Tim Groser points to the success of the NZ-China FTA as an example of what New Zealand expects to gain from a TPP deal

The following is the speech given at the APEC Business Advisory Council meeting in Auckland today.

By Tim Groser*

I would first of all like to thank the NZ/China Council for providing this forum for business leaders here in Auckland for the APEC Business Advisory Council meetings. To our foreign guests, especially those who are making their first visit to New Zealand let me extend the warmest of welcomes.

In terms of the climate – both literal and economic - you have come to New Zealand at the right time. We hope you will do more than talk about the APEC Business Advisory Agenda and actually do some business here. This is a country very much open for business.

On this occasion, I want to take the liberty of looking through the direct ABAC agenda and comment more generally on trade agreements and the benefits they bring.

After all, that is the reason you are here and there is an on-going debate on trade agreements in most ABAC member economies, as there is in NZ.

The NZ and Global Economic Outlook

Starting with the NZ outlook, we are well aware that there are challenges ahead of us in pursuit of our economic, social and political agenda.

But we are very focused on what needs to be done, and we have a clear plan for this small but successful country.

Looking at the economic data – we expect to be back in Budget surplus next year, we are among the fastest growing developed countries, inflation is within our agreed band, business confidence is at an all times high, all 14 regions of New Zealand are growing – 12 of them faster than any time in the last decade, and jobs and real wages are growing. Of course we want to improve on this performance.

But all in all, you will find the mood here pretty optimistic.

This is not some Pollyanna view and none of this has happened by chance. It has taken over five years of discipline and great effort by the Government, by NZ businesses and by NZ households to achieve these results – in the face of very negative international economic conditions.

And we are well aware that there remain risks out there that we need to be aware of.

The world economy is in better shape than it was 3-4 years ago as it started to emerge from the most severe global crisis for 70 years. But if you were by nature a pessimist there are clear points of fragility you could focus on:

- The recovery in the major developed economies, particularly Europe, whose combined GDP is even larger than the United States, could hardly be described as robust. Unemployment in the Eurozone is double what it is here. There are also obviously huge issues yet to be resolved if the authorities are to find lasting solutions to weak and unprofitable banks. People who are obsessed with profitable banks and financial institutions should reflect on what happens when you have unprofitable financial institutions. In our country, you would not have to go far: just ask any New Zealander who tragically lost their life savings in one of our largely NZ owned finance companies that could not pay its creditors. But some politicians just don’t get this and I don’t think they ever will.

- With respect to the United States, it is reasonable to assume that the US economy will continue in the more positive direction of late, stimulated in part by massively accommodative monetary policy, known in a wonderful euphemism as ‘quantitative easing’. Richard Fischer, President of the Federal Reserve of Dallas, pointed out late last year that money was cheaper in the United States than at in any time in the last 237 years! However, there are all manner of uncertainties around how best to end quantitative easing since this cannot be maintained indefinitely. And on this, I read recently one senior US market player quip “there are certain things we all wish could be un-invented, starting with nuclear and chemical weapons and ending with boy bands. I confidently predict we shall add ‘quantitative easing’ to that list”.

- With respect to the emerging economies, they too face challenges. Some face huge challenges in terms of their currency and monetary policy settings – starting with, but not limited to, Argentina.

The most important of them is of course China. I am much more optimistic about China moving forward than many commentators.

The Third Plenum has set out a clear agenda of reform to be pursued by China’s new political leadership. Our Prime Minister has met President Xi and Premier Li on a remarkable number of occasions recently – I have been present at several of these meetings.

Yes, it will be a challenge to shift from an investment to a consumption focus. But I would not bet against the new political leadership achieving its strategic objectives.

With respect to the slowdown in growth, personally I think it is over-hyped. First, some slow-down is all but inevitable. I only know of one exception – the City State of Singapore – which has maintained phenomenal rates of growth even after achieving high levels of income.

All other countries which have achieved sustainable growth from the first countries to participate in the Industrial Revolution, through to Japan and Korea in the post-war era have experienced slower growth after earlier explosive growth.

There are good conventional reasons for this, and I cannot see why China would be an exception. The only question is when, and my view is that it could be a long time. Is China becoming a ‘rich’ country? Well, on a per capita basis there are 92 countries richer than China, according to IMF and World Bank data. There is a lot of scope left for catch up with the current economic frontier represented by OECD levels of wealth.

In any event, what matters to Chinese businesses, to Chinese people and to countries like ours trading with China is the additional increment of growth and thus new opportunities year by year. Well, engage in some simple mental arithmetic. If China in the next few years grows at ‘only’ 7%, the additional increment of growth the following year will be far larger than the increment of growth 10 years ago, when the Chinese economy was growing at 10% but was half its current size. 7% of US$10 trillion is far larger than 10% of US$5 trillion. Do the math.

Coming back to New Zealand, one of the reasons I feel this country could indeed become a highly successful, albeit small cog in the global economy, provided we maintain our direction and focus, is about the unprecedented liberalisation of trade and investment in the Asia Pacific region. This has changed in a positive way the landscape for New Zealand.

The Case For Trade Agreements

Over the last 30-40 years, NZ has suffered grievously, perhaps more than any other developed economy, from lack of trading opportunities. This is the consequence of massive protectionism and subsidies on the products where we are internationally competitive.

This was not an issue for NZ until 1973. That was the year when our dominant market, the UK, which had been completely open to us, joined the then EEC. From that date, protectionism became a huge constraint on our growth and incomes. I have no doubt this is one major reason why NZ was still the 6^th richest country in the world in 1975 but then started to slip sideways in the last quarter of the 20^thCentury. As a consequence, Trade Policy has been a very large part of any sensible NZ economic policy over the past decades. And frankly, to anticipate what I am going to say, we did not need then (or need now) any econometric model to tell any responsible NZ Government that they needed to negotiate new trade agreements to provide our people with opportunities and space to compete.

A simple way of looking at it is that NZ tends to sell what we do best to middle income and high-middle income consumers. In the past, by and large, they lived only in Europe and North America and there we faced historically huge barriers and massive unfair subsidisation, until successful trade negotiations in the last GATT Round, the Uruguay Round, started to chip away at these trade barriers. But NZ is no longer totally dependent on what happens in Europe and North America and thus access to their middle class customers. Today, the middle class of Asia is emerging. It is estimated today around 500 million and as soon as 2030 will be some 3.5 billion. This is simply a phenomenal opportunity and what is driving NZ Trade Policy.

But economic opportunity is one thing. As an exporter you still need access to those consumers and this is about trade agreements.

To the New Zealanders present, I will put it bluntly. We will never persuade certain people who are trying continually to foment opposition to NZ’s participation in these agreements in spite of New Zealand’s demonstrable need for trade opportunities and a fairer deal in world trade. They have been opposed to the GATT and WTO. They opposed the NZ/Singapore FTA, the origin of both TPP and the AANZFTA Agreement which is merging the contiguous FTAs of Australia/NZ with the ten countries of ASEAN. Some of them opposed the recent deal with Taiwan and most of all – because it involves the United States – they are opposed to TPP, the Trans-Pacific Partnership negotiations. When they wake up and realise there is another TPP-like negotiation going on – RCEP, or Regional Closer Economic Partnership Agreement which involves 16 countries including crucially China – I am sure they will be opposed to that too.

I am not going to talk about them directly, because they are not my concern. In fact, I can go further: I think they feel the same way about us – we are not their concern either. I don’t believe for a minute that either I, as Trade Minister, or the National-led Government of which I am a part, is their real audience. They are trying to influence other people, and other political constituencies. They are hoping that they would, if given the political opportunity, take NZ in a different direction on trade, when historically NZ has had a strong and highly successful bipartisan approach to trade for at least three decades.

It is not that we, and people with the same pro-trade views, have not thought closely about the issues. Start, not with models, which try to look forward, but with empirical work done on the link between open trade policies and growth, which looks backward to measure practical results.

The Gains from Trade: Empirical Work

The most comprehensive survey of hundreds of scholarly articles over the last decade or two was put together in 2011 in a collective study by the world’s pre-eminent international economic institutions – the OECD, the World Bank, the WTO, the ILO, UNCTAD. It was called ‘Policy Priorities for International Trade and Jobs’.

I only have time to give you their overall conclusion. Their conclusion is dripping in irony, which is rare for such organisations:

“Despite all the debate about whether openness [on trade] contributes to growth, if the issue were truly one warranting nothing but agnosticism, we should expect at least some of the estimates to be negative…The uniformly positive estimates suggest that the relevant terms of the debate by now should be about the size of the positive influence of openness on growth….rather than about whether increased levels of trade relative to GDP have a positive effect on productivity and growth”.

Even that will not stop some outlier academic coming out with a different view. But such views are extreme views. The overwhelming majority of economists support open trade policies. As the OECD caustically said, the debate should be only about the size of the positive gains from trade.

Econometric Modelling of Trade Agreements

Econometric models provide a way to look ahead, rather than look backwards through empirical research. Personally, while I am indeed interested in what they show (particularly the direction of travel, rather than the precise number which will always either overshoot or undershoot), I recall advice I received at university decades ago from one of NZ’s most distinguished academic economists and teachers, Professor Gary Hawke. As I recall his advice, he said models were never ‘the answer’ to what policy makers should do, but an aid to judgement. Absolutely.  Models can be instructive, but that is all. Decisions involve a range of other considerations.

Think about it. Any model has to input certain assumptions about the future. So the number they crank out at the end is a direct reflection of the assumptions they have inputted, as well as the technical excellence or otherwise of the model design. Trying to model trade negotiations still under negotiation, when not even those directly involved in the negotiation know the outcome, means judgement is required on what assumptions to use. Clearly, if you approaching modelling from a pre-conceived political starting point, you can input assumptions to give you whatever answer you want.

Second, there is a huge problem with modelling trade agreements because they may change behaviour in ways that past stochastic relationships would fail to predict almost by definition. I remember the original modelling done in 1979 for the CER negotiators (I was one of them) by the IAC – the forerunner of today’s Productivity Commission in Canberra. I can’t remember the number they came up with, but I certainly remember the conclusion – neither NZ nor Australia should bother negotiating a real Free Trade Area because the gains from trade were neither here nor there.

Well, had we followed that advice, how on earth would NZ have started a process of reform of crippling import licensing and high tariff policies, ridiculous subsidies and a whole range of policies that were associated with those policies? There was a dynamic involved. The trade agreement known as CER changed behaviour in NZ fundamentally. There would have been no political pathway for the decision taken a few years later in 1988 to abolish global import licensing. No econometric model could pick up these dynamic, often political economy, effects.

The Singapore/NZ FTA, had it been subjected to the test of an econometric modelling exercise, would never have passed. In goods, it is only a slight exaggeration to say the model would have predicted near to zero gains, since neither NZ nor Singapore applied anything other than trivial tariffs against imports. But that was not the reason we initiated this exercise. It was strategic. It led to both TPP and AANZFTA and was consciously designed to do this. As the initial chief negotiator of this agreement, I did not need any model to tell me what was in NZ’s interest.

TPP has been subject to a range of modelling. The NZ Sustainability Council has done an analysis and has come up with a figure about one quarter of the gains found in another set of models, carried out by the Petersen Institute in Washington, and led by Professor Petri of Brandeis University.

There is a range of issues here. The Sustainability Council study believes the negotiations on financial services will undermine our ability (and Australia’s) for effective financial regulation. No it won’t, because our ability to maintain a prudent financial system trumps trade policy every time so we would never agree to such provisions and I do not believe the Australian Government, whose regulatory policies clearly have a huge impact on NZ-domiciled banks, would either.

Equally, in this particular modelling study, there are – consistent with the most vocal TPP opponents – large negative statements made about Investor-State Dispute Settlement. We have made it clear on countless occasions we won’t agree to ISDS provisions that do not include proper policy space for key matters that any responsible NZ Government in the future will need for health, environment and monetary policy. We have sensibly designed ISDS provisions in a number of NZ FTAs. They have worked just fine.

There are some legitimate and very technical points focusing on the link between trade liberalisation and investment. And here I would agree: this is very difficult to model. There should be a general assumption, I believe, that trade and investment integration agreements will stimulate investment but trying to put a number on it, is tough.

The NZ/China FTA is a classic example. While I could never prove it, it is inconceivable that two of China’s largest dairy companies would be investing the thick end of half a billion dollars in new ‘greenfields’ dairy processing companies in NZ without the FTA, even though the investment could in theory have taken place had there been no FTA. One could say a similar thing about Fonterra’s decision to invest in 33 giant dairy farms in China – very hard to believe that would have happened without the huge expansion of trade in the FTA which has stimulated commercial players’ interest in investment.

There is an old technical term in economic literature for this called ‘The Demonstration Effect’ of Trade Agreements. Very difficult to model, but deeply implausible to believe there is no relationship. NZ needs new investment and we will not generate sufficient on our own. I am sure TPP, if indeed we conclude it and the NZ Parliament passes the legislation necessary for any NZ Government to ratify it, would have a positive effect on inward and outward investment. But putting a figure on it is a bit of a challenge.

The Peterson Institute is one of the most influential and most respected think tanks anywhere in the world when it comes to research on the international economy. I have been reading their material and attending the odd seminar at their headquarters in Washington for many years. The Peterson Institute modelling of TPP was reviewed at our request by the NZ Institute of Economic Research in 2012. The NZIER critique is very measured, professional and careful. It noted all the caveats you need to be aware of around modelling and uncertainty around assumptions. But I would challenge anyone to read the original NZIER critique and argue that the overall ‘take’ with respect to the Peterson Institute modelling is anything other than a positive one. The NZIER critique describes the Peterson Institute Modelling as ‘ambitious, but not unrealistic’.

So we have drawn on some of the Peterson Institute’s modelling to buttress the argument to the NZ people that this is a negotiation that potentially could confer major benefits. Even I – maybe the biggest sceptic of econometric modelling among the New Zealanders who are deeply involved in trade policy – have quoted from the study. Again, I emphasise the word ‘potentially’. Our Government is not going to put before the NZ Parliament, and thus the NZ people, any agreement that we do not consider confers substantial net benefits to NZ. We are not yet in a position to make that judgement. We will make it only when and if the negotiation is complete.

Going back to the Peterson Institute modelling, there is actually a whole range of estimates in that study and they measure different configurations of TPP (ie nine countries, through to even 16, since it is completely implausible to believe that if we do finally nail TPP with 12 or less members it would stop there with that membership). Further, the model measures a variety of different things – exports, trade, FDI and the more complex concept of ‘welfare’ which incorporates these elements. And the number I have focused on is growth of exports from a TPP that included Japan – by 2020 it suggests the export gains for NZ could be NZ$5.16 billion.

Forget the precise figure – it is not going to be $5.16 billion to the nearest decimal point. In theory it could be, but in practice there is about as much chance of landing precisely on this figure in 2020 as the proverbial monkey, given infinite time, would type out the complete works of William Shakespeare. What matters is the direction of travel. It could be less and it could be substantially more.

Past Estimates of Gains from Trade

My experience is that in most cases econometric predictions of gains from trade have under-estimated, not over-estimated the benefits of good quality trade agreements and sometimes substantially. I will give you one example, very close to home: the NZ/China FTA.

When the then Government presented the FTA to Parliament, it accompanied the complete FTA agreement with some modelling done objectively by highly competent modellers.  We have now had five years of operation of the FTA. So how did the model turn out?

Well, armed with what the modellers did not have at their disposal – the benefit of hindsight and actual, not predicted, data - we know the answer. The predictions proved to be hopelessly wrong.  And I imagine that no-one would have been more pleased with this outcome than the authors of the original modelling.

In terms of export growth, the model predicted annual NZ export gains of $180m - $280m. Last year NZ exports to China grew $3 billion, some 11 times higher than the upper bound prediction and an astonishing 17 times higher than the low end model prediction of export gains.

When measured in percentage terms, the model prediction proved equally hopelessly inadequate. In reality 2013 NZ exports to China were a fraction under NZ$10 billion, up 293% from NZ$2,534m in 2008. Just to hammer the point home: the professional modelling massively under-estimated the growth.

Of course there were other factors than the FTA behind the stupendous growth in NZ exports to China, including obviously faster Chinese economic growth sucking in imports. But China was enjoying very fast rates of economic growth between 2004 and 2008 too – ie before the FTA coming into effect. And in that four year period to 2008, NZ exports to China grew at a compound annual growth rate of 2.3%; in the subsequent post-FTA four year period to 2012, NZ exports grew at a compound growth rate of 28.6%, in crude terms ten times as fast.

By the way, I am expecting exactly the same thing from the agreement we started to implement from 1 December 2013 with Taiwan. The figures I have been quoting as gains, will, I think, prove substantially wrong – but in a positive direction that will please whoever is NZ’s future Trade Minister and, more importantly, NZ exporters and the people who work for NZ export companies.

And What Do Exporters Tell Us?

Yet another way to make sensible judgements about the benefits of trade agreements is to listen to the people we depend on to use them – our exporters.

A year or two ago, the Government surveyed 854 NZ export companies to get their views on whether trade agreements, particularly FTAs, have benefited them. The result was extremely positive. Over 75% of our export companies saw positive increases (some substantial) in their business profitability from the removal of these barriers in several of our trade agreements.

Conclusion

Given the recent debate, I thought it might be useful to look at a variety of different ways to help any Government, and stakeholders, assess the benefits of trade and thus participation in international trade agreements, whether in the WTO, bilateral FTAs such as the NZ/China FTA or the new complex regional mega-deals like TPP.

There is a variety of different ways of looking at this, and econometric modelling is only one of them. Each is worthwhile and each has got something to tell us on the matter. You could start with economic theory, where the consensus among professional economists around the gains from trade and the costs of protectionism is about as solid as you would find on any major tenet of economic theory. You can look at the vast body of empirical work that has been done – as did the OECD, the ILO, the WTO and other major international institutions in the recent study I referenced earlier. You can, and should, look at the results of modelling, as long as you do not get seduced by their deep sophistication and the false precision of a number which they churn out that in the real world will never be correct. You can look at far less sophisticated measures which I have not described here such as tariff revenue saved. They all agree on the direction of travel – trade agreements, as long as they are well designed, bring benefits.

Equally, you do not have to be a researcher to understand that growth in incomes is about specialisation, which leads to higher productivity. This is the essential basis to the higher real wages that we all want to see. The idea that a tiny economy like NZ – fearful of entering into any agreement which would infringe on our ‘sovereignty’ – would be better served by cutting itself off from this global movement towards trade and investment integration, is to my mind literally absurd.

Paradoxically, many of those on the far left of NZ who talk endlessly about avoiding anything that might infringe on ‘sovereignty’ are vehemently in favour of legally binding international agreements in other policy areas that would stop, for example, certain countries exploiting their ‘sovereign right’ to destroy whales and fish stocks, or put international limits around countries’ ‘sovereign right’ to put whatever carbon emissions they want into the atmosphere. By the way, I am in favour too of well-designed international negotiated agreements to achieve exactly these limitations on sovereignty but I try to maintain a minimum and credible level of consistency.

Trade is vital to jobs, to a growing economy that can provide New Zealanders with a range of good choices. NZ is a country which has suffered grievously from the sovereign right of other countries to cut us out of their markets, to subsidise relentlessly their companies and competitive sectors not just in their domestic markets but in other markets through export subsidies, and to refuse to recognise our technical or quarantine standards as legitimate for sale to their consumers.

Protectionism has been a disaster for NZ over the past 30-40 years. Thanks in part to these pretty well designed trade agreements I am very optimistic about this country’s long term future. We are in a much better space today and I see every reason to believe it will get better still.

Thank you.

------------------------------------------------------------------------------

Tim Groser in the New Zealand Minister of Trade.