Submission to Cabinet Economic Committee

Wellington, 19 October 1979

No. E (79) 208. CONFIDENTIAL

Australia - New Zealand Economic Cooperation

Background

1. At its meeting on 21 August, Officials reported to the Cabinet Economic Committee on preparations for the meeting of the Prime Ministers of Australia and New Zealand that is to be held in February 1980.
2. A team of Australian Officials, that will include the Permanent Heads of the Department of Trade and Resources, Prime Minister and Cabinet, Industry and Commerce and Foreign Affairs, as well as senior officials from the Treasury and the Department of Business and Consumer Affairs and the Department of Primary Industry, will visit Wellington for discussions with their New Zealand counterparts on 1-2 November 1979.

General

1. Attached is a report of the Chairman of the interdepartmental Working Party that has been coordinating the work that Departments have been undertaking on the opportunities and implications of any moves by Australia and New Zealand to seek a closer economic relationship. This report incorporates in summary form the main points that emerge from the various working papers that have been prepared by individual Departments. These papers have been prepared with a view to their forming a general basis for discussion at the Permanent Heads meeting on 1-2 November. It is intended that suitably abbreviated versions of these papers should be handed to the Australians in advance of the meeting. Papers prepared by the Australian side, which will be handed over to us at the same time, will serve a similar purpose. The full papers, which it is not proposed should be given to the Australians, will form the basis of the brief for the New Zealand side for the meeting. It was thought inappropriate at this stage to attempt to formulate recommendations on the specific forms of any new trading arrangements and policies on such matters as import licensing, export incentives, tariffs, etc. The papers, and therefore the attached report of the Chairman of the Working Party, represent an initial exploratory survey of the issues that are thought to be at stake in the Australia - New Zealand economic relationship.
2. The discussions expected to take place at the 1-2 November meeting will be exploratory in nature. It is hoped that the two sides will be able to isolate the basic issues that would underly any move by Australia and New Zealand to seek an economically closer relationship, and that on the basis of this understanding, further work can be undertaken by both parties in preparation for the meeting of Prime Ministers that is expected to take place around February 1980. It is considered likely that officials from both countries will want to meet again before the Prime Ministerial meeting to seek agreement on the specific areas of the Australia - New Zealand economic relationship which should be the focus of attention for the two national leaders when they meet.
3. A copy of a draft agenda for the 1-2 November meeting, in the form of a telegram to the New Zealand High Commission in Canberra, is attached.
4. Officials are keeping under review the question of consultations with interested groups such as the Manufacturers’ Federation, the Federation of Labour, and the Australia/New Zealand Businessmen’s Council. It is agreed that any formal consultations with such groups should be conducted on the basis that the work undertaken so far does not lead to any conclusions being reached about the kind of policies or institutional structures that might be sought for regulation of the growth of trans-Tasman trade, and that no conclusions are being drawn about the more specific areas of cooperation, such as the development of specific sectors of the economy or joint approaches to deal with the world at large.

Recommendation

1. It is recommended that the Committee: 1. note the approach, outlined in the report of the Chairman of the Working Party on Australia- New Zealand Economic Cooperation, that New Zealand officials will adopt in their discussions with their Australian counterparts at the Permanent Heads’ Meeting on 1-2 November 1980; and 2. approve the draft agenda for the meeting contained in the accompanying draft telegram to the New Zealand High Commission in Canberra.

Attachment

Report of Working Party on Australia - New Zealand Economic Cooperation

PREFACE

The work summarised in this brief arises from the decisions of the Prime Ministers in Lusaka to investigate possibilities for closer economic cooperation. Those decisions built on events including work for the Nareen meeting and was stimulated by the visit of Mr Anthony early this year. (CEC paper Australia-NZ Economic Cooperation: Progress Report, C (79) 162 refers).1 The work described below follows the programme laid out in that paper. The Prime Ministers agreed in Lusaka on the following points:

• review the full range of options in a positive spirit and investigate both general and specific areas of cooperation;
• exchange information between officials of both countries;
• Prime Ministers to meet in February 1980;
• rapid structural changes of a ‘drastic’ nature are to be avoided in any moves to greater cooperation;
• Australia and New Zealand should join forces wherever possible in facing the outside world.

The Working Party was established to examine the possibility of closer economic cooperation and to assess the implications for NZ’s economic strategy against the broad background of New Zealand’s continuing search for economic and trade opportunities wherever these can be found. In identifying additional opportunities for growth in the trade and economic relationship with Australia, equal attention has been paid to identifying the accompanying costs, but recognising that in the end the nature of the exercise is a search for new growth opportunities in the bilateral relationship with Australia.

SECTION I

Introduction

The subject of closer economic relationships between Australia and NZ is vast. It poses endless questions for many of which we can never hope to have precise answers. As yet we have only accomplished the first stage of analysis of these questions and there is much that remains to be done to dispel the mists of uncertainty which envelop the subject. It is all but impossible to construct a programme of research that leads to a clear conclusion as to what would be the precise long-run advantages and disadvantages to NZ’s interests of various schemes for a closer relationship. This is not surprising considering the experiences of other countries in developing closer economic relationships. The final effects have rarely been predicted with any certainty although it can fairly be said that the disruption has never been as great as was feared. This lack of certainty need not of itself inhibit movement towards closer economic relations. The precedents show that closer relationships between countries do not come about from blind commitments to some precisely defined future relationship. Rather, agreement is reached to establish procedures to negotiate changes in the policies that regulate the relationship against the background of a general commitment to closer cooperation. As a consequence of this commitment greater weight is given to expanding the relationship when national economic decisions are made. Such agreement establishes a direction of change but the Governments can modulate the pace of change to ensure adequate safeguards to deal with problems as they arise. The essential point is that to begin such a process it is not necessary to know precisely where it will end. What is required to make a decision to start the process is the knowledge that closer economic cooperation in some form is consistent with national economic development strategy.

It is also necessary to know what issues should be addressed in the foreseeable future if a move is taken in that direction.

The attentions of the Working Party on Australia-NZ Economic Cooperation have been directed at these questions. The work is preliminary but is suggested as the appropriate basis for introducing interdepartmental discussion and talks with Australian officials. The following numbered paragraphs contain some broad conclusions drawn from each of the various working papers and it is hoped that this will convey an overall perspective on the work so far. Papers on transport, energy industrial development and the joint marketing of primary produce are nearing completion and it is anticipated that these will be added to the brief for the Permanent Heads’ meeting.

1. New Zealand’s Development Strategy

Poor growth performance by the NZ economy has led to a reappraisal of development strategy and it is being reoriented towards a more efficient use of resources to achieve a more internationally competitive economy capable of a better performance in world trade. Considering that Australia has already made substantial progress along similar lines the NZ strategy would likely be advanced by closer cooperation with Australia. While trade under the existing arrangements has increased it has been based in part on exploiting the differences in the two countries protective structures regarding raw materials and semi-finished goods. This has not often resulted in the establishment of internationally competitive industries. As we have no choice but to develop such industries there is little long-run advantage in continuing to expand trans-Tasman trade on this basis even if Australia were prepared to perpetuate the past approaches. Consequently it is in NZ’s interests to seek to expand cooperation with Australia but on a basis that is more consistent with the merits of our own economic development strategy.

1. Australian Development Strategy

The path of Australia’s industrial development is fairly clearly in the direction of greater international competitiveness and less reliance on high levels of protection. Movement will be cautious, particularly in respect of labour intensive industries and in periods of unemployment. At times there will be steps backwards but the policies have been followed for many years and it is expected that they will be followed for years to come.

1. Relative Competitiveness of NZ and Australia

It was noted in the introduction that conceptual and empirical problems rule out a full assessment of the net gain in welfare to NZ of lowering the barriers to trade between the two countries. The dynamic effects on the economy of freer trade would have to be analysed considering the time phasing of the changes and the form of the arrangements chosen. Besides the effects on the protective structure of the economy the effects on consumption of having a wider range of goods at different prices would have to be accounted for. While this full assessment is unlikely to be achievable the short-term effects on the production side can be assessed. Any move to a more open trading arrangement would change the configuration of pressures for rationalisation and new investment in NZ industries. The short-term problems of managing any new arrangements will arise from the first-round impact on industry. With this in mind an assessment has been made as to the competitiveness of NZ industry by comparison with Australia. Aside from indicating the sectors of industry where freer trade could be expected to lead to growth or retrenchment this study indicates the potential for diversion and creation of trade under free-trade and customs union arrangements. It indicates the possible balance of advantage from NZ’s point of view. The study shows that roughly half of New Zealand manufacturing industry (by number of establishments, employment, output and exports) would be expected to benefit from unrestricted free trade. Another quarter constituted a grey area. It contains companies which would be likely to adjust successfully to the changed economic circumstances. Other companies in this group would not. The final quarter comprised those industries and companies which would be unlikely to survive in their present form in the longer term. On the basis of an assumption of a free trade area with low area-content rules and a customs union with relatively high external tariff rates the paper concludes that a free trade approach is less conducive to the diversion of trade than is a customs union. However, it concludes that by itself the study is not a sufficient basis for drawing conclusions about the most appropriate nature and pace of change.

1. Coordination in Major Industrial Developments

Australia is much better endowed with industrial raw materials than New Zealand which constrains the scope for cooperation in this area. There is some scope for coordination in some manufactured products and finished goods. Overall there is likely to be competition between New Zealand and Australian industry in both world and domestic markets.

1. Implications for New Zealand’s Other External Interests

The external implications of a closer economic relationship with Australia are balanced in favour of pursuing such a relationship providing it is based on the adoption of complementary growth strategies. It is assessed that an outward-looking trans-Tasman partnership would have the capacity to devote greater resources to economic development within the region, trade would prosper and the stability and security of the region would benefit. In such a development New Zealand’s distinctive historical role in the Pacific, which is an essential element of New Zealand’s external relations, would be enhanced. On this basis therefore there would be much to gain, both for New Zealand and for the region as a whole. The extent to which New Zealand could continue to claim ‘special’ treatment for traditional exports to some traditional markets, and the degree to which other governments concerned felt particular obligation towards New Zealand, could be reduced. On the other hand such effects would be offset by the extent to which the new Australian relationship opened up new opportunities. There will be some difficulties to overcome in protecting the legitimate interests of developing countries of the region in the course of developing a closer relationship with Australia. None of these is expected to be insurmountable.

1. Comparison of Australian and New Zealand Tariffs

A series of partial studies comparing Australian and New Zealand tariffs lead to several broad generalisations to which there are of course exceptions. The Australian tariff is the main instrument of protection and as such has been tested by the market and is an expression of the Government’s strategy. This is not the case in New Zealand and it is likely that there will be considerable pressure in any rationalisation for New Zealand to adopt Australian tariff levels. New Zealand tariffs are generally higher than Australian tariffs where both countries have an industry to protect and the New Zealand tariff is also supplemented with import licensing. In the area of consumer goods New Zealand’s protective policies are considerably more restrictive but this is less so in the intermediate goods area. Imports of industrial raw materials and capital goods which New Zealand does not produce are subject to very little intervention. To the extent that Australia protects these same goods its tariffs are also much higher. Hence a simple adoption of the Australian tariff by New Zealand could reduce protection on final goods and raise the costs of some industrial inputs. Rationalisation of tariff structures need not of itself require termination of import controls but this could be considered particularly where Australia has tariff quotas and high rates of tariff that provide similar levels of protection.

1. Free Trade for Agriculture

Most NZ agriculture products already enter Australia free of tariff. The exceptions are a few preserved vegetables, fresh onions and potatoes, milk powders, apples, butter and alcoholic beverages. Quotas apply to cheddar cheese and pig meat and there is voluntary restraint on meat, peas and beans. The largest items in the trade are vegetables, fish, wool, cheese, fruit, seeds and boneless beef. There have been substantial increases in some of the non-restricted categories in recent years. If restrictions were lifted from cheese, beef, some milk preparations and preserved and fresh vegetables, increased exports could be expected. NZ butter and cheeses may not have a price advantage in Australia if Govt subsidies were harmonised. NZ has quantitative import controls over a much wider range of agricultural products than does Australia. Tariffs are also applied. The sole rights to import wheat, pip fruits, citrus fruits and eggs rest with marketing boards. Removal of these inhibitions to imports could see increases in imports of wheat, canned fruit, and citrus fruit during the NZ season, apples, wine and possibly tobacco. Each of these local industries might have to face up to rationalisation to some degree.

1. The Monetary Sector and the Exchange Rate 1. THE EXCHANGE RATE Trade between Australia and New Zealand is quite sensitive to changes in the exchange rate. The improvement in New Zealand’s competitiveness is one factor behind the reduction in our trade deficit with Australia over the last ten or fifteen years. Economic integration, even if confined to a closer trade relationship, could benefit from consultations about the methods of fixing the exchange rates of the countries with a view to reducing to a minimum unnecessary fluctuations. It should be recognised that any attempt to impose a static exchange rate while economic conditions, particularly inflation rates, differ, would hinder rather than promote trade. The implications for the exchange rate of lower tariffs, import restrictions, subsidies and exchange control which might result from integration would have to be borne in mind as negotiations proceed. 2. EXCHANGE COTNTROL Exchange control policy on current payments is already quite relaxed in Australia and New Zealand, but relaxation of controls on capital payments across the Tasman could be considered. It is possible, even likely, that a considerable outflow of capital for investment purposes would develop, unless the return on investment in New Zealand appeared competitive with Australia. As an intermediate step, it may be possible to negotiate some relaxation while continuing certain exchange controls as safeguards. The speed with which exchange controls are dismantled has important implications for the exchange rate and for monetary policy. If steps were taken in this direction, a need for a common policy vis-a-vis the rest of the world would emerge. 3. INTEGRATION IN THE FINANCE SECTOR It is not suggested that integration in the finance sector should be high on the agenda for negotiation with the Australians. However, steps in this direction would assume greater significance if barriers between the capital markets were to be broken down. Many legal, administrative and policy questions would arise. Matters which might deserve attention are financial regulation, the operation of branch offices, taxation, financial instruments and insurance.
2. Foreign Investment Policy

Foreign investment plays a significant role in the development of both Australia and New Zealand. Direct investment flows from Australia to New Zealand in the last few years exceeded flows in the other direction by a very large margin. New Zealand’s approach to regulating foreign investment is broadly similar to Australia’s.

Although there are economic arguments which favour liberalisation of foreign investment policy vis-a-vis Australia, there is little reason to expect that substantial new flows will result from such a step taken in isolation. It is possible, even likely, that flows stimulated by liberalisation would tend to favour Australia. An argument in favour of liberalisation is that it would permit rationalisation of industries which are established in both countries and which are involved in trade.

Discriminatory relaxation raises the question of whether general relaxation would be preferable. This parallels arguments regarding trade in goods. A relaxation vis-a-vis Australia alone would be contrary to the OECD code unless it were part of a special monetary or customs system. (The same issue arises for exchange control policy.) There would be many administrative difficulties, including identification of the source of foreign investment, and the enduring problem of foreign ownership in key sectors would remain.

1. Institutional Issues

While NAFTA is intended to provide a mechanism to work towards free bilateral trade the arrangement whereby the private sectors of either Government can prevent the addition of items to the schedules means that tariffs are removed in areas where neither side could anticipate any reduction in the level of its own trade. Hence the development of trade has not been based on comparative advantage and promoting the growth of internationally competitive industries which is the economic justification for free trade arrangements. However while a variety of institutional arrangements can be contemplated for the development of free trade areas the character of any mechanism must derive from the pattern of economic and trade relations that apply with and between member countries and debate about such arrangements cannot be separated from debate about the nature of relationship as a whole. The removal of non-tariff barriers represents a more difficult objective than the lowering of tariffs but is facilitated by the existence of broad understandings as to common economic objectives. Any institutional arrangements must act as positive instruments to balance pressure for maintenance of the status quo.

Conclusion

The main theme reflected in the contributions to this brief and perhaps its central conclusion is that closer economic relations is only likely to succeed against the background of close political and social sympathies and provided that there is reasonable harmony in the policy objectives of the two countries and especially their economic policy objectives. The divergence of the two economies in recent years partly explains the difficulties with NAFTA and further divergence particularly in policies on protection would make progress in the relationship more difficult. Greater harmonisation of the two economies might conceivably by pursued by both countries pursuing an inward-looking protectionist stance in relationship to everyone except each other. It is difficult to imagine why either country would find such an arrangement in its own interests if only because protectionist economy still seeks to obtain its imports at the cheapest prices available in the world. A closer relationship is therefore conceived in this brief as being within the context of outward-looking trading strategies in both countries. Hence the implementation of the Government’s economic strategy evolved in recent years and perhaps most concisely expressed in the last Budget is fundamental to the development of a closer relationship with Australia. Growth strategy based on the development of internationally competitive export industries is assumed for NZ.

Any resources released from sectors unable to compete over the longer term are to be absorbed by the more competitive sectors and by the major new industrial developments in prospect. In tandem is the assumption that Australia will continue to pursue policies that in many respects place it further ahead in the conception and application of this approach than New Zealand. With these assumptions of more liberal trading tendencies in both countries many of the potential problems of closer economic relations are minimised because greater trade with each other is fixed within that general framework. Hence expanded trade between the two countries cuts off few options for the expansion of trade with other countries. Also the prospects for significant diversion of trade are reduced and there is a lower risk that NZ adapts its economy to match a larger Australian economy which is not itself adapting to the world trade scene at large.

For the purposes of the initial discussion and briefing for the Prime Ministers meeting in Lusaka it was a useful simplification to think in terms of a spectrum of alternatives from limited free trade area to full economic union. At this stage of the analysis these concepts are too crude to be a helpful basis for further study because the conditions of a customs union or a free trade area can vary widely and the arguments for or against any such option depend entirely on the particular characteristics of the broad options that are established. To derive the guidelines for further analysis it is more important to set in place the principles around which any arrangement is to be designed rather than simply selecting a single form of institutional arrangement. It is important to establish what the elements of a more cooperative relationship will be rather than to jump to early conclusions about the particular institutional forms.

Both Governments have indicated their dissatisfaction with present arrangements and this brief offers an analysis of why the status quo is unsatisfactory. In short it is because these arrangements have not encouraged trans-Tasman trade in a pattern consistent with outward-looking national economic strategies aimed at the development of internationally competitive industries.

The next step towards making significant progress in the relationship is to reach agreement within and between the two Governments on the following points:

1. Both countries are pursuing outward looking development policies to achieve greater trade through more efficient agricultural and industrial development;
2. A closer relationship between the two economies set along the right lines is consistent with the pursuit of these policies;
3. The pattern of trans-Tasman trade has not been entirely consistent with developing such a relationship;
4. While changing the nature of the relationship along these lines would enhance long-term economic prospects it would also involve structural adjustment problems that would have to be addressed.

The work done so far and summarised in this brief shows that there are wide ranging possibilities for developing the relationship and some serious problems that would need to be analysed and policies developed to cope with them.

However, if agreement on these basic points could be reached then it would be fruitful to consider in detail the means to achieve a closer relationship. Future work should be directed at these specific quarters and the scope of this work will be defined by the outcome of the Permanent Heads’ meeting.

GC SCOTI Chairman

Interdepartmental Working Party

[ABHS 950/Boxes1221-1226, 40/411 Part 21A Archives New Zealand/Te Whare Tohu Tuhituhinga 0 Aotearoa, Head Office, Wellington]

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