Stairwhey to Heaven

Could the dairy boom make our country rich again? Ruth Laugesen reports.

Economist Kel Sanderson says two years ago, everything he thought he knew about where New Zealand's fortunes lay began turning upside down.

The road to riches everyone agreed was high-value manufacturing. And the road to slipping living standards was to churn out basic foodstuffs and raw materials.

But a funny thing happened. World commodity prices for basic raw materials like food, minerals, metals and timber began to climb and climb, and then rocket.

"We started to say hey, you would expect these prices to be going down, but they're not," says Sanderson, director of Business and Economic Research Limited.

Amongst the most astonishing price rises were dairy products, which make up 21% of our merchandise exports. By June this year, world dairy prices were double what they were a year ago.

On Friday Fonterra updated its forecast payout for the current season to a new record, $6.40 per kg of milk solids, or an average of $689,000 for each Fonterra dairy farmer. The payout will pump $8 billion into the $163b New Zealand economy, up $2.4b on last season

This is no statistical blip, says ANZ chief economist Cameron Bagrie. Something remarkable is going on, something "fundamentally huge" for our future living standards, and those of our children, if we are prepared to fully grasp the opportunity.

"We're sitting on a pot of gold. The last time commodity prices were at this sort of level, was way back in the 1960s when New Zealand was in the top five wealthiest countries in the OECD," he says.

Bagrie says there is now a "massive mind shift" going on about what we need to do to make us rich. Ever since the reforming 1980s, we have been told New Zealand is too reliant on the farm, and should diversify into manufacturing.

And despite flurries of reports and political hand-wringing, about two-thirds of New Zealand's merchandise exports still come off the land. That figure hasn't budged much in 25 years.

But now, instead of wailing about our stubborn reliance on the land, some economists are celebrating it.

"Global trends are now working in our favour. Thankfully we didn't drop our rural base and get away from the heartland," says Bagrie.

"I think New Zealand is sitting on the cusp of something pretty special here, in terms of where our commodity prices have gone to, and where I think they're likely to go over the next five to 10 years.

"If we get the strong commodity prices and we get the productivity growth to match, we'll move back up the OECD rankings. The challenge is, are we going to catch this magic bus or is it going to pass us by?" says Bagrie.

Westpac agri-economist Doug Steel is calling it "one of the biggest positive shocks the New Zealand economy has seen, possibly similar to the Korean War wool boom".

BNZ chief economist Tony Alexander is picking the flow-on effects will further strengthen dairying regions like Waikato, Taranaki, Canterbury and Southland, making it easier for those regions to keep their young people and offer them work. And he says it will provide a challenge to Auckland.

And at Treasury, manager of forecasting and monitoring David Galt says he would put the dairy price rises as the biggest improvement in New Zealand's terms of trade since the "massive lifts" of 1972-1973 - a generation ago - when meat, wool and dairy prices shot up briefly.

It's a long way from the 2003 Knowledge Wave conference, at which speakers lamented New Zealand's "commodity mentality". Is it possible that our future lies, once again, in grass?

Fonterra chairman Henry van der Heyden told the Sunday Star-Times New Zealand's real strengths are becoming more starkly apparent.

"New Zealand's point of difference is pastoral agriculture and that's our place in the sun. We've got to get everyone to accept that," he says.

"Our advantages are around climate, soil type and excellence in applying knowledge, and getting value out of that," he says.

Put simply, we are the most efficient in the world at turning grass into protein. Fonterra is heavily into the bulk production game. It plans to expand its business by taking its know-how to the new grass-growing locations that will emerge as New Zealand's dairying competitors, and to join forces.

China, South America and Eastern Europe are all being targeted by Fonterra to form partnerships and milk supply chains from the farm-level up.

Over the last 10 years, says van der Heyden, Fonterra averaged about $1800 to $1900 a tonne for milk powder. Currently prices are up at $4500 a tonne. He expects long-term they will ease back to roughly $3000 a tonne.

Why are prices so high? He points to a variety of factors.

Demand is rising and rising, as a result of rapid population growth and higher incomes in China and India. As those countries become wealthier, more people are eating more protein in the form of meat, eggs and milk.

And supply is not keeping pace. For one thing, the biofuels boom has driven up feed corn prices for American dairy farmers, because agricultural land is being used for ethanol production instead.

Other suppliers, in Europe, are producing less because of the removal of subsidies. In Australia, the prolonged drought means their dairy farmers have been unable to boost production.

The good news story for New Zealand spreads beyond dairy into currently lacklustre beef and lamb. Reserve Bank governor Alan Bollard predicted in a recent speech that the same factors driving dairy prices skyward would over time also bring increasingly favourable prices for meat and forestry, the country's second and third largest commodity exports behind dairy.

But if commodity prices have gone up, couldn't they just as easily plummet again, leaving us as economically stranded as ever?

Not necessarily. Many experts believe we are seeing a fundamental break from the patterns of the past. They reason that a rising Asia will continue to create heavy demand for food, minerals, metals and wood, and that supply will not be able to fully keep pace.

"We've all seen commodity price booms and busts before, so you've got to be a bit careful to read the latest increases in world markets as being completely structural. I would expect half of the price rises to be sustained going forward," says Doug Steel of Westpac. "Having said that, if product prices in the long terms are 50% higher than they have been in the last 10 years, then that's certainly a good news story for New Zealand dairy farmers, and New Zealand Inc in general. It's great news," says Steel.

It won't just be dairy farmers who directly benefit. While the primary sector only makes up about 7% of the domestic economy, once linked industries are considered (such as fertiliser manufacture and transport of farm goods), the primary sector makes up 17% of the economy.

Not only will the economy benefit from the cash injection of the boosted dairy payouts in the short-term, but in the long-term higher payouts are expected to put upward pressure on New Zealand's exchange rate.

While that will put pressure on some other exporting industries, it will also be good for New Zealand's standard of living if the dollar buys more abroad. "It means that for New Zealanders, every single dollar they have can buy more goods and services on the world market," says Steel.

But Dr David Skilling, head of think-tank, the New Zealand Institute, is sceptical. "The danger is we treat this increase in dairy prices as a silver bullet that will solve our economic problems. It's unlikely to be quite as significant as that. It's certainly a good thing.

"But it's not going to close the gap with Australia or things of that nature. And it doesn't mean we can't forget about transforming the economy. Perhaps we have bought a bit more time."

He still believes we are dangerously over-reliant on the land, and on shipping heavy, bulky goods to far-off markets.

He worries that New Zealand has remained frozen in time. While new industries like IT, wine and biotech are growing fast, they remain a mere speck in comparison to the mighty cow.

For him, transforming the economy means a shift to a "weightless" economy, one which makes its money exporting serdhvices and know-how in communication, construction, financial IT and other business services. That would mean a lot more research and development spending, more spending on universities, world-leading communications infrastructure, and attracting selective foreign investment.

However, for all Skilling's despair about New Zealand's refusal to diversify, there has been some change. Non-commodities manufacturing has grown from 25% of merchandise exports in 1987 to 33% today.

Bagrie says much of that is in specialist niche manufacturing like Fisher and Paykel and Tait electronics. While some of that manufacturing is now under pressure or has moved off shore, other pockets are still growing.

But he says while the dairy boom is a golden opportunity, one thing stands between us and the top half of the OECD rankings. That is our dismal productivity growth.

"We've got one thing that is working in our favour which is fantastic, but we're going backwards in another direction and that's disturbing.

"Over the past 10 years we've seen a big decline in productivity growth," he says.

At its heart, productivity growth is about New Zealand getting more wealth from the labour and capital it is using, to earn its living.

That can mean lowering costs say when a factory automates a production line and cuts jobs.

Or it can mean increasing output by using soil and grass research to increase dairy yields from a farm. Or it can mean earning more for goods by producing a designer vodka that people are prepared to pay high prices for.

Bagrie says if productivity is not turned around, the dairy boom will be "an opportunity that will pass us by".

"The issue is whether we're prepared to grab it by the scruff of the neck and have a real good crack at this. We've got the broad economic platform, it's just a question of getting the small things done right," says Bagrie.

On his list is everything from lower taxes, to a more competitive telecommunications sector, to a more business-friendly Resource Management Act, to a more reliable energy supply for Auckland.

Kel Sanderson says even with high commodity prices, New Zealand still needs to change what it does. But that change may mean leveraging our natural advantages in the primary sector and creating more elaborate products.

"If we do smarter things with pieces of wood and smarter things with milk, that way we're going to be in good heart going forward, no matter which way the cookie crumbles," he says.

And Sanderson says the boom will give us a chance to address one of the biggest potential threats to the dairy industry that it will be seen as environdhmentally "dirty" by international consumers.

Already here the dairy industry is under attack for nutrient run-offs, for its thirst for water in Southland and Canterbury and for cows' whopping methane emissions that contribute to climate change.

Sanderson says there was little chance of addressing these when real prices were going down, and farmers were "squeezing the last bit out of their land".

"You have to be able to afford to be kind to an environment. As an industry it would be really good if you saw them investing some of that windfall gain, future proofing, on the environmental side of the business," he says.

- © Fairfax NZ News