What Recovery? Will the Economic Recovery Filter Down?

Listener: 22 July 1995.

Keywords: Macroeconomics & Money;

The economic question I am most often asked is “What recovery?” For almost three years politicians and the commentators have been claiming there has been an economic recovery, but apparently the majority of the population do not believe them.

Partly it is a question of the meaning of “recovery”. Your columnist is partially to blame. In early 1992 he, among others, identified a recovery on the basis of an expansion in the manufacturing sector which had begun in late 1991. Then the term “recovery” had its orthodox economic meaning to describe the stage after the bottom of the business cycle, when the economy begins to “recover” from the downswing. The politicians seized upon the expression to mean that the decline of the rogernomics era was over, and that New Zealand was back on a sustainable growth path.

We have now experienced a very long economic expansion – for three, going on four, years. It is the second longest we have had in the post-war era, surpassed only to the 1959 to 1961 boom, and it may yet better. While it is by no means as long (or as strong) as the upswing out of the slump of the 1930s, there is a lesson in that comparison. A very depressed economy tends to have a long recovery (orthodox, non-politician sense) phase.

Economic activity was very depressed by late 1991, the policies of the incoming National government having collapsed the fragile economy they had taken over. However an oddity of the subsequent expansion (note I am not using the expression “recovery”) is that it has not been a consumption led one. Usually at some stage in the upswing, household and government spending begins to expand rapidly. But not this time.

When people ask “what recovery?”, they seem to be saying “I dont feel any better off”. The statistics support them. At the time of the 1993 election per capita household consumption was a fraction lower than it was at the time of the 1990 election. Consumption had peaked in early 1989, and fallen thereafter, so the populace was feeling pretty bruised in November 1990 (as Labour will tell you), and no less bruised in November 1993 (as National will tell you). Average household consumption only returned to the 1989 peak at the end of 1994.
Even that statistic is misleading as a measure of welfare. First, “government spending” is still falling in per capita terms. Replace the very abstract expression by environmental spending, education, health care, heritage assets, policing, roading, social support, and so on, we can easily see that public spending cuts can hurt people’s welfare. They do so in trivial ways too. Telephone any government agency and count the rings before it is answered.

A second reason is that the income tax cuts of 1988 favoured the rich, increasing the after-tax income of the top 10 percent by about a fifth. The tax cuts were funded by just about everyone else paying more tax, so they have had a cut in their consumption, which is not reflected in the average. We can understand the jubilation of the rich over the economic expansion for they certainly have had a major boost to their incomes in the last decade, although few others have. There are not many rich asking “what recovery?”.

The tensions of an expanding economy and stagnant consumption have been eased a little by strong household spending over the last year. Preliminary indications are that some of the additional spending has been out of savings. This would be unsustainable. Either there will be slower growth in spending, or something else will have to give.

Hints of this pressure come from Geoff Thompson, president of the National party, who has demanded the government bring forward its promised income tax cuts. No government can be elected by only the 10 to 20 percent benefiting from this recovery.

The other strong pressure is coming through from wages. The Employment Contracts Act (ECA) regime was ideal for holding wages during the depressed stage of the economic cycle. It is less able to contribute to wage restraint during a substantial expansion. Some would say that the structureless wage system of the ECA reinforces a wage explosion once the fuse is lit.

To change the metaphor, my impression is the wages dam is leaking in various places in the private sector, but it is not yet seriously breached. When it does everyone will blame the Governor of the Reserve Bank, since wage pressures will add to inflation. That would be wrong, for the issue is much more fundamental than monetary policy. For years workers have been told about “the” recovery. Now they want to share in it, to make it “our” recovery. The expectation that the Governor can put his fingers in all the holes in the dam is absurd.

Whether you think there has been a recovery in the economists’ meaning of the term, or the politicians’, we still face complex issues of economic management. Those who think there has been no recovery for them – the majority, according to the statistics – will say hear, hear!