Data Doldrums: The State Of the Economy Won’t Do National Any Favours in The Poll

Listener: 23 October, 1999

Keywords: Macroeconomics & Money;

Two major economic indicators for the June quarter were released a couple of days before the Prime Minister announced the election date. Both were depressing: the current account deficit – how much New Zealand has to borrow overseas – was at near record levels; while GDP – how much New Zealand produces – declined. There will be no further major official statistics released before November 27th, although the importance of each minor one will be over-played. (Both the Treasury and the Reserve Bank macro-economic forecasts published during the election campaign are likely to be more subdued in comparison to their last ones.)

It is easy to dismiss the two official statistics as aberations. Some commentators did, while the financial markets panicked, driving down the exchange rate and share prices. There is measurement error and random events so we should treat each statistic with caution. Nevertheless the new ones belong to a coherent account of the economy.

The mid 1990s were dominated by one of our longest and strongest post-war economic booms, attributable to a recovery from the stagnation of the 1980s, a sharp rise in our terms of trade (although the relative prices of exports have since fallen back), and a strong world economy. The economy went into downswing in early 1997 (just after the election), but not for long, because of the coalition public spending in the second half of 1997, which lifted the economy into a mild cyclical upswing. It was quenched by the Asian Financial Crisis with its collapse of key export markets. The July 1998 income tax cuts expanded the economy again in late 1998. The most recent expansion seems to be weak (according to the recently published data), and it may even be over.

It is easy to explain the weakness on special factors: the drought did not help farm production, while the hike in world oil prices is raising the import bill and reducing consumers’ effective spending. But such explanations are reminiscent of children who explain all their successes in terms of their beauty, intelligence, grace and wisdom, and all their failures on events outside their control.

The fiscal packages of 1997 and 1998 prove that a government can internally reflate an economy, by increasing domestic spending. But that does not address the external sector, and much of the spending goes on imports. Thus the stimulus of the package is weak on the production side, so the domestic reinforcing (multiplier) effects are muted as imports rise, and the spending blows out through the current account. Unless external conditions are very favourable, we experience weak, fragile upswings easily knocked over by external shocks. There will be another recovery as exports expand again, but those based on domestic expansion (by reducing the fiscal surplus) cannot contribute to prosperity in the short term without compromising the balance of payments.

When will this end? The short answer – which makes we economic commentators appear ignorant (if honest) – is that no one knows. A slightly longer one is that the phase ends when the hooks holding up the US sharemarket fall out of the sky, and the slump in share prices reduces the world’s willingness to loan each New Zealanders the $US20 or so a week, we each need to pay for extra imports. (Another possibility is when the Chinese financial system falls over, with a similar effect. I am assured by experts that the worries of a few months ago no longer appertain. Be very afraid.)

A third possible ending is to change economic policy. I agree with the broad direction of the “Knowledge Economy” package which recognizes that the government can positively influence the production process. But there is also a need to address the tradeable sector. New Zealanders have a huge appetite for foreign exchange. If we cannot earn enough, while given that heavy borrowing is unsustainable and direct import restrictions are likely to be largely ineffective, a reduction in incomes seems inevitable. That means higher unemployment and a lower standard of living.

My forecast is that the economy will look less prosperous a month after the election, than it does a month before. That has happened for most past elections.