Dairy's role in sustaining New Zealand - Fonterra

10 Dairy’s role in generating growth
in unlimited quantities for the expansion of a sector. It does not consider how those
resources might otherwise have been used in the economy – their opportunity cost. In
reality, resources are scarce and any additional resources used in the dairy sector must
be diverted from other industries. The output of these industries must therefore fall. The
overall macroeconomic impact of the increase in demand in one sector should take into
account these losses elsewhere in the economy.
• It does not account for relative price changes. For example, it assumes that wage rates
do not change as the demand for labour rises or falls, and that the prices of intermediate
goods such as transport and business services do not change in response to shifts in
demand. In reality, if there is additional demand for workers in the dairy sector, this will
place upward pressure on wages across the economy. Even though this wage pressure
might be relatively small, it will still have a negative impact on input costs for other firms
in the economy, and could lead to a drop in output. A similar story is true for intermediate
inputs. As the dairy sector demands more of these inputs, their price rises for all other
firms in the economy, causing their output to fall.
Multiplier analysis therefore tends to vastly overstate the economic impacts of changes
in demand in a specific sector. These unrealistically large impacts are thus not particularly
informative for policy makers or firms.
CGE models explicitly address both resource allocation and relative price shifts, allowing for
a more credible, richer analysis of economic contribution. These models tend to produce
more conservative estimates of impacts, but are more consistent with economic theory and
practice. See Appendix B for a fuller discussion.
2.4 Modelling scenarios
We investigate the impact of the dairy sector with two historical scenarios to show how real
changes in the dairy sector translate into benefits for the rest of the economy. The historical
scenarios examine the benefits that have accrued over the past decade:
• milk solids payout increases
• growth in the sector over the last 10 years.
These two scenarios jointly capture both the benefits to the economy of the long term
growth in the sector and the short-run wealth gains from increased milk solids payouts.
• milk solids payout increases
• growth in the sector over the last 10 years.
These two scenarios jointly capture both the benefits to the economy of the long term
growth in the sector and the short-run wealth gains from increased milk solids payouts.
2.4.1 Scenario 1: The price of milk solids
The world price of milk solids has a significant impact on the dairy industry and the wider
New Zealand economy. It has also been fairly volatile of late, as can be seen from Figure 5.
This first scenario assesses the effects on the economy of changes in the milk solids price paid
to farmers. In order to generate higher prices for milk solids we assume that the world price
has risen due to increased world demand for dairy produce. Increased world demand for
New Zealand’s dairy produce leads to rises in both milk prices for New Zealand dairy farmers
and over a sustained period a rise in the quantity of milk solids produced domestically.
We calibrate the price increases in this simulation to be ± $1/kg milk solids in Fonterra’s
payout. So we are asking: what are the flow-on impacts for the New Zealand economy from a
$1 increase or decrease in the Fonterra payout?