Why have the do-nothing policies of the 1980s gone out of fashion?
Listener: 11 March, 2006.
Keywords: Macroeconomics & Money;
Just under 20 years ago, the Kiwi dollar was overvalued. A spendthrift government was running a large internal deficit that had to be financed by borrowing. As the offshore loans flooded in, attracted by high interest rates, the exchange rate (the Kiwi dollar relative to overseas currencies) was pushed up.
Exporting became less profitable and importing more profitable. Export firms stagnated, those that competed against imports closed down, there was widespread unemployment, and the economy stagnated, with six years of falling per capita output. In 1985 we were in the top half of the OECD on a per capita GDP basis (just). By 1993 we were about 20 percent below the OECD average, securely in the bottom half.
At the time, the conventional wisdom said that the exchange rate was determined by the market. There was nothing that policy could usefully do about it, they confidently said. Interfering would only make things worse …
A waking Rip van Winkle from those times would be greatly puzzled by today’s policy debate, which says that the government ought to do something about our high exchange rate, which is once more strangling the export sector (there is hardly any import substitution left) and which promises to stagnate the economy again. We may not agree about what the Minister of Finance and the Governor of the Reserve Bank should be doing, but we seem to agree they should be doing something. What is the difference, Rip might ponder. Why have the do-nothing policies of the 1980s gone out of fashion?
An easy answer is that the policy advisers of the 80s, much honoured at the time, made a cockup roughly comparable to that made by the equally admired advisers of the early 30s. In some respects, the Roger-nomics recession was more severe than the Depression – it was certainly longer. The important difference was that in the early 30s the entire world economy was suffering. In the 80s, it flourished while New Zealand stagnated.
This time, the world economy is neither in depression nor in a reasonably balanced expansion. Rather, the US economy is stimulated by a huge and growing fiscal deficit, arising from tax cuts that generate consumption but not as much production or savings. This savings deficit is financed by the Chinese and Japanese. When they switch to safer havens than the US dollar, the world economy is likely to suffer a wrenching blow, although there is little agreement on exactly what will happen.
Although the current difficulties that the New Zealand economy is facing are not entirely of our making, we are exacerbating them. This time, however, the culprit is not the government’s fiscal stance. Today it runs a modest surplus rather than the deficit of the 1980s. (There would be one, had National been elected with its extravagant tax cuts, and simultaneous promises not to cut government spending, although nobody believed them because their lips were moving.)
So this time the nation has a savings deficit from household overspending. Rip would vaguely recall that in the 80s the do-nothings said that since households made optimal decisions (how did they know?), there was no need to worry – even if their effect was to unintentionally wreck the export sector and growth. This government is introducing savings incentives (despite opposition from the do-nothings), but they have yet to impact.
Meanwhile, the Reserve Bank uses high interest rates to discourage household overconsumption and excessive investment in housing. The economy is slowing down – not surprisingly, given that the export sector’s profitably is undermined by the high exchange rate. The popular concern issue is whether the economic expansion is just faltering, or whether there will be a contraction (as occurred in the late 80s). The greater worry is how long it all will last. Will it turn into a prolonged recession? Will New Zealand still be slowing down (or contracting) when the world economy wrenches?
Rip does not know the answers. But he would notice that we are once more fighting the last war, hardly thinking through the new issues that challenge us. He might conclude that although we have learnt a little from our past mistakes, he expects us to make new ones.