After the Covid crisis comes the hard grind

In part one of a three-part series commissioned by investment firm Jarden, Dr David Skilling examines the impact of Covid-19 on New Zealand's economy

New Zealand has been recognised around the world for its high-quality response to Covid-19. As this country transitions from lockdown, it is useful to look broadly at our experience and the options ahead from an international perspective.

NZ as exceptional

New Zealand’s success in reducing new cases to zero is built on what are among the tightest lockdown measures in the world — tighter even than Italy and France — going hard and early. Partly as a consequence of these policy measures, New Zealand has generated strong outcomes, suffering only 22 deaths and 1504 cases at the time of writing.

But New Zealand is not unique in performing well.

In Asia, Hong Kong and Taiwan have performed strongly, with better records on cases and deaths per capita than NZ. This country’s trajectory of cases per capita is also similar to Australia, which implemented a more liberal approach to lockdown than NZ.

And in Europe, countries like Greece, Slovakia, Austria and Norway have also managed the growth in cases down to low levels — and close to zero in the case of Iceland. Borders are being reopened and domestic activity is being resumed.

So while New Zealand has handled a very difficult situation in a high quality way, we are not exceptional in this. We can take pride in our record, but we shouldn’t take the publicity about our success too seriously as we move into the hard grind of recovery.

NZ as an island

New Zealand’s remote island location — our giant moat — has supported these strong outcomes. Being able to reopen the domestic economy more quickly, and with more confidence, than others is certainly a positive. But New Zealand is not an isolated island from an economic perspective: New Zealand, along with other small economies, is exposed to the global economic fallout of Covid-19.

Around the world, there is not a direct relationship between initial success in controlling the domestic spread of the coronavirus and the nature of the economic outlook. For small economies, it is the nature of the external exposures that matter at least as much. These specific exposures are significant for New Zealand, and it is not clear that this country is better positioned for economic recovery than the rest of the world.

The closure of borders will hit international tourism as well as immigration. Relative to other advanced economies, New Zealand is highly exposed to tourism: international tourism generates over 4 per cent of GDP and more than 5 per cent of employment. This sector will likely come back slowly, even as our borders begin to reopen gradually. International seat capacity growth into New Zealand will probably be constrained for some time.

Migration inflows have been running at about 1.4 per cent of resident population a year, providing significant support for headline GDP growth. But net migration flows will move to zero, with closed borders likely with many of our key markets (India, China). This will create skill gaps in pockets of the economy (construction, agriculture, care), with frictions likely in the ability of New Zealanders to fill these jobs, delaying the speed of the recovery process.

These effects, combined with the domestic labour market shock, are likely to put downward pressure on house prices (already very stretched on a range of international measures). In turn, this would lead to subdued private consumption spending, further weakening the pace of the recovery.

New Zealand’s performance in controlling Covid-19 cases does not guarantee a strong recovery because of these material external exposures. It is striking that the IMF’s forecast GDP growth for NZ (in April’s World Economic Outlook) is among the lowest in the advanced economy group. And other economies that have successfully controlled Covid-19 — like Hong Kong, Taiwan, Greece, and Iceland — also face challenged economic outlooks because of their specific exposures to the post-Covid global economy.

Of course, the failure to effectively control Covid-19 — as in the US — will lead to higher economic costs. But for small economies, it is the international exposures that loom large.

Looking ahead

For New Zealand to do as well in the recovery phase as it has in the crisis phase will require creative, aggressive action on a sustained basis. The recent Budget provides a sense of the magnitude of the challenge. The Treasury’s baseline forecast is a contraction of over 10 per cent in GDP in the year to December 2020, and unemployment peaking at 9.8 per cent.

A GDP contraction of this size is unprecedented in the official data, and unemployment has not been this high in over 25 years. This will be offset by the deployment of fiscal stimulus, but there are also downside risks such as a second wave of infections in New Zealand or offshore.

This near-term challenge is reinforced by persistent structural challenges in the NZ economy, such as low levels of productivity, innovation and exporting. And the post-Covid-19 global economy will also have some structural differences, from the nature and intensity of globalisation to new growth sectors. New Zealand needs to move with strategic intent in response, which can be seen in three stages.

The initial crisis response has been handled well to date, but a clear pathway to removing remaining restrictions is needed — along with protocols if there is a second wave. The second stage is to support the recovery over the next one to two years, which includes the smart reopening of borders — where New

Zealand is currently moving in a much more cautious manner than others — as well as providing more targeted support to households and key parts of the economy. Fiscal constraints will require hard choices.

The third step is the reconstruction of the New Zealand economy, positioning it for competitive success. For example, leading on the transition to green and digital, with particular reference to New Zealand’s key internationally oriented sectors, as I argue in a recent paper for the Productivity Commission. We need to work backwards, with the design of the recovery phase informed by the strategic direction of reconstruction. This should be the focus of intensive work and debate as a matter of urgency.

New Zealand last faced a shock of this magnitude in the 1970s. But the policy response was not welljudged, leading to a highly distorted, poorly performing economy. New Zealand needs to respond now in an outward-looking way, managing through the crisis in a way that strengthens the New Zealand economy. Many other small economies are already actively thinking and acting in this way, from Singapore to Scotland, and New Zealand will need to move with intensity and purpose if it wants to emerge from this crisis in a distinctive way.