Reflections from the ends of the earth

I have been in New Zealand this past week.  New Zealand’s current international claim to fame seems to be as a preferred location for billionaires escaping from the US.  Physical isolation has long been an economic challenge for New Zealand, but it turns out that there are benefits from being in Middle Earth, far away from Washington DC, Brexit, and North Korean missiles. Indeed, in February, geologists announced that New Zealand is on its own separate, newly-discovered continent: Zealandia.  But New Zealand’s remote location notwithstanding, aspects of its recent experience are relevant for an international audience.

First, New Zealand is noteworthy for its strong economic performance over the post-crisis period.  GDP growth has averaged close to 3% since 2012, well above the advanced economies average, on the back of factors such as Chinese demand for dairy, record tourism flows, as well as record-high rates of immigration (at around 1.5% of resident population).  Unemployment has reduced to 5.2%, and the government is running a fiscal surplus.

This record shows that small economies can do well even in a challenging global environment, as I noted last week.  In New Zealand’s case, this is supported by strong intrinsics and being in the right markets at the right time.  These intrinsics include the functioning of New Zealand’s political institutions. New Zealand is just onto its third Prime Minister since 1999. This political stability has underpinned New Zealand’s strong economic and fiscal performance over the past period, and contributed to the relative absence of support for inward-looking, populist policies.

The caveat is that this is largely input-driven growth: New Zealand’s labour productivity growth and per capita income growth remain low, and the exports/GDP ratio has not increased.  This means that New Zealand’s growth is particularly exposed to reversals if there is a shock to tourism or migration, or to a key export market. And New Zealand is increasingly running into supply side constraints (infrastructure, housing, etc) that will constrain growth.

Second, New Zealand faces exposures to a changing international economic and political environment. New Zealand has done well over the past 20 years in securing FTAs, including with China in 2008, and can lay claim to being an author of the TPP (and New Zealand’s just-released Trade Strategy outlines an ambition to do more of this).  But this is hard work for a small country without immediate regional integration options (as the UK will discover, signing FTAs with larger countries outside the immediate region is difficult).  This mode of engagement also creates challenges for New Zealand in an increasingly complex geopolitical environment, with increased protectionist sentiment and big power politics.

Chinese Premier Li Keqiang was in New Zealand during the week. New Zealand has been described as having a ‘model relationship’ with China, but the Premier stated that ‘To scale new heights, we need to go further. In the past 45 years of our diplomatic ties, our relations and co-operation have reached unprecedented levels and our interests have become more intertwined than ever before…The question now is how can we do even better?’.  He suggested moving to ‘high-tech-driven, high-value-added, whole-industrial-chain co-operation’.  Commitments were made to upgrade the existing FTA to the ‘most advanced’ with a developed country, and New Zealand agreed to participate in China’s OBOR initiative.

A deeper relationship with China offers many opportunities for New Zealand, but creates exposures – particularly as international economics and politics become harder to separate. Issues of economic concentration risk, and the broader strategic consequences, are becoming a more salient issue for New Zealand.  China has a history of squeezing smaller countries with commercial exposures, from Norway to South Korea.  As with other countries in the region, but with the advantage of physical remoteness (‘a strategic dagger pointed at the heart of Antarctica’ as a former Prime Minister had it), New Zealand aims to remain friends with all.  But this balance is becoming more difficult as economic exposures to a more assertive China increase, and as questions arise on the commitment of the US to partners in the region (the withdrawal of the US from TPP is one worrying example of this).

Third, New Zealand’s recent experience reminds that no country is an island. New Zealand’s economy has been deeply (and visibly) affected by international labour and capital flows.  The ongoing strength of migration flows, which is changing the face of New Zealand, reflects the relative strength of the New Zealand economy (and more recently ‘safe haven’ flows of people, in a way similar to safe haven financial flows into Switzerland in times of stress).

And as with other small advanced economies, QE in the US and Europe has pushed New Zealand interest rates to record low levels and has placed the NZD under upward pressure. New Zealand house prices are up by about 50% since 2011; household debt is around 90% of GDP, one of the highest in the developed world; and there are a record-high number of construction cranes on the Auckland skyline.  Normalisation of interest rates on the other side of the world will likely have a substantial impact on the New Zealand economy.  Higher rates could lead to significant financial stress on household balance sheets, on the property market, and on the real economy. Indeed, there are recent signs of moderation in house price appreciation.

In many ways, New Zealand offers a positive example of strong small country performance in an increasingly challenging world.  But New Zealand – as with many other small economies, from the Nordics to Singapore – faces many exposures. New Zealand may be physically remote, but global developments look no less concerning from the ends of the earth: geopolitical tensions in the Asia Pacific, the risks of protectionism and big power politics shaping international commerce, and the stresses associated with interest rate normalisation. There should be no complacency, even in a high performing country. There is nowhere to hide in the global economy.