Dairy s role in sustaining New Zealand

Transcription

1 Dairy s role in sustaining New Zealand - the sector s contribution to the economy REPORT TO FONTERRA AND DAIRY NZ December 2010

2 About NZIER NZIER is a specialist consulting firm that uses applied economic research and analysis to provide a wide range of strategic advice to clients in the public and private sectors, throughout New Zealand and Australia, and further afield. NZIER is also known for its long-established Quarterly Survey of Business Opinion and Quarterly Predictions. Our aim is to be the premier centre of applied economic research in New Zealand. We pride ourselves on our reputation for independence and delivering quality analysis in the right form, and at the right time, for our clients. We ensure quality through teamwork on individual projects, critical review at internal seminars, and by peer review at various stages through a project by a senior staff member otherwise not involved in the project. NZIER was established in Authorship Prepared by: Chris Schilling, James Zuccollo and Chris Nixon Quality approved by: John Ballingall Date: Version: 15/11/2010 3:49 PM Final Acknowledgements:

3 Key points Dairy makes a very strong direct contribution to the NZ economy The dairy sector directly accounts for 2.8% of GDP, or $5 billion. This contribution is: o greater than the GDP contribution of the fishing, forestry and mining sectors combined o around 10 times as large as the GDP of the wine sector o about 3 times as large as the forestry and logging sector o over a third of the GDP contribution of the entire primary sector (dairy and meat farming and processing, horticulture, fishing, forestry, mining) o 40% larger than the entire utilities sector (electricity, gas and water) o 2/3 as large as the entire construction sector o 15% of the total GDP of the goods producing industries and o provides 26% of New Zealand s total goods exports. And contributes to the health of the NZ economy in many ways But the sector s influence extends well beyond its direct impacts. Dairy is closely intertwined with the rest of the economy. This includes the jobs it delivers, the income that these workers earn, its links to supplying firms, the effects of rural economic growth on urban centres, the tax revenue it provides and the public services that can be funded from this tax revenue. These links are shown in the figure at the end of this section. Of the $10.4 billion of dairy products exported in 2009, o $7.5 billion is used to purchase raw milk from the dairy farming sector. o $1.5 billion is retained as returns to labour and capital (i.e. wages and rate of return). o $625 million is spent on intermediate inputs from New Zealand. This includes $85 million of plastic containers, $45 million on electricity and $22.5 million on financial services. o Imported intermediate inputs account for $310 million largely plastic containers ($182 million) and other food products to be used in processing ($30 million). o $730 million is spent on retailing/wholesaling costs that get the dairy products from the plant to market. Of the $7.5 billion value of raw milk output, $3.0 billion is retained as returns to land, labour and capital. A further $3.6 billion is spent on domestically produced intermediate inputs, such as fertilizer ($447 million), feed ($723 million), agricultural services ($446 million), financial services Dairy s role in generating growth C

4 It generates jobs The dairy sector employs around 35,000 workers, excluding those who are self-employed (which could be up to 10,000 people). The sector will indirectly support many more jobs in industries that supply dairy, and that experience the benefits of additional income flowing into the region due to dairy volume and/or price growth. It provides more jobs than each of the finance and accommodation sectors; around 65% more than the sheep and beef farming sector; 75% more than the fruit growing sector and double the jobs in the wood processing sector. In districts such as South Taranaki, Waimate, Otorohanga and Matamata-Piako, the dairy sector directly accounts for between 1 in 4 and 1 in 5 of the total number of jobs in the region. A $1 per kg payout increase results in the wealthier dairy sector and upstream and downstream industries employing approximately 4,600 more full time equivalent workers. It creates export earnings that improve Kiwis standard of living Dairy exports were $10.4 billion in calendar year 2009, accounting for around 26% of NZ s total goods exports. This contribution far outstrips that of any other goods export sector. Dairy exports are twice those of the meat sector, over 6 times larger than all fruit exports, nine times larger than wine exports, twelve times larger than aluminium exports and 17 times larger than wool exports. In fact, dairy exports are about the same as the sum of the next four largest export sectors: meat, wood, mineral fuels (oil) and fruit & nuts. Through its export earnings, the dairy sector makes a positive contribution to narrowing the current account deficit. Without this export growth, New Zealand would have had to face increased foreign liabilities and interest on foreign debt. A smaller deficit reduces New Zealand s country risk premium on mortgage and other borrowing costs, which benefits all households and firms that are borrowers. The volume growth in the dairy sector over the last decade has resulted in New Zealand households being a cumulative $6.4 billion better off than if dairy activity had stagnated at 1999 levels. A $1 dairy payout increase delivers additional income of over $270 per year of additional spending per man, woman and child in New Zealand. This year s increase of $1.17 per kg will generate an extra $316 per person in New Zealand. It fills the tax coffers The dairy sector generates a substantial amount of tax revenue for the government, through the income taxes of farmers, corporate taxes of processors, and the GST and other taxes on the income and spending that dairy stimulates in the rest of the economy. And because the sector has raised taxation revenue, benefits flow not just to the dairying districts but across the country as a whole. Increased tax revenue coming in means more money to spend on essential services such as schools, hospitals and police. In 2009, these sectors are 0.7%, 0.6% and 0.2% better off because of the growth in the dairy sector over the past decade. D Dairy s role in generating growth

5 It drives many rural economies: when dairy farmers are smiling, the whole region smiles Dairy production is hugely important for many regional economies. It injected over $700 million into the Southland economy in 2009, with South Taranaki and Matamata-Piako both receiving well over half a billion dollars. For smaller district economies such as Ashburton ($471 million), Waipa ($361 million) and Selwyn ($270 million), the value of dairy production, relative to the total size of the economy, is likely to be significant. As noted above, as many as 1 in 4 jobs in some rural areas are in the dairy farming and processing sectors. The dairy volume expansion over the past decade has delivered an additional $650 of income per person in the Southland region and $590 per person in the Canterbury region above what would otherwise have happened. Northland ($110 per person) and the Waikato ($270) have also been major winners. A $1/kg increase in milk solid prices delivers $170 per person of additional income in Northland and Taranaki, $130 per person in the Waikato and $140 in the Manawatu- Wanganui region. It benefits urban consumers too Firms benefit from selling goods and services to the dairy sector. The average dairy farmer spends well over half of their income on goods and services to support on-farm operations. Many of these goods will come from urban areas. Households benefit from the additional government spending that is facilitated by the tax revenue generated by the dairy sector. They also pay lower mortgage and business borrowing costs due to the reduction in the current account deficit (and thus the interest rate premium on overseas funds) due to dairy export revenue. The dairy sector s strong export growth over the last decade has improved New Zealand s balance of trade, and allowed for increased consumption spending. This export growth reduced New Zealand s net foreign liabilities to GDP ratio by over 1%. Together with the exchange rate appreciation, this has saved households a cumulative $1.2 billion in interest repayments on foreign debt over the past decade. Dairy s role in generating growth E

6 Figure 1 F Dairy s role in generating growth

7 Contents 1. The current contribution of dairy Purpose of report Direct contribution to GDP Contribution to regional incomes Contribution to export performance Contribution to Balance of Payments Contribution to Contribution to other sectors performance Supply chain Dairy farming Dairy processing 7 2. Modelling dairy s economic contribution over the past decade Objective of modelling Modelling technique Advantages of CGE modelling Modelling scenarios Scenario 1: The price of milk solids Scenario 2: The growth of dairying over the past decade How we analyse the modelling results Milk solids price spike Headline results Detailed results Direct effects: the dairy sector Indirect impact on other industries Macroeconomic effects Regional impacts Production growth over the last decade Headline results Detailed results Direct impacts Indirect impacts on other industries Macroeconomic effects Regional impacts Conclusion 24 Dairy s role in generating growth G

8 Appendices Figures Tables Appendix A CGE modelling framework 25 A.1 The MONASH-New Zealand CGE model: overview 25 A.2 Dynamics of the MONASH-NZ model 26 A.3 Database structure 26 A.4 Production structure (Horridge, 2008b) 28 A.5 Regional extension 29 Appendix B CGE and multiplier analysis 30 Appendix C Limitations of analysis 32 Appendix D References 33 Appendix E Dairy statistics 34 Appendix F Value of regional dairy production 38 Appendix G Changing dairy export markets 39 Figure 1 Impacts of dairy growth on the rest of the economy F Figure 2 Growth in dairy exports over past decades 4 Figure 3 Importance of dairy to regional 5 Figure 4 Model structure of the sector 6 Figure 5 Change in milk solids price: Figure 6 Processed milk solids 11 Figure 7 Gross regional product impacts 17 Figure 8 Dairy gains since 1998/99 21 Figure Gross regional product impacts 23 Figure 10 Components of a CGE model 25 Figure 11 The MONASH-NZ database 27 Figure 12 Production structure 28 Figure 13 Changing markets for New Zealand s dairy exports 39 Table 1 Value of regional dairy production 2 Table 2 Export values 3 Table 3 Farming industry structure 7 Table 4 Dairy processing industry structure 7 Table 5 Indirect impacts Table 6 National results 16 Table 7 Increase in gross regional product 17 Table 8 Average Cap Farm Cashflow 18 Table 9 Indirect impacts 2008/09 21 Table 10 National results Table 11 Increase in gross regional product 23 Table 12 IO vs. CGE multipliers 31 H Dairy s role in generating growth

9 1. The current contribution of dairy 1.1 Purpose of report This report identifies the dairy sector s current contribution to the New Zealand economy and looks at how changes in the dairy sector over the past decade have benefited districts and households in New Zealand. 1.2 Direct contribution to GDP The dairy sector, comprising farmers and dairy processors, directly contributed around $5.0 billion of value added (or GDP) to the New Zealand economy in 2010, around 2.8% of the total GDP figure 1. By way of comparison, dairy GDP: is greater than the GDP contribution of the fishing, forestry and mining sectors combined is around 10 times as large as the GDP of the wine sector is about 3 times as large as the forestry and logging sector accounts for over a third of the GDP contribution of the entire primary sector (dairy and meat farming and processing, horticulture, fishing, forestry, mining) is 40% larger than the entire utilities sector (electricity, gas and water) is 2/3 as large as the entire construction sector accounts for 15% of the total GDP of the goods producing industries Note that these figures are the direct contributions only. They do not take into account the links that the dairy sector has with the wider economy. In reality, the dairy sector also has indirect and induced effects on the New Zealand economy. The indirect effects accrue via the industries supporting the dairy sector (fertiliser, agricultural services, transport, etc). When the dairy sector grows, these supporting industries will also grow. The induced effects are attributable to the additional spending of dairy sector farmers and workers following a boost in dairy returns. This spending will be directed into sectors such as housing, clothing, bars and cafes, entertainment, etc. Some of these linkages are discussed in section 1.7 below Calculated from Statistics New Zealand SNA GDP by industry data and NZIER s industry database. Measured in 2010 prices. 2. Unless one uses an unrealistic and non-credible methodology, it is not possible to calculate the total (direct plus indirect and induced) GDP contribution of dairy. See section 2.3 and Appendix B for further explanation Dairy s role in generating growth 1

10 1.3 Contribution to regional incomes In many rural areas, the contribution of the dairy sector to the local economy is far greater than the national average of 2.8% mentioned above. The dairy sector pumps hundreds of millions of dollars of revenue into regional economies each year. Table 1 shows the 15 highest revenue generating dairy districts in New Zealand. Dairy production injected over $700 million into the Southland district economy in 2009, with South Taranaki and Matamata-Piako both receiving well over half a billion dollars. For smaller district economies such as Ashburton ($471 million), Waipa ($361 million) and Selwyn ($270 million), the value of dairy production, relative to the total size of the district economy, is likely to be significant 3. Also see Box story 1. Table 1 Value of regional dairy production $ millions, 2009 Region Dairy revenue Southland South Taranaki Matamata-Piako Ashburton Waikato Waipa Selwyn South Waikato Rotorua Otorohanga New Plymouth Hauraki Tararua Timaru Clutha Notes: Source: (1) Based on $5.50 price per Kg MS, 35c per Kg MS for stock sales and 4c per Kg of MS for other income Dairy New Zealand, Fonterra, NZIER 1.4 Contribution to export performance Dairy exports were $10.4 billion in calendar year 2009, accounting for around 26% of NZ s total goods exports. As Table 2 shows, this contribution far outstrips that of any other goods export sector. The third column in the table shows that dairy exports are twice those of the meat sector, over 6 times larger than all fruit exports, nine times larger than wine exports, twelve times larger than aluminium exports and 17 times larger than wool exports. In fact, dairy exports are about the same as the sum of the next four largest export sectors: meat, wood, mineral fuels (oil) and fruit & nuts. 3. Regional GDP information at this level of detail is not available from Statistics New Zealand, so the shares cannot be calculated. 2 Dairy s role in generating growth

11 Table 2 Export values $ millions, 2009 Sector Export value How many times dairy exports are larger than sector s Dairy products 10,398 Meat products 5, Wood products 2, Mineral fuels 1, Fruit & nuts 1, Machinery parts 1, Fish 1, Miscellaneous 1, Wine & other beverages 1, Aluminium Electrical machinery Precious metals & stones Wool Wood pulp Iron & steel Optical & medical equipment Paper & paperboard Vegetables Plastics Hides & skins Notes: (1) Source: Dairy NZ, Fonterra, NZIER Final report - 16 November 2010 Over the past decade, dairy export values have grown by more than 8% per year. Dairy has grown more rapidly than most primary sectors, and has become an increasingly important contributor to New Zealand s total food and beverages and overall merchandise trade. Figure 2 Growth in dairy exports over past decades Figure Annual average 2 Growth growth in in dairy export exports values, over past decades Annual average growth in export values, Source: Statistics New Zealand, NZIER Source: Statistics New Zealand, NZIER Dairy s role in generating growth Export growth has been driven by a combination of strong global income growth for 3

12 Export growth has been driven by a combination of strong global income growth for the majority of the decade, as well as a change in the composition of the markets that we sell to. As economies such as China and other parts of Asia experience higher living standards, their tastes and preferences change, and staples such as rice, lentil and beans are replaced with higher protein foods. The changing composition of New Zealand s dairy markets is shown in Figure 13 in Appendix G. China, for example, accounted for 0.4% of New Zealand s dairy exports in 1989 and now takes over 12%. The relative importance of major markets such as the UK, Japan and Mexico has dropped over this period. 1.5 Contribution to Balance of Payments The strong export growth from the dairy sector has been a key factor in New Zealand s current account deficit (CAD) narrowing in recent years. This is important because as the CAD rises as a proportion of GDP, foreign investors and ratings agencies start to have concerns over the ability of the New Zealand economy to withstand any unexpected negative economic shock (such as a global pandemic or financial crisis). These concerns translate into New Zealand having a higher risk premium attached to it on foreign borrowings that is, it becomes more expensive for New Zealand firms, households and the government to borrow on international markets. The most obvious channel would be through higher household mortgage repayments. The strength of the dairy sector has been very evident as New Zealand recovers from the global financial crisis and domestic recession. With domestic demand continuing to be anaemic, it is the export side of the economy that is being relied on to generate economic growth. It has recently been noted that dairy s growth has resulted in New Zealand s trade surplus being at its highest level for eight years. 1.6 Contribution to National The dairy sector in New Zealand is a major employer, and is vital for a number of districts. On-farm is around 24,000 nationwide, with dairy processing providing another 10,000 jobs. These figures do not include those dairy farmers who are registered as selfemployed. Although dairy does not reach the levels present in a number of services sectors (for example, there are 110,000 workers in pre-school and school education alone), it provides more jobs than each of the finance and accommodation sectors (both around 32,000); around 65% more than the sheep and beef farming sector (20,500); 75% more than the fruit growing sector (19,300) and double the jobs in the wood processing sector. Regional In districts such as South Taranaki, Waimate, Otorohanga and Matamata-Piako, the dairy sector directly accounts for between 1 in 4 and 1 in 5 of the total number of jobs in the region. The sector will indirectly support many more jobs in industries that supply dairy, and that experience the benefits of additional income flowing into the region due to dairy volume and/or price growth. 4. Department of Labour (DoL), Regional Industry Tool There is no official count of self-employed dairy farmers, but the figure has been estimated by Dairy NZ at around 10,000 based on owner-operator and sharemilker numbers. 4 Dairy s role in generating growth

13 Final report - 16 November 2010 Figure 3 Importance of dairy to regional Dairy Figure farm 3 and Importance processing jobs of as dairy % of total in regional Dairy farm and processing jobs as % of total in region Source: DoL, NZIER A complete A complete table table of of dairy statistics statistics for each for of New each Zealand s of New 74 Territorial Zealand s Local 74 Authorities is contained in Appendix E. Territorial Local Authorities is contained in Appendix E. 1.7 Contribution to other sectors performance Of course, the dairy farming and processing sector do not operate in isolation. They have strong upstream and downstream links to other parts of the New Zealand economy. 1.7 Contribution to other sectors performance Supply chain Of course, the dairy farming and processing sector do not operate in isolation. They The dairy sector can conceptually be broken into a dairy farming industry and a dairy have strong processing upstream industry. Dairy and farming downstream generates links the raw to milk other that the parts dairy of processing the New industry Zealand economy. uses as an input, and produces processed dairy products for sale to domestic consumers, export markets and other industries Supply chain The dairy sector can conceptually be broken into a dairy farming industry and a dairy processing industry. Dairy farming generates the raw milk that the dairy processing industry uses as an input, and produces processed dairy products 6 for sale to domestic consumers, export markets and other industries. 6 In our model, we have a variety of processed dairy products, but for simplification for this work, we consider one generic processed dairy product. Similarly, farm income from other sources than just milk 6. In (e.g. our model, stock we have and a variety other of processed sales) dairy is included products, but in for the simplification modelling for this but work, not we consider singled one generic out in processed the reporting. dairy product. Similarly, farm income from other sources than just milk (e.g. stock and other sales) is included in the modelling but not singled out in the reporting. NZIER Dairy s role in generating growth 6 Dairy s role in generating growth 5

14 Final report - 16 November 2010 Figure 4 Model structure of the sector Figure 4 Model structure of the sector Source: NZIER At each stage of production there is also labour, capital and other intermediate. At each stage of production there is also labour, capital and other intermediate Dairy farming The structure of the farming industry is shown in Table 3. The farming sector produced around $7.5 Dairy billion farming worth of raw milk in the 2009/10 production year for sale to the processing operations. As expected, farming uses a lot of land and the labour is not a large part of the The structure of the farming industry is shown in Table 3. The farming sector farm s costs. The on-farm sector employs around 24,000 full time equivalent (FTE) workers. The produced around $7.5 billion worth of raw milk in the 2009/10 production year for sale primary cashflow costs for farmers are fertiliser for the land and feed for the animals. These to the processing two industries operations. are heavily affected As expected, by movements farming demand uses for a milk lot of products. land and the labour is not a large part of the farm s costs. The on-farm sector employs around 24,000 full We can break down the $7.5 billion of raw milk into the following parts: time equivalent (FTE) workers. The primary cashflow costs for farmers are fertiliser for the land $3.0 and billion feed is retained for the as returns animals. to land, These labour two and industries capital. are heavily affected by movements $3.6 in billion demand is spent for on milk domestically products. produced intermediate inputs, such as fertilizer ($447 million), straw and feed ($723 million), agricultural services ($446 million), financial services We can break ($341 down million), the machinery $7.5 billion repairs of ($198 raw million) milk into and the petrol/diesel following ($80 parts: million). $3.0 billion $440 million is retained is spent as on returns imported to inputs land, such labour as fertilizer and capital. ($138 million), pharmaceuticals ($111 million), feed ($31 million), agricultural equipment ($26 million) and pesticides ($16 $3.6 billion million). is spent on domestically produced intermediate inputs, such as fertilizer ($447 million), straw and feed ($723 million), agricultural services ($446 $290 million is spent on margin services such as transport. million), financial services ($341 million), machinery repairs ($198 million) and petrol/diesel ($80 million). $440 million is spent on imported inputs such as fertilizer ($138 million), pharmaceuticals ($111 million), feed ($31 million), agricultural equipment ($26 million) and pesticides ($16 million). $290 million is spent on margin services such as transport. NZIER Dairy s role in generating growth 7 6 Dairy s role in generating growth

15 Table 3 Farming industry structure Input Dairy farming Comment Land 21% Includes Gross Margin Capital 15% Labour 5% Domestic intermediates 47% Ag services, feed, fertilizer Imported intermediates 8% Fertilizer, pharmaceuticals, feed Margins 4% Transport Source: NZIER Dairy processing The dairy processing industry takes the raw milk and turns it in to products that can be sold to customers and consumers. The industry produces a wide range of dairy products, from milk and cheese to ice cream and butter. The vast majority of the industry s input costs are the purchase of the raw milk, which accounts for 70% of the industry s costs. In addition, the processing industry uses about $1.1 billion of capital and employs close to 10,000 FTE employees. Of the $10.4 billion exported by our model s dairy processing sector: $7.5 billion is used to purchase raw milk from the dairy farming sector. $1.5 billion is retained as returns to labour and capital (i.e. wages and rate of return). $625 million is spent on intermediate inputs from New Zealand. This includes $85 million of plastic containers, $45 million on electricity and $22.5 million on financial services. Imported intermediate inputs account for $310 million largely plastic containers ($182 million) and other food products to be used in processing ($30 million). $730 million is spent on retailing/wholesaling costs that get the dairy products from the plant to market. Table 4 Dairy processing industry structure Input Share Comment Capital 7% Includes Gross Margin Labour 7% Raw milk 66% Other intermediates 12% Other farm inputs Other imported intermediates 6% Mostly plastic packaging Margins 2% Retailing and wholesaling costs Source: NZIER Dairy s role in generating growth 7

16 Dairy exports and rural livelihoods Any inquiry into the New Zealand economy and its workings has to at some point focus on the central driving force of economic growth: trade. Trade is important because over time New Zealand s spending must equal its income. Without international trade the income of New Zealand businesses is limited by domestic spending. International trade removes this limit. With dairy exports at 26% of goods exports, the impact of the dairy industry on economic activity is considerable. The money that farmers spend in their communities and in other parts of the country drives further economic activity the more they earn on international markets the more they spend in New Zealand. Dairy farmers success is mirrored not only in their local communities but also in the cities of New Zealand which produce the goods and services that are bought by farmers. Even imports have a local component since they have to be transported to the point of sale. Nobody understands this more than the mayors of the districts, regions and cities of New Zealand. Peter Tennent, Mayor of New Plymouth, says that while the dairy industry in his region only makes up 2% of the workforce, 100% of the community are the benefactors of their efforts. When dairy farmers are smiling, the region smiles. Hugh Vercoe, Mayor of the Matamata Piako District, also knows how important dairy is to his district: not only are we reliant on the dairy [farming] industry, we have five dairy processing plants and very active sale yards. This helps to maintain a vibrant community. David Adamson, CEO of the Southland District Council says that the dairy industry has changed the face of Southland. He adds that its economy has weathered the recession well, mainly because of the influence of the dairy industry. In the first instance farmers spend their incomes on industries that directly support their activities. They buy more cows, upgrade equipment, buy fertilizer, repay debt and make land improvements. David Adamson suggests that this is the most visible sign of the impact of dairy growth on the Southland region: most of the money earned by farmers is spun out into the community. Since most of the goods and services come from outside of the provinces, other communities benefit as well. In work done by NZIER (2003) it is shown that it takes about 18 months for this economic ripple effect of additional export revenue to fully work through the New Zealand economy, all of which leads to stronger household spending and business investment. What would New Zealand look like without the dairy industry? Peter Tennent finds it difficult to imagine this situation but one thing he does know is that New Plymouth would not have been judged the best place to live on the planet by the United Nations backed Liv.com Awards without the dairy industry we d still be smiling but not as wide and there d be far fewer businesses here. Similar sentiments are echoed by David Adamson and Hugh Vercoe. Both said there would be fewer businesses, less vibrant community, and fewer job opportunities. Not only would there be fewer job opportunities and increased movement of people to the cities, those cities would also be poorer. The dairy industry has had a major impact on New Zealand society and economy for over 130 years. Those involved in running districts and cities closest to the dairy industry well understand the positive impact of dairying, not just on their regions and cities but on the rest of New Zealand. 8 Dairy s role in generating growth

17 2. Modelling dairy s economic contribution over the past decade 2.1 Objective of modelling The section above has shown that the dairy sector has witnessed significant growth over the past decade. A key question is: how has this growth benefited the rest of the economy? In particular, we are interested in two aspects of this growth: The short term impacts of milk solids payout increases The longer term impacts of volume growth in the sector over the last 10 years. We examine these two aspects using a relatively newly developed economic model of the New Zealand economy. 2.2 Modelling technique The dairy sector interacts with the rest of the economy by generating exports and, using intermediate inputs such as fertilizer, and competing for use of land, labour and investment. In order to get a sense of how the New Zealand economy as a whole might be impacted by production and price changes in the dairy sector, we need to use an economic model that takes these interactions into account. We use NZIER s dynamic Computable General Equilibrium (CGE) model of the New Zealand economy to evaluate the impacts of the price and volume growth in the dairy sector. 2.3 Advantages of CGE modelling Our dynamic CGE model is a more robust framework than alternatives approaches for estimating the contribution of the dairy sector to the New Zealand economy. The most commonly used alternative is input-output (IO) or multiplier analysis. IO or multiplier analysis has two significant limitations: It does not adequately consider the reallocation of resources following a shock to the economy, such as a surge in demand for dairy exports. In particular, multiplier analysis assumes that resources (land, labour, capital, energy, intermediate inputs) are available Dairy s role in generating growth 9

18 in unlimited quantities for the expansion of a sector. It does not consider how those resources might otherwise have been used in the economy their opportunity cost. In reality, resources are scarce and any additional resources used in the dairy sector must be diverted from other industries. The output of these industries must therefore fall. The overall macroeconomic impact of the increase in demand in one sector should take into account these losses elsewhere in the economy. It does not account for relative price changes. For example, it assumes that wage rates do not change as the demand for labour rises or falls, and that the prices of intermediate goods such as transport and business services do not change in response to shifts in demand. In reality, if there is additional demand for workers in the dairy sector, this will place upward pressure on wages across the economy. Even though this wage pressure might be relatively small, it will still have a negative impact on input costs for other firms in the economy, and could lead to a drop in output. A similar story is true for intermediate inputs. As the dairy sector demands more of these inputs, their price rises for all other firms in the economy, causing their output to fall. Multiplier analysis therefore tends to vastly overstate the economic impacts of changes in demand in a specific sector. These unrealistically large impacts are thus not particularly informative for policy makers or firms. CGE models explicitly address both resource allocation and relative price shifts, allowing for a more credible, richer analysis of economic contribution. These models tend to produce more conservative estimates of impacts, but are more consistent with economic theory and practice. See Appendix B for a fuller discussion. 2.4 Modelling scenarios We investigate the impact of the dairy sector with two historical scenarios to show how real changes in the dairy sector translate into benefits for the rest of the economy. The historical scenarios examine the benefits that have accrued over the past decade: milk solids payout increases growth in the sector over the last 10 years. These two scenarios jointly capture both the benefits to the economy of the long term growth in the sector and the short-run wealth gains from increased milk solids payouts. milk solids payout increases growth in the sector over the last 10 years. These two scenarios jointly capture both the benefits to the economy of the long term growth in the sector and the short-run wealth gains from increased milk solids payouts Scenario 1: The price of milk solids The world price of milk solids has a significant impact on the dairy industry and the wider New Zealand economy. It has also been fairly volatile of late, as can be seen from Figure 5. This first scenario assesses the effects on the economy of changes in the milk solids price paid to farmers. In order to generate higher prices for milk solids we assume that the world price has risen due to increased world demand for dairy produce. Increased world demand for New Zealand s dairy produce leads to rises in both milk prices for New Zealand dairy farmers and over a sustained period a rise in the quantity of milk solids produced domestically. We calibrate the price increases in this simulation to be ± $1/kg milk solids in Fonterra s payout. So we are asking: what are the flow-on impacts for the New Zealand economy from a $1 increase or decrease in the Fonterra payout? 10 Dairy s role in generating growth

19 Final report - 16 November 2010 Figure 5 Change in milk solids price: $ per kg, prices Figure 5 Change in milk solids price: $ per Figure kg, Change prices in milk solids price: $ per kg, prices Source: Dairy NZ Scenario Source: 2: Dairy The NZ growth of dairying over the past decade Over the last Scenario 10 years 2: The the growth dairy of sector dairying has over grown the past significantly, decade increasing milk solid production Scenario Over the by last 58% 2: 10 years between The growth the dairy 1998/89 of sector has and dairying grown 2008/09. over significantly, In the this increasing case past milk study, decade solid we ask the questions: Over the production last what 10 by if years 58% it hadn t between the dairy grown? 1998/89 sector and has 2008/09. what grown would In this significantly, case the study, economy we increasing ask have the questions: missed milk solid out on production if dairy what had if by it hadn t stagnated 58% grown? between at and /89 what production would and the economy 2008/09. levels? have In missed this case out on study, if dairy we had ask the questions: stagnated what 1999 if it hadn t production grown? levels? and what would the economy have missed out The factual is the actual volume path as it occurred; the counterfactual is volumes on if dairy The factual had stagnated is the actual at volume 1999 path production as it occurred; levels? the counterfactual is volumes remaining remaining at 1998/99 levels, as per Figure 6. at 1998/99 levels, as per Figure 6. The factual is the actual volume path as it occurred; the counterfactual is volumes remaining Figure at 1998/99 66 Processed levels, milk as milk solids per Figure solids 6. Million kgs Figure 6 Processed milk solids Million kgs Source: Dairy Statistics 2008/09 Source: Dairy Statistics 2008/09 NZIER Dairy s role in generating growth 12 NZIER Dairy s role in generating growth 12 Dairy s role in generating growth 11

20 2.5 How we analyse the modelling results In analysing the modelling results we take a systematic approach of tracking the impacts as they flow through the economy, beginning with the direct impacts on the dairy sector itself. We look at the export and domestic markets, and how the sector responds to growth with increased and investment. We then analyse the flow-on or indirect impacts on other industries. We split indirect impacts into the following industry categories: Supplying industries industries that supply dairy with intermediate inputs are likely to benefit from a stronger dairy sector. These are industries such as agricultural services and the fertilizer industry. Household expenditure industries industries that households spend money on are likely to benefit from increased income that comes through higher and wages, and increased returns to capital from a growing dairy sector. Government industries industries that rely on government funding are positively impacted by a stronger economy and bigger tax takes, as this increases the money available for the government to spend. Competing export industries industries that compete for resources (such as land and labour) with the dairy sector lose from dairy s growth. Finally, we examine the macroeconomic effects. Here we report both value-add (GDP) and Net Economic Benefit/welfare (private and public consumption) measures. There are two ways to think about the way that export growth will affect GDP: (i) GDP is the sum of the value of expenditure on goods and services made in New Zealand and exports are a component of that expenditure, so a change in exports directly affects the level of GDP. The change in exports will then have flow-on effects on other parts of the economy, as described in our results section. (ii) GDP is also the sum of the value of resources utilised in the economy. Increased dairy exports are generated, in part, by gains in productivity. Greater productivity allows the same resources capital, land and labour to generate greater value, so GDP increases as productivity rises. Thus we expect export growth to have a direct impact on GDP and, in the long run, a positive impact. Although GDP is the most commonly used measure of economic performance, it does not capture necessarily how well off we are as a country. GDP is essentially a measure of how many goods and services New Zealand produces it shows the size of the economy. Consumption shows how much household and government spending increases following a change in the economy. It is more appropriate than GDP as a measure of welfare (see Coleman, 2008), particularly in cases where we expect changes in the terms of trade 7. Ultimately, the objective of an economic development is to raise the living standards of the population. Living standards are better proxied by household and government spending ability than by GDP. Thus our preferred NEB/welfare measure is consumption. Our CGE model allows us to determine, once all inter-industry effects and factor price changes have occurred, the additional boost to New Zealand s GDP and NEB/welfare resulting from a price change in the milk solids payout or volume growth in the sector. In addition, we also report other macroeconomic indicators such as wages and. 7. We use the term welfare here not in the technical economic sense but merely as a synonym for wellbeing. The claim is merely that changes in consumption better proxy changes in welfare than do changes in GDP. We do not claim to actually measure welfare in the technical sense. 12 Dairy s role in generating growth

21 3. Milk solids price spike 3.1 Headline results A short term increase in the price of milk solids generates immediate benefits for the national economy. The national benefit of an increase of $1/kg in the Fonterra payout is a welfare gain of $1.2 billion, as proxied by private and public consumption. In addition, national GDP is expected to rise by $400 million 8. The richer dairy sector would generate of approximately 4,600 more FTEs and wages would later start to rise 9. The welfare gain is larger than the GDP gain due to the impact of exchange rate movements: the improved terms of trade allows us to consume more of our GDP (i.e. we have to export less to pay for a given amount of imports making the country better off as a whole) the currency appreciation leads to a reduction in the value of New Zealand s foreign debt. Both effects improve New Zealanders household purchasing power and allow greater consumption of goods and services. 3.2 Detailed results Direct effects: the dairy sector In the first simulation the increased world demand for dairy products drives up both the price and volume of dairy exports. That is passed on down the supply chain and results in a $1 per kilogram of milk solids increase in payments to dairy farmers. The increased payout and volumes cause the dairy sector grows strongly to generate the extra production. The increased payout causes investment in the farming industry to grow by 44%, and by 20%. Investment in the processing component of the industry grows by 14% and by 5.5%, relative to what would otherwise have occurred. Investment growth is higher than growth because capital accumulation tends to lag behind growth. The farming component of the sector grows more strongly because we have assumed that the benefits of higher world prices will be passed on to farmers. If dairy processors were to increase their profit margins instead then the differences would diminish This is on top of the income generated by the base price. That is, if the 2011 price (say) is $5 and the 2012 payout is $6, our results look just at the additional income generated by the $1 price increase. 9. The direct impact on the economy of a $1 increase in the milk solids price is a $1.3 billion increase in gross output. That gross output generates about $590 million of GDP once the cost of intermediate inputs is subtracted. Furthermore, the effect of the increased dairy output is to increase the price of resources to other industries and thus reduce their output. The net effect on GDP of the $1.3 billion injection, once all these effects have been taken in to account, is the $400 million we report. Dairy s role in generating growth 13

22 3.2.2 Indirect impact on other industries The indirect impacts can be broken down into the industry categories described in section 2.5. The numerical results are summarised in Table 5. Supplying industries industries that supply dairy with intermediate inputs are likely to benefit from a stronger dairy sector. However, the fertilizer industry loses 0.2% of its sales. That counterintuitive result arises from the movements in the exchange rate, which will be discussed further in the next section. As exports rise, imports become relatively cheaper and that causes primary producers to switch away from domestically produced fertiliser in favour of imported fertilisers. Government expenditure industries as expected, the increased incomes from the higher milk solids payout boost tax revenues and enable the government to spend more providing services such as education, health, and law and order. Household expenditure industries industries that households spend money on are likely to benefit from increased incomes generated in the dairy sector through and wage increases, and increased returns to capital. Such industries include housing and real estate (which takes a large share of households budget), and consumption goods from the retail trade sector. Competing export industries industries that compete for resources with the dairy sector suffer from the dairy sector s increased spending power. That is particularly so for the sheep and beef sector, which uses many of the same resources. In addition, the appreciation of the New Zealand dollar that results from increased exports of dairy products hurts all exporters, as seen by the drop in production of the textile and horticulture sectors. 10. The second simulation with a $1 per kilogram price decrease shows near identical effects in the opposite direction. In the interests of brevity we report only the results for the price increase here. 14 Dairy s role in generating growth

23 Table 5 Indirect impacts 2010 Percentage deviation in value added from BAU levels, selected industries Industry Type Impact Agricultural services Supplying 0.09% Fertilizer Supplying -0.2% Retail Household expenditure 0.7% Real estate Household expenditure 1.1% Residential property Household expenditure 0.03% Schools Government 1.1% Hospitals Government 1.3% Police Government 0.8% Apple and Pear Competing export -3.0% Sheep and Beef Competing export -0.4% Textiles Competing export -1.3% Source: NZIER Macroeconomic effects The national results follow naturally from the direct and indirect impacts described above. We focus on the key macroeconomic variables described in section 2.5: and Gross Domestic Product (GDP), as well as consumption, which is a measure of NEB (how well off we are). The NEB/welfare gain for New Zealand, proxied by private and public consumption is an increase of 1.2%. That represents an extra $1.2 billion of goods consumed in New Zealand, relative to the situation if the price of milk solids had remained constant. This equates to over $270 of additional spending per man, woman and child in New Zealand due to the $1/kg price increase. The change in real GDP of 0.24%, or $395 million, represents the increase in the value of goods and services produced in the economy. The benefits arise from the increased flows of income to farmers being distributed throughout the economy via supplying industries and government and household spending. The NEB gain is larger than the GDP gain for two reasons: An increase in the price of dairy exports improves New Zealand s terms of trade. An increase in the terms of trade allows us to consume more of our GDP. The assumed increase in demand for dairy exports causes a currency appreciation that leads to a reduction in the domestic currency value of New Zealand s interest repayments on foreign debt. This improves New Zealanders household purchasing power and allows greater consumption of goods and services. Under different assumptions about the mechanisms of foreign investment, this contribution is dampened (see Appendix C). Overall, the increased milk solids price draws wealth into the country via dairy exports and that leads to an increase in New Zealand s wealth and, thus, our living standards. The impact on export competing industries is negative because of the appreciation of our currency. However, that same appreciation allows us to buy more from overseas as can be seen by the rise in imports and private consumption (see Table 6). Dairy s role in generating growth 15

24 The increased production in dairy draws in more labour, which is shown by the rise in. Note however that, in our modelling, is assumed to vary much more quickly than wages. In the short timeframe of this simulation we would not expect to see much impact on wages because they have not had time to adjust. Similarly, while the rate of return on dairy capital has risen, the level of capital in the industry has not yet had time to accumulate. Table 6 National results Real percentage deviation from BAU levels Indicator Percentage change Levels change, $ millions GDP 0.24% $400 Private Consumption 1.2% $1,200 Public Consumption 1.2% $360 Exports (volume) -1.8% -$1,000 Imports (volume) 1.4% $720 Employment 0.35% 4,600 FTEs Hospitals Government 1.3% Police Government 0.8% Apple and Pear Competing export -3.0% Sheep and Beef Competing export -0.4% Textiles Competing export -1.3% Source: NZIER Regional impacts The impact on the districts is in proportion to the importance of the dairy industry to the region. The majority of New Zealand s dairying is in the central North Island and that is reflected in the strong growth of Taranaki, Waikato and the Manawatu. However, dairy is also very important to the small Northland economy, which is why the large gains are seen there. Districts that have strong red meat industries, such as Canterbury, suffer due to the competition for resources from the growing dairy sector in this simulation. Similarly, districts that depend on exports, such as Tasman s wine and Auckland s manufacturing, see low growth due to the costs imposed by the appreciation of the exchange rate. The impacts of a $1/kg price increase on per person consumption or living standards in each region are shown in Table Dairy s role in generating growth