David Carey
OECD
Naomitsu Yashiro
OECD
Axel Purwin
OECD
OECD Economic Surveys: New Zealand 2022
OECD Economic Surveys: New Zealand
1. Key Policy Insights
Abstract
The New Zealand economy recovered quickly from the COVID-19 shock thanks to effective virus containment, measures to protect jobs and incomes and highly expansionary macroeconomic policies but is now overheating and house prices have soared. The Reserve Bank has begun to tighten monetary and macroprudential policies with a view to achieving its price and financial stability objectives. Together with policy measures to increase housing supply, this should help moderate housing price inflation. While the fiscal deficit has begun to fall from the highs reached during the first wave of the COVID-19 shock, additional consolidation measures will be needed to put public finances on a sustainable path, including an increase in the pension eligibility age. New Zealand has a solid institutional framework to reduce greenhouse gas emissions but needs to implement additional abatement measures to meet its objectives. The carbon price needs to increase substantially and complementary measures taken that address market failures not corrected by carbon pricing alone.
New Zealand’s coronavirus elimination strategy has paid off so far. Strict confinement measures were implemented quickly (Figure 1.1), helping to limit the COVID-19 health toll. This strategy, together with measures to protect jobs and incomes and highly expansionary macroeconomic policies, laid the foundations for a rapid recovery from the deep downturn in the second quarter of 2020. Thus, by the third quarter of 2020, real GDP had already recovered to the pre-COVID-19 level, earlier than in any other OECD country. Stimulus has been so effective that employment may have reached its maximum sustainable level, unemployment has fallen considerably below the OECD’s estimate of the non-accelerating inflation rate (4.5%) and inflationary pressures have increased. The border restrictions needed to support the virus elimination strategy are increasingly creating challenges for the economy. They tend to exacerbate skills shortages, put export markets that require physical contact at risk and prevent recovery in the large tourism sector (Box 1.1). Lockdowns to crush sporadic community outbreaks have also taken their toll.
Figure 1.1. New Zealand’s initial response to COVID-19 infection was exceptionally swift
Number of days between the number of COVID-19 cases surpassing one per million persons and introduction of confinement measures, 2020
Source: Computed by the Secretariat from the OECD COVID-19 Policy Tracker; OurWorldInData.org
New Zealand has partially recovered from a long-term widening in the gap in living standards relative to the leading OECD countries. New Zealand’s GDP per capita (at purchasing power parity) declined from approximately 75% of the US level in the mid-1970s to around 60% from the early 1990s to late 2000s before steadily recovering to around 70% in recent years (Figure 1.2, Panel A). The decline would have been greater and the subsequent partial recovery smaller had the terms of trade not increased. Labour productivity followed a similar pattern but at a lower level: it fell from around 65% of the US benchmark in the mid-1970s to 55% in the mid-2000s before recovering to around 60% in the late 2010s and again, terms of trade increases attenuated the decline and strengthened the recovery. The shortfall in GDP per capita reflects low productivity levels (Panel B), which have persisted despite catch-up potential and substantial improvements in policy settings (de Serres, Yashiro and Boulhol, 2014[1]).
Economic and policy developments since the previous Survey have been dominated by COVID-19 and measures taken to minimise its health and economic impact. As noted above, the elimination strategy and significant macroeconomic stimulus enabled the economy to bounce back quickly to the pre-COVID level. However, policy stimulus has contributed to overheating the economy, a house price boom from already elevated levels and substantial increases in household- and government debt. The Reserve Bank of New Zealand has rightly begun a monetary policy tightening cycle. It has also indicated that house prices are unsustainable and has tightened macro-prudential policies. The government continues to implement reforms to reduce regulatory and infrastructure financing barriers to increasing housing supply. In March 2021, it announced a package of measures to increase new housing supply, especially of affordable housing, including by providing more finance for the associated urban infrastructure development and for developing vacant or underutilised land for housing, and to discourage investment in rental properties other than new builds. Border restrictions have drastically reduced net migration, reducing the inflow of an important source of labour for some industries, and the government is implementing a migration policy reset to reduce lower-skilled immigration permanently. The government plans to reduce public debt slowly, eventually increasing room to support the economy should future adverse shocks strike and to cope with the budgetary costs of population ageing, although not to pre-COVID levels. Policy changes will be needed if population ageing is not to result in large increases in public debt.
Figure 1.2. The declines in GDP per capita and labour productivity relative to US levels have been attenuated by terms-of-trade gains
1. At current PPP exchange rates.
2. Labour productivity is measured using total employment rather than hours worked, as data on hours worked only stretches back to 1986. There should not, however, be a big difference in evolution between the two measures of labour productivity. The United States is used as a benchmark because it has long been the productivity leader across a wide range of industries and because there is little difference between values for the United States and the population-weighted upper half of OECD countries.
3. Trading gains, or losses, equal the current trade balance deflated by a single price index, minus real exports, plus real imports. Trading gains thus capture the difference between real GDI and real GDP.
Source: OECD (2021), Economic Outlook 110 (database).
Box 1.1. Key features of the New Zealand economy
New Zealand has a small population (5.1 million) but a relatively large land mass (268 thousand square kilometres − a little bigger than England and a little smaller than Japan). Services account for the same share of value added as the OECD average, but primary industries are larger and goods-producing industries smaller (Figure 1.3). The largest service activities are real estate, education and social work activities, and wholesale and retail trade. By far the largest primary industry is dairy.
Figure 1.3. New Zealand’s service sector is large, as in other countries, but agriculture is larger and manufacturing smaller than elsewhere
Source: Stats NZ; OECD (2021), National Accounts (database)
New Zealand’s largest categories of exports are agricultural, tourism and horticultural (Figure 1.4, Panel A). It is highly dependent on Asian and Australian export markets, which take two thirds of its exports (Panel B). China (including Hong Kong) is by far New Zealand’s biggest export market, followed by Australia and the United States. New Zealand’s export intensity (27%) is the lowest among small OECD economies (population less than 20 million), largely owing to the country’s geographical isolation (Figure 1.5); import protection is low. New Zealand is poorly integrated in global value chains (GVCs), partly as a result of its geographical isolation (Figure 1.6).
Figure 1.4. The largest export categories are agriculture and tourism and the largest export markets China and Australia
1. Year to June 2021.
Source: Stats NZ.
Figure 1.5. New Zealand's export intensity is low for a small country
Exports of goods and services, 2019
Note: The OECD Smalls line refers to the average for OECD countries with a 2019 population of less than 20 million.
Source: OECD (2021), Trade in goods and services (indicator), doi: 10.1787/0fe445d9-en, 2021.
Figure 1.6. New Zealand is not well integrated in global value chains
Source: OECD (2021), Trade in Value Added (database).
The government is also laying the groundwork to make economic growth more environmentally sustainable. New Zealand has recorded the second largest increase in greenhouse gas (GHG) emissions amongst OECD countries since 1990 and emissions per capita are high (Figure 1.7). The zero carbon amendments to the Climate Change Response Act 2002 were legislated in 2020 with multi-party support and commit New Zealand to reducing domestic non-biological greenhouse gas emissions to net zero by 2050 and biological emissions by almost one half. The amended Act also makes New Zealand’s Emissions Trading Scheme more effective, notably by imposing five-year rolling caps on emissions and limiting the extent to which caps can rise owing to additional units entering the scheme from auctions and free allocations. Action is also being taken to improve water quality, which has been degraded by the huge expansion of the dairy industry and inadequate urban water infrastructure. Minimum standards for water quality have recently been set at the national level, with communities free to choose by how much they want to exceed them. The government has also decided to implement the Three Waters Reform Programme (drinking water, wastewater and storm water) that will shift water service delivery from local councils to four regional entities that will have greater ability to plan and fund more resilient and reliable water infrastructure across regions and communities than local councils and be more efficient.
Figure 1.7. Greenhouse gas emissions growth and per capita levels are high
Note: Greenhouse gas emissions excluding land use, land-use change, and forestry.
Source: OECD (2021), Environmental Statistics (database).
Against this background, the key messages of the Survey are that:
While terms-of-trade gains and rising labour utilisation rates have limited the long-term decline in GDP per capita relative to the richest countries, they cannot be relied upon indefinitely. The only long-term solution to sustain high living standards is to boost productivity, notably through making better use of digital technologies, which is the subject of this Survey’s thematic chapter.
House prices have soared from already high levels relative to fundamentals, affordability for first homebuyers has fallen to extremely low levels and the risk of a housing market correction has increased further, making it vital to complete reforms to ease constraints on housing supply and to tighten macro-prudential regulations.
While the strong economic recovery has accelerated reductions in budget deficits from the high levels reached during the pandemic, structural deficits and medium-term government indebtedness will only decline slowly. Fiscal policy should be tightened in the near term to reduce the stabilisation burden on monetary policy. While this will also reduce the needed future tax increases and/or expenditure cuts to finance long-term expenditure pressures, further measures will be required to ensure fiscal sustainability.
Ambitious objectives have been set for reducing greenhouse gas emissions. To maintain support for achieving these objectives and maximise wellbeing, it will be important to implement a coherent and equitable package of price and complementary policy measures that minimises costs for achieving a given amount of abatement.
The economy bounced back quickly from the COVID-19 shock but inflationary pressures have increased markedly
New Zealand’s economy shrank sharply in the second quarter of 2020 (Figure 1.8, Panel A) owing to the strict lockdown (Alert Level 4) imposed in late March, which shut down businesses considered to be non-essential (Box 1.2). Early virus containment allowed many sectors including construction to re-open in late April under Alert Level 3 and most businesses had returned to full operation by June. The economy rebounded strongly, regaining the pre-pandemic GDP level in the third quarter of 2020 and rising to 4.5% above the pre-COVID level by the second quarter of 2021, one of the strongest recoveries among OECD countries. At this point, economic growth had far exceeded the potential rate (estimated to be around 2 ½ per cent) since the second quarter of 2020, quickly closing the output gap. However, tourism-related sectors, such as transportation or accommodation, had not recovered owing to ongoing tight border restrictions (Panel B and C).
Strict containment measures were reintroduced in August 2021, when community transmission of the Delta variant broke out, and maintained in Auckland until early December, resulting in a 3.7% fall in real GDP in the third quarter of 2021. Confronted with the more contagious Delta variant and with high vaccination rates, the government shifted from an elimination strategy to minimisation and protection in December 2021 (see Box 1.2). It also announced the progressive easing of border restrictions and an expansion in intensive-care-unit capacity but, faced with the even more contagious Omicron variant, deferred the first stage of Managed Isolation and Quarantine (MIQ) free travel. The government is currently reviewing plans for the phased reopening of the border with announcements to be made in early 2022.
Figure 1.8. The economy bounced back quickly from the pandemic-induced contraction
1. Mobility change is a comparison relative to a baseline day before the pandemic outbreak. Baseline days represent a normal value for that day of the week given as median value over the five-week period from 3 January to 6 February 2020.
2. Cumulative change between 2019Q4 and 2021Q3, not seasonally adjusted.
3. Cumulative change between 2019Q4 and 2021Q3, seasonally adjusted.
Source: Stats NZ; Google LLC, Google COVID-19 Community Mobility Report
Box 1.2. New Zealand’s public health policy response to COVID-19
From elimination to minimisation and protection
New Zealand’s early response was characterised by a swift and stringent lockdown to eliminate community transmission. The government introduced a four-tiered Alert Level system on 20 March 2020 and imposed the most stringent lockdown (Alert Level 4) in the system, which mandated people to stay home and closed schools, universities and non-essential businesses. These lockdown measures were relaxed on 28 April and Alert Level 2 (some restrictions) was imposed from 13 May. With all domestic cases eliminated, nearly all restrictions on social and economic activities were suspended on 9 June although there were more requests for behaviours to limit the spread of the virus should it reappear, such as QR scanning, mask use and self-isolation for people feeling unwell. New Zealand experienced small, localised outbreaks in August 2020 and in February and June 2021, which it stamped out through early lockdowns. The aggressive elimination strategy resulted in sizable fluctuations in economic activity but was effective in saving lives (there were only 23 COVID-19 related deaths by early August 2021). However, the arrival of the highly contagious Delta variant in mid-August 2021 challenged this strategy. Despite the Alert Level 4 nationwide lockdown and the subsequent prolonged lockdown in Auckland (until early December) and nearby regions and businesses and schools in the rest of the country operating under raised Alert Level settings, the number of community infection cases did not fall to zero.
New Zealand’s COVID-19 strategy has shifted from elimination to minimisation and protection, the success of which depends on achieving a high vaccination rate across its population. New Zealand started a single-provider-focused (Pfizer/BioNTech) vaccination programme in February 2021, but the early stages of the roll-out were slower than in most other OECD countries. The government initially prioritised the vaccination of individuals at higher risk of contracting COVID-19, such as those working in managed isolation and quarantine- and long-term care facilities, followed by vulnerable groups (for example, persons aged 65 or over). Vaccination of the rest of the population started in late July with those aged 60 or over, and was extended to everyone aged 12 or over on 20 August, at which point only 19% of the population was fully vaccinated (compared to the OECD average of 50% at that time). The vaccination pace accelerated in October, eventually allowing New Zealand to exceed the OECD average (Figure 1.9). However, a delay in take-up among some population groups, such as young Māori, has been a challenge. Strategies to increase these groups’ vaccination rates should be strengthened through reducing barriers to access vaccines and more intensive community engagement and information campaigns in partnership with community organisations (OECD, 2021[2]). The government has also mandated workers in health, educational and correctional sectors as well as border workers to be vaccinated.
On 3 December 2021, New Zealand transitioned from the Alert Level system to a new COVID-19 Protection Framework (CPF), which has three settings (red, orange and green) for restrictions on movements and activity that depend on health system preparedness and population public health dynamics and reinforces incentives to be vaccinated.
In the red state, where action is needed to protect the health system and/or protect at-risk population groups, hospitality will remain open for people with vaccination certificates and education and retail will be open with public health measures but gathering limits, physical distancing and mask-wearing mandates will be imposed. Working from home will be encouraged.
In the orange state, where community transmission is increasing the pressure on the health system and there is increasing risk to at-risk populations, everything remains open for people with vaccination certificates and gathering limits currently applicable in the rest of the country will be lifted. Businesses that choose not to use vaccination certificates will either be closed or be subject to public health measures.
The green state is where there is limited community transmission of COVID-19, and the health system is ready to respond. There are no restrictions on people with vaccination certificates. Businesses that choose not to use vaccination certificates will face restrictions on numbers and spacing on their premises.
Auckland and some other North Island regions entered the CPF at the red level and the rest of the country at the orange level. Auckland’s borders with the rest of the country were opened on 16 December, subject to people crossing the boundary being vaccinated or having proof of a negative COVID-19 test. The whole country moved to the red level on 24 January following the detection of community transmission of the Omicron variant.
Figure 1.9. The vaccination rate is above the OECD average
The share of the total population fully vaccinated, 24 January or latest
Note: Small advanced economies are defined as the OECD countries with populations of 1-20 million and with per capita incomes above USD 30 000.
Source: ourworldindata.org/coronavirus
Border control measures have been stringent
New Zealand closed its border to foreign non-residents on 19 March 2020, with few exceptions. Citizens and residents returning from abroad needed to be isolated in Managed Isolation and Quarantine (MIQ) facilities for 14 days upon arrival. The number of MIQ places available has fallen far short of demand, preventing many New Zealanders from returning, including those making business trips to support export business, and skilled immigrants from entering the country.
In April 2021, the government introduced a bilateral measure with Australian states that removed the quarantine requirement for Australian and New Zealand residents arriving from Australia and for other travellers who had stayed in Australia for at least 14 days. However, this “travel bubble” was suspended in July 2021 after the outbreak of the Delta variant in the most populous Australian states.
In November 2021, the government reduced the number of days that vaccinated travellers entering New Zealand must spend in MIQ to seven days, followed by a short period of self-isolation at home. It also announced that New Zealand citizens and residents would be exempt from stays in MIQ facilities and would instead self-isolate for seven days from early-2022. Travellers would also have to comply with vaccination and testing requirements in addition to the self-isolation period. The timeline for MIQ-free travel was pushed back in December 2021 due to the global spread of the Omicron variant, which also prompted the government to shorten the period for pre-departure COVID tests for travel to New Zealand and increase the period of MIQ stays to 10 days. The government is reviewing plans for the phased reopening of the border and is expected to make announcements in early 2022.
Health system support
New Zealand’s aggressive elimination strategy against COVID-19 was partly motivated by its relatively low capacity to treat acute infection cases: the number of intensive-care beds in New Zealand relative to population is one of the lowest in the OECD (Figure 1.10). The government allocated just over NZD 1.1 billion for the public health response to COVID-19 and an additional NZD 1.4 billion for the COVID-19 Vaccine and Immunisation programme. It also allocated NZD 31.5 million to increase intensive care beds, and an additional NZD 10 million for ventilators to boost Intensive Care Unit (ICU) capacity. Short training programmes were offered to enable health professionals who are not ICU specialists to acquire the skills needed to assist fully trained staff in this area. This, however, has not remedied the fundamental shortage of qualified ICU personnel.
Figure 1.10. New Zealand’s intensive care unit capacity is low
Number of intensive care beds per 100 000 population, 2020 or latest year
Source: OECD (2020), Beyond Containment: Health systems responses to COVID-19 in the OECD
International cooperation
Aside from vaccinating its own population, New Zealand is donating 2.4 million doses of the AstraZeneca vaccine to the COVAX Facility to support vaccination programmes in developing countries like Samoa and Indonesia. Since October 2021, New Zealand has also been giving Pfizer COVID-19 vaccines to the Cook Islands, Niue and Tokelau to support vaccination of their 12-15 year-olds.
Source: OECD COVID Policy Tracker; Ministry of Health.
The recovery has been led by consumption, residential investment and goods exports. Consumption has been buoyed by strong household income growth, which has been supported by substantial government subsidies and transfers during lockdown periods, high labour income growth and large housing wealth gains (Figure 1.11, Panel A). Residential investment was growing strongly before the pandemic in response to shortages and an easing in regulatory constraints (see below) and has since accelerated further, reaching the highest share of GDP since the early 1970s. It is also very high by international comparison (Panel B). An increase in domestic tourism has also contributed to the recovery. After having recovered to the long-run average, business confidence has slipped markedly (Figure 1.12, Panel A). Expectations for own growth (Panel A) and business investment intentions (Panel B) have also declined but remain at robust levels.
External demand for New Zealand’s commodity exports is buoyant, pushing prices up and maintaining terms of trade at record levels (Figure 1.13, Panel A). However, tourism exports, which accounted for one fifth of exports pre-COVID-19, have collapsed owing to a pandemic-induced reduction in demand and border restrictions (Panel B). The current account deficit fell in 2020, when consumer expenditure was constrained by confinement measures, but has since increased markedly (Figure 1.14, Panel A). New Zealand’s net international investment position has improved over the past decade, though net international liabilities remain high by international comparison (Panel B).
Figure 1.11. House prices and residential investment have increased
1. Quarterly average. 2. For 2021, data for the first three quarters were used. 3. The shaded area shows the OECD average plus/minus one standard deviation.
Source: OECD (2021), National Accounts (database); Real Estate Institute of New Zealand, House price index
Figure 1.12. Business opinion points to solid economic growth and business investment
1. Percentage expecting improvement minus percentage expecting deterioration.
2. The shaded area indicates the projection period. The business investment intentions is the percentage of firms expecting to increase investment in property, plant and equipment in a year's time less percentage expecting to decrease investment.
Source: ANZ Bank (2021), Business Outlook Survey; OECD (2021), Economic Outlook 110 (database).
Figure 1.13. Robust commodity demand has boosted the economy but tourism has been hit by the pandemic
1. Real trade-weighted index from the RBNZ. 2. Terms of trade for goods are published on a quarterly basis and have been interpolated to get monthly values.
Source: ANZ Bank (2021), Commodity price index; Stats NZ, Balance of payments statistics; RBNZ
Figure 1.14. The current account deficit has returned to the pre-COVID-19 level and the net international investment position remains low by international comparison
Source: OECD (2021), Economic Outlook 110 (database); RBNZ
The labour market is tight and there are widespread reported skills shortages. The number of paid employees regained the February 2020 level in early 2021 and has since continued to rise very quickly, especially in goods industries (Figure 1.15, Panel A). Following a short-lived increase, the unemployment rate has been falling since late 2020 and is now well below the 4.5% OECD estimate of the non-accelerating inflation rate of unemployment (NAIRU) (Panel B). Employers report extreme difficulty in finding labour, partly owing to the need to navigate up and down COVID-19 alert levels and to manage supply chain disruptions (Panel C). Tight border restrictions have reduced the inflow of skilled migrants to a trickle – net migration has fallen from 40 000 in 2019 to 1 000 per quarter - aggravating skills shortages. Wage growth has rebounded from the COVID-related slowdown in 2020, especially for private sector hourly earnings, to around pre-COVID levels (Panel D). Overall, labour market indicators suggest that the market is now very tight (Table 1.1). The employment rate is the highest since the Household Labour Force Survey began in 1986 and the unemployment- and underutilisation rates are the lowest since 2007. With a high share of businesses planning to increase recruitment, a further pick-up in employment growth is on the cards, which is likely to boost wage growth further.
Figure 1.15. The labour market is tight
1. The adjusted LCI is a measure of wage inflation. As such, it measures changes in pay rates for a fixed quantity and quality of labour input and thus adjusts for wage increases that are due to the employee being promoted, more experienced or more qualified.
Source: Stats NZ; OECD (2021), Economic Outlook 110 (database); NZIER (2021), Quarterly Survey of Business Opinion
Inflation has increased to well above the RBNZ’s 1-3% target band, reflecting large increases in both tradables and non-tradables inflation (Figure 1.16, Panel A). The increase in non-tradables inflation reflects a lack of spare capacity in the domestic economy. Capacity constraints in trading-partner economies have also contributed to the increase in tradables inflation as have commodity price increases. Insofar as capacity constraints reflect supply-chain disruptions, including to freight services, they are likely to be temporary. Underlying inflation has also increased to above the target band (Panel B). Household and two-year business inflation expectations have increased and the proportion of firms planning to increase selling prices has soared (Panel C). However, five-year business inflation expectations remain anchored. Interest rates have increased but remain very low (Panel D).
Table 1.1. Labour market indicators are back to pre-COVID-19 levels
1. As a percentage of the labour force.
2. The working age population is defined as the population aged 15 or over.
3. As a percentage of the working-age population.
4. Year-on-year percentage change.
5. Data from the Quarterly Employment Survey.
Source: Stats NZ.
Figure 1.16. Inflation has increased
1. The RBNZ Survey of expectations covers a mixture of business leaders and professional forecasters. 2. Median value. 3. Quarterly average.
Source: Stats NZ; OECD (2021), Economic Outlook 110 (database); ANZ Bank (2021), Business Outlook Survey; RBNZ
Cyclical core inflation has increased since the onset of the COVID-19 recession (Box 1.3). While this has also occurred in other countries, it contrasts with the significant decline that normally occurs in a recession. Indeed, in contrast to a typical recession, the COVID-19 recession was driven less by demand than supply. As the pandemic-related constraints on mobility have eased, economic activity has bounced back quickly. With little economic slack to absorb, there is unlikely to be a long period of cyclically strong, non-inflationary growth. As in other countries, the purging of excesses, such as high indebtedness and misguided investments, that typically occurs in recessions has not occurred. If anything, such excesses have increased.
Assuming that the underlying primary deficit falls by 1.1% of potential GDP between 2021 and 2023, that the overnight cash rate progressively rises by 200 basis points by early 2023 and that the border gradually re-opens from early 2022, economic growth is projected to ease from an estimated 4.7% in 2021 to 2.5% in 2023 (Table 1.2). The slowdown reflects the passing of rebound effects from the COVID-19 shock, tighter macroeconomic policy settings and much reduced gains in housing wealth and the terms of trade. Inflationary pressure will remain strong even after temporary effects from high fuel prices and supply chain disruptions pass, as the economy continues to grow faster than potential and the unemployment rate remains well below the natural rate, which the OECD estimates to be 4.5%. Re-opening of the border will help to ease labour shortages only gradually as inflows of migrant workers will be limited by new immigration rules. It will nevertheless support export business that requires physical contact and allow the tourism sector (comprising 6% of GDP, or 9% including related activity, before the pandemic) to recover.
Box 1.3. Cyclical inflation has increased since the start of the COVID-19 recession, in contrast to declines in past recessions
Inflation often follows the direction of the overall economy. As the economy expands, demand for labour and goods is high relative to supply, causing wages and prices to rise. In recessions, the situation is reversed and excess supply causes inflation to decline. The prices of some goods (shorthand for goods and services) are, however, less sensitive to general economic activity and instead depend more on industry-specific factors.
Core inflation can be decomposed into a cyclical component, which reflects goods that are sensitive to the current state of the economy, and an acyclical component, which reflects goods that are less sensitive to the state of the economy. Following Mahedy and Shapiro (2017[3]), goods with prices that exhibit a statistically significant negative relationship with the unemployment gap (the gap between the unemployment rate and the NAIRU) are classified as cyclical and others acyclical; examples of cyclical goods are restaurant meals, housing rentals and telecom services.
During the global financial crisis years 2008-2009, cyclical inflation in New Zealand dropped off whereas acyclical inflation started to increase (Figure 1.17). The shorter recession in 2010 was followed by a decline in both cyclical and acyclical inflation and subsequently by a longer period where cyclical inflation was at a higher rate than acyclical inflation. The recent economic crisis, triggered by the Covid-19 pandemic, has not, however, been followed by a decline in cyclical inflation. Rather, cyclical inflation remained unchanged in the first two quarters of 2020, only to rise as fiscal stimulus packages were launched and economic activity resumed. It thus seems as if this crisis, due to the very fast course of events and the prompt actions taken by the government and central bank, will not be followed by the usual phase of economic recovery, in which low cyclical inflation allows for non-inflationary growth. This development mirrors that in the United States (Federal Reserve Bank of San Francisco, 2021[4]) and in many other OECD economies.
Figure 1.17. Cyclical inflation has increased since the onset of the COVID-19 recession, in contrast to declines in past recessions
Note: The shaded areas in the figure indicate recessions, defined as periods between a peak and a trough in economic activity. The recession period should also contain successive quarters of negative growth.
Source: Own calculations using the Mahedy and Shapiro (2017[3]) methodology; Stats NZ.
The main downside risk to the outlook is that the phasing-out of coronavirus-related border restrictions is delayed, for instance owing to the emergence of new COVID variants against which vaccines are less effective. A delayed border reopening would postpone the entry of migrants needed to ease skills shortages as well as recovery in the tourism sector. On the other hand, the removal of border restrictions in other countries, especially Australia, could encourage New Zealand residents to emigrate, aggravating skills shortages, especially in the construction sector. A sharp slowdown in China, New Zealand’s largest trade partner, would reduce commodity export prices, lowering farmers’ incomes and consumption. There is also a risk of a large fall in house prices from current elevated levels, given the outlook for an easing in shortages, higher interest rates and more restrictive prudential policies (Figure 1.18). Were this to occur, there would be a large negative effect on private consumption owing to the high level of household debt (Figure 1.19). Continued or worsening global supply chain disruptions would fuel higher inflation for a prolonged period, weighing on private consumption, and constrain economic activities through shortages of imported materials. The main upside risks include stronger than foreseen global demand for New Zealand’s agricultural products and public health conditions that permit a more rapid phasing-out of restrictions on economic activities than assumed. Events that could entail major changes in the outlook are identified in Table 1.3.
Table 1.2. Macroeconomic indicators and projections
Annual percentage changes unless specified, volume (2009/10 prices)
1. Contribution to changes in real GDP; 2. As a percentage of potential GDP; 3. As a percentage of the labour force; 4. Consumer price index excluding food and energy; 5. As a percentage of household disposable income; 6. Goods and services; 7. As a percentage of GDP; 8. As a percentage of potential GDP; 9. National Accounts basis excluding unfunded liabilities of government-employee pension funds.
Source: OECD (2021), Economic Outlook 110 (database), updated for 2021Q3.
Table 1.3. Events that could entail major changes to the outlook
Figure 1.18. Asset price correction is a major macro-financial risk
Index scale of -1 to 1 from lowest to greatest potential vulnerability, where 0 refers to long-term average
Note: Each aggregate macro-financial vulnerability indicator is calculated by aggregating (simple average) normalised individual indicators. Non-financial includes: private bank credit, household credit and corporate credit. Asset market includes real house prices, price to income ratio, residential investment and real stock prices. External position includes the current account (CA) balance as a percentage of GDP, export performance and net international investment position (NIIP) as a percentage of GDP. Fiscal includes the difference between the interest rate on the government bondsand expected growth rate (r-g), government budget balance and government gross debt, both expressed as a percentage of GDP. Financial includes household debt, the share of non-performing loans in total loans, external bank debt as percentage of total banks’ liabilities, housing loans, and capital and reserves as a proportion of total liabilities (leverage ratio).
Source: OECD calculations based on Refinitiv; OECD, Economic Outlook 110 (database); Reserve Bank of New Zealand; Stats NZ.
Figure 1.19. Household indebtedness is high
Household debt as percentage of net disposable income, 2020 or latest year available
Note: 2019 data for Chile, Estonia and the United States, 2018 data for Japan.
1. Reserve Bank of New Zealand data, including debt on rental properties.
Source: OECD (2021), Economic Outlook 110 (database); OECD, National Accounts (database); RBNZ.
Monetary and financial stability policies were relaxed in response to the COVID-19 crisis but now need to be tightened further
Monetary policy responded promptly to the COVID-19 shock (Box 1.4). The Large Scale Asset Purchase (LSAP) programme boosted credit supply and is estimated by the RBNZ to have reduced long-term government bond yields by around 1 percentage point. This abundant credit supply, combined with the temporary removal of loan-to-value-ratio (LVR) restrictions and low mortgage interest rates, resulted in strong growth in mortgage lending (12% in the year to July 2021), particularly to investors; household debt rose from 159% of net disposable income in the December quarter of 2019 to 169% in the June quarter of 2021. The share of high-risk lending characterised by high LVR and debt-to-income (DTI) rose rapidly (Figure 1.20).
Figure 1.20. Mortgage lending has accelerated, including more high-risk lending
High-risk shares of new mortgage lending by buyer type
Note: Investors covers all lending to borrowers where at least one investment property secures the loan.
Source: The Reserve Bank of New Zealand (2021), Financial Stability Report, November 2021
Highly leveraged borrowers are more exposed to future increases in interest rates than others, especially as mortgage interest rates are only fixed for short periods in New Zealand - 78% of outstanding mortgages will have their interest rates reset within one year (Reserve Bank of New Zealand, 2021[5]). The RBNZ estimates that an increase in the one-year mortgage rate from around 2.5% currently to 5% would increase a typical recent owner-occupier’s debt-servicing ratio from around 30% currently to above 40% (Reserve Bank of New Zealand, 2021[6]). Highly indebted households may reduce their consumption sharply in response to higher mortgage interest rates, which would dent economic growth.
The RBNZ reinstated LVR restrictions at pre-pandemic levels in March 2021, and further tightened them for investors in May 2021. This slowed down new lending to investors with high LVRs but lending to first-home buyers and other owner-occupiers remained strong. LVR restrictions were tightened in November 2021 when the cap on the share of new lending to owner occupiers with LVRs above 80% was cut from 20% to 10%. In August 2021, the Minister of Finance agreed to allow the RBNZ to impose debt serviceability restrictions, including debt-to-income and debt-servicing-to-income ratio restrictions, in a Memorandum of Understanding with the RBNZ should it decide that they are warranted. These restrictions, if introduced, would potentially limit further debt increases as house prices rise and protect borrowers from the risk of becoming unable to service their debt. They would complement loan-to-value ratio restrictions, which protect banks from losses in case of large declines in house prices, in boosting the resilience of the financial system. To wit, in 2017 Norway introduced a limit on mortgage lending of five times the gross annual income of borrowers, bringing down the share of mortgage lending exceeding this threshold from 8% in 2016 to 3% in 2018 (Finanstilsynet, 2018[7]). The RBNZ has not decided on whether to implement debt serviceability restrictions. Implementation of a debt-to-income cap could take six to nine months but a regulation on the minimum test interest rates banks use in their serviceability assessments could be put in place sooner. RBNZ analysis indicates that a debt-to-income cap would bite most on investors, followed by higher-income owner occupiers, as these groups borrow at the highest debt-to-income multiples on average. Other options such as a test interest rate floor or debt-servicing-to-income cap would have larger impacts on low-income households and first-time home buyers (Reserve Bank of New Zealand, 2021[8]).
In response to faster than anticipated economic recovery and rising inflation pressure, the RBNZ halted the Large Scale Asset Purchase programme in July 2021 (Box 1.4) and is mulling a strategy on how to manage its substantial government bond holdings, which amount to 16% of annual GDP. The Funding for Lending Programme, which has disbursed about NZD 3 billion so far, is to remain in place until its expiration at the end of 2022. The RBNZ increased the policy rate by 25 basis points in October 2021 and again in November 2021, taking the rate to 0.75%, and projects further increases to 2% by end-2022, which is the RBNZ’s estimate of the neutral nominal rate, and to 2.6% by end-2023 (Reserve Bank of New Zealand, 2021[9]). This is likely to slow housing demand as an increase in the policy rate is fully passed through to mortgage lending rates in six to seven months, albeit with some variation among banks (Bernhard, Graham and Markham, 2021[10]). The government bonds operation strategy may result in the RBNZ reducing its bond holdings by not replacing maturing bonds or selling bonds directly to the Treasury. The revised monetary policy stance is appropriate in light of the overheating economy and rising inflation expectations (Reserve Bank of New Zealand, 2021[6]). At the same time, the RBNZ should stand ready to adjust the tightening cycle and support the economy, should the economic shock from the Delta variant be greater than expected.
Box 1.4. Monetary policy response to the COVID-19 shock
Reduction in the policy rate
In March 2020, the Reserve Bank of New Zealand (RBNZ) cut its policy rate (the overnight cash rate) by 75 basis points to 0.25%, and committed to maintain this rate for at least 12 months. The cut followed the two cuts totalling 75 basis points in May and August 2019.
Increasing credit supply
The RBNZ also announced in March 2020 a Large Scale Asset Purchase (LSAP) programme of New Zealand government bonds amounting to NZD 30 billion (about 10% of annual GDP) over 12 months (quantitative easing). The programme limit was subsequently expanded to NZD 100 billion over two years. The LSAP was halted in July 2021, one year ahead of schedule, after NZD 55 billion of government bonds (16 % of GDP) had been purchased.
The RBNZ also introduced the Funding for Lending Programme in December 2020, providing up to NZD 26 billion worth of low-cost funding to banks based on their outstanding credit to New Zealand borrowers and increases in lending.
Relaxing macro-prudential regulations and postponing increases in capital adequacy requirements
The RBNZ temporarily removed loan-to-value ratio (LVR) restrictions in April 2020, so that banks could smoothly implement a six-month principal and interest payment holiday for mortgage holders. The RBNZ also postponed the beginning of the seven-year transition period for achieving the new capital ratio requirements that was planned in 2020 (see below), to July 2022.
New capital requirements risk tightening business lending
In order to increase the resilience of New Zealand’s banking sector to be able to withstand a once in 200 years scale financial shock, the RBNZ decided in late 2019 to increase banks’ capital adequacy requirements to 18% of risk-weighted assets for the four Domestically-Systemically Important Banks (D-SIBs) and to 16% for the other, smaller banks. Such ratios are among the highest in OECD countries (Figure 1.21). The new capital regulation requires banks to increase the minimum capital requirement from 8% currently to 9% by July 2023, and build up a large prudential capital buffer equivalent to 9% of risk-weighted assets for D-SIBs and 7% for other banks by July 2028. Capital must be mainly Tier 1 capital, while additional Tier 1 capital and Tier 2 capital can comprise only 2.5 and 2% of the required capital ratios, respectively. The prudential capital buffer is composed of the countercyclical capital buffer (1.5% out of 7%), which the RBNZ can release during economic downturns in order to allow more lending, and the capital conservation buffer (5.5%), whose breach triggers supervisory measures by the RBNZ.
Figure 1.21. Proposed new capital requirements exceed those in other OECD economies
Tier 1 capital requirements, as a percentage of risk-weighted assets
Note: For banks judged to be domestically systemically important but not globally systemically important. D SIFI (domestically systemically important financial institution) buffer is the average across banks to which it currently applies. Pillar 2 requirements are averaged across systemically important banks where data are available. For Switzerland, Pillar 2 requirements are based on the highest total capital required among non-globally systemically important banks. For Sweden, data are based on common equity tier 1 requirements averaged across the three major banks. For Australia, APRA will require major Australian banks to hold 10.5% Core Equity Tier 1 capital by 1 January 2020 and is currently proposing further increases in total capital requirements for major banks. Rules on risk weighting of assets vary across countries.
Source: Bank of England; European Systemic Risk Board; Australian Prudential Regulation Authority; Bank for International Settlements; The Office of the Superintendent of Financial Institutions (Canada); Financial Services Agency (Japan); Norges Bank (Norway); Financial Services Commission (Korea); Finansinspektionen (Sweden); and FINMA (Switzerland).
While this reform will eventually strengthen the resilience of the banking sector, it requires banks to raise large amounts of additional capital or reduce riskier assets, such as lending to small businesses. However, the impact of the capital requirement on credit growth and the risk of credit rationing are substantially reduced by allowing a transition period of seven years, according to the Reserve Bank of New Zealand (2019[11]). The bankruptcy rate has remained low so far (Figure 1.22), thanks to the financial support provided in response to the COVID-19 shock, notably via credit guarantees and the robust economic recovery that improved firms’ cash flow. Overall, firms are using positive cash flows to deleverage and improve their balance sheets, which is resulting in growing deposits and declining loan balances even in sectors most affected by the pandemic (Reserve Bank of New Zealand, 2021[5]). Nevertheless, bankruptcies may surge once financial support schemes are withdrawn completely, especially in the tourism sector. The RBNZ should carefully monitor the impact of new capital requirements on business lending, particularly during economic downturns. It is also important that an effective operational framework for the countercyclical capital buffer be established following the consultation the RBNZ will carry out in 2022.
Figure 1.22. The number of bankruptcies remains low for now
Number of bankruptcy adjudications, 6-months moving average
Source: New Zealand Insolvency Trustee Service (2021), Insolvency procedure statistics
The monetary and financial stability policy framework is being updated
In 2017, the government initiated a review of the Reserve Bank of New Zealand Act 1989 that has now been partially completed and legislated. The first tranche of the Reserve Bank of New Zealand (RBNZ) reforms concerns monetary policy and was enacted in 2018, replacing the previous Policy Targets Agreement with a Monetary Policy Remit, adding ‘supporting maximum sustainable employment’ to the economic objectives of the RBNZ and providing for the creation of a Monetary Policy Committee (MPC) with responsibility for formulating monetary policy, in lieu of the former model in which the RBNZ Governor alone had this responsibility. Most foreign central banks have monetary policy committees and some, notably the Federal Reserve and the Reserve Bank of Australia, have dual mandates. In February 2021, the Minister issued a Remit to the Monetary Policy Committee instructing it to assess the effect of its monetary policy decisions on the government’s objective to support more sustainable house prices. The Remit only requires the RBNZ to assess and communicate the impact of its decisions on this objective, not to add it to the other monetary policy objectives.
The second tranche concerns institutional and accountability reforms and was enacted in 2021, replacing the single decision-maker model with a governance board tasked with all RBNZ responsibilities other than those given to the MPC, strengthening reporting and accountability requirements, reframing and clarifying the financial policy objective of the RBNZ by changing it from ‘soundness and efficiency’ to ‘financial stability’, and providing for a Financial Policy Remit issued by the Minister of Finance.
The third tranche concerns prudential regulation and supervision of deposit takers and the introduction of deposit insurance. These reforms are included in the Deposit Takers Bill to be submitted to Parliament in early 2022 and that is expected to be enacted in early 2023 and to become fully operational after a long transition period. The Bill creates a uniform regulatory framework for all deposit-taking institutions and provides the framework for regulating and supervising them and for managing and resolving any deposit taker in financial distress. The Bill also creates a deposit insurance scheme, as recommended in past OECD Surveys (Table 1.4). The crisis management and resolution framework is being brought more into line with international arrangements, including by having a ‘No Creditor Worse off’ provision and introducing contractual bail-ins, which will only come into effect once the RBNZ has completed its Capital Review. Planned deposit insurance coverage is up to NZD 100 000 per depositor, per institution. This is a big improvement on the current absence of such insurance. It would still be lower than in many other countries (Figure 1.23) but New Zealand’s comparatively high capital ratios offer greater protection.
Table 1.4. Past OECD recommendations on financial stability and actions taken
Figure 1.23. The proposed deposit insurance coverage is relatively low
Depositor protection limits, per depositor per institution (thousand USD), as of end 2019
1. Proposed protection limit (NZD 100 000).
Fiscal policy and debt sustainability
Fiscal policy will be mildly contractionary
The fiscal balance deteriorated sharply in the wake of the pandemic, owing to reduced fiscal revenue and the massive fiscal response to COVID-19 (Box 1.5). The Total Crown balance, the government’s preferred fiscal measure that includes operating activities of the central government, state-owned enterprises and the RBNZ but excludes those of local governments, fell from a surplus of 2.4% of GDP in FY 2019 (fiscal years end 30 June) to a deficit of 7.3% in FY 2020. The Total Crown deficit narrowed to 1.3% of GDP in FY 2021 as the economic impact of confinement measures diminished along with their budgetary costs but jumped to 5.7% of GDP in FY 2022 mainly owing to COVID-19 related expenditure to support the economy through the outbreak of the Delta variant. The New Zealand Treasury projects the fiscal deficit to be almost eliminated in FY 2023 as this expenditure eases, followed by steadily growing surpluses over the next few years as COVID-related spending continues to be phased out. From FY 2023 onwards, fiscal expenditure will continue to decline as a share of GDP but will increase in nominal terms, not least because the government set an increase in cumulative fiscal spending allowances amounting to NZD 6.0 billion in FY 2023, NZD 10.0 billion in FY 2024 and NZD 13.0 billion in FY 2025.
Following the highly expansionary stance in FY 2020, fiscal policy was strongly contractionary in FY 2021 but highly expansionary in FY 2022 (Table 1.5). The fiscal stance will again be strongly contractionary in FY 2023 as COVID-related expenditure falls and turn mildly contractionary afterwards abstracting from large infrastructure investments yet to be approved. The government earmarked NZD 12 billion prior to the pandemic to the New Zealand Upgrade Programme to invest in transport, hospitals, schools and regional communities. Furthermore, “shovel-ready” infrastructure investment projects amounting to NZD 2.6 billion are to be rolled out by FY 2022. The Housing Acceleration Fund, announced in March 2021, will allocate NZD 3.8 billion to investment in critical infrastructure that supports large housing developments.
Table 1.5. The fiscal stance is projected to become contractionary
Per cent of GDP (except where noted), Fiscal Year ending on 30 June
1. Core Crown includes government departments, offices of parliament, the New Zealand Superannuation Fund and the Reserve Bank. Total Crown consists of core Crown plus Crown entities (such as the Accident Compensation Commission and Callaghan Innovation) and State-owned enterprises.
2. Based on operating balance before gains and losses.
3. % of potential nominal GDP.
4. Excluding Earthquake Commission and Southern Response payments and receipts related to the Canterbury and Kaikoura earthquakes.
5. Including Reserve Bank settlement cash and bank bills.
Source: Treasury (2021), Half Year Economic and Fiscal Update 2021
With little slack left in the economy, the fiscal stance should be tightened more rapidly to avoid concentrating the burden of macroeconomic stabilisation on monetary policy. To reduce the risk of large public investment overheating the economy and accelerating inflation further, the government should avoid concentrating infrastructure investment in the near term and instead spread it over a longer horizon.
Box 1.5. Fiscal response package against the COVID-19 shock
The fiscal package amounted to 20% of GDP
The government announced its initial support package of NZD 12 billion in March 2020, followed by the NZD 50 billion COVID-19 Response and Recovery Fund (CRRF) in May. The massive fiscal response included not only fiscal stimulus but also sizable expenditure on public health measures (see Box 1.2). The largest budgetary measure was the Wage Subsidy, which initially was paid to businesses that lost at least 30% of revenue due to the COVID-19 crisis so that they could continue to employ and pay their staff. The scheme cost NZD 14 billion (4.5% of GDP) and covered 71% of businesses and 60% of employment at one point. While the first wave of the Wage Subsidy expired in November 2020, the Government has continued to use the Wage Subsidy during subsequent lockdowns, though the eligibility conditions have been tightened over time. The fiscal package also included infrastructure investment in transportation, environment, housing and community development amounting to NZD 3 billion, NZD 2.6 billion of which was allocated to “shovel-ready” projects that can start within a year.
Support measures for households and workers
The main measures included a non-means tested Covid-19 Income Relief Payment (CIRP) for individuals who lost their job or self-employment because of COVID-19. Benefits payments were increased as well, including a doubling of the winter energy payment. A fund for boosting trades and apprenticeship training was launched aimed at retraining about 10,000 hospitality and aviation sector workers for jobs in other sectors.
Support measures for businesses
The main measures included the Business Finance Guarantee Scheme, where the government bears 80% of the risk of loans for solvent SMEs, and the Small Business Cashflow Scheme, a public loan scheme allowing small businesses to borrow up to NZD 100 thousand plus NZD 1 800 for each full-time equivalent employee without interest during the first year. The Resurgence Support Payment provides cash support to businesses or organisations experiencing a revenue decline of over 30% due to an increase in the COVID-19 alert level. Measures to alleviate financial stress for highly indebted businesses, such as a six-month interest and principal payment holiday for mortgage holders and SMEs and debt hibernation were also introduced. Regarding taxation, a tax loss carry-back scheme was introduced and corporate income tax changes such as an increase in the provisional tax threshold and the reintroduction of depreciation charges for commercial buildings were implemented.
A clearer fiscal consolidation plan is needed to ensure long-term debt sustainability
In the Half Year Economic and Fiscal Update 2021, the Treasury projects net Core Crown debt to peak at 40% of GDP in mid-2023 and to decline afterwards (Table 1.5). In the longer run, however, the debt-to-GDP ratio is likely to increase substantially, driven by population ageing and healthcare expenditure growth. The share of the population aged 65 or above will rise from 16% in 2020 to 25% by 2060 (Stats NZ, 2021[12]). As a result, the Treasury projects that old-age pension expenditure will increase to 7.7% of GDP in 2060 from 5% in 2021. The Treasury also projects a large increase in health-care expenditure, from 6.9% of GDP in 2021 to 10.6% of GDP in 2060, owing to excess cost growth as more effective but expensive treatments become available and to population ageing (The Treasury, 2021[13]). Based on these increases, the OECD projects that gross general government debt would increase from 49% of GDP in 2021 to around 140% of GDP in 2060 (baseline projection) and continue rising rapidly thereafter (Figure 1.24); the increase would be greater if it were not for drawings after 2050 from the New Zealand Superannuation Fund, which was established to help pre-fund population-ageing-related growth in pension expenditure (The Treasury, 2021[13]). Reforms to slow growth in health-care and pension-related expenditure would reduce increases in the debt-to-GDP ratio while higher interest rates would accentuate them.
The government’s long-term fiscal strategy announced in early 2021 is to stabilise net core Crown debt as a share of GDP by the mid-2020s, which will be met according to the latest fiscal projections (see Table 1.5), and then reduce it as conditions permit. The government will run an operating balance consistent with meeting this long-term debt objective. While this strategy is vague compared to the one prior to the COVID-19 pandemic, which was to reduce net core Crown debt to 20% of GDP by 2022, large uncertainties surrounding the economic outlook make it difficult to commit to specific numerical targets in the short term. The government also considers current debt levels as prudent and is oriented more toward addressing long-standing infrastructure gaps, for instance in healthcare, than engaging in imminent debt reduction. Nevertheless, there is a case for issuing a clearer commitment to improving the long-term fiscal position, for instance by providing an explicit long-term debt-ratio target. Such a commitment would bolster New Zealand’s strong reputation for fiscal prudence, which is essential for a small open economy running current account deficits and exposed to global shocks and natural disasters. It also helps avoid large increases in government debt interest costs, which would substantially reduce room for discretionary spending and/or necessitate tax increases (The Treasury, 2021[13]).
Figure 1.24. Reforms are needed to prevent population-ageing fiscal pressures from pushing up government debt
Gross general government debt, SNA basis, % of GDP
Note: The baseline scenario corresponds to the case where healthcare and pension spending grows along the historical trend. In the pension reform scenario, the eligibility age for New Zealand Superannuation is raised from 65 to 67 over 4 years from FY2025/26 to 2029/30. The healthcare and pension reforms scenario corresponds to the case where healthcare expenditure growth is reduced by 0.5 percentage point from the baseline in addition to the pension reform. The higher interest scenario assumes that nominal interest rates rise faster than in the baseline and reach 5.5% in 2060 (as opposed to 4.3%).
Source: OECD computation based on information in NZ Treasury (2021), Statement on the Long-term Fiscal Outlook and Long-term Insights Briefing
Extending working lives, namely by linking the pension eligibility age to life expectancy, as recommended in the 2017 Economic Survey of New Zealand (Table 1.6), is essential for credibly ensuring pension sustainability; estimates of the impact of selected reforms on GDP (Table 1.7) and the government budget balance (Table 1.8) are shown in Box 1.6. This could be done in such a way that the proportion of adult life expected to be spent in retirement remains constant, as in Finland. The government is opposed to increasing the pension eligibility age from 65, where it has been for the past quarter century, partly out of concern that groups with shorter life expectancy, notably Māori and Pasifika, would be disadvantaged. It would be preferable to address these concerns through measures to limit the impact on these groups instead of freezing the eligibility age for everyone. One such measure could be to provide the pension on a means-tested basis from age 65 until the life expectancy-linked eligibility age, at which point the pension would no longer be means tested; New Zealand had such a system before the current system (flat-rate, non-means-tested pension available from a single eligibility age subject to residency qualifications) was introduced in 1977 and again temporarily during the 1990s when the pension eligibility age was being increased from 60 to 65.
The government has announced profound health-care reforms that are expected to reduce administrative costs and disparities in care but have ambiguous effects on government expenditure. The reforms include replacing 20 District Health Boards (DHBs) with a new Crown entity (Health New Zealand) that runs hospitals and commissions primary and community health services. A new Māori Health Authority will monitor the state of Māori health, which has been worse than for other New Zealanders, and commission health services and develop policy focused on Māori. The impact on government expenditure is ambiguous because the cost of granting universal access to uniform health care services could easily outweigh the savings from increased efficiency. The government aims to alleviate health-care costs and the burden faced by hospitals by strengthening preventive care, in line with a recommendation in the 2015 OECD Economic Survey of New Zealand.
More rigorous planning in public investment and more transparent and competitive procurement would enhance efficiency and ensure timely and on-budget delivery of infrastructure assets (OECD, 2021[14]). For instance, the Ministry of Transportation and the Treasury reported that some NZD 5.5 billion worth of transport infrastructure projects funded by a NZD 6.8 billion envelope under the New Zealand Upgrading Programme lacked robust execution plans and risk assessment, thereby exposing their delivery to significant risks (Ministry of Transport and The Treasury, 2021[15]). Their cost estimates also turned out to be optimistic, and an additional NZD 2 billion was required. While the envelope was meant to prioritise projects that contribute to transit-oriented housing development and emissions reductions, few projects were aligned with these priorities. In order to ensure good value for money, the government should guard against implementing large infrastructure investments that are not based on thorough planning and cost-benefit analysis. Planning capabilities by the government agencies tasked with delivering large projects also need to be enhanced to ensure the efficient use of infrastructure funds.
Competitive tendering is essential for cutting costs and ensuring value-for-money in procurement. At 37%, the weight of procurement in New Zealand’s fiscal expenditure is relatively large, as is its weight in the economy (Figure 1.25). Any procurement contract by government departments, non-public service departments (such as New Zealand Police and the New Zealand Defence Force) and most Crown entities that exceeds NZD 100 000 must be openly advertised on the Government Electronic Tenders Service (GETS) and contracts awarded must be posted with expected expenditure. Yet, only NZD 1 billion worth of contracts were published on GETS in 2020, a tiny fraction of the NZD 42 billion in total procurement (Millar, 2021[16]). Some procurement, such as many of the COVID-19-related emergency procurement contracts, is exempt from open advertising. Also exempt is what is called secondary procurement, where a government agency purchases from a panel of pre-approved suppliers or under an All-of-Government and other contracts specified in the Government Procurement Rules. Government agencies purchase from a panel of suppliers to save time and screening costs. However, panel members are often large incumbent firms and while there is a chance for new firms to be selected as new members, the selection process only takes place every few years. This reduces competition and therefore pressure for delivering better products and services at lower cost. Furthermore, it deprives young innovative firms of the opportunity to grow by tapping into large demand, hampering diffusion of new technologies (see Chapter 2). The exemption to open procurement through purchasing from a panel of suppliers should be removed, while strengthening the screening capabilities of government agencies.
Table 1.6. Past OECD recommendations on fiscal policy and actions taken
Figure 1.25. The weight of procurement in fiscal spending is relatively large
The weight of government procurement as % of general government expenditure and GDP, 2019
Source: OECD (2021), Government at a Glance 2021
Box 1.6. GDP and fiscal impacts of this Survey's key recommendations
This box summarises the potential long-term impacts of selected key recommendations in this Survey on GDP and the fiscal balance. Because it is often impossible to estimate the impacts of the exact reforms recommended due to the lack of suitable theoretical or empirical models, the quantification is based on scenarios that only capture some aspects of these reforms. The quantified impacts are merely illustrative and are subject to large uncertainties. The estimated fiscal impacts describe only the direct impacts and do not include indirect impacts on fiscal revenue and spending stemming from households and firms’ responses to policy changes.
Table 1.7. GDP impact of selected key recommendations
Source: OECD simulation based on the framework by Égert and Gal (2017[17]).
Table 1.8. Fiscal impact of selected key recommendations
Source: NZ Treasury (2021[13]); OECD simulation based on the framework by Égert and Gal (2017[17]).
Structural policy reforms to improve wellbeing
Improving wellbeing in the aftermath of the COVID-19 shock
Wellbeing remained resilient during the pandemic but existing challenges were exacerbated
Before the pandemic, New Zealanders enjoyed generally high levels of wellbeing. Compared with other OECD countries, overall outcomes were particularly good for employment, air quality, social support and the gap in life expectancy by education level (Figure 1.26, Panel A). However, household disposable income was low, despite a large share of people usually working long hours or not having much time off work, housing affordability was poor and the gender gap in feelings of safety very high. In terms of the four capitals – natural, economic, human and social – that underpin future wellbeing, New Zealand ranked among the top third of OECD countries for government net financial worth and trust in government and in others in 2018 but ranked amongst the bottom third for greenhouse gas (GHG) emissions per capita and endangered species (Figure 1.26, Panel B).
Figure 1.26. New Zealand performed well on several OECD How’s Life indicators before the pandemic
Note: This chart shows New Zealand’s relative strengths and weaknesses in wellbeing compared to other OECD countries. Longer bars always indicate better outcomes (i.e. higher wellbeing), whereas shorter bars always indicate worse outcomes (lower wellbeing) – including for negative indicators, marked with an *, which have been reverse-scored. Inequalities (gaps between top and bottom, differences between groups, people falling under a deprivation threshold) are shaded with stripes, and missing data in white. For the future well-being dashboard: ❶ = top-performing OECD tier, ❷ = middle-performing OECD tier, ❸ = bottom-performing OECD tier. ➚ indicates consistent improvement; ↔ indicates no clear or consistent trend; ➘ indicates consistent deterioration, and “…” indicates insufficient time series to determine trends since 2010. For methodological details, see the Reader’s Guide of How’s Life? 2020.
Source: OECD calculations based on OECD How's Life? 2020
Disposable income inequality was higher than the OECD average despite market income inequality being around the OECD average, owing to below-average redistribution through taxes and transfers (Figure 1.27, Panel A). Income inequality has widened over time as high-income households have enjoyed faster income growth than others in recent decades (OECD, 2020[18]). The relative poverty rate (the share of households with incomes less than 50% of the median) was close to the OECD average (Panel B), but the child poverty rate, which is one of the government’s main wellbeing objectives, was higher than the OECD average in 2018, especially among certain groups, namely Māori and Pasifika (Panel C). The child poverty rate (both before- and after housing costs) had been declining before the onset of the COVID-19 shock but was stable in the first half of 2020 (the latest period for which data are available) (Figure 1.28). The share of children living in households with less than 50% of the median household income after housing costs are deducted was 18.4% just before the COVID-19 shock, but 21% for Māori and Pasifika children (Stat NZ Child Poverty Statistics).
Figure 1.27. Income inequality is above the OECD average and child poverty is high
Source: Stats NZ; OECD (2021), Income Distribution (database).
While the impacts of the COVID-19 shock on wellbeing are yet to be fully assessed due to unavailability of indicators that covered the pandemic period, some survey results summarised in the Wellbeing Outlook of Budget 2021 indicate that New Zealanders remained healthy, financially secure overall and well connected to others during the pandemic. The government’s successful handling of COVID-19 (Box 1.2) and effective macroeconomic policy response (Box 1.4 and Box 1.5) contributed to these outcomes. Nevertheless, the COVID-19 shock exacerbated some wellbeing challenges present before the pandemic, such as relatively high income inequality and poor housing affordability. Also, the pandemic has affected all groups in the labour market but inequalities by sex, age and ethnicity slightly widened in 2020, before reverting to historic levels.
In order to attenuate a potential increase in income inequality and child poverty resulting from the COVID-19 shock, the government included in Budget 2021 an increase in all weekly main benefit rates by between NZD 32 and 55, in line with the recommendation of the Welfare Expert Advisory Group. The main benefits increased by NZD 20 on 1 July 2021 and the second increase will follow on 1 April 2022. They came on top of the 3.1% increase in 1 April 2021 from wage indexation. Families with children enjoyed a top-up of NZD 15. The government projects that these measures will lift between 19 and 33 thousand children out of poverty on the after-housing-costs measure. Reforms to help households exit benefits by reducing barriers to work would further reduce child poverty. Although the average labour tax wedge in New Zealand is low in comparison with many OECD countries (Figure 1.29, Panel A), sole parents with children and single-earner married couples with children face one of the highest marginal effective tax rates on labour income (Panel B). This is because means-tested benefits and tax credits are withdrawn quickly as earnings increase beyond 65% of the average wage (OECD, 2021[19]). The loss of a large part of extra earnings through taxation and abatement of benefits discourages such households from working more, locking them into in-work poverty (Nolan, 2018[20]).
Figure 1.28. Reduction in child poverty progressed toward the targets before the COVID-19 shock
Primary measures of child poverty by the government
1. The share of children living in households with income less than 50% of median household income.
2. The share of children living in households with income less than 50% of median household income after housing costs are subtracted.
3. The share of children living in households lacking six or more out of the 17 items in the material deprivation index, which include things like having two pairs of shoes in goodcondition and not putting off visits to the doctor. The dots in 2027 are the target level for each measure.
Source: Stats NZ (2021), Child Poverty Statistics
By far the largest means-tested payment in New Zealand is Working for Families, which is a package of four tax credits amounting to NZD 3 billion (3.5% of total tax receipts) that is paid to families with children; these tax credits account for most of the cash transfers shown in Figure 1.29, Panel A. To reduce in-work poverty traps and high marginal effective tax rates, Working for Families abatement thresholds should be increased and abatement rates reduced, as recommended by the government’s Welfare Expert Advisory Group (2018[21]). Abatement thresholds, which in practice have been adjusted on an ad hoc basis during the Budget process, should be more systematically adjusted to ensure that they reflect well recent inflation in living costs, notably by indexing thresholds to inflation (Welfare Expert Advisory Group, 2018[21]). The government should also review and adjust abatement thresholds more regularly and frequently to ensure that they reflect current economic conditions and support exit from benefits of low-income households.
Figure 1.29. The labour tax wedge is among the lowest in the OECD
1. The marginal effective tax rate is the marginal rate of income tax plus employee social security contributions less cash benefits. 2. Sample average.
Source: OECD (2021), Taxing Wages 2021
Strengthening a wellbeing approach in policymaking
Budget 2020 rightly focused on countering the socioeconomic impacts of COVID-19 and supporting affected New Zealanders. The pandemic also disrupted the government’s efforts to elaborate tools, frameworks and datasets needed to implement wellbeing objectives more rigorously into the Budget, as substantial reallocation of resources was needed to deploy urgent support measures.
Budget 2021 refocused on wellbeing, with priorities on keeping COVID-19 at bay and accelerating the recovery while addressing key challenges like climate change, housing affordability and child poverty. Budget 2022 was formulated with the following wellbeing objectives in mind:
Just Transition - supporting the transition to a climate-resilient, sustainable and low-emissions economy.
Physical and Mental Wellbeing - supporting improved health outcomes for all New Zealanders and minimising COVID-19 and protecting New Zealand’s communities.
Future of Work - enabling all New Zealanders and New Zealand businesses to benefit from new technologies and lift productivity and wages through innovation.
Māori and Pacific Peoples - lifting Māori and Pacific Peoples’ incomes, skills and opportunities, including through access to affordable, safe and stable housing.
Child Wellbeing - reducing child poverty and improving child wellbeing, including through access to safe and stable housing.
Going forward, there is scope to further strengthen the capabilities of government agencies in integrating wellbeing analysis into policy planning, including with respect to the requisite cost-benefit and value-for-money analyses (Table 1.9). This requires wellbeing indicators that are quantifiable, sufficiently granular and statistically reliable. Government agencies should avoid basing their policies on indicators that are highly subjective, general or based on very small samples, and use subjective indicators in tandem with objective ones, as stressed in the 2019 OECD Economic Survey. The wellbeing priorities in the budgeting process can be complemented with practical guidelines to facilitate their implementation. In the first Wellbeing Budget in 2019, wellbeing priorities were too general to guide government agencies effectively and did little to narrow down the budget bids received by Treasury. Cross-ministerial groups were set up for Budget 2020 to select policies for each of the Budget priorities. As the wellbeing budgeting framework continues to develop, it is essential to ensure that it can be implemented by government agencies without incurring large additional burdens.
Table 1.9. Past OECD recommendations on wellbeing budgeting and actions taken
Enhancing productivity growth
As in many other OECD economies, labour productivity growth declined after the global financial crisis, to about a half of the pre-crisis rate (Figure 1.30, Panel A). Slower productivity growth has been due to limited capital deepening and subdued multifactor productivity growth (Panel B). The former reflects weak capital investment and the latter the absence of strong competition pressures that enhance innovation and resource allocation, limited integration into the global economy, weak innovation and knowledge transfer, and high qualification- and skills mismatches, as extensively reviewed in the 2017 OECD Economic Survey of New Zealand. Capital investment has been held back by the high effective corporate taxes that reduce the attractiveness of New Zealand as a location to expand profitable operations.
Figure 1.30. Productivity growth slowed down
Note: Labour productivity is defined as value added per hour worked. Capital quality refers to changes in the composition of the capital stock among different types of assets.
Source: OECD (2021), OECD Compendium of Productivity Indicators, OECD Publishing, Paris.
New Zealand’s small and regionally fragmented domestic market and geographical remoteness limit competition. According to the OECD Product Market Regulation Indicator, regulatory barriers to competition in New Zealand are fairly low, and the administrative burden to start new businesses is among the smallest in the OECD (Figure 1.31). There is, however, room to simplify regulations by publishing all subordinate regulations currently in force online, like in Australia or in other small advanced economies. The scope of state ownership is also more extensive than in many other OECD countries, and some state-owned enterprises enjoy preferential treatment. High state ownership also limits competition in the network sector. While regulatory barriers to competition in services are low, the retail grocery sector is dominated by a duopoly of two large retail supermarket chains (Commerce Commission, 2021[22]). The Commerce Commission initiated a market study on the retail grocery market in November 2020. In its draft report, circulated in July 2021 for consultation with stakeholders, the Commission reported that the two retailors earn persistently high profits, charge higher grocery prices than in other OECD countries, and tend to avoid competing on price with each other (Commerce Commission, 2021[22]). Other grocery retailers are unable to compete on price and product range, nor can they access competitively priced wholesale supply because the two large retailers are also the largest wholesalers and only supply themselves. The Commerce Commission has proposed options for interventions in the draft report, ranging from the two major retailers undertaking to supply other retailers with groceries on fair and non-discriminatory terms, to fostering entry and growth of a third large retailer or, as a last resort, to vertically separating the retail and wholesale businesses of the two large retailers. The Commission will narrow down these options through the consultation to final recommendations, which will be submitted to the Minister of Commerce and Consumer Affairs in March 2022.
Figure 1.31. Regulatory barriers to competition are low overall but state ownership is high
OECD Product Market Regulation Indicator, indexed as least (0) to most (6) restrictive, 2018
Note: This chart displays the overall Product Market Regulation (PMR) Indicator value as well as its selected sub-components. Other SAE (Small Advanced Economies) are Austria, Belgium, Denmark, Finland, Ireland, Israel, the Netherlands, Norway, Sweden and Switzerland.
Source: OECD (2018), OECD Product Market Regulation Indicator
Adjusting the corporate tax rate to competitive levels
Corporate income tax rates are higher in New Zealand than in most other OECD countries, and are especially high compared with some small advanced economies (Figure 1.32). The high nominal rate (Panel A) encourages internationalised firms to shift profits abroad or locate their highly profitable activities outside New Zealand. The high marginal effective rate (Panel B) discourages firms, including multinationals, from investing more as it increases the user cost of capital, contributing to low rates of capital investment in New Zealand (OECD, 2017[23]; 2021[24]). The difference between nominal and effective tax rates is smaller in New Zealand than in most other OECD countries because the corporate income tax base is broader, despite the reinstatement of depreciation deductions on industrial and commercial buildings in 2020. Reducing the nominal corporate tax rate to align the effective rate with those in Australia and small advanced economies would encourage investment in tangible and intangible capital that contributes to productivity growth; previous OECD recommendations on taxation are listed in Table 1.10. It would also reduce incentives for internationalised firms to minimise the share of profits declared in New Zealand. However, these benefits need to be weighed against fiscal and other costs of reducing the corporate tax rate. For instance, lowering the corporate tax rate (28%) further below the top two marginal personal income tax rates (38% and 33%) could endanger tax integrity by encouraging wealthy individuals to shift income to corporate entities to reduce their tax liabilities. It would also reduce taxation of economic rents (Tax Working Group, 2018[25]). Inland Revenue will explore the role of the tax system in promoting investment and productivity in its 2022 Long-Term Insights Briefing, which will provide an opportunity to consider the appropriateness of the current corporate tax rate and possible reforms.
Figure 1.32. The corporate tax rate is high, especially compared with other small advanced economies
1. Sample average.
Note: Effective tax rates (ETRs) are forward-looking synthetic tax policy indicators calculated on the basis of a prospective, hypothetical investment project. See (Hanappi, 2018[27])for the OECD methodology. Small advanced economies are defined as the OECD countries with populations above 1 million and below 20 million people, and with a per capita income above USD 30 000.
Source: OECD, Tax database
Table 1.10. Past OECD recommendations on taxation and actions taken
New Zealand’s inward Foreign Direct Investment (FDI) has been smaller than in many other OECD countries (Figure 1.33), holding back trade and integration in global value chains (Figure 1.5, Figure 1.6), which often act as channels of technology diffusion from the world’s productivity frontier. Prior to the COVID-19 pandemic, New Zealand retained a comprehensive foreign investment screening process with a wide range of investment requiring notification to and approval by the Overseas Investment Office (OIO), imposing significant compliance costs and uncertainties on foreign investors and constraining service trade. In May 2020, the scope of FDI subject to screening was temporarily expanded to all foreign investment that entails taking a stake in any New Zealand business that results in more than a 25% ownership interest, or increases an existing interest to or beyond 50, 75 or 100%. The government revoked this temporary measure in July 2021, and streamlined the FDI screening regime, introducing measures to exempt some transactions from the regime and alleviate administrative burdens. For instance, the scope of the national interest test applied to foreign governments or government-affiliated investors has been narrowed, which should facilitate equity investment by foreign pension funds. Some low-risk transactions like transfer of debt obligations were exempted from screening, and so were increases in interests in sensitive land that do not cross ownership or control limits. Exemptions were also introduced from the definition of an overseas person for New Zealand managed investment schemes and incorporated entities, including companies listed on New Zealand’s Stock Exchange that are majority owned and substantially controlled by New Zealanders (overseas persons holding 10% or more of total shares collectively hold 25% or less of total securities). Repeat investors will be subject to streamlined background checks. Furthermore, statutory timeframe limits will be specified for each consent application, providing more certainty to foreign investors.
Figure 1.33. The inward FDI stock is small for a small open economy
Inward FDI position, % of GDP, 2020¹
Note: OECD countries with populations above 1 million and below 20 million people, and with a per capita income above USD 30 000, are defined as small advanced economies. 1. 2019 values for Belgium, Norway, Finland, Luxemburg, Portugal, Australia, Mexico and Korea.
Source: OECD (2021), Foreign Direct Investment Statistics
While these recent reforms are in line with the past OECD recommendation (Table 1.11) and thus welcome, the government should monitor their effects on FDI and streamline the procedures further if the new regime fails to stimulate investment. It also has been noted that FDI in New Zealand has not contributed much to the creation of new, innovative exports (New Zealand Productivity Commission, 2021[26]). The government should complement general reforms with targeted measures to attract FDI in important sectors or technology areas where multinational enterprises can play a large role in diffusing advanced technologies and providing training opportunities.
Table 1.11. Past OECD recommendations on increasing productivity and actions taken
Exporting is a fundamental avenue for firms to achieve sufficient production scale to bring down unit costs. As in other OECD countries, exporting firms in New Zealand are more productive and invest more in capital and innovation than non-exporting firms (Sin et al., 2014[27]). This occurs because exporting allows them to gain sufficient scale to justify costly investments aimed at boosting productivity (see Chapter 2). However, because of the small domestic market and absence of adjoining markets within free-trade blocs, New Zealand’s firms have to penetrate distant markets before attaining some production scale (New Zealand Productivity Commission, 2021[26]). In order to foster these so-called born-global firms, New Zealand needs effective coordination between innovation support and export promotion that strengthens competitiveness of young innovative firms and catapults them into export markets (Chapter 2). It is also important that these support measures promote the exports by women-owned businesses, which are usually less internationalised. New Zealand signed the Global Trade and Gender Arrangement (GTAGA) in 2020, together with Canada, Chile and now Mexico. The initiative aims at promoting mutually supportive trade and gender policies in order to improve women’s participation in trade and investment, and in the furtherance of women’s economic empowerment. New Zealand also has room for enhancing efficiency in its border procedures through better access to information on border ruling, boosting the use of advance ruling, and streamlining and automating border clearing processes (as shown by the OECD Trade Facilitation Indicator).
Research and development (R&D) spending is low, with differences in industry composition explaining only a small part of the shortfall from the OECD average (OECD, 2017[23]). Business-based R&D spending is the lowest among small advanced economies. Government support to business-based R&D is now putting less weight on direct grants and more on tax incentives. The generosity of R&D tax credits is close to the median of OECD countries (OECD, 2021[28]). In addition, the R&D loss tax credit scheme allows firms to cash out 28% of the deficit related to R&D expenses. The R&D tax credits also benefit firms with a tax loss position or income tax payment that is inferior to R&D tax credits, via tax credit refunds. The cap on the latter has been raised as a part of the fiscal response to COVID-19. The shift from direct grants to R&D tax credits is a common trend across the OECD and would benefit a wider scope of firms than research grants. Nevertheless, R&D tax credits are insufficient as a means to guide innovation to broader societal needs, and represent suboptimal instruments to encourage investment in knowledge at the interface between basic research and actual product or process development (OECD, 2021[29]). Thus, they should be complemented by targeted grants considering the need for focused innovation support for strategic sectors or technologies that would accelerate New Zealand’s productivity catch-up. For instance, the government’s Industry Transformation Plans envisage focusing innovation effort to raise productivity on high-potential export-oriented sectors of the economy. However, targeted grants should be evaluated based on their impacts using a rigorous, transparent and independent monitoring system and withdrawn if found unsuccessful (New Zealand Productivity Commission, 2021[26]).
Knowledge transfer from Crown Research Institutes and universities, for instance through research collaboration, has been weak (New Zealand Productivity Commission, 2021[26]). One reason is that funding mechanisms do not provide sufficient incentives for knowledge transfer activities. For instance, only two out of seven Crown Research Institutes have substantial industry funding shares, focused on land-based industries and geothermal technologies. Financial incentives for university researchers to engage in applied research are also weak (New Zealand Productivity Commission, 2021[26]). Aligning universities’ specialised research areas with topics that are most relevant to issues faced by New Zealand firms is important for leveraging the role of universities as a platform for international research collaboration and knowledge diffusion for the development of strategic sectors and technologies.
As explored extensively in the 2017 OECD Economic Survey: New Zealand and (Adalet McGowan and Andrews, 2015[30]), a sizable improvement in labour productivity is expected from reducing qualification and skills mismatches. The major impediment to improving the mismatches is the slow responsiveness of housing supply to demand, which hampers the movement of workers to areas with jobs that match better their qualifications and skills. If housing-related reforms (see below) progressed enough for the price elasticity of new housing supply to rise to US levels, labour productivity could rise by 2¼ per cent as a result of reduced mismatches.
Maintaining labour market flexibility while enhancing equity
The labour market is more flexible in New Zealand than in most other OECD countries. Employment protection legislation (EPL) is less strict (Figure 1.34), albeit more restrictive than in most other English-speaking countries, and wage bargaining fully decentralised − essentially confined to the enterprise level, as in Canada, the United Kingdom, the United States and 10 other OECD countries. This flexibility, together with strong incentives to work and macroeconomic stability contribute to high performance on quantitative labour-market indicators and to low employment-rate gaps for women, immigrants and people with disabilities (OECD, 2018[31]), but not for Māori and Pasifika. The government plans to consult on a possible reform to reduce the costs borne by displaced workers and has introduced legislation to reform the wage-bargaining system to increase workers’ bargaining power.
Figure 1.34. Employment protection legislation is less strict in New Zealand than in many other OECD countries
Strictness of employment protection, individual and collective dismissals (regular contracts), 2019
Source: OECD (2021), Indicators of Employment Protection
Introducing income insurance to improve support for displaced workers and those who lose their jobs because of non-injury-related health conditions or disabilities
Workers who experience involuntary job loss typically suffer a substantial reduction in wellbeing, especially during downturns. In the short term, displacement reduces economic security and harms mental health, while in the long term it adversely affects earnings, health and mortality risk (Hyslop et al., 2021[32]). Wage losses during the first five years after job displacement are estimated to amount to NZD 15.4 billion assuming that 100 000 workers per year are displaced (ibid). The impacts on workers losing work due to a health condition or disability are similar to those on displaced workers (Perry, Kenney and Tereshchenko, 2009[33]). In New Zealand, numbers leaving work owing to a health condition or a disability are more stable than those affected by displacement and less affected by economic cycles. Nevertheless, workers with health conditions and disabilities are vulnerable to job loss in recessions and to experiencing long-term unemployment.
Governments provide unemployment payments to support displaced workers and their families conditional on satisfying job search requirements and sickness-disability payments subject to satisfying medical criteria. All but two OECD countries – Australia and New Zealand – have unemployment insurance, which provides earnings-related payments for a limited period. Displaced workers who have not found a job at the end of this period may be eligible for lower, means-tested flat-rate benefits (i.e., unemployment or social assistance) if their household income is low enough. Australia and New Zealand only offer such unemployment assistance benefits. Similarly, while most OECD countries have income insurance for workers who lose their jobs because of a health condition or disability, New Zealand and Australia only provide means-tested flat-rate benefits where the health condition or disability is not accident-related (New Zealand) or work-related (Australia). In New Zealand, loss of income up to a limit (NZD 131 911 for the year to 31 March 2022) and medical costs caused by accidents are insured by the Accident Compensation Corporation (ACC).
In New Zealand, only one third of the unemployed receive unemployment benefits, often because the unemployed are ineligible. Displaced workers and their families who receive little or no unemployment payments experience a sharp loss in income, which can make meeting living expenses difficult, especially in a country where housing costs are so high. These difficulties oblige many displaced workers to find another job quickly, even if it does not represent a good match for their skills. As reported in the 2017 OECD Economic Survey of New Zealand, skills mismatch is higher in New Zealand than in most other OECD countries. While redundancy pay, which is voluntary in New Zealand, reduces these difficulties, its coverage (one-half of displaced workers) and generosity (34 weeks of wages) are no higher than in countries that also have unemployment insurance (OECD, 2017[34]). Moreover, there are significant differences by age, gender, educational attainment and occupation, with actual protection depending on a worker’s bargaining power and the good will of the employer. Workers made redundant because of a business failure are less likely to receive redundancy pay due than other laid-off workers.
While private unemployment- and disability insurance already exist in New Zealand, few workers avail themselves of it because it is expensive owing to adverse selection - insurers are obliged to charge high premiums to protect against the risk that buyers have private information that suggests that they are a greater risk than can be gleaned from information available to the insurer. This is why unemployment- and disability insurance are usually compulsory in other OECD countries (adverse selection also explains why health insurance is compulsory in most countries).
The government has signalled its intention to open a public consultation on a proposed social insurance scheme for displaced workers (i.e., unemployment insurance for workers made redundant) and for those who lose their jobs because of a non-injury-related health condition or disability (i.e., sickness and disability insurance) jointly developed by the government and employer- and employee representatives. Budget 2021 indicated that the proposed scheme could give workers replacement rates of around 80% for a limited period with minimum and maximum caps. Such a replacement rate for economic displacement coverage would be very high by international comparison - the OECD average is around 60% - but more in line with OECD average replacement rates for health or disability insurance. After expiry of social insurance entitlements, people still unemployed or with work capacity reduced by 50% or more could apply for the current means-tested unemployment- or sickness benefits. The introduction of unemployment insurance was recommended in the 2017 OECD Economic Survey of New Zealand (Table 1.12) and the reduction in the gap in income protection between people who lose their jobs because of an accident-related- and non-accident-related health condition or disability was recommended in OECD (2018[35]).
Table 1.12. Past OECD recommendations on labour markets and actions taken
A potential benefit of unemployment insurance is that it may allow displaced workers to search longer for jobs that may better match their skills. Whether or not increased search duration results in better job matches is an empirical question; theoretically, increased search duration could result in higher-quality job matches but it could also result in depreciation of skills or send negative signals to employers that worsen job match quality. Based on a review of meta-analyses Schmieder, von Wachter and Bende, (2016[36]), Tatsiramos and Ours (2014[37]), and Hyslop et al. (2021[32]) conclude that increased search duration does not produce benefits overall in the form of higher-quality job matches. This is not to deny that some displaced workers, notably high-skilled workers, are likely to benefit from better job matches; for many low-skilled workers, any job match is likely to deliver similar productivity benefits. At the same time, there could be a tipping point where skills depreciation increases. In these circumstances, unemployment insurance design features such as short benefit duration, effective enforcement of activation requirements and diminishing replacement rates over time could increase the likelihood of better job matches. Should the scheme be implemented with a high replacement rate, it will be important to develop effective active labour market policies (ALMPs) to reduce the risk of increasing structural unemployment. Based on a pooled analysis of 31 advanced countries, Escudero (2018[38]) finds that sufficient resources and programme continuity are particularly important for ALMPs to improve aggregate labour market outcomes. Moreover, start-up incentives and measures aimed at vulnerable populations are more effective than other ALMPs in reducing unemployment and increasing employment, especially for the low-skilled.
A social insurance scheme would also be likely to improve the resilience of New Zealand’s economy and job market to shocks by bolstering automatic stabilisers, especially given that such schemes typically have strong fiscal multiplier effects. Modelling by the OECD suggests that New Zealand has about average resilience to shocks. The impact of such a scheme on automatic stabilisers would depend on its size, generosity and the responsiveness of financing sources (levies, contributions or taxes) and redundancy payments to a downturn.
Fair Pay Agreements will strengthen worker bargaining power
Another plank in the government’s Workplace Relations Package aimed at increasing low-paid workers’ earnings, as discussed in the 2019 OECD Economic Survey, is to increase wages by strengthening worker bargaining power through the introduction of Fair Pay Agreements that stipulate minimum wages and conditions for workers in low-paid occupations or sectors. The legislation that the government hopes to introduce in Parliament by early-2022 has widened coverage to all occupations across the economy. Workers or their union representatives can initiate a Fair Pay Agreement bargaining process if 1000 or 10% of workers in an occupation support it. Employer representatives must negotiate and unions may not strike during the negotiation, which the government considers not to violate New Zealand’s International Labour Organisation obligations concerning freedom of association and the right to strike in collective bargaining because these rights are preserved for other forms of bargaining. The obligation for both bargaining sides to use best endeavours to establish and maintain a productive relationship with all the workers or employers in coverage is a significant burden, far more demanding than the obligation to negotiate in good faith that exists in the current Employment Relations Act (Ministry of Business, 2021[39]). This problem is all the more acute given that New Zealand has few employer organisations and union coverage is low, at 19%. In the event that agreement is not reached, the Employment Relations Authority will make a binding determination. In many cases the system is likely to result in bargaining stalemates and determinations fixing terms by the Employment Relations Authority, limiting the added benefit of bargaining (MBIE, 2021[40]).
As discussed in the 2019 OECD Economic Survey, cross-country evidence suggests that Fair Pay Agreements could increase employment and reduce wage inequality for full-time employees (OECD, 2018[41]) but reduce both labour- and multifactor productivity growth in the covered sectors (OECD, 2017[42]). This suggests that lower flexibility at firm level, which characterises centralised bargaining systems, may result in lower productivity growth. OECD (2018[41]) suggests that organised decentralisation within the framework of sector-level agreements (Traxler, 1995[43]), which allows for elements of working conditions and organisation to be determined at company or individual level under certain conditions, may deliver better employment and wage inequality outcomes without lower productivity. As sector-level agreements that also cover small and medium-sized businesses, Fair Pay Agreements could help spread best practices in terms of personnel management, training, health and safety, technology usage, insurance, or retirement packages (OECD, 2019[44]). In this regard, Fair Pay Agreements could play a significant role in enhancing labour market security and strengthening workers’ labour market adaptability (OECD, 2018[41]). As evolving demands for products and services as well as technological change are quickly affecting skills needs, the social partners could provide active support to workers displaced from their existing jobs to help them back into good jobs (OECD, 2019[44]).
Fair Pay Agreements may help to unwind some of the wage compression that has occurred owing to large minimum wage increases by strengthening bargaining power for workers earning more than the minimum wage. As a result of substantial minimum wage increases, low-paid workers have experienced higher wage growth than middle- and high-paid workers; wage-rate growth for the least educated workers has also far outstripped that for the most educated workers (Table 1.13).
Poor targeting of the proposed system may create significant labour market inflexibility and costs when it is used in sectors without a demonstrable labour market issue, such as a ‘race to the bottom’ in sectors with heavy use of tendering (MBIE, 2021[40]). The low threshold for initiation means that the system could be used in situations where the marginal improvement in terms and conditions for existing workers is achieved at a significant cost to employer flexibility, raising the risk that the system reduces productivity and that benefits to workers are less than costs to employers and of providing the system. Such problems could be attenuated by raising the threshold for initiation or limiting coverage to sectors with clearly identified labour market problems.
Table 1.13. Hourly earnings have grown fastest for those in the lowest-paid jobs or with the lowest levels of education attainment
Note: Median earnings for main wage and salary job. Comparable data for earlier years are not available
1. Low-paid, medium-paid and high-paid occupations have average hourly earnings at least one standard deviation below the mean, within one standard deviation of the mean or at least one standard deviation above the mean, respectively.
2. Sales workers and labourers.
3. Technicians and trade workers, community and personal service workers, and clerical and administration workers.
4. Managers and professionals.
Source: Secretariat calculations using data adapted from Stats NZ income statistics
Making housing more affordable
Runaway house prices are a major drag on wellbeing in New Zealand, especially for first-home buyers, and are by far the greatest concern identified by households in the IPSOS NZ Issues Monitor (2021[45]). Real house prices had already increased much more than in most other OECD countries since the turn of the century before the COVID-19 pandemic hit (Figure 1.35, Panel A), but went on to rise by another 30% since then, largely owing to the monetary policy measures implemented to support the economy (Reserve Bank of New Zealand, 2021[46]). House prices have also increased more relative to fundamentals – household income and rents – than in most other OECD countries (Panels B and C). The large rise in house prices has increased wealth inequality between house-owners and non-owners. Had the price of non-housing assets remained constant, it would have reduced overall wealth inequality, which was close to the OECD average in 2018 (OECD Wealth Distribution Database), because the majority of households in New Zealand own housing and the wealthiest households hold a higher share of their wealth in non-housing assets than the rest of the population (Symes, 2021[47]). However, amidst rapidly rising prices for most assets, it is not clear a priori how the wealth distribution has changed.
Figure 1.35. Real house prices have increased more than in other OECD countries
Source: OECD (2021), Economic Outlook 110 (database) and Analytical House Price Indicators
Housing affordability is also low by international comparison. National Accounts data show that the share of income spent on housing is higher in New Zealand than in most other OECD countries (Figure 1.36, Panel A). The New Zealand share is, however, somewhat overstated as proxy rental properties used to estimate imputed rentals are not stratified by location, resulting in the weight for Auckland, where rental properties are both more common and more expensive, being too high. Actual expenditure on rent (i.e., excluding imputed rentals) in the private- and subsidised (i.e., social) rental markets taken together is high as a share of income (Panel B), especially for low-income households renting in the private rental market (Panel C). The share of social rental housing in the total housing stock is low in New Zealand (Figure 1.37, Panel A) and, despite government funding for an additional 8 000 units between 2021 and 2024, will remain low. New Zealand spends a higher than OECD average share of GDP on housing allowances (Accommodation Supplement, which is not available to people in social housing, whose rents are already subsidised) (Panel B).
The long-term increase in real house prices and decline in affordability reflect strong demand growth combined with a weak supply response; as noted above, the recent spike in prices reflects the increase in demand resulting from substantial easing in monetary policy, an increase that has been accentuated by the expectation that housing supply will be slow to respond. While strong income growth has boosted demand, this factor only accounts for a small part of the price rise since 2000 given that the house price-to-income ratio has risen sharply (see Figure 1.35, Panel B). A major driver of demand has been the decline in interest rates since the 1990s, which has been greater than in most other countries. Another has been the large increase in net migration from the turn of the century until 2020, when COVID-related border restrictions slowed net migration to a trickle. Coleman and Landon-Lane (Coleman and Landon-Lane, 2007[48]) estimate that a 1% increase in population pushes house prices up by 10%, largely because housing construction fails to respond rapidly to new demand from immigration.
The housing supply response has been constrained by restrictive and complex land-use planning, infrastructure shortages and insufficient construction-sector capacity (2017 and 2019 Economic Surveys of New Zealand). While housing supply responsiveness is higher than in many European countries, it is lower than in North America and Nordic countries and has not been sufficient to contain house prices in a context of huge declines in interest rates and high population growth. New housing supply lagged substantially behind demographic demand over the past decade (Figure 1.38), especially in Auckland, where the shortage is estimated to have reached 40 000 to 55 000 dwellings (Coleman and Karagedikli, 2018[49]).
Figure 1.36. Housing affordability is low
1. Sample average excluding Chile, Mexico, Korea and the United States for which gross income instead of disposable income is used.
Source: Stats NZ; OECD (2021), National Accounts at a Glance; OECD (2021), Affordable Housing database
Figure 1.37. The share of social housing is low and public expenditure on housing allowances is high
Note: For New Zealand, data on social rental dwellings refer to the number of social housing places (public housing) that are funded through central government, and do not include social housing provided by local authorities (15% of the social housing stock). For more details about the data for the other countries, see the OECD Questionnaire on Social and Affordable Housing, 2021.
Source: OECD Questionnaire on Affordable and Social Housing (QuASH), 2021.
Figure 1.38. New housing supply ran behind demographic demand in the years preceding the pandemic
12-month moving average
Note: Projection by RBNZ.
Source: Reserve Bank of New Zealand (2021), Monetary Policy Statement, August 2021
To increase the housing market’s capacity to respond to demand, the government released the Urban Growth Agenda (UGA) in 2019. Its primary focus is on removing barriers to supply in the urban land- and infrastructure markets, as recommended in past Surveys (Table 1.14). Through accommodating and managing growth, the UGA also aims to improve choices around the location and type of housing, improve access to employment, education and services, assist emission reductions and build climate resilience, and enable quality-built environments, while avoiding unnecessary sprawl. The UGA consists of five interconnected focus areas that cover aspects of urban and infrastructure planning and provision:
Infrastructure funding and financing enabling a more responsive supply of infrastructure and appropriate cost allocation;
Urban planning to allow for cities to make room for growth, support quality-built environments and enable strategic integrated planning;
Spatial planning (initially focused on Auckland and the Auckland-Hamilton corridor) to build a stronger partnership with local government as a means of developing integrated spatial planning;
Transport pricing to ensure the price of transport infrastructure promotes efficient use of the network; and
Legislative reform to ensure that regulatory, institutional and funding settings are collectively supporting UGA objectives.
The government is making progress in reducing urban planning barriers to housing supply. The National Policy Statement on Urban Development 2020 (NPSUD) puts in place the urban and spatial planning pillars of the UGA. The NPSUD, which sets out objectives and policies for urban development to which councils must give effect under the Resource Management Act 1991 (RMA), removes overly restrictive barriers to growth up and out in locations that have good access to existing services, public transport networks and infrastructure. It also directs local authorities to facilitate greater supply and make planning responsive to changes in demand, while seeking to ensure that new development capacity enabled by councils is of a form and in locations that meet the diverse needs of communities and encourages well-functioning, liveable urban environments. These reforms will be taken further with the Natural and Built Environment Act (NBA) that the government is currently consulting on to replace the RMA, which has imposed excessive planning restrictions on urban construction. The NBA will provide for land use- and environmental regulation, laying out a mandatory set of national policies and standards to support natural environmental limits, outcomes and targets. These will be incorporated into combined regional plans prepared by local and central government and local Māori tribes (mana whenua). The main difference from the RMA is that people will have to work towards stated outcomes – this represents a shift to planning from consenting, which is effects based. An outcomes-based system, however, could be inefficient as the costs of achieving the stated outcomes could be excessive in some localities. There are related concerns about the high degree of central planning and a potential lack of protection of private property rights, for example from a loss of property value caused by a heritage protection classification included in the local council’s district plan, without compensation for the owner.
Table 1.14. Past OECD recommendations on housing and actions taken
In September 2021, the government released the Government Policy Statement on Housing and Urban Development (New Zealand Government and Ministry of Housing and Urban Development, 2021[50]), which sets out the government’s vision for housing and urban development and the key actions underway to realise this vision. In addition to system reforms like the Urban Growth Agenda, Reform Management Act reforms and tax settings, the Statement also outlines how the government will work with others and look to catalyse and enable development through government-led development and partnering with others – with a strong focus on partnering with Māori. A key focus is to increase the supply of affordable homes for ownership and rent.
In December 2021, the Resource Management Act was amended with cross-party support to reform urban planning laws to permit greater housing density in New Zealand’s five largest cities (Auckland, Wellington, Christchurch, Hamilton and Tauranga). The changes allow up to three dwellings of up to three stories that occupy no more than 50% of the site without the need for planning consent. Previously, district planning laws typically only allowed for one dwelling of up to two stories per site. It is estimated that these changes will increase housing supply by 48 000 – 105 000 over the next five-eight years. City councils in the five largest cities are required to apply these new Medium Density Residential Standards from August 2022.
Progress is proving to be more difficult in alleviating the infrastructure barrier to increasing housing supply – local councils have little capacity to borrow money to build new housing-related infrastructure and no incentive to increase rates on current property owners to pay for it. A step towards alleviating this barrier was taken with the Infrastructure Funding and Financing Act 2020. It gives local councils greater access to finance through Special Purpose Vehicles (SPVs) to fund and construct infrastructure to support housing and urban development. SPVs will repay any finance raised by charging a levy to those who benefit from the infrastructure (for example, homeowners in the area serviced by the new infrastructure). A government agency is working with local councils to put deals together. However, none has come to fruition yet. Local councils still need greater incentives to accommodate growth, for example by sharing tax bases linked to local growth, as recommended in past Surveys (see Table 1.14).
The government announced a package of measures in March 2021 to increase housing supply, especially of affordable housing, and to discourage investment in rental properties other than new builds. A key measure was the creation of the Housing Acceleration Fund (NZD 3.8 billion), to increase the pace and scale of home building. It includes the Infrastructure Acceleration Fund (NZD 1 billion, NZD 350 million of which is ring-fenced for the Māori Infrastructure Fund), which is to help fund the critical infrastructure needed for housing development, especially in locations that have infrastructure constraints and that are facing the biggest housing supply and affordability challenges. The Housing Acceleration Fund also includes additional resources to accelerate the development of vacant or underutilised Crown-owned land, operate in more regions, and deliver a broader range of affordable housing options for rental and homeownership. Furthermore, the government will allow the Homes and Communities government agency (Kāinga Ora) to borrow an additional NZD 2 billion to purchase land and support its development. To discourage investment in rental properties other than new builds, the government extended the bright line for capital gains to be taxable from five- to ten years on all future purchases of investment properties except new builds and phased out mortgage interest deductibility over the next four years on all investment properties other than new builds, which will retain deductibility for 20 years, and properties on which capital gains are taxable.
The planning measures implemented, and those taken in recent years, such as the Auckland Unitary Plan and policy changes to facilitate reconstruction following the 2010 and 2011 Canterbury earthquakes, have contributed to increasing the responsiveness of housing supply to demand – new housing supply is growing at the fastest pace in half a century (see Figure 1.38). Moreover, they have supported a large switch from construction of single to multi-dwelling properties (apartments and townhouses), especially in Auckland. This switch has increased the supply of more affordable, conveniently located housing. Building consents data suggest that new housing supply will be growing even faster by mid-2022. Supply will get a further boost as the March 2021 measures gain traction. Combined with the decline in demographic demand associated with the sharp fall in net migration, the high level of house construction should continue to drive down the shortage that developed in recent years and, should net migration remain much lower than in the past, as expected, eliminate it within the next few years.
Several factors are likely to reduce demand for housing further. The most important are an increase in interest rates to more neutral levels, which would make residential property investment less attractive and result in a substantial increase in debt servicing costs (Figure 1.39), and intensified use of macro-prudential tools (see above). The government’s recent tax measures to discourage investment in existing rental properties together with lower LVR limits on mortgages for such properties has already reduced the share of mortgage lending for them from 21% at the beginning of 2021 to 17% in November. With increased housing supply and reduced demand, the Reserve Bank expects house prices to begin to fall modestly from late 2022, eventually reaching more sustainable levels (Figure 1.40). If nominal house prices were to remain at their current level, it would take eight years for the median price-to-income ratio to return to the pre-COVID level.
Figure 1.39. Debt servicing costs for new buyers would be much higher at neutral interest rates
Estimated debt servicing costs1 for new buyers as a share of income
Note: The neutral interest rate is the short-term interest rate at which monetary policy is neither expansionary nor contractionary. The neutral 5-year mortgage rate equals the neutral short-term rate plus a term premium plus lenders’ interest-rate margin.
1. Debt servicing costs include both interest and principal repayments, based on a 30-year mortgage term. Estimates are for buyers purchasing at the median selling price with a 20% deposit.
Source: Reserve Bank of New Zealand (2021), Monetary Policy Statement, August 2021
Figure 1.40. It will take many years for the median house price-to-income ratio to return to the pre-COVID level if house prices do not fall
House price-to-income ratio
Note: Projection by RBNZ.
Source: Reserve Bank of New Zealand (2021), Monetary Policy Statement, August 2021
Making economic growth more environmentally sustainable
Reducing greenhouse gas emissions
New Zealand has amongst the highest GHG emissions (excluding land use, land-use change and forestry) per capita among OECD countries and they have only declined by 10% since 1990, less than the OECD average (see Figure 1.7). Energy-sector emissions comprise 42% of total emissions (Figure 1.41, Panel A) and are growing rapidly (44% since 1990), mainly driven by very high growth (96%) in road transport emissions; energy industries’ emissions share is much lower than the OECD average (Panel B) because electricity generation is 81% renewable (mainly hydraulic). The other major contributor is biological emissions from agriculture – mainly methane – that make up almost half of total emissions, a much higher share than the OECD average. They have grown by 17% since 1990, driven by increased use of synthetic nitrogen fertiliser and higher dairy cattle numbers. Emissions will need to fall substantially in both of these sectors if New Zealand is to transition to a low-emissions economy.
Figure 1.41. The agricultural sector accounts for a large share of GHG emissions in New Zealand
GHG emissions share (excluding land use, land-use change and forestry), 2019
Source: OECD (2021), Green Growth database
New Zealand is estimated to have met its unconditional commitment to reduce GHG emissions by 5% from the 1990 level by 2020 by relying on net emissions and removals from eligible forestry activities (109.2 Mt CO2-e) and carrying over unused units (23.1 Mt CO2-e) from the first Kyoto commitment period to fall within the carbon budget for 2013-2020 (509.8 Mt CO2-e). It is unlikely that New Zealand will be able to respect future international commitments without substantially reducing gross emissions – it is not clear what future rules will be concerning forestry sinks and international carbon markets have lost credibility in recent years (Figure 1.42).
Reducing GHG emissions has become a more pressing policy priority in recent years. A major step forward was the passage of the 2019 ‘zero carbon’ amendments to the Climate Change Response Act 2002. The amended Act aims to achieve net zero GHG emissions excluding methane from agriculture and waste (over 40% of current emissions and mostly from agriculture) by 2050 and at least a 24-47% reduction in these methane emissions from 2017 levels (with an interim target of 10% by 2030). It also created the Climate Change Commission to advise the government on feasible policies to meet abatement targets and adaptation strategies, recommend domestic emissions budgets and hold it accountable. The Commission (2021[51]) recommended gross domestic emissions budgets for the period 2021-2035 that entail progressively deeper reductions, thereby reducing the costs of stranded assets and avoidable business failures from making steeper cuts upfront. If these budgets were achieved, long-lived GHG emissions would be cut by 63% by 2035 from the 2019 level, biogenic methane emissions by 17% and total emissions by 42%.
Another major improvement to framework conditions is the strengthening of the longstanding New Zealand Emissions Trading Scheme (NZ ETS), which is New Zealand’s most important abatement instrument – it covers emissions from 96% of non-agricultural GDP (Box 1.7). The New Zealand Climate Change Response (Emissions Trading Reform) Amendment Act 2020 aligns the NZ ETS with the goals of the Paris Agreement and the ‘zero carbon’ amendments to the Climate Change Response Act 2002. The Emissions Trading Reform sets a cap on available emission permits that is derived from the carbon budgets and limits permits entering the system much more than in the past, bringing New Zealand’s ETS into line with other cap-and-trade schemes and potentially opening the way for linkage to them. The Reform also phases down free permit allocations to emissions-intensive exporting activities (currently covering 60-90% of permit requirements, depending on the degree of emissions intensity) by a minimum annual rate of 1% over 2021-30, 2% over 2031-2040 and 3% over 2041-2050. It also created a cost containment reserve that can be used to limit prices and a price floor below which permits will not be sold into the scheme. The initial containment reserve trigger price (NZD 50) was breached in the third auction, which was held in September 2021; the clearing prices in the first two auctions, held in March and June 2021, were NZD 36 and NZD 46, respectively. The secondary market price of emissions permits was NZD 68 (EUR 41) per tonne in early December 2021, compared with an EU ETS price of EUR 77.
Box 1.7. Main features of the New Zealand Emissions Trading Scheme
The New Zealand Emissions Trading Scheme (NZ ETS) is a market where emissions permits are traded. The unit of account is the New Zealand unit (NZ unit, or unit for short), which equals one tonne of carbon dioxide. Buyers are businesses in the NZ ETS, all of which are required to give the government a unit for every tonne of greenhouse gas (GHG) emissions (CO2 equivalent) they emit. Sellers are eligible foresters who receive units from the government for carbon dioxide absorbed by their trees and entities that hold more units than they need. Units also enter the market through free allocations from government to businesses that are emissions intensive and highly exposed to international competition. The government also sells units directly to the NZ ETS through auctioning, which began in March 2021. While provision has been made for approved overseas units to enter the system, no overseas units have yet been approved.
The government sets a cap on emissions covered by the NZ ETS based on the five-yearly emissions budgets mandated by the New Zealand Climate Change Response (Emissions Trading Reform) Amendment Act 2020 that are updated annually after deducting emissions not covered by the ETS (just over one half of the total). Net emissions budgets are currently 292, 307 and 212 million tonnes of CO2 equivalent over 2022-2025, 2026-2030 and 2031-2035, respectively (73, 61.4 and 48.4 million tonnes of CO2 equivalent in annual average terms, respectively). For the first five-year period, the average annual cap on gross emissions is 31.9 million tonnes of CO2 equivalent and the share of free allocations progressively falls to 22% by 2026 (Table 1.15).
Table 1.15. NZ ETS unit limit settings
The Act also created a cost containment reserve that can be used to limit unit prices and a price floor below which permits will not be sold at auction into the scheme. The trigger price for releasing units from the cost containment reserve into the NZ ETS was NZD 50 in 2021, rising to NZD 70 in 2022 and NZD 98.34 by 2025. The floor price was NZD 20.40 in 2021, rising to NZD 21.56 by 2025.
The Act also subjects agricultural GHG emissions to a carbon price, as recommended in past Surveys (Table 1.16), from 2025. The favoured option is to cover them by a farm level levy/rebate system. A partnership between the government and the agricultural sector has been established to prepare for this pricing mechanism, including the development of on-farm accounting and reporting systems for GHG sources and sinks. However, if this partnership has not made enough progress by 2022 for implementation in 2025, agricultural emissions will be brought directly into the NZ ETS from 2022, with livestock emissions priced at the processor level (e.g., milk processors and abattoirs). GHG emissions from fertilizers would then probably be covered upstream under the NZ ETS at the importer/manufacturer level. If agriculture is brought within the ETS, free allocations of permits will initially cover 95% of the sector’s requirements.
With current measures and assuming a carbon price of NZD 35 per tonne of CO2 equivalent in the ETS, which was the cap before the first permit auction occurred, New Zealand is not on track to meet either its 2030 objective (30% below the 2005 level or 11% below the 1990 level) or its 2050 objective (Figure 1.42). The government is currently preparing an Emissions Reduction Plan for publication in 2022 which is to outline policies and actions to help bridge the gap between the current emissions trajectory and the trajectory required to meet the 2050 targets. The Climate Change Commission (2021[51]) estimates that New Zealand can meet its abatement objectives from domestic sources with increases in the carbon price to NZD 140 per tonne by 2030 and NZD 250 per tonne by 2050 and implementation of the package of measures it recommends, which include the following:
Make sure that all government policy and investment decisions support the transition to low emissions;
Support innovation, mobilising finance for low-emissions investments and supporting behavioural change;
Reduce emissions from existing and new urban areas, including by phasing out gas connections to homes;
Introduce measures to ensure that vehicles entering the fleet are efficient, accelerate the uptake of electric vehicles, and create options to decarbonise heavy transport and freight;
Decarbonise the energy system;
Accelerate the switch to low-emissions fuels for process heat and transform buildings to have low emissions;
Introduce policies, tools and incentives to speed up emissions reductions from agriculture;
Reduce reliance on forestry carbon removals, manage afforestation and incentivise the reversion and planting of new native forests to create a lasting carbon sink;
Develop an equitable transition strategy.
Complementary measures to carbon pricing are essential to reduce abatement costs, not only where it is too costly or technically difficult to apply pricing mechanisms to individual emitters, but also where there are market failures not addressed by carbon pricing. For example, higher carbon prices increase demand for housing that is close to amenities and well served by public- and active transport options but complementary urban planning policies, such as the Urban Growth Agenda (see above), and transport policies are needed to make the supply of such housing more responsive to demand (i.e., to increase the price elasticity of supply of such housing). Similarly, while higher carbon prices increase demand for more energy-efficient buildings, regulations that establish more demanding standards than would otherwise be met reduce information failures that arise from buyers not being well informed about the long-run costs and benefits of adopting lower emissions options or believing that these benefits would not be reflected in the price of their building when they sell or let it, resulting in a greater increase in the supply of such buildings than otherwise. Another example of complementary policies is the need for public support for Electric Vehicle (EV) charging infrastructure, which helps to overcome coordination problems in the diffusion of EVs (people will not buy EVs if the charging infrastructure is inadequate and investors will not supply such infrastructure if there are too few EVs to make it profitable). In other words, a suite of policies is needed to achieve abatement targets at least cost, with emissions pricing working in conjunction with companion policies that that help to provide a wider range of low emissions options. At the same time, it will be important to ensure that measures are indeed complementary to carbon pricing to avoid risk of high-cost abatement in situations where lower-cost abatement would be forthcoming through the ETS. An example where caution would be required is the proposed NZ Battery Project, which would provide the electricity system with a backup for intermittent supply from renewables and thereby enable the renewable share to be increased from around 93% under a business as usual scenario to 100%. On the one hand, there is risk of abatement costs far higher than the NZ ETS price, and a risk of lower demand for emissions permits from electricity generators that lowers the permit price, resulting in lower-cost abatement elsewhere not occurring. On the other hand, careful investigation of long-term emissions reductions can be justified if the time horizon prevents markets from pricing the benefits, and the supply of ETS units in New Zealand can be managed by the government including to account for the impact of complementary measures.
Figure 1.42. New Zealand is not on track to meet its GHG abatement objectives
1. Nationally Determined Contribution.
2. United Nations Framework Convention on Climate Change.
Source: Ministry for the Environment (2021), New Zealand’s Projected Greenhouse Gas Emissions to 2050
Table 1.16. Past OECD recommendations on green growth and actions taken
Taxing environmental externalities more effectively
Revenue from environmentally related taxes is relatively low in New Zealand (Figure 1.43). Transport fuel taxes are lower than in most other OECD countries and most fossil fuel uses outside the road sector are not taxed (OECD, 2019[52]). While more effective pricing of carbon and other GHG emissions should be pursued primarily through the New Zealand Emission Trading Scheme, taxation can be used to internalise environmental externalities that the emissions trading scheme cannot address. For instance, taxes for fuels used in transport could be increased to internalise social costs linked to transport, such as local air pollution and congestion (OECD, 2017[23]). As technology improves, congestion charging is likely to be a more efficient way of internalising local social costs caused by transport. The United Kingdom, Singapore and Sweden already have such charges and Israel is planning to introduce one. A cross-party Parliamentary Committee recently recommended that the government should propose legislation to enable congestion pricing, and implement a congestion pricing scheme in Auckland. Since mid-2021, the government is progressively increasing and expanding the national waste disposal levy. The government is also considering a range of other options for increasing environmental taxes.
Figure 1.43. Environmental taxation is limited compared to other OECD economies
Environmentally related tax revenue as a percentage of GDP, 2019 or latest year available
Note: The data refer to 2018 for Colombia and Israel, 2016 for Australia and the United States, 2014 for Canada and Korea. OECD countries with populations above 1 million and below 20 million people, and with a per capita income above USD 30 000 are defined as small advanced economies.
Source: OECD (2021), Policy Instruments for the Environment (PINE) (database).
Keeping corruption low
Perceived corruption in New Zealand is equal lowest (with Denmark) in the OECD (Figure 1.44, Panel A), tax transparency is high and anti-money laundering is relatively effective (Figure 1.45). New Zealand’s policy settings to control corruption are generally best practice (Figure 1.44, Panels A, B and C). Nevertheless, the OECD Working Group on Bribery’s 2016 report (OECD, 2016[53]) stressed the need for New Zealand to strengthen enforcement of its foreign bribery offence. In response, New Zealand has made significant attempts to identify foreign bribery offences. It funds a position at the International Anti-Corruption Control Centre (IACCC), which was set up in 2017, and has responded to around 200 requests from this organisation. However, none of them has led to an investigation of a foreign bribery offence in New Zealand. The Serious Fraud Office (SFO), which investigates financial crimes including corruption, has increased international engagement, cooperating with and providing assistance to overseas agencies and joining the International Public Sector Fraud Forum. The SFO continues to open investigations where information is received that leads to suspicion that an investigation may disclose serious or complex fraud (including corruption) but none has resulted in a corruption charge. Reasons for the apparent lack of cases include that: New Zealand does not have the same risks as other jurisdictions owing to the size and make up of its economy; and a lack of New Zealand activity in issues identified overseas given that New Zealand receives few requests for assistance from foreign agencies other than the IACCC.
Figure 1.44. Corruption is very low
Note: Panel B shows the point estimate and the margin of error. Panel D shows sector-based subcomponents of the “Control of Corruption” indicator by the Varieties of Democracy Project.
Source: Panel A: Transparency International; Panels B & C: World Bank, Worldwide Governance Indicators; Panel D: Varieties of Democracy Project, V-Dem Dataset v11
Figure 1.45. Tax transparency is high and anti-money laundering is relatively effective
Note: Panel A summarises the overall assessment on the exchange of information in practice from peer reviews by the Global Forum on Transparency and Exchange of Information for Tax Purposes. Peer reviews assess member jurisdictions' ability to ensure the transparency of their legal entities and arrangements and to co-operate with other tax administrations in accordance with the internationally agreed standard. The figure shows first round results; a second round is ongoing. Panel B shows ratings from the FATF peer reviews of each member to assess levels of implementation of the FATF Recommendations. The ratings reflect the extent to which a country's measures are effective against 11 immediate outcomes. "Investigation and prosecution¹" refers to money laundering. "Investigation and prosecution²" refers to terrorist financing.
Source: OECD Secretariat’s own calculation based on the materials from the Global Forum on Transparency and Exchange of Information for Tax Purposes; and OECD, Financial Action Task Force (FATF).
Findings and recommendations
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