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Clarky's Comment - June 2013, Optimising Land Use in New Zealand

Optimising Land Use in New Zealand

 The government is quite rightly focused on materially improving New Zealand's economic performance. Part of the Business Growth Agenda is to move export earnings from 30% to 40% of GDP by 2025. It is now widely recognised that such an ambitious target will not be achieved without material improvements in earnings from our primary, land-based industries.

The single biggest contribution that the forestry sector can make in the short term (i.e. by 2025) is through increased processing of logs within New Zealand. But confidence to invest $10's or $100's of millions into internationally competitive wood processing facilities is also premised on confidence in ongoing fiber supply.

It is ironic that we are currently witnessing divestment away from commercial forest plantations, in favour of pastoral farming despite forestry providing an economic return on capital employed that on average is considerably higher than for pastoral agriculture. And in terms of contribution to GDP forestry has been delivering more than drystock farming, per hectare occupied.

Contribution to GDP (Primary Production only) Per Hectare Occupied
Sources: NZIER and MPI data

 

So why are forests not being replanted, and the land converted to pastoral uses? I think there are two main reasons.

  1. The second main reason is, I think, one of investor confidence in public policy around the two types of land use. Whereas pastoral farming includes an option value to change land use or at least change crops or stock types on parts of that land in response to changing economics, under forest use the investor is locked in for up to 30 years. This covers 10 election cycles.

    Some recent treatment of forest owners is sending a clear signal to investors that they are increasingly being asked to provide public benefits in addition to extracting a commercial return from their tree crop. An example is the grandfathering of nutrient pollution rights based on historic land use in the Lake Taupo catchment. Based on the impact on relative land values under grass or trees, this in effect reversed the principle that "polluter pays" to one of "polluter benefits". Variable treatment under the RMA (harvest sediment in streams versus invisible but much more damaging nutrient pollution) also serves to send the message to investors that farm-based pollution is acceptable but harvesting steep erosion-prone terrain is a highly risky undertaking that can potentially result in prosecutions. The indefinite taxpayer shielding of agriculture from the Emissions Trading Scheme, while pre-1990 forests owners receive partial compensation for being locked into forest use forever is another example. The message to investors is clear – convert trees to pasture if you get the chance, and never plant pasture land in new trees.
  2. Forests are, in the main, planted as a purely financial investment, with forecast returns estimated on expected biological growth, costs and log sale prices. Some land value appreciation may be built into forecasts by those that own the land as well as the trees, but over a very long investment cycle, the contribution of land value increase is relatively minor. Much more material to forecast returns is the land cost that must be carried for the full cycle of up to 30 years. Hurdle rates for investment are in the order of 7% - 8% real per annum over the investment period. Under current land values (that have more than doubled in the last decade) that hurdle rate is not met, so investment has dried up and divestment is gathering pace.

    Based on analysis of data from model farms and surveys run by both Beef and Lamb NZ Inc. and by the Ministry of Primary Industries (MPI), over the last 10 years drystock farmers, on the other hand, have tolerated return on capital invested at much lower rates, averaging just 1.4%. Naturally such low returns translate to higher land values, effectively excluding forestry use, not because it is less profitable, or contributes less to New Zealand's overall wealth, but simply because of the different investment hurdle rates of the two types of investor.

Is there a problem?

The problem is that, from a NZ Inc. perspective, the loss of a viable forest industry is pretty material from a number of angles:

  1. Over-reliance on just one or two major export streams (dairy and meat) that in turn both rely on the health of grass seems unwise.
  2. Forests protect our steep lands from continuous soil erosion (albeit expose soils for a few years every 30 years during harvesting).
  3. Forests give a measure of peak flood protection.
  4. Forests provide habitat for native birds and insects, and protect fresh water quality.
  5. Forests are widely used for recreation.
  6. Forests provide the feedstock for a very large export and wood processing industry that is forecast to be exporting $5.0 billion within a couple of years, second only to dairy. This contribution to New Zealand's export receipts is generated from a private sector investment in the current standing crop of commercial forestry of around $20 billion.
  7. Wooden building products, newsprint and paper-based packaging would have to be replaced by imports if the wood processing industry retracts.
  8. Expansion of forests and use of wood for fuel and as a long-lived building material contributes positively to New Zealand's greenhouse gas emissions profile.

So is there a solution?

Market land values are what they are. No amount of political or economic commentary can change that, as we note from what is happening with Auckland residential land values. It is a simple supply/demand matter.

Regulation of land use is abhorrent to most Kiwis, despite being the norm practiced in Europe for generations. Regulation also reduces the flexibility of investors to react to changing product demand and prices. That flexibility has been very important to New Zealand's economic performance in the past.

Any changes that level out the playing field such that private land use decisions align more closely with what is good for NZ Inc. will require that costs associated with pollution and the value of public benefits provided are sheeted back to the private land owners. Only the government can install such a regime, and probably only over a decade or so of transition. But the alternative of not having political leadership to make that transition is potentially a very big future taxpayer bill to provide the public benefits of forest cover, without the current $20 billion of private sector support.

Optimum land use, including accounting for "externalities", is critically important for New Zealand to meet its growth aspirations sustainably and responsibly