Ex-Cabinet Minister turned OECD official Simon Upton highlights range of risks facing NZ economy over 40yrs including global warming, pollution, pandemics, war, financial crises, deficits...

By Alex Tarrant

She's a hard road travelled finding someone more pessimistic than Bernard Hickey, but that journey may just be over.

Delegates at a Treasury-Victoria University conference on the government's long-term fiscal projections this week were treated (subjected?) to a half hour presentation of the risks facing New Zealand's economic outlook from former National Party Cabinet Minister, now Organisation for Economic Cooperation and Development (OECD) official, Simon Upton.

His message? Don't bank on 40 year projections which don't recognise the risk that the economy will be hit by a major shock (or major shocks) during that time. Because it will.

You can read Upton's full speech to the conference here, or watch it in the video above.

Below are a few key comments:

A much larger economy would place increasing pressure on the planet’s capacity to absorb waste and supply vital ecosystem services, Upton said.

"The baseline case (with no policy change) for the OECD Environmental Outlook to 2050 projects the global economy to almost quadruple by 2050 from US$75 trillion to US$300 trillion. The OECD’s share of the global economy will decline from a little over half global GDP (54%) to less than a third (31%)," he said.

"Needless to say NZ becomes an even more vanishingly small element of a much less familiar geo-political world."

No country would be immune from the global environmental pressures of such a world whose impacts would be transmitted directly (as in the case of climate change) or indirectly (through declining environmental quality affecting global supply chains).  

"The Outlook’s baseline case projects that the world is on course for a 3-6 degree increase in global average temperature by the end of the century (2-3 degrees by 2050), a 55% increase in demand for water (with 40% of the world’s population living in areas of severe water stress by 2050), a further 10% decline in biodiversity by 2050 and more than double the number of premature deaths from airborne pollution (particulate matter and ground level ozone)," Upton said.

In some cases (notably airborne pollution) the ageing profile of OECD populations would place them at particular risk.

"As an open economy, New Zealand can expect to feel the consequences of rising resource scarcity and environmental damage through trade linkages and directly experience the local consequences of globally-induced climate change," he said.

"Depending on the severity of environmental pressures, New Zealand could become an increasingly desirable destination for migrants as well as benefit from demand for the biological output of its resource base in a world needing more food.

"The global scale of potential climate change has reinforced the impression that environmental change is the most likely source of catastrophic risk.  This may not be so.  For a carefully measured assessment of the relative orders of magnitude that can reasonably be attached to known risks, Smil (2008) is essential reading."

Viral pandemic, mega war

"On the basis of a rigorous assessment of the known statistical level of exposure to risk of fatality caused by large scale catastrophic events, Smil identifies only one risk emanating from the natural world – a viral pandemic – to which a high probability of mortalities in the region of 10⁵ (10 to the power of five) can be attached within the next fifty years.  He ascribes a similar level of probability to a mega-war (defined as a ‘potentially massive armed confrontation’)," Upton said.

"Conflict is not good for smoothly advancing prosperity. To those inclined to dismiss such risks, Smil counsels pondering on the ubiquity throughout history of irrationality, the drive for power and dominance and how as a species we might respond to unpleasant social and environmental developments:-

Doing that might lead one to conclude that despite many localised problems, the second half of the twentieth century was an exceptionally stable and an unusually benign period in global terms, and that the probabilities of more painful events will greatly increase during the next 50 years."

Natural hazards, biological risks

Then there were natural hazards and biological risks.

"New Zealand’s vulnerability to seismic and volcanic events is well known. I barely need to mention it in this city or after the Christchurch earthquakes," Upton said.

"Natural disasters have the potential to impose economic shocks that knock New Zealand’s growth prospects and thereby undermine the government’s ability to raise tax revenue.  

"Prudentially, New Zealand’s geological endowment requires the Government to run its finances on the basis that it will have to face recurrent fiscal burdens in the same way countries like the Netherlands face water management expenditures or other countries face significant defence expenditures for geo-political reasons," he said.

"A similar reasoning applies to New Zealand’s relatively high exposure to biological risk given the biological base of the economy."

Climate change

While not a ‘natural’ disaster in the same sense, anthropogenic climate change posed unknown but potentially significant economic risks within the 40 year horizon under consideration.  

"Significant climate change is already locked in and global emissions trajectories suggest that the chances of holding average global temperature increases to 2 degrees are fast dwindling,"Upton said.

"The global community faces a choice in the next decade of either acquiescing in significant climatic disruption or costly adjustment because of the failure to take comprehensive measures over the last twenty years," he said.

Acknowledgement of risks not matched by action

Like many countries, New Zealand’s stated acknowledgment of the risks was not matched by actions that could significantly reduce those risks.  

"While the costs of placing economies at a competitive disadvantage from acting unilaterally are prominently advertised, the costs of a collective failure to act are discounted," Upton said.

"This is a long-run challenge that will not go away and the costs that will be encountered either adapting to the consequences or trying to limit their extent are likely to weigh on future growth.  This places a further question mark over future growth scenarios based on benign assumptions about the physical world," he said.

Financial crises

One other class of risk to smoothly advancing prosperity deserved comment – financial crises.

"The financial sector is capable of delivering shocks with every bit as much impact as natural disasters. Such shocks can swiftly impose constraints on a government’s fiscal position for many years," Upton said.

"Economic crises are not rare events. A recent study estimates that since 1970 there have been a total of 147 banking crisis, 218 currency crises and 66 sovereign debt crises.  As the world is now well aware, this is not just an emerging markets phenomenon.  Thirty one of the 34 current OECD members have experienced at least one systemic banking crisis since 1970 and 32 have experienced at least one of a banking, currency or sovereign debt crisis over that period.

"Against this backdrop New Zealand is fortunate not to have been among those having experienced a banking crisis although this may be as much a consequence of prudent Australian regulation governing our largely Australian-owned banking sector.  

"Serial failures by other New Zealand financial intermediaries over the last thirty years have destroyed a significant share of private savings which suggests that New Zealand has lacked important management skills and has failed to regulate appropriately. There is no room for complacency," he said.

External debt

One specific source of economic vulnerability for New Zealand was its external indebtedness position and the risk of a "sudden stop" in capital inflows if foreigners turned-off New Zealand as an investment destination.  

"Encouraged by New Zealand’s economic performance and prospects, sound institutions and policy settings, foreign investors have been willing to fund New Zealand’s sustained current account deficit.  This has seen the net international investment position expand to a net liability of over 70% of GDP," Upton said.

"Good management and a bi-partisan track record of taking unpalatable political decisions when required has shielded New Zealand from greater investor scepticism.  

"However, investor sentiment cannot be assumed to be unshakeable.  A significant and sustained negative reappraisal of NZ’s risk profile could see GDP and employment fall as activity contracts and the fiscal position deteriorate.  Only our institutions (like this process we’re engaged in) and political probity keep those prospects at bay," he said.