This Survey is published on the responsibility of the Economic and Development Review Committee of the OECD, which is charged with the examination of the economic situation of member countries.

The New Zealand economy is beginning to gain some momentum, with post-earthquake reconstruction, business investment and household spending gathering pace. Risks to growth remain, however, stemming from high private debt levels, weak foreign demand, large external imbalances, volatile terms of trade, a severe drought and an exchange rate that appears overvalued. The main structural challenge will be to create the conditions that encourage resources to shift towards more sustainable sources of prosperity. Incomes per head are well below the OECD average, and productivity growth has been sluggish for a long time. Lifting living standards sustainably and equitably will require structural reforms to improve productivity performance and the quality of human capital.

The outlook for the NZ economy in 2013 and beyond looks brighter than seen thus far in the recovery. Negative international spillovers may gradually diminish as global growth picks up. Construction investment should be supportive, due to Canterbury rebuilding and housing strength more generally. Meanwhile, banks have further strengthened their capital positions, boding well for future stability. Fiscal policy has embarked on a steady tightening path, which is appropriate. With inflation still very low, monetary policymakers can provide short-term support while monitoring risks from high house prices and household debt.

As its workforce ages and major economies shift towards producing higher value-added goods and services, New Zealand will face increasing challenges to remain globally competitive and maintain high living standards. Future growth will need to come increasingly from productivity gains, and resources will have to shift towards activities that rely more on skills, technology and intangible assets. Strengthening international linkages will be crucial to overcoming geographic disadvantages and will require improvements in the information and communications technology infrastructure, together with innovation leveraged off the country’s strong primary industry knowledge base. Continuing to raise skill levels and the pensionable age will also help counter the effects of ageing. Lifting national saving, partly by targeting a higher public saving rate, will reduce the persistently high relative real interest rates and the sustained overvaluation of the real exchange rate, which potentially harm economic activity. To improve the sustainability of growth, revenues from non-renewable resource extraction need to be invested for the benefit of future generations and greater efforts devoted to mitigate the damage to natural capital from economic activity, particularly with respect to water quality.

The NZ labour market is among the most flexible in the OECD, and outcomes for its young people have been among the best. However, labour-market opportunities are heavily determined by initial education, where New Zealand’s system is also successful and innovative in many ways. Average PISA results are among the OECD’s highest, but the dispersion of performance is also high, indicating a sizable group of underachievers. Those in disadvantaged groups tend to have poor scholastic outcomes. These initial educational handicaps show up in higher drop-out rates and youth joblessness, greatly limiting these youths’ future life chances. Indeed, intergenerational persistence in educational and employment outcomes appears very high. From both a social and economic point of view, it will be essential to develop more fully the human capital of the fast growing demographic group of ethnic minorities. Better teaching quality is needed, with more attention devoted to diversity of student needs and learning approaches to keep children in school. A related problem is the apparently large divergence between the nature of skills supplied by the education sector and the skills demanded by employers. A greater role for youth apprenticeships could help to raise skill levels while aligning them better to the economy’s needs. All this has an important bearing on the government’s ambition to secure strong and sustainable growth with rising living standards and equal opportunities for all.