The case for corporate reform

An interview with business analyst Rod Oram

by Gordon Campbell

A few weeks ago, business commentator Rod Oram ran a column in the SST pointing out how New Zealand’s export trade still has the same damaging, unsustainable pattern as it did back in 1911. Despite the advances in education, telecommunications and the related advantages from New Zealand being part of the developed world, our export trade really hasn’t changed its essential nature over the past 100 years. Only the main customer has changed : from being Britain’s “little farm’ on the other side of the world in the days of Empire, we are fast becoming China’s little farm, down in the South Pacific. By next year, Oram reports, China will also have replaced Australia as our largest source of imports.

Much is made of the inter-generational dependency on welfare. Yet the fact we are still shipping overseas the same low value-added, barely processed kind of agricultural commodities – dairy products, wool and logs – as we were a century ago, indicates an intergenerational failure of government policy, and a related failure by business to adapt and evolve. Corporate reform, not welfare reform, should perhaps be the greater priority.

Not only is China buying up our raw commodities – its presence is also being felt at the top end of the value chain, via taking a controlling interest in Synlait Milk, one of our promising producers of added-value dairy products. Despite the government’s enthusiasm for our FTA with China, the trade pattern under that pact seems headed in entirely the wrong direction. During the same time that we have significantly boosted the volumes of our traditional exports in dairy products, logs and wool, China has been using its FTA opportunity to export to us an increasingly sophisticated array of goods, from locomotives for Kiwirail, to computers. As Oram wrote in the SST :

Our top two imports from China in 2006 were $495 million of computers and $132 million of women’s clothing ; last year, the top two were $677 million of computers and $409 million of telecommunications equipment. In other words, what we sell to China is getting more commodified and less sophisticated. But what we buy from China is getting less generic and more technological.

They get it : we don’t. They are marching up the value-added chain. We are not. In particular :

We are running a massive trade deficit [with China] on services such as intellectual property, royalties, professional services and the like. In the year to June last year, we exported only $7 million of such knowledge wave products to China, but we imported $34 million worth from them.

Of course, we can continue down this road for a short while longer. In this year’s Budget for instance, the Key government set aside funds to irrigate more land in order to generate the dairy production we will need to sell in greater volumes, if we are still to afford the technology imports we associate with living in a developed country. (Clearly, there would be damage to the environment and to our 100% Pure tourism brand, from any marked intensification of dairy production.)

For decades, New Zealand’s failure to add significant value to its land-based exports has been lamented, loud and long. Yet the ‘Knowledge Wave’ conference of 2001 came and went, without leaving any noticeable impact on how we do things in New Zealand. A few weeks ago, the New York Times criticized the current atrophy in US political and corporate thinking ( about jobs and economic growth ) in terms that seem relevant to New Zealand as well –

If [the centre right] is as deeply concerned about….out-of-work people as they claim to be, they might have offered ideas of their own that have some possibility of creating jobs. Instead, they have been chanting the same tired and discredited mantras offered since the 1980s: huge tax cuts, huge cuts in safety-net spending, the clear-cutting of regulations, and the inevitable balanced-budget amendment.

In election year 2011, much the same array of ‘tired and discredited mantras offered since the 1980s’ passes for an economic strategy in New Zealand. As senior citizen Bob Dylan once put it: “Nothing succeeds like failure, and failure is no success at all.”

The political trick of managing policy failure, of course, is to assert that it is in fact, a success. With that in mind, Werewolf put the counter- argument to Oram : namely, that China is well on the way to becoming the world’s biggest economy. New Zealand is locking our raw commodities in at the ground floor to this expanding market, as they up-skill and supply us in return with the manufactured goods we need. What’s not to like about that situation?

A number of things, Oram replies. Put simply, he believes that an economy based on commodity exports simply cannot meet our aspirations. In the first instance, New Zealand needs to decide how much economic growth it needs in order to meet the social and economic outcomes it wants. “Lets say we would wish to double the size of the economy in 15 years… and in ways that don’t destroy the environment. That means we would have to double the rate of our growth, which [currently] trundles along at under 2 % a year. “ Doing so, he estimates, probably means our export sectors have to more than double in size in fifteen years…since the domestic economy (partly thanks to population size, skills shortages and the like) can’t be expected to do the heavy lifting that this would entail.

Oram : “ So now you’re looking at export sectors – which are a third of the economy – and we need it to become 40 – 45 % of the economy. Then you say to the dairy industry – how are you going to more than double, in real terms your contribution to the New Zealand economy over the next 15 years ? Well, you’re going to get some small productivity increase. You might get some uplift in commodity prices, But don’t bank on that…[because] around about $US3,500 a ton for milk powder is pretty much the price threshold for many consumers.” [The current price per ton in June 2011 was circa $4306 a ton. Consumers are crying foul.]

Given that there isn’t room for a major uplift in prices, the only way to chase enhanced profits on the scale required would be via an increase in volume. “So…by and large you’re going to double the output you’re going to have to double the number of cows. We have 4.8 million cows now. So I say to the dairy industry – where do you plan to put the next 4.8 million ?” Clearly, some see that future in cramming cows into sheds, much along the lines envisaged here.

Essentially the same logic, Oram believes, applies to the potential growth in tourism. “We bring in 2.4 million tourists [on average] when in fact the average [amount spent] per tourist, per year, is actually falling and has been for almost five years now. So you say to the tourism economy that’s going to play its role in growing the size of the New Zealand economy : ‘Are you going to bring in another 2.4 million tourists a year into this country ? And if so, where are you going to put them ?’ That problem, he says, faces any economy strategy based on the peddling of commodities – and for planning purposes, tourism should best be considered as a commodity.

Meanwhile, the agricultural competition from overseas – from countries closer to global markets, and with cheaper land prices – is ferocious. Oram approvingly cites the case of a Waikato family operation that has bought thousands of acres in south-west Missouri. The point being ? “They paid one quarter of the price for that land, than they do in the Waikato, for producing a product with the same international price.”

All very well basing an export economy on commodities. “Yet the lion’s share of the profits on those accrue to supermarkets and to other people downstream, not to us, and by a very significant margin. “ The same challenge,he agrees, applies to manufacturing as well. “ Unless we’re further involved down those value chains, however hard we work, we’re going to get very little of that back.”

For all that, Werewolf suggests, the purchase of Synlait Milk by Bright Dairy from China has highlighted a recurring problem, to do with the apparent lack of investment capital. When New Zealand lacks sufficient sources of capital can and should we prevent foreigners coming in and buying into our promising new companies and reaping the bulk of the rewards? Oram : “We could stop them doing it with rules and regulations..” In his view, that would send the wrong signals. So…do we need to channel what domestic forms of investment capital we do have more productively? “That’s one way of doing it. The other way is to convince [foreigners] to invest in other things.”

Meaning ? Sure, he indicates, when other countries want to grow a new industry or expand an existing one, they will invite and involve foreign capital – but only in arrangements that primarily benefit the recipient. “So that you’re not just a supplier of cheap labour, or of cheap milk, or whatever.”

To date, New Zealand hasn’t tried very hard (or been very successful ) in this respect. We’ve tended to put out the welcome mat for Chinese capital, without imposing much in the way of conditions that might conceivably deter investors. “We’re not targeting it in any way at all,” Oram agrees. “ We’ve just put up the “For Sale” sign. We need to invite and manage foreign capital productively.”

Through what mechanisms? Right now, Oram believes the rebuilding of Christchurch offers an opportunity to lift our game, and to create a blueprint for joint ventures elsewhere in the country. “The CBD in Christchurch was dying before the earthquake struck. Lots of Christchurch firms were hanging on in very low rents and in very horrible old buildings. The centre of Christchurch had lost quite a bit of its economic rationale, well before the earthquake. So if you’re going to rebuild the centre of Christchurch, you’ve got to come up with some new economic rationale for being there. You can’t just put up new office buildings and try and attract people back from the suburbs. They might come back, but then you would crash the suburban property market, which would then devalue the new buildings in the CBD. You actually want to grow the CBD economy fast enough to absorb that new activity, without pulling in any new activity from the suburbs.”

Right. So what sort of things might we do? Christchurch is situated close to Lincoln, he says, which carries out good dairy farming research. [Christchurch] has got a medical school. “How about a lacto-pharmaceuticals institute in the centre of town, close to the hospital and medical school – and that would be working out what are the therapeutic values from milk, and taking that further into bio-actives and lacto-pharmaceuticals ? That’s very difficult science. We have very few people doing it. And its very expensive science. Nestle has been doing this for years. And last year – in what should be a very scary development for us – Nestle announced an incremental investment of $US500 million in that kind of science.”

If it wants to remain globally competitive, New Zealand has to respond to that kind of challenge. “Why don’t we say to China – yes, you’re interested in feeding people protein. But you’re also very interested in pushing on up the technology curve. So lets do that together, in milk. Why don’t you and your scientists and your money get together with us and our scientists and our farming expertise and some of our money, to create a counterweight to Nestle? You would structure that deal to protect our rights to the IP [Intellectual Property.] It’s a case of using foreign capital and our expertise to create what we could not do on our own. It does something far more valuable with our milk and thus our farms than we could do on our own..” Along the way, it could create a new and world leading research centre in Christchurch that could become a focal point in the rebuilding of the city.

Does he see any sign of the current government seeking to play that kind of brokering role? “ No. Its worse than that. I’ve known for a long time that the government is incapable of thinking in these ways. The previous government did – at a broad level – understand these things, but found it very difficult to operationalise them.”

If anything, things have got worse. “I first started talking to John Key when he was chosen to be opposition finance spokesperson, and I always found he knew surprisingly little about the economy, and it was very superficial…he just doesn’t get it. He thinks that if you just increase the irrigated land in Canterbury by 40% then that this is economic growth. Even though the Cabinet papers have shown an internal rate of return [from irrigation] of 6.4% . That’s a lousy investment. They just don’t get it. The government is solely focussed on the incremental growth of existing business.”

Such an approach cannot conceivably succeed in lifting New Zealand’s standard of living. Treasury, Oram points out, is forecasting little change in the rate of growth all the way out to 2015. “The underlying rate is still stuck under 2%. Our net international liabilities get a lift with re-insurance money coming in for Christchurch. But by 2015, Treasury shows that they’re back to 85% of GDP, which is where they were in 2007. How are current economic policies changing this? Answer : They’re not.” The current government, to the extent it has an economic plan at all, appears to be driving in a direction where failure is all but guaranteed.

Not that government hasn’t kept itself busy, along the road to nowhere. The US political economist Robert Reich, has effectively summarized the economic agenda that has prevailed since 1980 in one highly effective 2 minute 15 second video here.

The current push for welfare reform – and its rhetoric of creating incentives to encourage far more independence – seems particularly ironic, given the current context in New Zealand. For decades, there has been a continuous drum roll of requests by local business for government to come to its aid – by lowering its tax rates, paying for its research and development, passing industrial relations legislation to reduce its labour costs, managing interest rates, lowering the exchange rate against the greenback etc etc. The developed world over, could there be a business sector any more dependent on state assistance – and more in need of incentives to encourage self-reliance – than the corporate beneficiaries of New Zealand’s private sector ?

Oram agrees. “ You’ve pushed one of my more excitable buttons. I’ve lived and worked in four countries for a long time as a business journalist. I’m English. But the order was Canada, the UK, the US, then back in Canada. So this is the fourth English-speaking business community I’ve got to know well. It is the one that is – by far – the most dependent on government. I’m astonished. Dependent in the sense that they seem to be incapable of having any strategic thought, or ambition without being dependent on government to deliver it. Now, the government has a role in this, but I keep saying to them – you are defaulting to government to tell you what that strategy is. You’ve got this the wrong way around. You’ve got to work out what your strategy is, and be very articulate to government to get appropriate support from them.”

And being articulate doesn’t simply mean the old time religion of tax cuts and small government ? “No. There is still an awful lot of that old thought process around but…there are actually some more interesting, more ambitious people around.” One of the first things that struck him when he arrived here in 1997 was an “incredible sense of loss of bearings, a loss of direction.”

Auckland businessman Sir Douglas Myers was still around back then. “ It was if they thought : all we know how to do is press on with that white knuckle reform – hence Myers saying that we’d taken a tea break etc. Yet it was sinking in that although all that reform had happened, and realistically there wasn’t all that more you could do – the benefits weren’t coming through. And its like – ‘Oh shit, what happens now? By and large we got what we wanted, but its not making a big difference.’ I found it quite fascinating, because it was still impossible to have any counter view to what the Business Roundtable and people like Myers were saying. It was a wonderful journalistic challenge to try and trigger any debate at all around that.”

We have moved on somewhat, he feels. Lots of companies – particularly in high value manufacturing – strike him as being vastly more capable than they were ten years ago. “To me what’s exciting is that they’re still profitable at 80 cents to the dollar – whereas ten years ago, they would be screaming for mercy at 60 cents.” Those pockets of capability are what keeps him going. “But there aren’t enough of them. We aren’t growing more of them. And the biggest problem is they themselves are not growing fast enough.”

He picks out an example, one he’s been watching for more than a decade. “So, a fantastically good company like Orion Health – Ian McCrae’s company – will this year finally get to $100 million in revenues, even though for a long time it has had a really important lead in technology. It has been getting fantastic traction for its products in the US and in Europe…It should by now be a billion dollar company. I know that its incredibly hard to do this stuff from New Zealand. But we’ve got to work out how to do it, because otherwise we don’t stand any chance at all.”

As with any forms of dependency….bad habits, deprivation and hanging out with the wrong crowd [Ireland, Finland and Israel have all been faddish role models for New Zealand business at one time or other] have all helped to explain why large swatches of our private sector have lost their bearings. The list of deprivation begins with our fabled lack of a capital gains tax on all but the family home, a tool seen as necessary and beneficial by almost every other developed country. (Even the American centre-right accepts it as a necessity, and haggles only over the level at which it should be set.) Supposedly, a capital gains tax here would help to channel investment capital far more productively – but would be politically unpopular with those who currently profit from its absence. Is this still a pothole in the planning road that has to be filled ?

Oram : “It would be one useful thing to do among quite a wide range of things to do. It would send some very good messages. It would send a very powerful message to many New Zealand businesses that their whole long term business model is about capital appreciation and not income along the way. Whether you buy a rental house hoping to sell it off later for more money and you don’t care if you don’t make any money in the meantime from rent….Or if you’re a dairy farmer, you are farming for capital gains.”

“You load up with debt, you go hell for leather to pay that off, you don’t pay much tax along the way….but the problem is, easy money comes along, as it did before the global crisis and dairy farmers increased their debt fourfold in then years, to $43 billion dollars. And all that did was drive up the price of land. So not only then can you really struggle to keep your head above water – just to make that work economically, but you’re entirely dependent on somebody to come along to pay more, to take it off yur hands.

Enter the Chinese, with an entirely different business model. They’ve got much lower capital than us, Oram says. “Some Chinese companies are selling infant formula directly to the consumer in China. Therefore if the New Zealand operations actually don’t make money at all, they couldn’t care less. Because they have a captive supply of infant formula which they can sell for a profit in China. And the corporate tax rate in China is 25% – compared to 30 % here.”

Therefore, any such theoretical Chinese operative might well want to minimize their profits here…and maximize them in China. “By dint of that completely different business model, the Chinese investor can afford to pay more for the land than a New Zealand farmer ever could.” And wear any losses, or only marginal levels of profit from their operations here. Hardly an ideal springboard for growing and maximizing the profit potential of the New Zealand end of the operation.

And how would a capital gains tax help to staunch that kind of process? “It wouldn’t turn it around entirely. It would depress the price of land, and slightly shift farmers to farming for income, and not for capital gains. And in the meantime of course, the government would have a new source of revenue.”

The capital gains tax question. Oram believes, has to be seen in the wider context of the country’s finances. “Our government finances look pretty bad at the moment, because [they] are the most leveraged to the economic cycle in the OECD. The vast majority of government revenue is from things like GST, income tax and profits. Which are, of course, dependent on the economic cycle. In boom times, when all those are going well, the government gets disproportionately more revenue than the rate of growth [would indicate.] Which was to Michael Cullen’s great benefit….”

On the downside though, it goes the other way around. “Government revenues fall disproportionately more than economic growth does. And that’s what we’re seeing now.” Other countries, by contrast, have sources of government revenue that are not so dependent on the economic cycle. For example, Oram explains, pretty much every other developed country has a social security tax on employment, a flat tax that helps to cover things like health care and pensions. “ Instead, we pay for those out of general revenue.”

But since its not a flat tax, how does a capital gains tax help in this respect ? “Whilst a capital gains tax obviously depends on economic cycles in how much buying and selling there is…it would help to give a more stable tax base to the government.”

A legacy of bad habits is also part of the rationale for corporate reform. Leaving aside for a moment the likelihood that government will once again – as it has with privatisations in the past – be worse off from the revenues it loses by selling down healthy assets ( this time, in the energy sector) than from what stands to gain by paying off the debt via the proceeds. Isn’t there also a risk that the partial sales programme of energy companies (and Air New Zealand) will soak up the available investment capital, and thus starve start-up and expanding companies of the investment funds that they need ?

Oram : “That’s partially a risk. But its not a straight trade-off – because those floats will be publicly traded on the stock-market whereas so much capital for business is actually private equity that –either formally or informally – comes through from elsewhere in the private sector. “ Some wealthy individuals may switch say $100,000 into the likes of Meridian Energy when it becomes available, and out of their other investments…”So you might get effects like that, but I don’t think it will be a big one.”

His main concerns lie elsewhere. Government could try to paint the partial sales programme in a virtuous light, he concedes, as a process of taking capital and re-investing it more productively. “But that’s not what they’re doing. Most of that money is going – it said so in the Budget – to fund schools and hospitals. So….its only a substitute for borrowing.” But as an investment decision ? “Its a dreadful waste of capital. At the moment, the only money [from the partial asset sales] that they’ve indicated would be re-invested is the $400 million for irrigation which as I’ve said, gives a 6.4% rate of return – which is a lousy investment.”

Earlier this year, business analyst Bernard Hickey also argued that the government stood to lose more than it gained from the partial asset sales:

This apparent reluctance to invest in the kind of research and technology essential for the creation of to a value-added productive economy is also reflected in New Zealand’s chronically low spending on research and development. While r&d spending increased between 2008 and 2010 – to a level of 1.3 % of GDP – the latest Statistics Department two yearly survey (from 2010) is hardly encouraging :

“ Despite these increases, New Zealand’s total R&D expenditure continues to be relatively low, compared with other countries in the OECD. Australia’s R&D expenditure made up 1.97 percent of GDP in 2006, and the OECD average was 2.33 percent for 2008. [ International figures for Australia are not available for 2008 or 2010. OECD average figures are not available for 2010. ]

Some of this shortfall in r&d spending is inevitable. Our economy is small, many foreign companies with a local presence do their r&d at head office back home, and we lack the huge spending on defence and aerospace that characterise larger economies, and which continue to produce spin-off benefits for the private sectors of Europe, Scandinavia, and the United States.

Even so, it is still striking how limited the r&d spend is by the New Zealand private sector. Ever since the days of the Department of Scientific and Industrial Research (DSIR) business has relied on the state, the tertiary institutions and SOEs to do the bulk of this work. The two yearly Stats Department survey shows that the government and tertiary institutions funded 54% of r&d in 2010, and business 38% – but even that figure is inflated, given that the survey includes the r&d spend by SOEs as part of the ‘business’ contribution.

In sum, much of the New Zealand business culture is almost a mirror image of the stereotypes that are far more commonly attributed to welfare beneficiaries. Our business culture is into instant gratification, shirks investing productively in the future, and is remarkably reliant on government for handouts, rewards and a sense of direction. It lacks incentive to change. It is the source of most of the country’s debt burden, and freeloads on others to pay for activities that should be its own primary responsibility. At the same time, it aggressively projects onto others the frustration it feels with its lot. Given the stakes involved, corporate reform is arguably a far more pressing challenge for New Zealand, than welfare reform.

One example of the tendency for projection ? For some people, it will always be a good time to shrink the size of the state, and to take a chainsaw to public sector jobs. No one begrudges efficiency. Yet at some point though the process risks becoming self –defeating. Wellington in particular depends a good deal for the health of its retail sector on the spending capacity of public servants. Given the flow-on effect of further depressing the national and local retail economies, does the current zeal for slashing public service jobs seem foolhardy to Oram?

“Oh, yes. And the Wellington City Council is engaged in some really interesting work on [compensating for] that, with its Wellington 2040 Strategy. The economic sjde is interesting because its finally sunk in that – as much fun that tourism and events are – they’re lousy as direct economic activity. There’s a nice feel-good factor around it. And that’s wonderful. But basically, it supports semi-impoverished artists temporarily – or people who manage to hang in on an NZSO salary through a career, and lots of bus boys and bed-makers.”

Sustaining that sort of activity, of course, has been personally important to some recent prominent figures in local government. So, what is Wellington now identifying as an alternative within the 2040 Strategy process ? “They’re finding it very difficult…and I appreciate how difficult it is.“ Similar problems face other metropolitan centres in New Zealand, he hastens to add. While Oram may have started out by focussing on the rural economy – and our problematic reliance on it – the flipside, for him, is the dire state of our urban economies.

“The problem is not just the centre of Christchurch,” he says. “ Its how Auckland, or Wellington or Dunedin earn their living. Only 9% of Auckland’s economic activity is exports. [Auckland’s] economy is astonishingly focused on just serving the consumption needs of its 1.4 million people. That’s no basis for an economy – and you not going to build a world-class city on serving lattes to your fellow citizens.”

Or to your fellow consultants? “No, that’s true ( laughs) I’m just as guilty… I’m part of that economy. Though once in a while, I do earn a little export income, which is good. “