Geopolitics, New Zealand and the Winds of Change
'Shaping Futures National Conference' Financial Services
A speech delivered to the
Council
in Auckland
On 7 September 2018
By Adrian Orr, Governor
2 The Terrace, PO Box 2498, Wellington 6140, New Zealand
Telephone 64 4 472 2029 Online at www.rbnz.govt.nz
Kia orana tātou kātoatoa
Tēnā koutou katoa
Welcome all
Thanks for the opportunity to speak today on such a far reaching topic. It is a pleasure and a
privilege, especially in front of such a large and important audience who impact the lives and
financial security of so many New Zealanders. It is also timely to chat about financial issues
given it is 'Money
Week', the annual awareness week championed by the Commission for
Financial Capability.
'what has the Reserve Bank Governor got to say about
I know many people will be thinking,
the -
anything long-term? Doesn't Bank just sit and watch for outbreaks of inflation shifting
the official interest rate on a needs-be basis? Some will even comment publicly, 'How dare
the Governor speak outside of their 1 to 3 percent inflation mandate!'
I hope to convince you we have a strong vested interest in, and influence on, the long-term
economic wellbeing of New Zealand. The long-term issues are critical to our task of
maintaining low and stable consumer price inflation, promoting a sound and dynamic
financial system, and meeting the currency needs of the public.
First, what do I see as the long-term challenges facing the globe?
society as
I summarise the key plague on economic 'short-termism'. This is the overt focus
on the next day, week, or reporting cycle. In contrast, by long-term, I mean anything that
ranges from 'outcomes' over the next few years, through to an 'idealised vision' that could
last inter-generationally.
A short-term focus can be driven by the need to survive from day-to-day. However, it is too
often driven by the desire to consume at an unsustainable rate. The desire for instant
gratification or reward can often leave behind a trail of unintended consequences. Some of
these consequences may impact on us personally, but we too often assume we won't be
the
one affected. An often-posted analogy of short-termism is the seasonal over-imbibing at the
staff Christmas party, and all of the personal and societal consequences that follow.
Let's get more tangible.
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We strive in business every day to achieve economic growth or economic security and
wealth. We also aspire to use this wealth in a pleasant, sustainable, natural environment that
we can call home. We also aspire to live and bring our families up in a safe place, of social
cohesion, being accepted and appreciated. And, we want to live in a place where everyone
can participate despite our differences, a 'diversification dividend' not cost.
Wow, what a cool place that would be. Where do I buy the ticket? A virtuous, wealthy, and
rich society.
Too often, however, due to short-termism, we view economic growth as something that
comes at the expense of a sustainable environment, or social cohesion and cultural
'vicious'
acceptance. How does this circle manifest itself so often around the world and
through time?
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The financial system plays a significant role. A financial system works best is sound and
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efficient when all relevant risks are adequately identified, priced, and allocated to those
who can best manage them. These are the risks, in large part, that may lead you to
consume/spend today, rather than save/invest for the future. You are either unconvinced you
or you haven't
will be compensated sufficiently for the risks that could arise through time,
thought that far ahead or that well. The problem is that focusing on the short-term means
that many risks are neither identified or priced, and often allocated to those who are least
aware of them and unable to manage them. Our financial systems are struggling globally to
identify, price, and allocate risk.
What have we witnessed over the last couple-of-hundred years or so? Incredible per-capita
economic growth. Millions of people have been lifted out of poverty, and there has been a
rapid increase in the human population and our longevity. This period represents an
unprecedented rise in many positive economic welfare measures. The growth in productivity
- -
output per person is amazing.
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But is all well, or at least as good as it could be? What are our big challenges globally and
at home in New Zealand?
There has been a rapid rise for many out of subsistence and into emerging or First-World
income status. But we continue to experience massive challenges that are, too often,
resolved through financial crises, wars or civil unrest; or at the cost of someone else or
something, such as the environment.
At present we experience challenges such as:
Environmental degradation, with climate change now well accepted as a significant impact
on economies worldwide. The impacts are physical through nature, and financial through
changes in consumer and investor preferences, and regulation.
Mass urbanisation and all of the challenges this brings is accelerating globally, quite the
opposite to what I was taught would happen when I was in school. Computers would mean
we all lived on lifestyle blocks in a paperless world. Yeah right.
I have seen global estimates from the World Economic Forum that some 60 percent of the
world population, within the next couple of decades, will live in cities with populations greater
than 10 million people, many of these in current Emerging Market nations. The challenges
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this brings to resources, infrastructure, and social cohesion are immense unprecedented.
And we complain about Auckland traffic.
Ageing populations are also dominating the outlook for the next 30-plus years, with Japan
being the canary for us all to watch. Their population is on the decline due to their
demographic profile weighted so much to the elderly. Savings and consumption patterns are
changing simply due to this population swing. The older have the savings and are
demanding less in goods, but more in services, especially human contact. Loneliness is a
significant and growing disease. Yet the owners of capital are struggling to create careers
out of caring for the elderly, at least at incomes that attract and retain the people needed.
The same could be said for tourism in New Zealand.
Mass migration (in addition to urbanisation) pressures are also growing globally, driven by
the factors mentioned above. Climate change means people must leave and find new
homes, witness the Sahara-African peoples virtually swimming to Europe. Social cohesion is
being challenged as national boundaries and beliefs are being threatened with change.
Which brings me to the income and wealth inequalities that come and go through
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economic history with the global economy currently testing fresh cyclical boundaries.
Well, even if the economic 'pie' has grown in total,
What do I mean by inequality? the
rewards are always skewed one way or another. Over recent decades, the rewards to the
owners of capital (profits) have outstripped the owners of labour (wages) more than
throughout economic history. In addition, wage growth both within, and more so between,
firms has become more dispersed. Supposed low-skilled jobs have been far out-paced by
high skilled jobs.
of 'superstar companies' that are in the 'winner take all (or most)'
Now we also have the rise
These superstar firms generally have lower ratios than
of an entire industry. 'wages-to-profit'
their competitors, accentuating the income divergence. How do they manage this? Through
superior economies of scale driven by technology and brand advantages that are not easily
replicable. Witness Facebook, Amazon, Google, Alibaba and so on. This is also true within
the financial sector, where big banks gain significant economies of scale, leaving smaller
This would be fine if it didn't lead to other problems such as
banks struggling to compete.
'too big to fail' and excessive risk taking incentives.
We are not immune to these issues locally, not by any sense of the word. But, we do have
opportunities to lead the globe in positive change if we can become more long-term in our
economic activity.
In New Zealand, we are being challenged on the environmental consequences of our efforts.
We also have significant ongoing migration and urbanisation, as people want to be part of
our place and together. We have creaking infrastructure and suffer from over-exuberant
asset (house) prices. We also have persistent and stubborn unemployment and low-income
challenges. This is especially so amongst Pasifika and Māori, despite their significant
contribution to our economic and cultural wellbeing, and despite the current labour
shortages. And, we have a rapidly ageing, and too often lonely, population.
Underlying these challenges is New Zealand's -
persistently low productivity growth or
economic output-per-person. The reasoning behind the low productivity is well understood
but, apparently, difficult to combat in a coordinated, persistent, manner.
An excellent paper by our own Productivity Commission,1 outlines succinctly the problem of
low productivity and the causes in New Zealand. In large part, our low output-per-person is
due to the of much our economic activity.
'capital-shallowness' This refers both to physical
and human (knowledge) capital. New Zealanders have low savings rates (personal capital),
meaning they don't tend to
draw advantage from profits (the returns to capital). Likewise,
many of our larger companies are driven to pay dividends (often offshore due to their
ownership) rather than re-invest in their own company, or New Zealand more broadly. These
challenges are compounded by the relatively small scale of New Zealand firms, and by a low
level of technology and knowledge dispersion between firms.
Paul Conway challenges us all, including policymakers: assist small, remote, firms into the
global economy; improve the matching of jobs and skills; use immigration wisely to lift
human capital; make investment easier and more effective; moderate the pace of population
growth to encourage capital-deepening; improve competition in the services sector; and
strengthen the economic returns from science and innovation.
So with problem identification and solutions outlined, wouldn't we just move on to resolution?
Short-termism challenges us always and everywhere.
Why do we run into roadblocks to long-termism?
Capitalism is necessary, and a marvel, driving human welfare in a strongly positive direction
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for a few centuries now. But we all know even Adam Smith, the godfather of free markets
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knew that capitalism is not perfect. Markets can, and do, fail for a variety of well
researched and understood reasons. Otherwise, why would we need government,
regulators, and a central bank?
A significant challenge is human myopia, the inability and/or unwillingness to think about the
After all, be
long-term. 'she'll right'.
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Myopia is actually incentivised in many of our contracts the drive to shorter deadlines and
frequent reporting for rapid personal gratification. This shorter horizon is a perverse
outcome. Annual bonuses for example can lead to excessive risk taking, lack of concern for
unintended consequences, and a desire for short-term cost cutting and lack of reinvestment.
intent of 'buying the employee in' to the
However, the bonus was implemented with the
business for long-term gain.
The myopia challenge is further enforced by what is known as the problem'.
'principal-agent
The advent of the remarkable limited-liability company structure has liberated economic
activity. These legal structures allow people to take risks with their and others capital, but
with more limited personal financial consequences.
The limited liability structures do, however, mean that responsibility for all of the outcomes of
business activity can be compromised. Hence the list of rules, regulations, and company
directorship codes that exist. The line between the owner of the capital (the principal) and
the manager of the capital (the agent) is lengthened. 'Who owns a company?' is a tough
question.2
This principal-agent separation gets even harder now that we have investment portfolios as
'growth assets'
our way of investing in ie, in business. The link is now the saver (owner of
the capital), the investment manager (who may even outsource parts of this), and then the
company agent. Principal-agent-agent. This represents in large part the industry structure
that most of the people in this audience operate in.
What does it mean? How responsible is each of the agents for the long-term preservation of
the principal's capital -
and how can the principal insist on this responsibility to the level that
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matters to them financially, ethically and otherwise? The asymmetry of information that
exists in favour of each of the agents in this chain dwarfs the principal's knowledge. Hence
the drive for transparency and burden of proof in business.
- -
Fortunately in some ways the growth of portfolio diversification means that a principal is
not overly exposed to any one 'rogue agent' or
unfortunate event. A Kiwisaver investor, for
example, owns several hundred, if not thousands, of companies in small proportions. For
every idiot company (or idiosyncratic risk) in a portfolio, there is likely to be an offsetting
genius.
Unfortunately, in other ways, the portfolio diversification even further reduces the drive,
willingness, and ability of the investor to demand disciplines on the companies they are
invested in. You have to cluster the investment managers to demand excellence from some
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of the firms in these portfolios to care about the long-term.
I won't labour a significant additional challenge too much, but let's not forget that
investment
managers are likewise incentivised to behave in a short-term manner too often also. The
outcome of their behaviour leads to the pro-cyclical nature of investing, including institutional
'herding' and locking in losses, rather than benefiting from bargain price opportunities.
Such
institutional (and business confidence) herding destroys wealth, increases financial volatility,
'there's nowt
and kills long-term strategies.3 As Frankie Howerd, the British comedian, said:
so queer as folk'.
'externalities' -
Another challenge is that of the tragedy of the commons (and also the
horizon). Too many risks are not priced (or managed) by any individual, and hence
underinvested in, or not owned or managed. Why would I, for example, spend all my money
can't
cleaning a river that everyone else can benefit from and/or continue to pollute? I
capture all of the reward I am owed.
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I am reminded of the first economics text book I was given at school (Samuelson) posing
the question on page one to entice my mind into the cut and thrust of economics (yawn,
stare out the window).
expensive and water is free?'
'Why are diamonds After all, you can live without the first
(perhaps as a bachelor), but not without the latter.
The answer was meant to be 'scarcity'.
Diamonds are rare and water is everywhere. Oh how
quick things change. The answer now is that diamonds are sold in part under a cartel and
marketed well, while water has never been properly priced - and hence too often misused
and polluted, with drastic current consequences globally.
What are we left with from short-termism? Misallocated capital, under invested labour,
pollution, and challenged societies. This is not the fault of capitalism. It is the reality of
human nature.
By the way, these thoughts are not the rantings of a single Governor of a central bank. The
issues are well understood. They in fact dominated the recent Kansas Federal Reserve
Bank Economic Symposium I attended in Jackson Hole, Wyoming, only a couple of weeks
ago. This is a prestigious annual gathering of wise economists, and me this time.
What were the Jackson Hole topics? Awareness of technology disruption and the rise of the
'superstar firms' -
winner takes all/most. Rising industry concentration of firms, in the US
especially. Economies of scale and 'intangible' capital that is excludable and hard to
replicate assisting this concentration. Rising inequality as people move to low wage/profit
firms away from high wage/profit firms. There was even a discussion of apparent
monopsony wage-setting behaviour by some firms, especially amongst franchise chains.
Can we get better at this capitalism thing? Yes we can.
Deliberate strategies exist to force savers/investors to behave more long-term. I refer you to
the New Zealand Superannuation Fund's website, where simple instructive examples (and
how to be in behaviour.
speeches) exist on 'long-term' Understand your purpose, your
endowments (your relative natural advantages), your investment beliefs, and then stick to
They've got it
the strategies that best exploit all of the above. down to one page of instruction
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say it simple, stupid.4
Also instructive, and critical, are the rapidly growing clusters of global capital concerned with
better managing the failures that can arise from 'short-termism'. Trillions of dollars of capital
are now joining efforts under various umbrellas. One cluster is the United Nations efforts
around: Principles of Responsible Investing; Carbon Disclosure Projects; Sustainable
Development Goals; and the Global Compact for Work practices. There are also private
sector and 'NGO'
groupings. For example: Focusing Capital on the Long-Term; Inclusive
Capitalism; and One Planet, a spinoff from the CoPP22 global climate change agreement
signed in Paris in 2016 (to which New Zealand committed). And, the International Forum of
led the way in developing guiding principles ("the Santiago
Sovereign Wealth Funds
Principles") for the
long-term management of sovereign funds.
camp, the G20 have established a Financial Stability
Directly in the Reserve Bank's
Taskforce effort focusing on carbon reduction management. Likewise, there is a newly
established Central Banks and Supervisors Network for Greening the Financial System, as
well as a rapidly growing green-bond market.
Where is all of this leading? Hopefully, these efforts will in part head off the usual manner in
which we 'reset the clock', through some kind of crisis or unrest. Significant global firms,
investors, regulators and representatives of civil society are banding together to work hard
on resolving the perils of short-termism. If company boards and managers have a
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longenough horizon, then there are no externalities all issues are endogenous to their actions
(eg, pollution, employment, inclusion, and sustainable profit).
A personally heart-warming recent local example is the group of New Zealand firms that
have signed up to a joint effort to reduce their carbon footprint, under the Climate Leaders
Coalition. This group has recognised that consumers are increasingly demanding
intergenerational justice, investors want to be properly rewarded for all of the risks they are
taking, insurers are increasingly concerned about the cost and ability to insure against
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climate volatility, and regulators are getting very itchy across many activities building
codes, firm behaviours and so on.
Where does New Zealand sit on the global stage for these long-term efforts?
I could argue that we are so small, no matter what we did across most of these issues, it
wouldn't impact global outcomes.
But I would prefer to argue that the world often looks to places like New Zealand for
leadership (or at least hope and safety). I also note that we are a small island nation,
agriculturally dependent, live mostly on the coastline, have significant foreign-country
dependency for capital and insurance, and sell a 'clean experience' to tourists.
Hence, we
rely heavily on our reputation and management of the long-term issues such as climate
change, social cohesion, and inclusion of all.
The great news is we are small, young of nation, lightly populated, green, kaitiaki
(caretaking) of spirit, not dependent on the export of fossil fuels, and have a strong rule of
law and sound moral compass. Significant and bold leadership is in our grasp.
What are the long-term challenges facing the Reserve Bank?
At the Bank we tell the story of Te Pūtea Matua (our Māori name) more often as that of the
Mahuta of New Zealand's financial
Tāne system.
Mahuta's
In Māori mythology, Tāne Mahuta is the god of the forest and birds. Tāne greatest
feat was that he separated Papatūānuku (the earth mother) and Ranginui (the skyfather) so
that sunlight could shine into his garden and grow independent of his parents. The Reserve
Bank rose for a similar purpose back in 1934, to enable New Zealanders to better grow the
foreign banks' -
New Zealand economy independent of and economies' credit cycles
particularly Britain and Australia.
You will hear a lot more of this in coming weeks. Why? First, storytelling is fun and helps
people connect to their daily tasks at the Bank. Second, the Bank is an ecosystem of many
activities, just as Tāne Mahuta is, especially with the wider garden (financial system).
Severing a root, trunk, or branch will have full ecosystem implications. Finally, we are
embarking on a Te Ao Māori strategy at the Bank to help us with diversity and inclusion in
thought, and to ensure we are operating effectively given the growing significance of Māori
New Zealand's financial landscape.
economic activity within
Te Pūtea Matua is in good stead for the future, but not without its challenges. These are
driven by technology, economic development, global connectedness, and broader
government, public, and employee expectations. It is an exciting and challenging time for the
team.
Our current priorities outline the scope of change underway for Tāne Mahuta:

our legislation (our roots) is under review, with the idea of modernising and refreshing
our scope and capabilities, including broader decision making committees. Witness our
new dual mandate for inflation targeting and contributing to maximising sustainable
employment;
 the production and movement of our money (our sap) is under review, with new storage
and distribution models, and the role of digital currency, being considered;

our payment and settlement systems and digital capability (our trunk) are being renewed,
and a move to the 'cloud';
with a view to ongoing reliability, security from cyber-risks,

our regulated financial institutions (the branches grafted on to Tāne Mahuta) are under
review, including our relationship management with them, and our expectations of their
business conduct, capital needs, failure management capabilities, and efficiency metrics;
and

our people (the caretakers or kaitiaki) are being reinvigorated, with a focus on developing
A Great Team, Best Central Bank
vision.
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Focusing on the long-term is core business for Te Pūtea Matua the Reserve Bank. The
maintenance of low and stable inflation is a necessary condition of sustainable economic
growth. We were pioneers in inflation targeting, with the goal decided by society (1-3%
annual inflation), and then the Bank being operationally independent to do its work. This
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operational independence is critical that is what ensures we do not suffer from
shorttermism. New Zealand, and much of the developed world, has a history of high and rising
inflation due to over-weighting near-term demands.
We also understand the importance of our financial stability and currency issue roles. We
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need to prudentially regulate in a manner that is both sound and efficient in all its forms
This means we 'bridge the gap'.
cost, allocative, and dynamic efficiency. principal-agent
Doing so means we can be unpopular with the regulated industries (the agents), which can
be noisy at times. We insist on an adequate capital buffer to absorb losses, internal
and 'skin in the game'
capability to manage the shop, via directors attesting to these factors.
We also insist on transparency so that customers and competitors can keep an eye on each
other. Likewise, for the large, systemically important, banks we insist on failure management
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capabilities where we can step in and keep the bank going so that the whole system
doesn't fail.
We can also be unpopular with wider New Zealand, as shifting interest rates and/or
implementing and altering the loan-to-value ratio that banks are allowed to lend at, are often
not immediate vote winners. These activities directly cut across our human instinct for instant
gratification, despite in the long-run maintaining a stable financial system and reducing the
scale of financial volatility and/or crises.
We aren't here to win votes, but
we are aware that our stakeholders are demanding more
from us, and we are responding. As a result, we have developed a new vision for the Bank,
A Great Team, Best Central
we want to be Bank.
have visualised 'our island' that we
All of our strategic priorities work towards this goal. We
will always move towards on the horizon, one that all New Zealanders can be proud of and
- - 'our island', we
that Tāne Mahuta our Bank can stand tall on. To reach need to be aware
of the long-term forces shaping the global economy, the very things we have just been
talking about. These factors will have a significant impact on the allocation of resources, and
the future wellbeing and stability of the New Zealand economy.
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We are embarking on, amongst other things, our own climate change strategy focused on
our own activities as well as our regulatory duties with concern for financial stability. We
need to factor climate change issues into our concern for financial stability and efficiency.
To be most effective, we are committed to working cooperatively on these issues, in
particular harnessing the New Zealand Council of Financial Regulators (COFR) to provide
longer-term leadership. COFR includes the Bank, the Treasury, the Financial Markets
Authority, and the Ministry of Business, Innovation and Employment. As part of our
commitment, the COFR are discussing their own 'island' or vision, so as to best identify work
- moving beyond a 'show and tell' group.
effort and prioritisation
And we will continue to use our strong international reputation and connectedness to work
with other central banks, international financial institutions, and global regulators to further
our understanding and, perhaps even, show leadership in places such as the South Pacific.
Collaboration and a long-term vision are critical to growing the wider financial ecosystem that
lies beneath the branches of Tāne Mahuta. At present, the systemically-important banks
dominate Tāne Mahuta's ecosystem. The important insurance sector is also patchy, both in
customer coverage and competitiveness.
Life insurance, for example, has a low coverage rate across New Zealanders and a high
premium-cost compared internationally. Meanwhile, general insurance has better coverage,
but the industry is heavily concentrated in the number of providers. Health insurance is also
complex, with the state-owned Accident Compensation Commission providing some cover,
with the rest of this sector's insurance provision highly
concentrated. Industry concentration,
low coverage, and high costs are not the greatest look for an efficient system.
In 2007, I co-authored a speech with Dr Alan Bollard, the then Governor. We outlined the
important role of the financial system and the unique challenges and weaknesses of New
Zealand. Since then, and following the Capital Market Taskforce, led by our late-friend Rob
Cameron, some things have changed and improved, much hasn't.
The growth of the NZ Super Fund, the depth of the Kiwisaver funds, and enhanced financial
market regulation (with the birth of the Financial markets Authority) are great outcomes.
Likewise, it is positive to see the Treasury committing to deeper bond issuance over a longer
horizon, to keep New Zealand in the market and providing a yield curve benchmark. And it is
encouraging that the Reserve Bank insisted on core liquidity measures for the banking
system, as well as robust capital levels, and failure management capabilities. In addition, the
insurance sector has a clearer regulatory regime.
However, much has not changed. Our listed equity market remains small relative to the
economy, banks remain dominant in intermediation, and it is difficult to invest outside of the
listed market in any scale with access limited. We still concentrate most of our investment in
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housing equity rather than productive equity relying on leverage from offshore borrowing.
This is not a formula that will create 'capital deepening' in our economic efforts.
A vibrant and healthy financial ecosystem requires deep capital markets, with a long-term
horizon, to best allocate capital in Aotearoa. We have much to work on to remain sustainably
prosperous, but we are committed and long-term focused.
Meitaki
Bibliography
Bollard, Dr Alan and Adrian Orr, (2007), 'Delivering sound and innovative financial services
for New Zealand', Background Paper for an address to the Canterbury Employers' Chamber
of Commerce,
https://www.rbnz.govt.nz/research-andpublications/speeches/2007/speech2007-01-26
Cameron, Rob, (2009), 'Capital Markets Matter: summary report of the Capital Market
Development Task Force', December.
Conway, Paul, (2018), 'Can the Kiwi Fly? Achieving productivity in New Zealand',
lift-off
International Productivity Monitor, No. 34, Spring 2018.
Haldane, Andrew G., (2015), 'Who owns a company?' Speech by Mr Andrew G Haldane,
Executive Director and Chief Economist of the Bank of England, at the University of
Edinburgh Corporate Finance Conference, Edinburgh, 22 May 2015.
Jukka Pelhman and Han van der Hoorn, (2010), 'Pro-cyclicality in Central Bank Reserves
management', IMF Working Paper 10/150, June.
Federal Reserve Bank of Kansas City (2018), 'Changing market structures and implications
for monetary policy', symposium
23-25 August 2018, Jackson Hole, Wyoming.
'White Paper' series,
New Zealand Superannuation Fund, www.nzsuperfund.nz
Statement of Intent
Reserve Bank of New Zealand (2018), 2018-2021, Wellington, June.
The Treasury (2018), website
https://treasury.govt.nz/news-and-events/reviewsconsultation/reviewing-reserve-bank-act
Reserve Bank of New Zealand (2018), 'Policy Targets Agreement 2018',
https://www.rbnz.govt.nz/monetary-policy/policy-targets-agreements/pta2018