the Weekend Herald.

"The bank would tend to take a kind of precautionary view. But at some point there is a question as to whether there has been a change which is not recognised and also, as I indicated in an interview the other day, whether the bank is interpreting the policy targets agreement as being as flexible as the Government intended it to be."

The policy targets agreement (PTA) between the Reserve Bank governor and the Minister of Finance requires the bank to operate monetary policy to keep inflation in the 0 to 3 per cent range, but in doing so to "seek to avoid unnecessary instability in output, interest rates and the exchange rate".

"It's a matter which is under review at the present time because with a new governor to be appointed the PTA is automatically up for renegotiation at that point. And if we feel we haven't been as explicit as we need to be in the PTA then maybe we have to look at the wording.

"I will be taking advice on that. But there is no rush. Clearly the bank's board will be engaged for some time in the process of developing a nomination [for a new governor]."

Former governor Don Brash said this week that the system was self-correcting.

If the bank significantly overestimated for any length of time the rate at which the economy's capacity was expanding, demand would outstrip supply and show up as rising inflation.

But it cut both ways, Brash argued. If the bank underestimated the rate at which the economy's potential was expanding and unnecessarily restrained demand, inflation would fall and threaten to become deflation.

The record of the past 10 years was that inflation turned out to be rather high in the target range, not low, Brash said. That suggested the bank had not been underestimating the growth potential.

And as for avoiding unnecessary volatility, monetary policy was an area in which a stock in time saved nine.

Cullen said that much of the Government's economic policy was about raising the potential growth rate.

But that was a task requiring incremental progress across a wide front for years on end. It was not amenable to quick fixes. "There are no magic levers. The search for those has been a false quest over recent years."

In the cause of lifting labour productivity the Government was investing in tertiary education and in lifting the skill levels of people already in the labour force, through industry training and apprenticeships.

It was also trying to increase the level and quality of foreign direct investment, he said. "Particularly new investment - I am not particularly concerned if we have a lot fewer New Zealand businesses bought from overseas."

Then there is the process of translating innovation into businesses. Funding has been increased for Technology New Zealand's technology for business growth programme, which accelerates the uptake of new technology by business.

Cullen said the Government would look at emulating a "cunning" Australian tax change aimed at attracting more foreign money into its venture capital market.

"If a United States pension fund invests in an approved venture capital fund in Australia - and 'approved' means it meets certain tests, including investing in Australian businesses - then their domestic tax rules can apply, and those funds are tax exempt in the US. So their Australian earnings are tax exempt when they flow back to the US. In that way the Australians leverage substantial growth in their venture capital industry at no real cost to the Australian taxpayer."

Cullen is wary of being drawn into a "race to the bottom", in which countries compete for internationally mobile capital and skilled labour with ever lower tax rates.

"We might think this will make us richer but the Government, at least, ends up being very poor indeed and, as a consequence, so does a large proportion of the population."

Cullen rejects the notion that its raising of the top personal tax rate from 33c to 39c in the dollar might prove counter-productive from an economic growth standpoint by encouraging those who are, or can realistically aspire to be, in that bracket to take their skills overseas.

"When you look at the profile of our out migration it by no means consists of all highly paid, highly skilled people. Our migrants to Australia over the last few years have been slightly less skilled than the average migrant into Australia. It is pretty much a vertical slice of New Zealand, which suggests it is not being driven by the top tax rate," he said.

"It is a little different, I think, for some of the migration to Britain and the USA, which is a little more concentrated in the young and the skilled. The problem we face in that regard is an issue simply of comparison of gross wages, which are obviously much higher."

People could gain a misleading impression of the gap in living standards if they simply took the gross wage or salary on offer and converted it at the prevailing exchange rate.

A New Zealand dollar went further if you spent it in New Zealand than if you exchanged it for, say, sterling and spent it in London.

The OECD calculates purchasing power parities for currency conversions to compensate for differences in price levels between countries. On that basis it reckons NZ$1 is worth US67c, 20c more than the market exchange rate.

Another factor that tended to exaggerate the income gap, Cullen said, was the simplicity of New Zealand's tax system, which apart from ACC did not have the sort of social security levies that made up a significant part of the tax burden in other countries.

"Tax plus our only social security levy, ACC contributions, for a single person on the average full-time wage represents about 20.5 per cent of total income in New Zealand. This is lower than 12 out of 15 countries in a recent Economist study," he said in his Budget speech last week.

A more broadly based study by the OECD of the tax burden on labour found New Zealand had the third lowest out of 29 OECD countries, he said. The New Zealand figure was less than half that of 15 OECD countries. nations.