Agriculture and Forestry in New Zealand: From Transition to Transformation

Address presented to Primary Resources Workshop, the Royal Society of New Zealand
Science House, 11 Turnbull Street, Thorndon, Wellington, 2007

by Murray Sherwin, Director-General, Ministry of Agriculture and Forestry

Introduction

Thank you for the invitation to speak at this Primary Resources Workshop. Perhaps more pertinently, let me thank the Society for choosing to convene a session such as this - focused on an issue crucial to New Zealand’s future prosperity – that of primary industry productivity.

If I can borrow a line from Paul Krugman:¹

"Productivity isn’t everything. But in the long run it is almost everything".

He also went on to restate a truism:

"a country’s ability to improve its standard of living over time
depends almost entirely on its ability to raise its output per worker.”"

The matter of productivity in our primary sector, what it has been doing, why and how to improve it in the future, is a subject that we have been thinking of a good deal in the Ministry of Agriculture and Forestry (MAF). So today I will share a few observations and perceptions that I have on those issues.

As much as the discussion about primary sector productivity trends and possibilities is vitally important to the policy development process, I think we need to acknowledge broad bounds of uncertainty around the sector’s productivity estimates and, in particular, our understanding of the drivers of changes in those numbers over time.

If I may draw from a former source of amusements as a central banker, it seems to me that measuring productivity is about as fraught as measuring output gaps and the NAIRU (Non-Accelerating Inflation Rate of Unemployment). Great concepts, important to understand them conceptually, and important in shaping how we think about the policy challenges. But almost impossible to quantify with real confidence, even with hindsight. So while I will quote numbers, and they are the best we have, I think we should be mindful of how much we invest in the explanation and analysis we draw from those numbers.

I am very optimistic about our capacity to deliver a successful, sophisticated, high performance economy and society that brings the higher living standards our people expect while drawing increasingly heavily from our primary industry base. I believe that New Zealand has a unique package of tangible and intangible values to offer the rest of this world from this small, isolated, island base. But it won’t come easily or automatically, and it will require us to pay increasing attention to a range of values that are increasingly important to our customers around the world.

But primary industries can continue to be the backbone of the New Zealand economy, and may even be able to place themselves into a rather stronger position in the future, given some of the advantages we can create here and given the evolving nature of the demand for high-quality protein and, for want of a better term, embedded water in the sorts of products we can produce here.

Let me first talk about agriculture and forestry’s recent history – about where we have come from. This is important as it provides a useful context for thinking about those future challenges and opportunities that await the sectors in the future, the probable strategies and policies that will be needed to support prosperous sectors, and MAF’s role in helping to shape them.

I have entitled today’s speech “Agriculture and Forestry in the New Zealand Economy: From Transition to Transformation”. I have done so because I believe we are now standing on the edge of a significant evolutionary step in New Zealand’s agricultural and forestry sectors.

Over the past 20 years or so, output and productivity growth in the sectors has been what we describe as “transitional” – shaped by the imperatives and flexibilities embedded in the wider New Zealand economy in the mid-1980s. These, for all the exceptions and remaining rigidities, more readily allowed resources to flow to more efficient use and enabled businesses to respond to opportunities and imperatives to innovate. I say imperatives because I think that innovation is often a matter of necessity for our primary industries, in the face of weak international prices, high exchange rates, barriers to trade or others’ subsidies. At times, our industries face the choice of either innovating or disappearing. Manufacturing, as we have seen recently, may often have the possibility of exiting New Zealand to produce from another base. Our primary industries are rather more limited (but not totally excluded) from that possibility.

The response to pressures, which we have seen pretty consistently over many decades, is to seek efficiency gains – often through increasing scale, but also through substitution of capital for labour. This highlights the real competitive advantages that New Zealand farmers have had over at least some of their traditional farmer competitors in other countries: the flexibility to aggregate properties and increase scale, as well as the capacity to shift land use from one activity to another in response to shifting market returns. More on that later.

To put a personal touch into this story of transition in our agricultural systems, I grew up on a dairy farm in the Waikato. As I started at primary school, my father was milking around 50 cows on 100 acres. Milking occupied a tedious 2 ½ hours, the shed waste was swept into a drain beside the shed to make its way to the local river system, like every other dairy farm at the time. Milk was collected twice a day during the season. Indeed, we had not long moved from cream can collection, with the skim milk being fed to pigs kept for that purpose.

By the time I started university, the neighbour’s farm had been bought, the herd was up to 220 cows, a new herringbone shed allowed milking to be completed in around 1 ½ hours, a large refrigerated milk vat provided for a once a day visit from the tanker, and a new ponding system held the shed effluent for subsequent spraying on the paddocks. Not bad for less than 15 years. I could go on talk about the closure of local schools, the abandoned community halls and other rural facilities that accompanied that process starting from the 1950s. It was just a part of the transitional process, a part of a willingness to change.

If sheer pressure on the bottom line drove some shifts in productivity, there have been more positive incentives to change and innovate as well. Our farmers and foresters have been steadily picking up the products of decades of research and development and finding ways to apply those to their operations to good effect. That is positive, of course. But almost certainly we are running behind our potential on that front, and I also envisage some added emphasis on technology transfer in the future as we strive to push closer to the production possibility curve.

If the past couple of decades can be characterised largely as transitional, what lies ahead?

I suspect that to meet the challenges ahead, we are likely to be looking beyond the transitional to something more transformational – driven by strong, well-grounded industry strategies, linking customers back to producers much more strongly than we do at present, and building sustainability firmly into our production processes as an integral and key part of what we offer our customers, and our neighbours in the domestic market. Without achieving that, we face a real struggle for future profitability in our international markets, and an equally important struggle domestically for the right to farm.

Agriculture and forestry’s recent history - sectors in transition

“While the production frontier has been moving out,
the main source of productivity has come from getting closer to the frontier.”

The headline numbers tell a positive story. Over the last two decades, the primary sector has experienced strong growth in both output and productivity. On-farm and on-plantation forest productivity growth was higher than in the economy. From 1988 to 2006, agricultural output grew 1.5 percent per year, but productivity grew at a higher rate of 2.2 percent, helping to offset the reduced contribution from input growth. That is, less inputs were used to produce more outputs, freeing up resources for use elsewhere in the economy (see Tables 1 and 2).

Table 1: Agriculture, forestry and downstream sectors TFP growth
(annual average growth rate %, 1972-2006)

Time period	Agriculture	Food, beverage & tobacco manufacturing	Forestry & logging	Wood & paper manufacturing	SNZ measured sector
1972-2006	2.0%		2.7%
1972-1984	-0.5%		1.3%
1984-2006	3.4%		3.5%
1988-2006	2.2%	1.0%	2.2%	0%	1.5%
1988-1993	-1.3%	1.8%	5.0%	-0.5%	1.1%
1993-2006	3.6%	0.7%	1.1%	0.2%	1.7%

Table 2: Contribution of TFP, capital and labour to sector GDP growth
(annual average growth rate %, 1972-2006)

Time period		Agriculture	Food, beverage & tobacco manufacturing	Forestry & logging	Wood & paper manufacturing	SNZ measured sector
1972-2006	Output growth	1.6%		3.4%
	K contribution	0.0%		0.3%
	L contribution	-0.4%		0.4%
	TFP contribution	2.0%		2.7%
1988-2006	Output growth	1.5%	2.0%	4.0%	1.8%	2.7%
	K contribution	0%	0.9%	0.5%	1.6%	1.1%
	L contribution	-0.7%	0.1%	1.2%	0.2%	0.1%
	TFP contribution	2.2%	1.0%	2.2%	0%	1.5%

During the same period, economy-wide productivity growth was 1.5 percent, with input growth of 1.2 percent resulting in output growth of 2.7 percent per year. A similar story exists for forestry and logging. During 1988 and 2006, productivity growth was 2.2 percent per annum. Output growth for forestry and logging was 4 percent per year as a result of increased productivity but also increased contributions of capital and labour of 0.5 percent and 1.2 percent respectively.

Over this period there have been significant fluctuations in the use of inputs, especially labour, in the forestry sector. This has contributed to the fluctuations in productivity growth. The fluctuations in labour input reflected the ownership restructuring in the sector during this period of time when many state-owned forests were sold to the private sector.

However, the off-farm and off-plantation stories are not so bright. The associated processing and manufacturing sectors experienced lower productivity compared with the on-farm sectors. The food, beverage and tobacco manufacturing average productivity growth was 1 percent per year during 1988 and 2006 while wood and paper products manufacturing productivity growth was almost flat during the same period.

I note that total factor productivity growth post-1984 was significantly higher than pre-1984 growth for both agriculture and forestry sectors (3.4 percent vs. -0.5 percent for agriculture; 3.5 percent vs. 1.3 percent for forestry), but also note that it wasn’t until around 1992 that our primary industries really began to recover from the trauma of the 1984 reforms.

Why?

While the aggregate numbers paint a relatively positive story for the primary sectors, it is the source of growth that really matters. And a closer examination of recent history indicates that the source of growth and productivity in sectors has in part been transitional – flexibility of attitude and of regulatory regimes has enabled a shift in the allocation of resources to higher producing areas (e.g., land use changes).

To illustrate that point, over the last couple of decades we have seen major changes in land use. Dairy farming has expanded into former sheep and beef land, forestry also expanded onto sheep and beef land, and some is now shifting to dairy. Horticultural uses, especially grape growing has emerged on secondary land throughout the country. Clearly, farmers and foresters have been responsive to the market pressures around them and resources have moved resulting in efficiency and productivity gains (see Figure 1).

Figure 1

Labour input into agriculture has also declined. This can be seen in Table 2 between 1988 and 2006, where the contribution to output from labour fell by 0.7 percent per annum. It is also reflected in the fact that the average North Island sheep and beef farm often managed by one family with some seasonal or contract work is now 4381 stock units on 447 hectares compared to 3736 stock units on 346 hectares in 1988. Likewise, the average dairy farm has increased in size from 65 hectares with 151 cows in 1988 to 118 hectares with 322 cows in 2006.

This is not to say that innovation leading to technical change has not been occurring also. Genetic gain has clearly been an important contributor over this period, in both dairy and, more particularly, lamb production. Milk solids per cow have been increasing as have both lambing percentages and lamb weights (see Figure 2) – to the point where lamb meat production today, from a flock of a little over 40 million sheep, is similar to production from the peak flock of over 70 million. Some of this has been genetics, some increased inputs such as nitrogen and some better management practices including pasture management. Unpicking and understanding this is a complex and challenging task.

Figure 2

Indications from MAF’s current research into the drivers of growth and productivity suggest that the main source of on-farm productivity gains have come from technical efficiency. That is, producing the same stuff but doing it better - eg, improved pasture management. So, notwithstanding my earlier comments about productivity measurement, if this is the case then scale, new technologies and changing production strategies (profit maximising or cost minimising) have not been as significant as contributors to productivity growth as our intuition may suggest.

The implications for this work will need careful consideration. The conclusions to date are tentative. But this is important and challenging research, which we intend to persist with. We need to understand the productivity puzzle better in order to generate more effective policy advice and higher quality government decisions. Equally important is the need to simulate discussions with and within the sectors, because that is where the real decisions that influence future productivity gains will be made.

The challenges ahead

So if the past 20 years have been relatively successful for our agricultural industries, can we expect that to continue for another 20 years?

I believe so. Clearly, there remains plenty of scope to continue to extract more from the existing technology base. Data on the relative performance of the existing crop of farmers demonstrates that possibility, But I doubt that will be enough, and I suspect that the next steps include some daunting challenges.

At a recent conference I provided an outline of what I believe are the major trends and opportunities for the agricultural and forestry sectors. I think these are relevant to today’s discussions and so let me summarise these for you.

1. The rise of the discerning global consumer…

We have seen a change in consumer expectations, both domestically and in our export markets. Consumers inevitably are becoming more sophisticated and discerning. As incomes rise in developing countries, they are consuming more western style foods. We are seeing a convergence of consumer tastes and demands leading to the emergence of global consumers.

The ‘global consumer’ places greater emphasis on buying foods that are safe, fresh, convenient, produced in a sustainable manner but also at a competitive price. They are looking for food products that have a broader range of flavour and other characteristics, including an ability to deliver a range of health and nutritional benefits and the ability to trace from the plate to the farm gate. There is a demand for all year supply of products.

At the top end of the market, even those “rational” attributes are not enough. Increasingly, our consumers will be seeking a more subliminal, even emotional, sense that the product is “right” for them. If we are to build our markets and command premium prices, we will need to be able to demonstrate that we offer products of integrity on many dimensions – safety, nutrition, environmental, carbon content as delivered to the consumer, animal welfare and others.

Much of our New Zealand production does not go directly into branded consumer products, but rather is sold, in the first instance, as ingredients into the food processing industries of the world. So while the shifting interests of consumers may be one step removed from our industries, I continue to believe that those influences will increasingly influence what we need to be able to produce and the qualities that our producers will need to be able to demonstrate in the market place.

2. The emergence of new forms of trade protection

While New Zealand and Australia have traditionally battled high tariffs and quantitative restrictions on exports of our primary products, my fear is that as we roll those back through WTO and bi-lateral/pluri-lateral trade negotiations, we will increasingly encounter new forms of non-tariff protectionism. The prime candidates here come in the form of sanitary and phyto-sanitary (SPS) restrictions, with constraints being imposed on the flow of goods in the name of biosecurity and food safety protection.

This has the potential to be a particularly pernicious form of protectionism, not just blocking access of our products to other markets but, just as importantly, undermining the WTO’s SPS Agreement, and the essential protections that it affords to countries such as New Zealand and Australia with genuinely unique and endangered species in need of protection from newly introduced pests and diseases.

3. Increasing supply from low cost producers

Traditionally, New Zealand has built its place in international primary product markets by being efficient – a low cost producer of products of acceptable quality. But can New Zealand sustain that strategy in the face of emerging competition, especially from South America and parts of Asia? In the past 15 years, growth in exports of many dairy, meat, horticulture and forestry products from China has been double that of New Zealand’s. A similar story emerges when comparing South American dairy, meat and forestry exports to that of New Zealand’s over the same period.

The UN Food and Agriculture Organisation (FAO) reported that over the past 20 years meat production in developing countries grew by 230 percent and dairy production by 200 percent. Much of the growth in these countries has been due to the adoption of technology and practices already developed and/or used in New Zealand.

While there sometimes remains a quality gap between agricultural exports from Australasia and those from emerging Asian and South American countries, the ability of producers to access resources, skills and technology to make necessary product improvements is already an obvious reality.

In many cases those countries also have large areas of low cost land with potential to be brought in to production and lower labour and other costs, which give them an additional comparative advantage.

In short, there seems to be a limited future in competing with the likes of China, India or Brazil for supermarket shelf space on price alone.

4. Demographic change and pressure on New Zealand’s natural resources

The composition of our population is changing. The urban population is growing and an increasing proportion of our population has been born outside of New Zealand. Only about 14 percent of New Zealanders live in a rural area. Over the last

generation or two, New Zealanders’ first hand experience of and association with agriculture and rural life have diminished sharply.

But there are other dynamics at work here. In the search for productivity growth and profitability, our agricultural systems are becoming more intensive, and in doing so, their supporting ecosystems are being pushed harder. Concurrently, the consumers of our products in the markets of importance to us are looking for something extra in their purchases. As already noted, the consumers we are interested in are seeking assurance that the products they purchase embody the values they regard as important – environmental, animal welfare and others.

Back at the farm, another influence is at work. Urban dwellers in search of some aspects of the rural lifestyle, are pushing out beyond the fringes of our suburbs – the lifestylers and the farmers have become neighbours and in some very real ways, competitors.

The imperative of sustainability in our production, processing and distribution systems is here to stay, as is the parallel squeeze from competing land uses.

We will need a new approach in the future…

The importance of agriculture and forestry sectors’ recent performance, the drivers of this performance, and the future trends and challenges have implications for future growth strategies and policies.

Productivity gains generated from the reallocation and better use of resources, which have contributed to growth and productivity in the sectors post the reforms of the mid-1980, can only take New Zealand so far. Once efficiency gains are realised, we need new innovations and technology to continue driving productivity gains. And these innovations will need to address the challenges discussed above. I would look to the associated manufacturing sectors to pick up the pace set by the on-farm and plantation sectors.

One of the benefits of economic reform is that it allows resources to move freely to their highest value use. Over recent decades we have seen the results of this with the expansion of dairying across the country, but how long can this continue? The current research also suggests that farm management practices are improving.

Ultimately we need innovation to generate new knowledge to allow us to expand the production frontier. While innovation is often incremental, such as refining existing technology, we need new technology that will allow us to produce more, produce highly valued products and allow intensification without many of the downsides of intensification such as environmental degradation.

Biotechnology is one area of promise, whether for greater production or to be able to maintain production with less input (eg, drought tolerant grasses). Technology such as new hybridisation techniques to try to achieve step-change in energy levels with fewer inputs has the potential not only to generate on-farm productivity gains, including reduced greenhouse gas emissions from our livestock industries, but also to provide a platform for generating new seed, plant breeding and related biotechnology service industries on the back of the new intellectual property.

This is one of the important roles of research, science and technology. We need to invest inside the farm and forest but also in our downstream industries. We know that because we are dealing with biological systems there are long time lags before the results of research and development (R&D) investment are realised. I think it is pretty clear that the competitive advantages we have today in primary industries reflect, strongly, the accumulation of intellectual property we have developed over the decades of investment in primary industry research. That should also warn us that the consequences of under-investment in primary industry R & D will only become apparent a decade or two after the event.

We also know that much of this research is public good in nature as it is very hard for one farmer to appropriate the benefits and thus public research is essential, especially in the truly transformative areas. The outcomes of RS&T spill over into other sectors and the environment, and also are the foundation for further commercial success. I’m often struck by the almost serendipitous nature of our R&D outcomes – it often seems that research begun for a particular purpose related to the performance of our livestock industries is as likely to generate innovations in human health or other fields as it is to meet its original purpose. But without the research base provided by our largest industries, in agriculture, horticulture and forestry, we would not have the platform for this spin-off work.

All New Zealanders have benefited from investment in RS&T. Better genetics through animal and plant breeding and the introduction of exotic sheep breeds has helped. The apples we eat today are not the same apples we ate 10 years ago and it is unlikely that consumers will pay top dollar in 10 years time for the apples we eat today. We have to continue to invest.

Capital is important. New technology is often more capital intensive. We need to ensure that we are not inadvertently placing barriers in the way of access to capital. The fact that we have a small domestic market could limit our capital growth. Again, policy setting regarding tax or capital accumulation, or financial market settings could also impact on capital growth. This could subsequently impact on productivity growth due to the embodied technical change associated with capital investment.

…And a broader policy approach to support primary sector performance.

But the future success of the sectors will be determined by more than just innovations that provide productivity gains. We need market structures and business models that are quick to identify shifts in consumer interests and quick to identify how those emergent market opportunities may be exploited profitably. As businesses like Fonterra and Zespri become more global, sourcing produce from around the globe and capitalising on their accumulation of skills and capability, their business structures will also need to evolve.

Environmental challenges are already apparent. Water quality in many areas of intensive farming is not up to scratch with rivers and streams contaminated from increased nutrients and animal faecal matter. Many shallow aquifers particularly in dairy farming areas, have elevated nitrate concentrations. Soil erosion has been accelerated by land clearance and unsuitable land management. Water allocation issues are an increasing concern. The area of irrigated land has been growing, some river systems and aquifers are overcommitted, and often the move to irrigation is accompanied by higher inputs of fertilisers and energy.

Farmland prices have escalated in recent years, in parallel with developments in our urban real estate. In many areas, it is likely that farm prices now exceed what is justified by productive returns. This adds to the pressure to lift productivity and, if not managed carefully, can exacerbate environmental problems as farmers force the biophysical limits of their productive systems.

The combination of changing expectations on the part of both international consumers and local urban populations, and increasing awareness of the environmental factors has lead to an increased focus on sustainability of production.

If our focus post-1984 was on economic efficiency and financial returns, it seems pretty clear to me that the 21^st century paradigm will be a broader concern centred on sustainability – economic/financial, environmental and social.

A point about the New Zealand setting

There are factors about New Zealand – our isolation and our relatively small size, in particular – that I think have a substantial bearing on our productivity conundrums.

Due to our small domestic market any agricultural or forestry firm wishing to achieve real scale, perhaps to fully exploit new intellectual property or an innovative business model or product, quickly faces the need to enter international markets – this usually requires substantial capital investment.

To achieve real scale, and to develop the sorts of high-skill, high-income jobs we need to support the first world lifestyle to which we aspire, we need to increase capital intensity – that is, capital employed per employee.

Capital intensity runs into a couple of hurdles – persistently high real interest rates, and an exchange rate with a 7 to 9 year cycle (from peak to peak) and an uncomfortably high peak. That sits very awkwardly with the sorts of investment horizons typically encountered in considering large scale investment decisions.

Agribusiness and forestry owners operate in an environment of uncertainty – of supply due to variability of production and weather patterns, and of revenue due to variability of international commodity prices and exchange rates. By its very nature, manufacturing, whether for agricultural production and exports or forestry, has high startup capital requirements.

The outcome, I think, is a risk profile on large scale capital investments that can be pretty discouraging for the potential investor.

We often ponder on the implications for New Zealand of having so much of our economic activity tied up with producer-owned co-operatives in the primary industries. (Our top five or six primary sector co-operatives have, in aggregate, a market capitalisation that exceeds that of the NZX50). For all their disadvantages, especially around the much talked-about access to capital, as Fonterra is at present grappling with, co-operatives have, at least, proved to be pretty effective at spreading the sorts of risks referred to above, and surviving through these exchange rate and other cycles.

Conclusion

To conclude, I believe there is huge potential left to improve primary sector productivity. The fact that our farmers and foresters continue working smarter not just harder is a positive sign for the sectors’ productivity growth. There has been, and continues to be, better use of resources due to improved farm and forest management practices. There has been, and continues to be, innovations in animal and plant breeding.

Over the last couple of decades, more and more farmers have approached best practice. This can be seen, for example, in pasture management, where farmers focused strongly on metabolisable energy and live weights of ewes which directly influenced lambing percentage and lamb carcass weights. This was complemented by better ewe pregnancy scanning technologies and enhancements in composite breeds.

Clearly there is still room for more to approach best practice.

The bigger challenge is to innovate and shift out the production frontier. This could be done either by new technology to cut costs, or by adding value through product differentiation such as convenience foods or foods produced in a sustainable way.

And what can policies do to help maintain and enhancing sector productivity growth?

We need an efficient public R&D system and innovation dissemination process. At the same time, a system that encourages private R&D and facilitates access to the foreign stock of knowledge. Also important are policies that facilitate capital and other inputs adjustment (or mobility). Public infrastructure such as transport and information and communication technologies is also important in helping the sector to cut costs. And finally, but not least important, is a regulatory system that helps the sector to enhance production efficiency instead of creating inefficiency or imposing rigidities.

New Zealand is currently celebrating 125 years of our first export of frozen meat. That was pioneering technology at the time, and the impact of that innovation echoes around New Zealand, and our standard of living, to this day. The science and technology that goes into producing our current and future output is outstanding. There are opportunities in the solutions we will eventually develop in response to challenges such as climate change, water quality, animal welfare, food safety and sustainable land use. Done well, we can contribute to better environmental outcomes, improve the productivity of our animal production systems, capitalise on the intellectual property created, improve the financial viability of our primary and downstream industries, enhance our reputation in the eyes of discerning customers internationally, and lay the foundation for the development of further intellectual property and future productivity gains.

¹ Both from Paul Krugman (1994). The Age of Diminished Expectations. The MIT Press

Contact for Enquiries

Director-General
Ministry of Agriculture and Forestry
PO Box 2526
Wellington

Tel: +64 4 894 0100
Fax: +64 4 894 0720
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