This piece is not rocket science. All it does is to quantify what anyone with a bit of economic sense already knows. New Zealand exports are driven by two things, or if we’re nit-picky (as the author is in this piece), three.

• World prices and world trade volumes (which you could lump together as world trade value)
• The relative strength of the NZ$.

How have our exports done?

To begin, let’s look at how our export values have done over the last 20 years.  Quarterly seasonally-adjusted merchandise exports from New Zealand rose an average 5.7% a year between March 1988 and December 2008.

What the graph clearly shows, however, is that it has not been one-way traffic. For example, there was a sharp rise in exports between June 1999 and June 2001, followed by a sharp decline over the following two years. What drove these changes? We hypothesize that it was the three factors already listed.

World prices

World merchandise prices increased by 59% in the 19 years between 1988 and 2007, according to the World Trade Organization. So much for inflation; this is an average of just 2.5% a year.

As a price-taker not a price-setter, New Zealand exporters are subject to world prices. A fall in world prices has to be borne by New Zealand exporters, while a rise in prices worldwide would benefit New Zealand exporters.

World trade volumes

The general rise in world trade volumes has been strong. Between 1988 and 2007, world export volumes rose 6.0% a year, or 204% in total.

The graph below shows the changes in world prices and trade volumes between 1988 and 2007 (2008 data is not yet available).

Combining these first two factors – world prices and world trade volumes – the value of international exports rose 382% in the 19 years, or 8.6% a year.

Exchange rates

 What about exchange rates? Exporters always bemoan a higher than desired exchange rate that pushes exports down. While this makes economic sense, are there numbers to prove it?

The Trade Weighted Index (TWI) represents the relative strength of the NZ$ against our main trading partners.

One anecdotal example is that during the period when New Zealand’s exports grew most rapidly (1999 to 2001) the TWI was at an all-time low. But is there stronger, econometrically sound evidence?

The hypothesis

Our hypothesis is that New Zealand export values (NZX) are a function of:

• World prices (WP)
• Changes in world trade volumes (WTV)
• The strength of the NZ$ (TWI).

As prices rise, we would expect export values to rise. As world trade volumes increase, New Zealand export values would also be expected to do so. And as the NZ$ strengthens, we become less competitive, and export values suffer.

Economic sense thus says that NZX should rise (all other things constant) as:

• WP rises
• WTV rises
• TWI falls.

Using 19 years of economic data, we were able to estimate an equation to explain changes in New Zealand to 2007. If you want the gory details, you can see the numbers at the end of this piece. More importantly perhaps to most readers, the graph below shows how well the equation explains changes in exports. In a nut-shell, it explains changes well.

What does the equation tell us?

The equation tells us that changes in the general international trade environment (i.e. volumes) and the TWI are the most important factors in determining changes in New Zealand export values.

• For every 1% rise in world trade volumes, New Zealand exports rise 0.83%.
• For every 1% rise in the TWI, New Zealand exports fall 0.81%.
• For every 1% rise in world prices, New Zealand exports rise 0.34%.

So what?

New Zealand has little control over world prices or trade volumes, but it can at least attempt to keep the TWI at reasonable levels. For example, if the TWI falls from its current level of 55.5 to 54.4, a 2% fall, all other things being constant, export values will rise $700m over the year (1.6%).

Given that the WTO expects world trade to decline 9% in 2009, control of the one factor we have power over becomes even more important.

The Reserve Bank can facilitate a weaker currency through monetary policy that keeps interest rates low, provided the commercial banks do their bit as well by passing on OCR cuts. If the banks play along, speculative investment in short-term high-interest investments in New Zealand will dry up. This will help keep the currency weaker, not so good for buying LCD TVs, but great for exporters.

At the same time, banks need to pass on cheaper credit to businesses. So far they have been very reluctant to do so, a bit of a cheek given that your tax dollars are providing a safety net for them. But if they pass on the lower interest rates, business investment will become cheaper (lower interest payments), and exporters will become even more competitive.

One final point is that NZX = Price x Export volume. So as the three factors move in a favourable direction for New Zealand export values, the result could either be a rise in New Zealand export prices, or a rise in export volumes. The former would be a bad way to raise export values – it reduces our competitiveness, as it is only a nominal measure. The latter is the way to go – increased volumes mean higher productivity, and build the capacity of our economy. But that is a story for another article.

To download a PDF version of this article click here.

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The numbers

Mathematically we hypothesize: NZX=f(WP, WTV, WTI). Using quarterly data for the 19 years from December 1988 to December 2007 (77 data points), regression analysis yields the following equation:

ln NZX = 0.338 lnWP + 0.831 lnWTV – 0.806 lnTWI + 19.923
t-stat:               3.345             32.090              -9.265
Adjusted R2 = 0.9711