Mind where you put our money

We've had some good luck, but that won't keep the economy growing next year, writes ADRIAN ORR*.

Over the past two or so years New Zealand has enjoyed a good run of opportune economic events - and not before time.

These have included good growing conditions, a low exchange rate, supply constraints in major export markets (due to drought and disease), and increased interest in living in New Zealand bringing net immigration back to record levels.

As a result, consumer confidence and house prices have been boosted, the Government's coffers filled and about 4 per cent economic growth generated this year. All of this comes as most major economies dig their way out of recession.

But questions remain as to how much of the recent growth is due to good fortune (cyclical) or good planning (sustainable).

On the cyclical front, most of the recent positive economic events cannot be relied on in 2003. New Zealand remains as exposed as ever to the swings and roundabouts of the global economy and weather.

Meanwhile New Zealand's growth potential has shifted little, as shown by the rising capacity constraints and inflation pressures. It is easy to see New Zealand reliving the mid-1990s during 2003 - a rising New Zealand dollar driven by strong relative inflation pressure at a time when our export markets remain at low ebb.

And, no matter how much 'flexibility' the Reserve Bank claims it now has, we will again be reminded that the cental bank has no tools to influence the 'mix' of monetary conditions.

Clearly the focus of policy must be on raising the growth potential.

The rising capacity pressures next year will be nudged along in part by increased Government spending. Infrastructure is screaming, as are most other areas of government including health, defence, and education. We must ensure next year that any Government spending makes its maximum positive impact on long-term growth.

Part of this Government investment process will involve the private sector in partnership on several major projects. While there is plenty of upside to partnership - including access to capital, expertise and risk sharing - there is also a steep learning curve. In particular, the public will continue to learn about 'return on capital' and various forms of user-pays. The Government will have a job steering us through these new tunnels.

On this note, unfortunately the current fashion of increasing utilities' regulation and capping profits may actually prove counterproductive to some long-term infrastructure investment. The current regulators must take account of New Zealand's sparse population and high fixed costs (and hence high required rate of return) when doing business in this country. Unrealistic profit caps in the name of the law will harm ongoing investment, as evident by the neglected infrastructure in many areas.

Next year the policy heat will also remain on immigration in terms of adding to demand pressures and increasing the capacity to grow. This debate will be run alongside Maori and Pacific Islanders' inclusion in the economy and the role of the Treaty of Waitangi. Property rights must be resolved so that Maori economic activity can continue forward at maximum pace. It is here that enormous progress could be made at minimum cost to the taxpayer.

Another issue will be household investment. Much wealth will again be channelled into housing, the drive to diversify and/or increase 'working capital' taking a back seat for a few more years. Fund managers have a huge task in keeping people focused on the long term.

Perhaps most interesting is the start of the Superfund next year. Where is it going to be put and what are the outcomes? Diversification and long-term gain is the name of the game. This implies investment in areas likely to produce best risk-adjusted returns.

This sounds obvious, but in practice diversification will be hard to ensure. Already cries for investment in New Zealand can be heard, even from the Stock Exchange.

The quantity of investment has never been an issue, rather it is the quality as illustrated by New Zealand's low capital productivity and negative EVA (economic value add) in many parts of the economy.

The Superfund must not be captured by this policy confusion when making investment decisions.

What policies are likely to raise the quality of investment? It's the 'usual suspects'.

These boil down to anything that raises an individual's incentive to be entrepreneurial and reduces the barriers.

The focus falls on tax levels, competition policy, compliance costs, regulation, law and order, welfare, education and so on.

Areas in which New Zealand is still muddling along.

Meanwhile, talk of incubators, clusters, knowledge waves, and picking winners can find their correct place in the economic debate. They are not new, and are at best complements to the usual suspects.

Of course the make or break of next year may simply come down to two cups - the America's Cup and the Rugby World Cup.

Will we be sipping champagne or sucking beer from the saucer?

* Adrian Orr is chief economist of Westpac.

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