Submission from Norrish to Talboys

Wellington, 15 December 1980

The Benefits to New Zealand from a Closer Economic Relationship with Australia

1. You asked for an assessment of the benefits to New Zealand from a closer economic relationship (CER) with Australia.
2. This paper takes account of developments at the Joint Permanent Heads meeting held in Wellington on 10 and 11 December. Because of the tight timing constraints, it has not been possible to seek the views of other Departments.

Scope of Paper

1. Officials have not yet attempted a comprehensive assessment of the benefits likely to arise for New Zealand from a CER along the lines now emerging. This is, therefore, a preliminary attempt to specify the more important economic and trade benefits. It does not attempt to examine any costs arising from a CER (eg any trade diversion costs, adjustment difficulties). Nor is it an attempt to examine the balance of advantage. That would require a separate evaluation of the concessions likely to be offered Australia by New Zealand.
2. The benefits can be grouped under four general headings: 1. direct (static) gains for New Zealand 2. long-term (dynamic) economic benefits 3. so-called ‘damage limiting’ benefits-ie what is the future of the NAFTA status quo if the CER exercise fails? 4. bilateral and regional foreign policy benefits. The first three are examined in tum below. We have not attempted to sum up the foreign policy benefits in this paper, but essentially they tum upon the desire to get in place a more appropriate structure for the economic and trading relationship and the creation of a stronger base for the expansion of economic and trading links with the Pacific and S E Asia.

Direct (Static) Trading Benefits

1. An analysis of the effects of eliminating tariffs necessarily considers the present structure of exports. Of course, if the tariffs being applied to New Zealand exports are having a trade-inhibiting effect, the exports will, by definition, be small. With that caveat, it should be noted that about three quarters of New Zealand exports by value are accorded duty-free treatment under NAFTA. The CER formulae for phasing out tariffs, therefore, will presumably have little or no direct effect on the greater part by value of existing New Zealand exports.
2. On the basis of Australian import clearances in 1978/79, some $44m worth of imports from New Zealand were accorded duty-free treatment because of Australian by-law approvals (analogous to New Zealand’s tariff concessionary system). The eventual elimination of tariffs, and the binding of rates to duty free, will thus confer a greater degree of security for a significant part of New Zealand exports already accorded duty-free treatment.
3. The benefits of eliminating tariffs on New Zealand dutiable exports (worth some $85m in 1978179) will naturally vary considerably from commodity to commodity.
4. It is clear from recent trade surveys and a major survey conducted by the NZIER in December 1979 of New Zealand’s 200 largest companies involved in the trading relationship that Australia has become a very competitive (and thus price-sensitive) market. The NZIER survey asked exporting companies to rank ‘trade-inhibiting factors’. After ‘transport costs’, ‘lower third country prices’ and ‘lower Australian prices’ were ranked respectively as the second and fourth most important factors inhibiting New Zealand exports. The removal of even relatively low tariffs on the (approximately) quarter of New Zealand exports by value now subject to duty could, in such circumstances, make the difference between making a sale and not making it. Certainly, some individual New Zealand exporters have indicated they see definite advantages in eliminating the Australian tariff on products of interest to them.
5. Many of New Zealand’s current or potential export winners (eg whiteware, carpets, apparel, cheddar cheese) are subject to Australian quantitative restrictions. The eventual elimination of current QRs will thus confer an important benefit on New Zealand.
6. The CER, in its present form, will not permit the imposition of new QRs. Therefore, under a CER, New Zealand exporters could depend on assured access to the area market. It could encourage New Zealand firms to make the investment decisions necessary to exploit the full economics of scale inherent in the area market without the possibility of a ‘dollar for dollar’ approach being imposed on them if they are successful.
7. The eventual removal of ‘gentlemen’s agreements’ that operate in some key agricultural areas (eg peas and beans, butter, non-cheddar cheeses) would confer important benefits on New Zealand. Although negotiations are only now beginning in earnest on these sensitive items, the Ministry considers Australia has already signalled these areas are negotiable and there is no reason why New Zealand should not at least be able to attain a useful base and assured growth in the Australian market thereafter. For political reasons, the form of any arrangement along these lines would clearly need the most careful consideration.
8. It should be noted that this very general assessment of trading gains in paras 5-11 above assumes Governments will endorse procedures for handling the deferred list of sensitive items along the lines recommended by Permanent Heads. The main issue at stake is a set of procedures which have been evolved effectively to guarantee eventual automatic movement of these sensitive products off the deferred list so as to make them subject to the tariff and access formulae. Thus, although New Zealand will hopefully negotiate a ‘deferred list’ which contains few items of significant export interest, at the end of the transitional phase, all goods would benefit from the CER rules eventually.

Longer-Term ‘Dynamic’ Economic Gains

1. The impetus a CER is likely to give to the further development of a more efficient, competitive and export-oriented New Zealand economy has been identified by many as an area of key importance. Earlier studies by Australian officials concluded that New Zealand will make much greater gains in this area than Australia and there are a number of theoretical reasons for accepting this conclusion.* [Footnote to original text reads: These issues were discussed in some detail in the 1979 NZIER study ‘Administrative Options for Closer Economic Relations between Australia and New Zealand’.] The 1980 Budget highlighted the contribution this exercise could make to a gradual restructuring of the New Zealand economy, particularly since a CER would complement other elements of the Government’s growth strategy.
2. In the final analysis, any assessment of the benefits in this area rests on a prior judgement: namely, whether it is considered that gradual and progressive trade liberalisation is likely to bring desirable changes to New Zealand’s industrial structure as it has evolved from policies of import substitution and high protection.
3. If the general case for gradual and progressive trade liberalisation is accepted, then this process of bilateral trade liberalisation could be considered a more palatable path than any unilateral removal of trade barriers, even if the latter could be expected to confer greater gains in pure economic terms. First, bilateral trade liberalisation has fewer adjustment difficulties (we are required to compete with a relatively high-cost country). Second, the pace of change can be controlled through the mechanisms of the arrangement which have been carefully designed to ensure gradual and progressive change. Finally, it may be more readily understood by the community since a CER will confer reciprocal benefits for New Zealand exports in return for lowering of New Zealand trade barriers. The CER is not a substitute for other approaches to trade liberalisation. But it could contribute towards a process of general change in protection policy if experience so gained under the CER appears to warrant it.
4. New Zealand officials have not attempted any quantification of these general, economic benefits. However, the Department of Trade and Industry carried out a study in October 1979 in an attempt to assess the broad competitive trends (‘The Potential for Trade Creation and Trade Diversion on the Basis of the Relative Competitiveness of Australian and New Zealand Industries’).
5. The study was based on an extreme proposition: a full customs union or free trade area overnight. No allowance was made for the gradual phasing in of trade liberalisation. The results of this study can be summarised as follows: * of the 83% of the sample of industries surveyed for which it was possible to make an assessment of their competitiveness vis-a-vis Australia, 50% (by value of production) could be expected to be able to benefit from expanded opportunities in a CER. These industries accounted for 53% of New Zealand’s manufactured exports. * 33% of the sample were not considered able to compete with Australia in their present fonn and under immediate duty free trade and unrestricted access.
6. The study illustrates a general point: those activities which New Zealand does best will prosper under a CER with Australia. Those industries involved in activities in which New Zealand is less efficient will face pressures to restructure. Provided the latter group of industries are given time to adjust (and the CER mechanisms developed in the 14 months since the survey are designed to do that), this pattern of development could be considered consistent both with Government policy and changes already taking place in the market place itself.
7. A CER could stimulate foreign investment in New Zealand from Australia and third countries. While opponents of the NAFTA in the 1960s argued the NAFTA would cause a ‘flight of capital’ across the Tasman, this did not occur. Some firms could well relocate in Australia under a CER but a recent survey by the Confederation of Australian Industry (CAI) suggest there could be strong incentives for Australian firms to relocate in New Zealand if their access to the Australian market was guaranteed.** [Footnote to original text reads: ‘The CAl surveyed its members who had subsidiaries operating in New Zealand. It discovered that, on average, the cost to these companies of employing labour in comparable activities in New Zealand was less than half (47%) the cost in Australia. This huge discrepancy was accounted for by lower wage costs in New Zealand and much higher “on-costs” in Australia (eg the generous holiday loadings).’]
8. Foreign firms could conceivably prefer New Zealand as a location within the single area market, particularly where such companies were interested in a base for their regional operations. The lower labour costs, New Zealand’s generally better industrial relations, New Zealand’s more generous export incentives (the CER will not involve any disciplines on export incentives applied to third country exports), and the absence in New Zealand of complex State/Federal regulations could all be factors here.
9. Clearly, the impetus a CER could give to foreign investment must remain a matter for conjecture. On balance, we consider New Zealand might do quite well from a CER on this score, particularly if this initiative were well received in financial circles and the general perception of New Zealand’s future prospects was enhanced.
10. There is a range of other long-term economic benefits known, in economic terms, as ‘X-efficiency gains’. Simply stated, this means that a CER could lead to improvements in any number of economic practices and institutions where inefficiencies have been allowed to creep in over the years. For example, a more competitive environment could put pressure on any outmoded regulatory mechanisms, the use of inappropriate industrial or service inputs, bad accounting practices: competition tends to have a cumulative effect.

‘Damage-Limiting’ Considerations

1. The CER exercise arose essentially because NAFTA was recognised as having ‘run out of steam’. It was no longer seen as providing an impetus for growth in trade. Recent Schedule A additions had become more and more trivial.
2. Any assessment of the benefits to New Zealand from a CER must consider the other side of the coin: what are the prospects for the trading and economic relationship under the NAFTA status quo?
3. The Ministry recognises this is an area in which it is difficult to arrive at definitive judgements. However, in general the ‘status quo’ option seems to hold the prospect of a loosening of economic ties and increasing frictions in the trading relationship best summed up in that infelicitous Australian phrase ‘dollar for dollar’.
4. Specifically, while it is considered goods on Schedule A would remain duty free, the likelihood is: * there would be no new Schedule A additions unless New Zealand offered equivalent access opportunities. * existing article 3:7 arrangements would be allowed to run their course and then lapse. These cover important New Zealand exports such as whiteware. * the Preferences Agreement1 which is up for renewal in 1981 would not be renewed, or would be substantially revised. Of all the possible deleterious changes, this could be the most serious for New Zealand manufactured exports. * special quota arrangements negotiated under the NAFTA umbrella would come under severe pressure from Australia, as has occurred with the case of apparel.

Conclusion

1. This assessment has sketched some of the benefits on a very general level. As negotiations progress it should be possible to refine the analysis considerably with greater emphasis on a commodity by commodity examination. It could be said, however, that the main purpose of the CER is to establish a framework for our most important economic relationship that is consistent with the direction of the broad economic policies of both countries. By removing the considerable uncertainties that have arisen in the NAFTA context, it is hoped to establish a climate for the growth of new and existing export industries in New Zealand based on free access to a market of 17 million people.

[ABHS 950/Boxes1221-1226, 40/411 Part 32 Archives New Zealand/Te Whare Tohu Tuhituhinga 0 Aotearoa, Head Office, Wellington]

• 1 The 1977 Agreement on Tariffs and Tariff Preferences.