Karen Silk of Westpac.
The Prime Minister's recently announced target of $30 billion two-way trade with China by 2020 might be seen as aspirational. Back in 2010 when the original target was set - to double trade with China (to $20 billion) in five years - the goal might also have been viewed as a bit of a stretch.
But move forward a few years: New Zealand's trade with China has grown to around $18 billion and targeting a 66 per cent increase over the next six years now looks a lot less daunting.
The increase in recent years has largely been driven by strong growth in exports. Exports now comprise more than half of our trade with China, and this trend is likely to remain a feature of future trade growth between the two countries.
The steep rise in export growth over the past few years has been largely driven by the emergence of industrial Asia and the resultant rise in demand for raw materials.
With demand outstripping global supply, the world is now paying top dollar for raw materials NZ produces competitively, and very little for transformation of those raw materials into finished goods.
New Zealand has adapted well to these global price signals over the past decade with migration towards the production and export of raw materials that also meet an increasing requirement for higher and safer standards in production.
In the year to December 2013, New Zealand exports to China were dominated by soft commodities (73 per cent of total export volumes) that left these shores with limited value addition. As an example, of the $2.8 billion of forestry products exported to China over that period, rough wood exports equated to $1.7 billion, with prepared wood (timber, wood pulp and paper) comprising almost 100 per cent of the residual.
In the short to medium term New Zealand is likely to travel further down this path and we can expect to see more milk powder and log exports, fewer sawmills, more wool and fewer carpets. For meat exporters, the increasing appetite of Chinese processors to complete value processing onshore is likely to result in the export of higher volumes of less-processed product (e.g. slaughtered carcasses).
The weighting towards raw materials reflects China's relative efficiency in the execution of transforming raw materials in to finished goods, and as a consequence they do not need to pay a large margin for transformed goods. With the key driver of efficiency being lower labour costs, the options to make the cost-benefit equation work in favour of transformed goods from NZ can only lie with further productivity improvement, maintenance of quality and / or new innovation not easily replicated in the short term.
The current position represents a classic example of free trade gains resulting from activity between trading partners reflecting the relative strengths of each - and this has to date been positive for the NZ economy.
Demand for NZ commodities is positively out of step with the broader global commodity story and you could argue we have in part been able to "capture" the value of Chinese productivity and cheap labour as a result of our ability to meet both the rising demand for protein flowing from increasing Asian urbanisation and the requirement for higher standards of food safety, in particular from China.
We would also propose that the formalisation of the significant investment undertaken over prior decades to build the NZ relationship with China through the 2008 Free Trade Agreement has offered a preferential advantage that has directly led to an increase in volume and value that can be ascribed to exports between our two nations.
Looking forward, global demand and supply dynamics are likely to result in increased competition from alternate sources of supply meeting Chinese demand (including the development of their own domestic food production practices).
For New Zealand to continue to benefit from trade with China focus needs to remain on ensuring the economy is as productive as it can be to maximise the value derived from increasing trade flow that carries heavy commodity characteristics.
This will require continuing investment in R&D driving production efficiency and quality gains across all parts of the commodity supply chain. Any inefficiencies and excess capacity within domestic manufacturing, transport and the broader services sector will need to be addressed as well as the development of a broad based ethos of continuous improvement in efficient and sustainable farming practices that support the current value ascribed to NZ's reputation as a source of "safe"food products.
With the above points in mind the argument that we should be adding more value to exports domestically in our trade with China becomes defendable, if we can point to some distortion that impedes the efficient functioning of the economy i.e. features that distort the true cost of production and therefore provide preferential advantage or disadvantage between industries. In NZ's case, possible distortions impeding additional value creation could include:
A lack of capital gains tax which when combined with the existence of income tax results in the situation where land-intensive forms of economic activity, such as farming or rental property ownership, may be taxed more lightly than other types of economic activity, such as manufacturing or earning a wage.
When you combine this with the natural climatic and environmental advantages supporting food production in New Zealand it is unsurprising that New Zealanders tend to opt for the land-intensive types of production over more labour intensive industries carrying a higher resultant cost.
Our very high exchange rate which negatively impacts on industries offering services domiciled in NZ such as tourism, education, health etc to offshore purchasers. However, intervention to manage down the exchange rate would require the implementation of capital controls, which could have very high unintended costs for the broader NZ economy. And of course, a lower exchange rate would reduce the wealth and income of anybody who owns or earns New Zealand dollars. This may not be something we want - countries that artificially undervalue their exchange rates are essentially subsidising foreign consumers at the expense of their own.
New Zealand is well-positioned to benefit from increasing trade with China as long as we ensure that we do not fall in to the trap of believing that the products and services, including quality, we offer are not easily replicated by others also seeking to participate in the economic boom created from the industrialisation of one of the world's largest economies.
Sustained benefit will come from ensuring we continue to focus on both sustainable and efficient production of those goods and services currently in demand and, importantly, investment in R&D to identify and commercialise offerings that meet the next wave of global consumer demand.
• Karen Silk is General Manager Corporate & Institutional, Westpac.