Notes for Radio NZ Nights with Brian Crump: 11 August, 2014

The indications are that economic growth is slowing down from the boom rates of the last few years. The slowdown may turn into a contraction – that is, output may fall. There is a view that the contraction began in the middle of 2015. (It is not possible to be sure. All the data is not in and is subject to measurement error. Last week’s labour force statistics gave mixed results with unemployment up, employment up and labour force participation down.)

The main reasons for the slowdown are:

            The private sector Christchurch rebuild has peaked; the public sector is still muddling along.

            Chinese economic growth is slowing down. This is probably structural. The productivity gains which enabled the 10-plus percent annual growth have been exhausted. The expectation is a future growth rate of around 5 percent. Still pretty good. However the worry about the Chinese financial situation continues.

            Added to China’s slowdown is that other economies important to us in South-east Asia and Australia have benefited from the Chinese growth and our export markets there may not expand as fast..

            There are mixed views about the Auckland housing market. It may have peaked, it may be about to peak. (The imponderables include any impact from the Chinese financial troubles; investors from there may have a marginal involvement but probably add to a speculative boom. The direct impact of the loan-to-value restrictions may be small but may take the top off the market.) Any reduction in the housing boom will impact on employment in a host of industries – real estate, surveyors, valuers, movers, builders, refurbishers, solicitors – as well as on house prices.

            The dairy price downturn.

Why have dairy prices slumped? Actually they are back to where they were about ten years ago. Perhaps a better question is why were they so high in between. It would seem that the opening up of the Chinese market following the FTA led to a surge in dairy prices because the world dairy industry could not keep up with demand increase in the short run. As time went on, though, the industry geared up for increased supply and is now in oversupply, depressing the international price. The oversupply arises because farmers invested on the assumption that the high prices would continue indefinitely. Perhaps the long-run price for dairy products is $4 to $5 a kilogram; it seems that much of the investment has been on the basis of a long-run price of $5 to $6 a kilogram. Critically that investment was debt financed.

So many farmers are carrying too much debt. The consequence is that they are struggling with negative cash flows after debt servicing. They will have to cut back spending, which will impact on their suppliers, on rural communities and ultimately the whole of New Zealand. Especially heavily indebted farmers will go under – I’m told that particularly includes share-milkers. We don’t know how long it will take before milk prices return to ‘normal’.

What to do? In some respects we’ve blown it. Market economies swing up and down as a matter of course. We’ve had a number of years in which conditions have been very favourable. We’ve treated them as ‘normal’ and while there have been some positive developments – say the broadband rollout – we’ve been borrowing for consumption rather than preparing for a more moderate future.

The Reserve Bank will probably continue to ease up, with an even lower floor interest rate (OCR). It will not be enough to offset the forces driving the downturn, nor the bad decisions of the past. The international evidence is that monetary policy by itself hardly lifts a contracting economy or if it does so it does so slowly. There is a need for fiscal policy.

There will be calls for austerity, cutting back government spending, say on the poor. Overseas experience shows austerity does not work.

Tax cuts which stimulate consumption are not easily reversible. Arguably the 2009 tax cuts should have been temporary, eased back as the economy expanded. But they were not.

I’ve argued for increased public spending on infrastructure although I don’t know whether there are projects ready to go ahead quickly. The mucking around in Christchurch shows how slow it can be to get things underway. Amongst the infrastructural spending worth bringing forward might be upgrading of poor quality housing, better connecting struggling regions to growth hubs, making more effort to meet realistic greenhouse emission targets, perhaps a bit more on conservation and heritage, more spending on health prevention and early detection and taking leaky school buildings seriously.

When asked what should be done I am reminded of the person told that he has lung cancer who demands his doctor do something about it. The doctor patiently explains she did. Whenever he came for a checkup she told him to give up smoking. He ignored her. His doctor may be able to help him through the next stage if he listens, but she cant reverse his past decisions.

Ultimately, we have to accept we have been making bad decisions – spending when we should have been saving; speculating rather than investing on realistic assessments of future outcomes; accumulating debt when we should be have been paying it down. We cannot easily reverse those mistakes. Anyone who says we can, hasnt understood the problem. In the past they were probably advocating the sort of advice that got us into the current uncomfortable situation.