KEY POINTS:
The latest OECD Economic Survey of New Zealand shows that the domestic economy has made some progress since the July 2005 survey.
However, Greece has passed New Zealand in terms of GDP per capita and we are now ranked 22nd of 30 OECD countries compared with 21st two years ago. Only Korea, the Czech Republic, Portugal, Hungary, the Slovak Republic, Poland, Mexico and Turkey are now below New Zealand.
In 1970, the first year the OECD compiled GDP per capita for member countries, New Zealand ranked ninth of 26 countries.
The Black Caps finished in the top four at the Cricket World Cup, the captain resigned and there were calls for other heads to roll. Meanwhile, the economy slipped closer to the bottom quarter of the OECD ladder yet there has hardly been a murmur on the issue.
The 2005 OECD Survey on New Zealand opened with the comment: "The economy has continued on its strong upward course and living standards - measured as GDP per capita - have risen steadily over the past decade, putting the country on track towards the Government's objective of returning to the top half of the OECD."
Two years ago the OECD believed that New Zealand had key policy challenges if it was to achieve this objective. These were:
* To raise productivity growth, which remains relatively weak by OECD standards.
* To increase the employment opportunities for highly skilled individuals, particularly women with young children.
* To enhance the management of public finances.
The OECD also identified a number of other issues including the need for a greater emphasis on results-based education, more competition to reduce the cost of telecommunications services, and a greater focus on innovation and research and development.
The 2005 survey was relatively optimistic with the Paris based organisation believing that the "country's prospects are bright, with potential growth projected to remain comfortably above 3 per cent per annum over the medium term".
The housing market received scant attention two years ago, and was first mentioned on page 22 of that survey.
The latest OECD Survey of New Zealand takes a more sombre view. It believes "there has been little progress towards the goal of lifting living standards to the OECD median".
The housing market is given extensive coverage throughout. The OECD believes "the economy may be at a turning point, with the pace of activity starting to pick up again, but this would be welcome news only if inflationary pressures have been eliminated. A period of slow growth is necessary to allow inflationary pressure to completely dissipate, even though this could be painful for some households".
The OECD believes that the pain could be particularly severe for exporters with wage growth slowing, job losses increasing and businesses postponing or cancelling investment plans.
The OECD continues to believe that low productivity growth is the main reason why New Zealand's GDP per capita is 16 per cent below the median. This is a complex area but the OECD highlights a number of reasons why New Zealand's productivity lags:
* The high volatility of the New Zealand dollar means that there are considerable shifts in export volumes and the sales of companies that compete against imports. This leads to the underutilisation of assets when demand declines.
* This volatility in demand discourages investment. Companies producing tradable goods and services are reluctant to invest in productivity-enhancing capital because of uncertainty over future demand.
* The domestic market is small and companies with an international focus often move offshore because of the volatile exchange rate. The OECD believes that the less productive companies remain at home while the more productive ones move overseas. A large number of companies forego export opportunities and remain too small to achieve economies of scale.
The OECD is extremely critical of New Zealand's export performance. We ranked 27th out of 30 countries for export growth between 1990 and 2005. We are still heavily dependent on agriculture exports and rank third behind Norway (North Sea oil) and Australia (resources) in terms of commodities as a percentage of total exports.
The situation facing New Zealand is quite startling. The country's GDP per capita is falling, compared with other OECD countries, because of low productivity. The low productivity is mainly due to a high and volatile exchange rate that discourages investment in productive-enhancing capital.
The Reserve Bank is increasing the volatility of the dollar through its aggressive interest rate policies.
In light of this it is not surprising that Fisher & Paykel Appliances announced it was relocating part of its manufacturing operations to Thailand with the loss of approximately 350 jobs in Auckland.
Business investment has fallen relative to housing investment in recent years. We are highly dependent on overseas money to finance this investment and housing doesn't earn any overseas income to meet the interest or repayment of these loans.
Thus the OECD believes that the huge current account deficit is unsustainable because only a small percentage of the country's massive offshore borrowings are being invested in the export sector or other foreign exchange earning activities.
Another housing-related concern is that the national savings rate has fallen because the sustained rise in house prices has stimulated housing equity withdrawal, mainly financed by foreigners. These withdrawals have funded consumption, boosted imports and created additional inflationary pressure.
The latest OECD survey focuses on three main areas to lift the country's GDP per capita. These are:
* Improving pension and retirement savings policies.
* Deepening and enhancing the efficiency of financial markets.
* Adapting the tax system to future needs, including the introduction of a tax on capital albeit at a lower rate than the tax on income.
The OECD's coverage of these three issues, which is 76 pages long, is disjointed, confused and politically unrealistic in a number of areas.
It suggests that KiwiSaver could be turned into a compulsory scheme but then points out that this could encourage politicians to scale back New Zealand Superannuation.
It also identifies distortions regarding the taxation of rental dwellings but concedes there was little political support for reform in this area.
The clear implication from the latest OECD Survey is that under current economic policy settings New Zealand has no hope of climbing back to the top half of the OECD on a GDP per capita basis. There is a far better chance that Korea will pass us in the next year or so and we will slip to 23rd of 30 countries. Then Czech Republic and Hungary, which are achieving far superior export growth than New Zealand, could be next to pass.
To reverse this trend the country needs more business investment, particularly in the export sector, yet the Reserve Bank's aggressive monetary policy has the opposite effect. Even if the NZ dollar falls it will take a long time for export investment to pick up because of fears that it will rise again.
Our economic policies have created windfall profits for the foreign owned banks, carry trade participants and even Warren Buffett who revealed in Berkshire Hathaway's recently released annual report that he had made over US$100 million ($135 million) from trading the kiwi.
Why do we pursue economic policies that drive our export sector to the wall while helping to generate massive profits for overseas interests?
Surely there has to be a better way to manage an economy.
* Disclosure of interest: Brian Gaynor is an investment strategist and analyst at Milford Asset Management.
