The economy may not follow any of the just released Treasury scenarios, but they provide a basis for a discussion on our economic track. (The graph on the main page is from the Treasury report.)
The best advice to give to an econometrics student is ‘don’t make forecasts, especially about the future’. Unfortunately, some economic institutions have to (so the student has to go through the theory), notably the Treasury and the Reserve Bank, who need a roadmap of where we are going in order to make operational decisions on how to drive.
The current maps are extremely unreliable; we just don’t know the new territory. The latest Treasury projections are an indication of their thinking in the run up to the budget. Not only do they stress an unusual degree of uncertainty, but they offer seven scenarios. In a number of key areas, my assessment is different.
I begin with their statement that ‘borders [are] assumed closed to foreign visitors for up to 12 months.’ My view is that the period of effective border closure is likely to be at least 24 months, that is until the world gets a widely distributed Covid19 vaccine. There may be some relaxation from today’s strict quarantine but a lot of economic activities will be effectively ruled out for that period, including international tourism, international education services, recruitment from overseas for short-period jobs and even much foreign investment (for instance, billionaires will find owning New Zealand homes less attractive). Even the live entertainment industry, dependent on foreign visitors will be severely curtailed.
I’ll come back to the sectoral implications, but the forecasts seem to underestimate the impact of the virus on the whole world. Presumably it will have worked its way through the richer countries by the end of the year, and hopefully there will not be a second wave in East Asia. But Covid19 has yet to really hit the rest of the world (with a few exceptions), presumably because they have fewer returning international travellers. But the virus is lurking there, and they generally have much less robust public health systems (and poorer statistics).
My guess is that some countries will still be struggling through 2022. If so, the rest of the world will have, to some extent, border restrictions. We may be able to do some bilateral deals – say with Australia and some Pacific Islands – but I am expecting we will have restrictions on visitors from with most countries because of international mobility which cannot prevent reinfection from poor countries.
This gloomy prognosis means that I am expecting that the world economic downturn will be worse that the Treasury seems to assess; it is said to be the worst since the Great Depression. If the experience of the GFC is any indication, the world economy may not return to a normal growth phase for, say, four years and that will be on a lower, and even slower, than its previous track.
What does this mean for New Zealand? The Treasury reports that ‘prices of New Zealand's key commodity exports have remained relatively resilient to date.’ If the countries which are our main foreign markets continue to feed their populations, the prices for our food exports may remain reasonably stable. On the other hand, oil prices are down and so are some other product prices such as forest products, although they may recover. I am less sure about manufactured prices. Let me join the Treasury and cautiously expect no unfavourable impact on our relative export prices (the terms of trade).
However, I do not think that they have paid enough attention to the impending collapse in some of our foreign exchange earners. Together, international tourism and educational services generate about a sixth of our export revenue.
Admittedly there will be some substitution by domestic tourists confined to home, but they wont be at the expensive end – we tend to stay with friends. And there may be other uses – hotels for the homeless. (Would it not be just great if the upper education sector abandoned its commercial pursuits and focused on education?)
A supply-side shock of this magnitude has happened once before. In 1966 the price of wool collapsed, also taking with it about a sixth of our foreign exchange earnings. Policy handled it very badly, ignoring the structural change or pretending that it was of no great significance. As a result, it took a decade to adjust and when we got back to ‘normal’, the long-run track was about 15 percent lower than the previous one.
Let’s be optimistic, assume we handle the impact more intelligently and that the magnitude of the damage is about half that of the wool price crash. (If we assume there will be no long-run impact, we will handle it badly.)
What all this suggests is that we shant be back on track until around 2026 and the economy will be tracking between 5 and 10 percent lower (depending upon the world economy).
That mucks up the Treasury short-term forecasts. Rather than its assumption of a short sharp drop and a rapid recover to somewhere near the pre-Covid19 track by late next year or shortly after, we may well be struggling for another five years at least.
Bugger! I have just made a forecast. Hopefully I am wrong. But it is what years of working on New Zealand’s economic history (see here and eventually here) has taught me. Econometrics and common sense is not enough. A knowledge of the past is as important.
(The next column reflects on the unemployment in the scenarios.)