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The Changing Institutional Environment

R.W.M. Johnson

My task is to set out a general view of the changing business environment in New Zealand, especially as it affects the agri-business sector. By agri-business we clearly are meant to include all economic activities which relate to the production and processing of agricultural and horticultural raw materials into final consumer products. We are not just talking about 'farming' or 'processing', but about all the activities which encroach in some way or another on the chain of activities from farm inputs like fertiliser manufacture through to finished products like Bernard Matthews roasts. The participants in this workshop have been invited from a cross-section of businesses which represent, hopefully, all the stages in the production chain from raw material producers to final consumers.

N.W. Taylor has recently provided some interesting figures on the size of the agri-business sector in New Zealand.[1] He estimates that some eighteen per cent of the work force is occupied in some aspect of the sector, and that around seventeen per cent of gross domestic product is generated in the sector. Neil defines the wider agricultural sector as including input supply, processing, distribution, and retail activities. More significantly, this part of the national economy, generates some sixty-six per cent of total merchandise exports. Given that many business activities are involved with both agricultural and non-agricultural business, it would appear that these labour and GDP figures are on the low side, and the size of the sector is somewhere around twenty to twenty five per cent of the tota1 economy. Thus the total agri-business sector is important to New Zealand, both as a major generator of national income and as the major contributor to total exports.

The broad pattern of economic policy changes since the July 1984 election will be well known to this audience. In a number of moves, the Government has relaxed controls on the financial sector, freed up the determination of the exchange rate, abolished a number of assistance measures for the agricultural sector, and set out on major reforms for the restructuring of the civil service. These actions, among others, have been taken to improve market signals to producers, to reduce distortions in the economy caused by undue subsidisation and transfers of resources, to allow the real cost of capital and other resources to be expressed in the market place and to reduce the cost of some government programmes in the budgetary process. In particular, it has been decided to remove all subsidies on fertiliser inputs, raise interest rates on loans from the Rural Bank to market levels, return sheepmeat marketing to the private sector and to reduce the credit facilities provided to the producer boards by the Reserve Bank. In addition, an element of deregulation has been partly or wholly introduced into the activities of the Wheat, Milk and Poultry Boards, which hitherto had enjoyed widely based powers of price and production control. On top of all this, the Government has embarked on a series of taxation reforms which have been particularly unsettling for many businesses in the agricultural sector, especially as regards livestock taxation.

As is widely appreciated, these changes have come at a time when overseas returns for primary products have been markedly depressed. Furthermore, the freeing up of financial markets and the exchange mechanism have resulted in higher exchange rates for the New Zealand dollar than was initially expected. These factors, together with the withdrawal of assistance, have resulted in a massive contraction of returns in large portions of the wider agricultural sector over the last two years, with widespread consequences for most businesses in the sector.

The process of adjustment has been more difficult for some businesses than others. Clearly, farmers have had to adjust to a contraction of revenues of up to 40 per cent in one year. Sheep and beef farmers were hit a lot earlier than the dairy farmers. Fluctuations and uncertainty about the exchange rate have involved the whole of the arable sector in recent months. Horticultural development has been depressed mainly by high interest rates rather than by market returns. Input supply industries have been harder hit than the farmers. Retrenchment by farmers causes an accelerated fall in demand for fertiliser, air services, chemicals and farm services. The stock and station industry has had to adjust through a major amalgamation Other service areas, like processing and transport have been protected to some extent by cost-related charging, but even in these areas amalgamation and rationalisation are taking place.

These adjustments will have important downstream effects. There will be a loss of jobs in the non-urban regions of the country; this will be reflected in an increase of urban drift of the population to the main centres and a resulting concentration of the population in the main cities. It must be asked whether the depopulation of the rural areas and towns is what we really want and whether there are long term impacts for those whose businesses are based on these areas?

It is now widely appreciated that the agricultural sector has had to take the brunt of the Government's economic reform programme so far. As already suggested, this was partly due to changes in world trading conditions and partly due to the new policy of non-interference in the market place. The agricultural sector was vulnerable because of its high exposure to changes in export receipts, and because of the high visibility of its government support. (The manufacturing sector, being protected by import licensing and tariffs, has a much less exposed public profile, and has therefore been less pressured to make instant reforms.) Federated Farmers have been well aware of this problem, and have made continued representations to Government for some equality of burden sharing between the agricultural sector and other sectors.

The major objective of these changes in Government policy is to improve the quality of economic decision making in the economy. It is believed that better decisions about resource allocation are made by individuals in the market place rather than by the State. It is believed some government measures have distorted the economic signals in the past and that "incorrect" decisions have been taken on major investments. In the agricultural sector, the current view is that Government should not set out a series of goals and targets for livestock development (as we had in the past), but that Government should provide the environment in which "correct" decisions can be made. This involves removing impediments to the smooth transmission of price signals and providing a tax environment which is quite neutral to different investment decisions.

In this environment, preferences for the export sector no longer have a place. Export enterprises should be identified by their true merits in terms of world prices and relative efficiency. In effect, Government has backed off a policy of picking winners - the new policy implies that economic returns are the best guide to enterprise choice and that business itself can make the appropriate decisions.

In this scheme of things, responsibility for the future prosperity of the agricultural sector falls on the business community. Future growth of national income and productivity depends on business investment. Thus the future growth of the agri-business sector largely depends on the actions of all the individual businessmen (including farmers) within it. Government remains responsible, of course, for the broad direction of monetary and fiscal policy and its consequent effects on the exchange rate, but in theory at least, it has absolved itself from setting the direction industry development will take. Thus the question of what is the future importance of agriculture in the national economy and exports largely boils down to how well agricultural industry can perform in terms of prices and costs compared with the rest of the economy. With appropriate technology, and appropriate macro-economic management, a rejuvenated and reformed agricultural industry could still be growing well into the 21st Century. In the meantime, however, the short term prospect is for contraction of business and necessary adjustments to lower turnover and profitability.

It is going to be more difficult for business in this new environment. With changes in the exchange rate procedure, in particular, there will be increased uncertainty surrounding forward exchange rates and export prices. This means that important decisions with regard to investment and planning have to be made with imperfect knowledge of future outcomes. In the past, external fluctuations were absorbed by the Reserve Bank buying all foreign currency and by the actions of the producer boards in stabilising payments to farmers. Producers lived in a pretty cosy world. These external fluctuations must now be absorbed by businesses and appropriate strategies adopted for dealing with them.

In this connection, there is likely to be considerable growth in mechanisms for dealing with risk and uncertainty. There appears to be a wide range of business strategies that will be required to meet the challenge. These range from buying forward exchange cover through the banks or taking out futures contracts with the NZ Futures Exchange Limited, through to managerial strategies that provide cover for exposed positions. A large number of these strategies appear to be just good business practice, but there clearly is a need to develop the mechanisms for handling uncertainty in the foreign exchange arena as the whole institutional set-up has been altered. Individual farmers, particularly, are going to find investment decisions hard to make until the mechanisms for pricing export products are more clearly understood. For individual commodities like wool, futures hedging may offer some security to the individual producer, though for more heterogeneous products there will clearly be difficulties in establishing a workable futures contract. There clearly remains some sorting out to do in determining what will be the future role of the marketing boards, private industry and individual farmers in stabilising prices and incomes in response to short term and long term fluctuations in overseas prices and exchange rates.

The new framework will result in changes in the relationships between firms in the agri-business sector. Less regulation will provide scope for greater price competition between firms, especially those providing services. This competitive pressure, plus the present fall-off in turnover, will bring about a desire for mergers, take-overs and amalgamation to achieve economies and market control wherever possible. Movements in this direction will run up against the remaining provisions for regulation of competition embodied in the revised Commerce Act. In addition to legal restraints of this sort, aggrieved clients of such business moves are likely to have a vocal if not legal objection to such changes.

In a wider sense, there will also be changes in the relationships between different groups of interests in the agri-business sector. Changes in the economic and legal framework change the power relationships between groups. The establishment of the producer marketing boards, for example, reflected earlier attempts to achieve countervailing power for the small man against the large, the foreign, and the powerful. At this level, political action is required to bring about change as rights of groups can only be established by appropriate legislation. There is therefore likely to be an emergence of new groupings of economic interest groups and resulting political action to bring about desired changes.

The environment for research and extension activities in the agricultural sector is also caught up in the process of change. The policy decision has been taken to progressively put the activities of the DSIR and MAF on a "user pays" basis over the next few years. For the organisations concerned, this will clearly require a rethinking of their service role in agriculture, and will require a re-assessment of their priorities along market demand lines. There obviously must be considerable reassessment of priorities as an organisation passes from providing free services to charging out for them. It is said that long term research activities will suffer in this process as no one will be willing to fund research with a long term payoff. If this is true, the case needs to be made that this type of market failure will occur and collective (taxpayer) funding should be continued.[2] There is no doubt that the organisations themselves have taken these matters in hand and are responding vigorously to the challenge that has been placed in front of them.

There is a challenge to the private sector in the proposed reorganisation of research and extension activities. Not only will the private sector have a greater say in what research will be done, but it will also have to make the funds available which formerly were provided by the taxpayer. This could well change the priorities in agricultural research. This move to privatise research and extension will not occur overnight, but it should be clear that the mechanisms for assessing and funding research projects from a business point of view will need to be developed and made to work properly in the near future. This represents a major opportunity for the agri-business sector in the coming years, as well as being an added cost.

As well as privatising research and extension activities, government is moving a number of government trading departments on to a corporate basis. Those for forestry, energy, lands, and conservation will impinge on the agricultural sector at some point and will require new responses from the private sector where their interests are involved with the new corporations. For example, such large trading groups may exert considerable buying power in the markets for inputs, livestock and services in an unregulated environment.

In this sense, of course, many of the existing statutory bodies in the agricultural sector have also to establish their position in the new economic environment. These have been established in the past to provide some balance in the power struggle between large and small firms. The Meat Board, for example, has recently undertaken a thorough reappraisal of its role in the changing meat industry.[3] The Board has announced that its role in the future will be as a catalyst for innovative and efficient processing, as an agent for promotion and market development, as a coordinator of marketing and quality control, and as service sector to the meat industry as a whole. With the announced changes in stabilisation funding for all the producer boards, there will no doubt be further restructuring announcements from each of the other statutory marketing boards, which will change in some way the existing commercial relationships with the private sector. There may be a need for new institutional arrangements which bring about equality in the market place by other than statutory means. These will require thought and development in the future.

The private sector has had a major tussle with the government over taxation in the last twelve months. From the government's point of view, these moves were taken to remove distortions from the income tax system and to obtain a clear relationship between investment and economic returns. The proposals for livestock taxation particularly, had widespread implications throughout the agricultural sector which would have changed many individual investment plans, especially for deer and goats. Many of the difficulties have now been resolved through the consultative processes set up by the government, though not everyone will be happy. Apparently, there has been a considerable drop in investment activity in the deer and goat area, and development will now be slower as a result. The new tax rules are the new environment, however, and future business decisions will have to be taken accordingly. This is most important for funding investment, as the flow of capital funds to agriculture and horticulture in recent years has been largely determined by the capital write-off provisions.

In summary, I see the following broad issues emerging from the above changes in the economic environment of business.

There has been a marked swing in favour of private enterprise. There are fewer impediments and regulations on what business can do. The actions of private enterprise therefore have a greater role in determining the economic future for society as a whole. This seems to me to carry a greater responsibility for business to act in the interests of society and demonstrate that private enterprise is a better system than the alternatives. Or does government retain responsibility for the social implications of the more market philosophy?

Greater market freedom means greater competition between firms and interest groups. There will be winners and losers. Constraints on unfettered competition will continue to be provided by the Commerce Act. Regrouping of many firms seems highly likely within those constraints.

There is not a clear view emerging of the future of the agricultural sector as a whole. It is difficult to judge whether it will be a bigger or smaller sector in the long term, though we know it is shrinking in the short turn. In turn this makes planning for the future more uncertain.

The general business environment is more uncertain and volatile. This relates to the exchange rate regime in part, and partly to the unpredictibility of market prospects and organisational changes taking place. Future planning needs to take account of these factors also, and retain a considerable measure of flexibility.

Finally, uncertainty to meet future changes is increased by the possibility of political change in the election sense. Could we go back to the system we had only a few years ago? This seems most unlikely. We can only go forward.

References:

[1] N.W. Taylor "Liberalising Agriculture", 4th National Business Conference, Otago University, April 1986.

[2] See "Economic Management: Land Use lssues". The Treasury, 30 July 1984, p. 40.

[3] The New Zealand Meat Producer, Vol. 14, No. 4, July-Sept 1986.