OECD sparks debate over NZ’s weak capital markets and policy gridlock – Richard Harman

The political challenge is that the easy solutions to strengthen our capital markets all have entrenched political opposition from different parties across the political spectrum.

The most obvious place to start seeking solutions would be the sharemarket.

Currently, the NZX has a value of about 35% of GDP. The Australian ASX has a value of around 115%.

Simply, our market needs more companies.

A quick way to start enlarging the market would be if the Government were to privatise some of its state-owned enterprises and crown-owned companies.

Kordia, TVNZ and Pamu would seem obvious candidates.

The OECD has long singled-out the comparatively small size of the stock market as a major factor in New Zealand’s low productivity statistics and therefore slow growth.

In 2011, it observed that the shallowness may be related in part to the prevalence of small businesses that lack the scale to attract foreign capital, making bank debt or private equity the most cost-effective financing option.

“Firms that grow beyond a certain size are often acquired by foreign corporations that then choose to publicly list offshore,” it said.

In this year’s report, the language was more urgent.

“New Zealand’s capital markets remain shallow by international standards, constraining long-term investment, innovation and productivity growth,” it said.

“Public equity markets have seen no major domestic IPOs since 2021, and many high‑growth firms rely on offshore investors or expensive bank lending.

“Limited domestic risk capital, modest private pension balances and a narrow investor base restrict the flow of patient capital needed for firms to scale.

“Expanding long‑term domestic savings is essential.”

Some highly successful New Zealand companies choose to list offshore.

Some, like Xero, are listed solely offshore, while the medical technology company, Volpara, was listed on the ASX and was then acquired by a South Korean company.

Rennie addressed this in a speech to the New Zealand Economic Forum at the University of Waikato last year.

“New Zealand’s low capital intensity is a key driver of our poor productivity performance,” he said. “New Zealand has much lower levels of capital per worker than OECD peers we compare ourselves to.

“Increasing this ratio would mean workers can use more, and better, technology and tools to do their jobs, which will increase productivity.”

Rennie will now be aware that officials and MPs who have looked into some of the recent closures in the forestry industry have been surprised at how little investment in plant and equipment has taken place in recent years.

Rennie told the Forum that while investment had been on an upward trajectory since 2007, it had not kept pace with the expanding workforce.

“A cause of this is likely to include New Zealand’s high cost of capital, which is in part due to relatively high tax rates on businesses, including on inbound investment, and high interest rates,” he said.

“Our taxation of investment is also uneven, which distorts investment choices.

“Such economic settings can discourage the acquisition of productivity-enhancing assets like machinery and equipment.”

But Rennie is up against a political brick wall when it comes to taxation reform.

That was evident in May in the reaction to the OECD report on the New Zealand economy, which devoted a substantial section to taxation reforms that could strengthen capital markets.

The OECD said New Zealand’s taxation of capital income and savings was complex and uneven, with housing taxed lightly relative to financial assets and especially pensions, and corporate income tax among the highest in the OECD.

“These settings distort household and firm investment decisions and suppress the accumulation of private pensions and other long-term financial savings, which is a critical issue not only for capital market development but also for retirement income adequacy,” it said.

“Addressing these distortions should be a central focus of a deep and wide review of the taxation of savings and capital income, shifting the tax burden away from contributions and annual returns and toward withdrawals.

“Such reforms would expand the pool of patient domestic capital available for equity markets and strengthen New Zealanders’ ability to build adequate retirement savings over time.”

Luiz de Mello, the director of the OECD’s Country Studies branch, proposed a number of Stock Exchange reforms, including new funds and easier listing requirements for smaller firms.

The country also needed higher long-term savings and broader retail participation in equity markets.

Having set up this outline, de Mello then ran straight into our Minister of Finance, who had been sitting alongside him as he set out a series of proposals that she was quick to reject.

First, he proposed that the Government gradually reduce the taxation on KiwiSaver contributions and instead tax the income delivered by the accounts on retirement.

He said this would bring taxation closer to international norms, significantly raise long-term household wealth, and deepen domestic capital markets.

Willis was having none of it.

“What the report proposes is quite a radical tax reform in the sense that it’s saying to completely change the way that you tax retirement savings. And doing that in a way that wouldn’t create a large number of people who are worse off but would create a big fiscal impost, i.e. a big reduction in revenue for the Government,” she said.

“It’s well-advertised and very clear in this report that we are now in a period of fiscal consolidation, and we’re trying to get the books back in balance.

“So radical tax reforms that require a deficit in the government books are not something that we’re actively exploring right now.”

But the OECD went further on tax.

“New Zealand’s taxation of capital income and savings is complex and uneven, with housing taxed lightly relative to financial assets and especially pensions, and corporate income tax among the highest in the OECD,” the report said.

“These settings distort household and firm investment decisions and suppress the accumulation of private pensions and other long-term financial savings, which is a critical issue not only for capital-market development but also for retirement-income adequacy.

“Addressing these distortions should be a central focus of a deep and wide review of the taxation of savings and capital income, shifting the tax burden away from contributions and annual returns and toward withdrawals.”

Willis immediately rejected both the idea of a review and a capital gains tax and blamed the Labour Government for people investing in housing.

“There is no review of taxation by the current Government underway,” she said.

In the absence of any new policy from National, two political parties, Labour and New Zealand First, would address the lack of capital through state-funded investment funds.

New Zealand First would simply borrow $1 billion, while Labour is proposing to package all the SOEs and other Crown investments into a sort of Singapore-style Crown holding company.

But they would not agree to the sale of any entity inside the holding company.

There is thus a huge gap in capital markets policy, which indicates a failure to address how more private savings are generated and how they are incentivised to stay in New Zealand.

Sooner rather than later, our politicians will have to address this.