OECD Economic Surveys: New Zealand 2022

Executive summary

The economy recovered quickly from the COVID-19 shock but is overheating

The economy shrank sharply in the second quarter of 2020 but bounced back quickly thanks to effective virus containment, measures to protect jobs and incomes and highly expansionary macroeconomic policies. Confronted with the highly contagious Delta variant and with high vaccination rates, the government shifted from an elimination strategy to minimisation and protection.

The strict confinement measures taken at the outset of the COVID-19 shock contributed to a relatively large fall in GDP in the second quarter of 2020 (Figure 1). However, New Zealand succeeded in eliminating the coronavirus and was able to re-open the economy with the exception of international tourist-related activities. The economy regained the pre-pandemic GDP level in the third quarter of 2020 and remained above this level despite shrinking by 3.7% in the third quarter of 2021 owing to the reimposition of strict containment measures in August 2021, when community transmission of the Delta variant broke out.

Figure 1. The economy rebounded strongly

Real GDP

1. EU countries that are members of the OECD.

Source: OECD (2021), OECD Economic Outlook 110 (database).

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Macroeconomic stimulus has been so powerful and the elimination strategy so effective that major labour market indicators are now stronger than before the pandemic. The unemployment rate fell to 3.4% in the third quarter of 2021, the lowest rate since 2007, and the employment rate increased to the highest rate on record. Wage growth has returned to the pre-pandemic level. With employers reporting record hiring intentions, the labour market is likely to tighten further, putting upward pressure on wages.

Inflation soared to 5.9% in the year to the fourth quarter of 2021, well above the Reserve Bank’s 1-3% target band, and core inflation measures increased to above the upper bound of the band. Five-year ahead inflation expectations have increased for households but less so for businesses.

The containment measures reintroduced in August 2021 were maintained in Auckland until early December, when the government shifted to a minimisation and protection strategy. The new COVID-19 Protection Framework has three settings (red, amber and green) that take into account health system preparedness and population public health dynamics. Individuals who are vaccinated against COVID-19 face fewer restrictions on their movement and activities, as in many other OECD countries. The government also announced its intention to open the border progressively to vaccinated travellers by April 2022 subject to a negative COVID-19 test result on arrival and after seven days of self-isolation but delayed implementation owing to the arrival of the Omicron variant. The government also announced an expansion in intensive-care-unit capacity with ventilators.

Macroeconomic policy tightening will slow growth towards sustainable rates

The Reserve Bank of New Zealand (RBNZ) is tightening monetary and macroprudential policies with a view to achieving its price and financial stability objectives. Government budget deficits have begun to fall from the high levels reached during the first wave of the COVID-19 shock and will decline gradually from 2022. Macroeconomic policy tightening will contribute to slowing growth from almost 5% in 2021 to 2.5% in 2023.

The RBNZ hiked the policy rate by 25 basis points in October and again in November 2021 to 0.75%, and projected further increases to 2.6% by end-2023. It halted its Large Scale Asset Purchases programme in July 2021 and is working on a strategy to manage its large government bond holdings (16% of GDP).

Highly expansionary monetary policy and the suspension of loan-to-value ratio (LVR) restrictions in 2020 spurred mortgage lending, pushing up household debt to 169% of disposable income and house prices to levels that the RBNZ judges to be unsustainable (Figure 2). To limit financial stability risks, the RBNZ has increased LVR restrictions and has begun a public consultation on introducing debt-servicing-to-income or debt-to-income restrictions. Tightening monetary and macro-prudential policies, lower migration inflows and the March 2021 tax measures to discourage investment in rental properties have reduced housing demand. This, together with policy measures underway or planned to increase housing supply should eliminate shortages and increase affordability.

Figure 2. House prices have soared relative to incomes

Median house price-to-income ratio

Note: Reserve Bank of New Zealand scenario projections.

Source: Reserve Bank of New Zealand (2021), Monetary Policy Statement, August 2021.

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Following a 9.7% of GDP fall in the government’s preferred fiscal balance measure to a deficit of 7.3% of GDP in 2019-20 (fiscal years end 30 June), the deficit remains high but is projected to be almost eliminated in 2022-23 as large COVID-related spending is phased out. Steadily rising surpluses are projected through 2025-26 as such spending continues to be phased out.

Economic growth is projected to slow in response to macroeconomic policy tightening and the stabilisation of commodity export prices, albeit at high levels (Table 1). Consumption growth will fall to a more sustainable pace as housing wealth gains diminish and employment growth slows. The unemployment rate will remain at very low levels and inflation will fall back to within the Reserve Bank’s target band by 2023.

The main downside risks to the outlook include a delay in border re-opening caused for instance by the emergence of more virulent COVID variants against which vaccines are less effective and a large and sudden house price correction. The main upside risks include stronger demand for New Zealand’s agricultural exports and public health conditions that permit a more rapid phasing out of restrictions on economic activities than assumed.

Table 1. Economic growth will slow

(Annual growth rates, %, unless specified)

	2021	2022	2023
Gross domestic product	4.7	3.8	2.5
Private consumption	6.0	2.4	1.9
Government consumption	9.2	4.3	1.4
Gross fixed capital formation	8.3	6.3	4.1
Exports	-1.4	8.9	5.8
Imports	14.8	7.8	4.5
Unemployment rate (%)	3.8	3.2	3.3
Consumer price index (yearly average)	3.9	4.5	2.7
Current account balance (% of GDP)	-5.0	-5.5	-5.4
General government fiscal balance (% of GDP)	-5.7	-4.4	-3.7
General government gross debt (% of GDP)	51.7	55.0	57.8

Source: OECD (2021), OECD Economic Outlook 110 (database), updated for 2021Q3.

The fiscal measures taken to support the economy during the COVID-19 crisis have substantially increased the government debt-to-GDP ratio. On unchanged policies, the debt-to-GDP ratio will rise considerably over coming decades owing to po-pulation ageing (Figure 3). Additional measures are needed to put public finances on a sustainable medium-term path, including linking the pension eligibility age to life expectancy.

Figure 3. Public debt will rise in the long run

Gross general government debt

Source: OECD computation based on NZ Treasury (2021), Statement on the Long-term Fiscal Outlook and Long-term Insights Briefing

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Boosting productivity by enhancing diffusion of digital technologies

New Zealand has considerable scope to boost productivity by fostering growth of its digital sector and stimulating digital innovation. This requires strengthening the domestic pipeline of digital skills, making sure that regulations evolve with technological change and enhancing exports by firms exploiting digital technologies.

New Zealand is relatively advanced in some aspects of digitalisation, such as the high share of small firms selling online or use of the Internet of Things. However, the digital sector is smaller than in other OECD countries and has relied heavily on skilled migrants to fill jobs requiring advanced digital skills. It is now facing a severe skills shortage caused by border restrictions in the short term and competition from other countries in the longer term. The domestic pipeline of graduates with advanced ICT skills is narrowing, as weak mathematics and science achievement by students in primary- and lower secondary schools closes the door to tertiary studies in ICT-relevant fields.

The diffusion of digital technologies is also held back by a copyright regime that does not accommodate the use of some digital technologies, the cost of adopting digital tools for small businesses and the difficulty of reaping high returns on investment in digital technologies by exporting.

The government has been developing several policy initiatives on digitalisation, including the Industry Transformation Plans to foster the development of digital technology and agritech sectors. It recently embarked on the production of a national digitalisation strategy, which aims to promote trust, inclusiveness and growth in the digital economy and society. This strategy would help stakeholders in a wide range of policy areas to work together in a coherent way.

The introduction of unemployment insurance would help to make the diffusion of digital technologies more equitable by reducing the burden on workers displaced by digitalisation - most displaced workers do not qualify for the means-tested unemployment benefit.

Further measures are needed to reduce greenhouse gas emissions

New Zealand is not on track to meet either its 2030 abatement commitment or its 2050 net zero carbon emissions target. It has a solid institutional framework but needs to implement abatement measures. The carbon price is too low and efficient complementary measures, which address market failures not corrected by carbon pricing alone, still need to be taken.

The zero carbon amendments to the Climate Change Response Act 2002 require a fall in net carbon emissions to zero and a 24-47% decline in biogenic emissions from agriculture (currently almost half of total emissions) by 2050. The amendments create the Climate Change Commission (CCC) to advise on measures to achieve these objectives and to monitor progress. NZ Emissions Trading Scheme (ETS) reforms in 2020 placed a hard cap on permits in the scheme and created a cost containment reserve that can be used to limit price increases and a price floor below which permits will not be sold into the scheme. Taking into account actual and recommended complementary abatement measures, the CCC estimates that inflation-adjusted carbon prices will need to rise from NZD 68 per tonne of CO₂-e in early December 2021 to NZD 140 by 2030 and NZD 250 by 2050 for New Zealand to meet its abatement objectives from domestic sources.

The government has already taken various complementary abatement measures, notably in the areas of urban development, building codes and the provision of public/active transport infrastructure and the CCC has recommended others. New measures will need to complement carbon pricing and avoid the risk of high-cost abatement in situations where lower-cost abatement would be forthcoming through the ETS.

The government is preparing an Emissions Reduction Plan for publication in 2022 outlining policies and actions to help bridge the gap between the current emissions trajectory and the one required to meet the 2050 targets.

 

MAIN FINDINGS	KEY RECOMMENDATIONS
Making growth more sustainable in the wake of the COVID-19 crisis
Faced with the Delta coronavirus variant, the government has moved from an elimination to a minimisation and protection strategy. Intensive Care Unit (ICU) capacity is low.	Increase ICU capacity and vaccination rates among vulnerable groups. Once vaccination rates are high, progressively relax border restrictions, as planned.
The recovery has been rapid and strong and the economy is showing signs of overheating. The government plans to increase the structural budget balance slowly and to reduce medium-term government debt only modestly. In the longer run, population ageing will substantially increase budget deficits and debt on unchanged policies.	Withdraw fiscal stimulus rapidly to reduce the burden of macroeconomic stabilisation on monetary policy. Commit to explicit long-term debt-to-GDP targets. Increase the old-age pension eligibility age by linking it to life expectancy and take measures to limit the impact on disadvantaged groups.
Inflation has increased to well above the Reserve Bank’s 1-3% target band but business five-year ahead inflation expectations remain anchored.	Tighten monetary policy to the extent necessary to bring inflation back within the target band and to ensure that inflation expectations remain anchored.
Household mortgage debt is high. The Reserve Bank has reduced loan-to-value limits and is consulting on introducing debt-servicing restrictions.	Complement loan-to-value restrictions by requiring banks to use minimum interest rates for assessing borrowers’ debt servicing capacity or by introducing debt-to-income restrictions.
Productivity is low by international comparison owing to muted product market competition, weak international linkages and innovation, and skills and qualifications mismatches. The comprehensive FDI screening regime was streamlined in 2021. Effective corporate tax rates are high by international comparison, holding back capital investment and FDI.	Remove barriers to competition in the retail grocery sector. Monitor the effect of reforms in the FDI screening regime and streamline the procedure further if needed. Complement R&D tax credits with targeted grants subject to strict evaluation and enhance knowledge transfer from research institutions. Consider the appropriateness of the current corporate tax rate.
The government has improved the legal framework for reducing greenhouse gas emissions but is not on track to reach net zero by 2050.	Complement rising carbon prices from progressively tightening the supply of emissions permits with targeted measures that address market failures not corrected by carbon pricing alone.
No progress has been made in increasing user charging for water, which is limited to Auckland, Nelson and Tauranga, or introducing congestion charging, although it is being considered in Auckland for 2024, when major improvements in public transport will be completed.	Ensure that the new water service delivery entities, which are to be established by 2024, are enabled and encouraged to apply volumetric charging for water and wastewater. Introduce congestion charging in Auckland.
Increasing housing affordability and better protecting displaced workers
The Infrastructure Funding and Financing Act 2020 gives municipalities greater access to infrastructure financing through special purpose vehicles (SPVs) but no deals have yet been made.	Identify and remove unwarranted barriers to SPV deals. Give city councils greater incentives to accommodate growth, for example by sharing local goods and services tax receipts.
Most displaced workers do not qualify for the means-tested unemployment benefit. The government will consult on introducing unemployment insurance to reduce the burden on displaced workers.	Introduce the Social Insurance Scheme being developed and incorporate design features that encourage a rapid return to employment.
Boosting productivity by unleashing digitalisation
New Zealand embarked on the production of a national digitalisation strategy, which aims to promote trust, inclusiveness and growth in the digital economy and society.	Advance the national digitalisation strategy by providing a strong mandate for strategic coordination across all relevant policy areas and by collecting the data needed to support it.
The domestic pipeline of advanced ICT skills is weak. Poor mathematics achievement limits the proportion of school students who can obtain the university qualifications needed for ICT careers. Employers have preferred to recruit experienced workers with advanced ICT skills rather than offer career paths that lead to these posts.	Improve mathematics and science teaching in primary schools, including by putting more emphasis on inquiry plus guided teaching using well-articulated knowledge bases for both the student and the teacher. Develop digital apprenticeships and internships and expand the GOVTechTalent graduate programme to all public sector organisations. Develop programmes to help Māori and women pursue digital careers.
Some of New Zealand’s regulations lack flexibility to accommodate disruptive digital innovation, a framework to support data portability, and agility to prevent anticompetitive mergers and acquisitions in digital services.	Move toward goal-based regulations that stipulate regulatory objectives while allowing flexibility in technologies used. Empower the NZ Commerce Commission to order merger parties to apply for its clearance, to halt integration between parties during its investigation and to order merger parties that are overseas entities to produce information for its investigation.
Policy support for digital innovation and export promotion measures are not well linked.	Provide seamless support to innovative digital start-ups for their early global expansion through better coordination between Callaghan Innovation and New Zealand Trade Enterprise.
The digital platforms for managing irrigation, fertilisers and tracking animals are not necessarily inter-operational, nor do they produce data that can be easily combined.	Ensure interoperability across digital tool platforms by requiring agritech players to adopt common standards, while letting them choose the most suitable common standards to converge to.