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How Alan Bollard’s jacket may help teach NZ how to be a service economy in the Asia-Pacific

Published on interest.co.nz (Auckland), 23 March 2015

For years, we have been warned that New Zealand is facing a manufacturing crisis. The Kiwi dollar’s high exchange rate would hurt exporters and drive industrial activities out of New Zealand.

This story has always been exaggerated, and in the light of actual increases in manufacturing activity such as the 1.0 percent growth reported for the last quarter, it looked more like a manufactured crisis than a manufacturing crisis.

Irrespective of such semantics, perhaps we should not even talk about manufacturing as much anymore and shift our focus to things that matter more. Alan Bollard’s jacket for example.

The former governor of the Reserve Bank and current executive director of APEC, gave a talk to The New Zealand Initiative in Wellington last Thursday. In his speech he highlighted the opportunities that an ever more integrated world economy brings, particularly as it is happening in New Zealand’s Asia-Pacific neighbourhood. However, Bollard also had some sobering warnings for his audience: If New Zealand wants to benefit from Asia’s rise, it needs to rethink its business model.

If you now wonder what Bollard’s jacket has to do with it, it is not actually his jacket but an example he used in his speech to visualise how much the world economy has changed – and how much production processes with it.

Citing research by the FMG Institute, Bollard revealed how much of the retail price of a mid-market suit jacket is explained by manufacturing activities and how much by everything else. The answer is surprising. Everything physical about the jacket (all the labour that went into its production, the shell fabric, lining, interlining, buttons, sleeve heads, shoulder pads, labels and hangtags) accounts for a total of just 9 percent of the jacket’s price.

The remaining 91 percent are what Bollard calls “invisible payments.” They consist of a wide range of services for retail, logistics, banking, marketing and other activities as well as payments for intellectual property and, of course, profits.

As Bollard asked his Wellington audience, “Do we really want to have the 9 percent of the value chain here in New Zealand – or would we not rather want to have a slice of the 91 percent?”

To ask this question is to answer it. And yet, it is not enough to intellectually understand that the bulk of value added does not happen in physical production but in the services that surround it.

For economists, this is a challenge in any case. Economics has traditionally focussed its production theory on physical production processes. This is unsurprising given that economics was formed in an age that was first shaped by agriculture and then industrialisation – both of which deal with visible, physical outputs. The insights from the 18th and 19th century are still valid, of course, but they do not capture the rise of the services economy which started in the 20th century and is dominating the 21st.

You could argue that in modern, developed economies, services are the most important component of economic activity as well as the least understood. Just assuming production functions and firms, as economics often does, does not get us far in really understanding the services economy we are dealing with today.

For New Zealand to tap into the wealth that is generated in a fast-developing Asia-Pacific, it needs to tap into the value added by the services economy, Bollard argued. But which services? Well, he gave his audience some ideas:

“Research & development, design, concept, market research, branding, marketing, logistics, business services, e-commerce, certification, quality control, transportation, packaging, retailing, advertising, after-sales, warehouse services, financial services, environmental services, rental & leasing, maintenance & repair, management consulting, intellectual property, legal services, accounting, computer services, human resources, training, security, printing & publishing, courier services, telecommunications, insurance, travel agency, cargo-handling, feeder services, single customs windows, authorised economic operators, electronic-warehousing, e-billing, data trading, data privacy, standards conformance, financial advice, regulatory conformance.”

The list is long enough but it probably is not even exhaustive. This is where New Zealand should seek to make its money in the future, Bollard argued and not just in primary activities. Though the case for a shift to services sounds plausible, it is certainly not straightforward.

For example, what would it mean for a New Zealand dairy company that is seeking to do increase its business in Asian markets? They might be aware that the return on assets is only 7 percent for farming, 9 percent for powder plants whereas it is 17 percent for marketing and even 29 percent for R&D and processing (according to figures presented by Dr Bollard).

But how would a New Zealand-based company be able to develop a marketing campaign for Asian consumers that are far away and about whose preferences it knows little?

The geographical and cultural distance from its Asian customers makes it hard for New Zealand businesses to move up the value chain and tap into the value added in product-related services. It is a challenge that Bollard realises all too well and for which there is no easy answer.

The best chance New Zealand might have to get its share of the 91 percent is to understand its Asian markets better. This would include both greater outward direct investment by Kiwi companies in Asia, and Fonterra is doing it already. It would also mean a greater openness to Asian foreign direct investment in New Zealand. Both would link the economies better and open a door for New Zealand to make more money based on the products it grows, manufactures or designs.

We may have believed that New Zealand was a rock star economy, but even rock stars have to learn new tunes every now and then. Learning how to be a service economy in the Asia-Pacific may be New Zealand’s next big challenge.

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