‘Business as usual’ won’t help economy
Economic theory says the New Zealand economy is in good heart. Economic reality says otherwise and needs to be respected. My view sides with reality.
The coming years are going to be bumpy. Apart from the global risks, the transitional costs of changing the structure and growth across the economy are being understated.
We are yet to fully identify and fill the voids being created as some sectors get hit.
The prevailing wisdom is the economy should perform okay. The Treasury, Reserve Bank, forecasting community and bank economists are all singing from the same hymn book.
Most economic fundamentals look sound. Inflation is contained, interest rates are low, and the Government books are in a strong position. Unemployment is low. Capacity constraints should be encouraging investment.
We don’t have the smorgasbord of red lights flashing such as rapidly rising inflation, rapid debt accumulation and sizeable valuation excesses that can signal a correction. We have some red lights, but it’s not across the board.
The economy is not showing the same late-cycle excesses we were seeing in 1996-1997 and 2006-2007. Then we were clobbered by the Asian crisis and global financial crisis.
The kiwi dollar has fallen, partly because the economic outlook for New Zealand has been reassessed internationally. The Reserve Bank relaxed loan-to-value ratio restrictions as housing activity softened. They could do it again. They could also cut interest rates.
Some key old economic drivers are either topped out or providing less impetus over the coming years. Construction activity has peaked as capacity constraints bite. House price inflation is cooling, migration inflows remain strong though easing. A lack of skilled employees is acting as a handbrake on the ability of firms to meet demand.
And some old drivers are still contributing. Tourism numbers continue to lift, migration figures are still huge, house prices in Auckland might be falling but a lot of regions are still seeing rises.
The economic theory is pointing to the combination of lifts in rural incomes via buoyant commodity prices, boosts from government spending, lifts in wages and a falling dollar to keep the economy trucking along. A lot of money is being thrown at lifting housing supply and infrastructure.
Voila, the economy (real gross domestic product or GDP) should be growing around 3 per cent. Happy days should be around the corner. Then there is the reality.
The economic expansion is old in the tooth. People are eying the global scene.
Businesses are getting whacked with price increases with wages at the epicentre. That’s not the concern. The worry is how to get the productivity growth to accompany higher wages.
The signals for business investment are not great. Capacity constraints are saying one thing but other signals are saying something else. Three key drivers of investment are growth (the accelerator channel), Tobin’s q ratio (the market value of assets versus their replacement cost), and the degree of certainty. Growth is waning, the market values of assets is softening while replacement costs go up (think construction costs or import costs for plant and machinery equipment), and we have uncertainty. Investment intentions in the ANZ Business Outlook Survey have ground to a halt, and signals from the likes of the survey need to be respected. Ignore business confidence, it’s a politically biased gauge. But the remainder of the survey is warning of bumpy times ahead. This is not like the 2000 “winter of discontent”. The Reserve Bank thumped the economy with 200 basis points of interest rate hikes that year. Government policy was only part of the issue. Hikes in 2000 were followed by interest rate cuts in 2001. The economy responded. The Clark Government had experience. This one does not.
The transitional costs of recalibrating the economy into a more sustainable model is being understated.
Almost all agree a migration, credit, dairy intensification and turbocharged house price model is not sustainable. We need to change. That change is taking place. “Hits” to growth are coming thick and fast and businesses are naturally eying what is next as 170-odd groups consult and eventually report. The Government wants to have its cake and eat it too. Well you can’t.
Either the economy can grow at 3 per cent on a business as usual basis, or it’s going to take time to transition the economy to something new. Think of it as telling the All Blacks to play with a round ball as opposed to an oval one.
Assume migration halves over the coming years and house price inflation levels out too as government policy shifts and affordability bites. The wealth effect on spending and growth from rising asset prices disappears. Small-to-medium sized businesses find it difficult to access credit. Home equity is less of an ATM. We aren’t going to see volume growth from the dairy or non-renewable sectors. It’s likely they will contract. Banks will be wanting money repaid so the boost from commodity prices will be diluted. Boosts to incomes via wages get eaten up by petrol levies and other pending taxes to pay for things.
These are big economic holes and they aren’t one-year gaps to fill. Suddenly 3 per cent GDP growth becomes 2 per cent. Throw in some uncertainty to boot and you have a sluggish economy.
Replacement sources of growth are needed. The hits and change ledger are abundant whereas the replacement ledger is light.
There is KiwiBuild, more infrastructure spend and the regional growth fund. None are gamechangers to fill growth voids. Two are just one-off fillips.
Successful change management requires a plan and the ability to articulate it and get buy-in. We are short on all counts. Until that changes, businesses are going to remain in a grumpy mood and grumpflation applies. That’s soggy growth with pressures on costs.
The onus is not just on the Government. The private sector is going to have identify the new opportunities too. It won’t happen overnight, but it will happen. That’s not a 3 per cent growth environment in the meantime though. Change takes time and there are upfront transitional costs.