I was asked what was the impact of these two events on the New Zealand economy. This hurried note covers some, but not all, the effects. a major omission is the impact of the private capital flows arising out of the compensation by insurers.
Keywords: Macroeconomics & Money;
These are harder questions to answer than they might at first appear to be. They depend precisely upon what we economists call the ‘counterfactual’, the alternative scenario.
THE CANTERBURY EARTHQUAKE
The counterfactual in regard to the earthquake is pretty straight forward. Suppose it had not happened.
Then today there would be more capital in New Zealand – according to the Treasury about $4billion. Since the total physical capital of NZ is probably about $800b, it looks as though the reduction was abound .5% which is not great, although the proportion is somewhat greater (ten times?) in the Canterbury area.
The government is committed to replacing that lost capital. That will involve an extra $4b of production. Let’s say it takes two year to do it (perhaps more).That would add an extra 1 percent to GDP for those two year.
However, we need to modify the estimate in two ways. First there is the ‘multiplier’. The extra construction means extra employment and the workers will spend their income and generate more jobs. However there will also be a displacement effect, in that some programs will now not go ahead, not only in Canterbury but elsewhere (because resources get deviated from their to dealing with the Canterbury demands).
An important element in the displacement will be the government funding decision. (Much of the reconstruction will be privately funded of course.) Will it simply add to its expenditure, or will it restrain expenditure elsewhere, perhaps because the resources are not available, perhaps because it is fearful of borrowing too much? I am inclined to think the government may well argue that the extra required borrowing is justified in the circumstances and should not compromise New Zealand’s credit rating so there may not be much reduction in government activity elsewhere.
So a reasonable assumption (in our current state of ignorance) is that the multiplier and displacement effects will broadly cancel out and, assuming the Treasury figure is correct, the earthquake is going to add about 1 percent to GDP in the next couple of years. And probably that amount of employment as well. But these activities will catch the economy up to where
it was before the earthquake.
There are a myriad of second order effects to be added to this story. For instance many of the replacement constructions will be to a higher quality and (possibly) productivity standard than what is being replaced. There will also be some additional public spending (e.g. trauma therapy).
The counterfactual here is very tricky. The Global Financial Crisis had exposed that we (and much of the rest of the world) had many overvalued assets, to the extent that some lenders would have to take a lost. The SCF receivership simply confirmed that was true in this particular case. So there are two issues we might want to think about.
The receivership brought about (albeit brutally) the realignment of the asset values faster than if things had wandered on which might be the counterfactual scenario (one thinks of the Japanese stagnation because they did not address their overvaluations fast enough). That suggests that the recession recovery might be a little earlier as a result but, remember, I think it is a few years off anyway.
The second issue is that of the Retail Deposit Guarantee Scheme. The counterfactual is a bit convoluted, but cutting through that, the essence is what is the effect of the government taking the loss rather than the depositors. What seems to be happening is that instead of depositors in SCF taking a $600m hit, the government is taking it.
Now you might think the two effects (depositors $600m better off; taxpayers $600m worse off) cancel each other out. However the government can borrow to cover its revealed deficit in a way the depositors cannot and so the impact will lift the economy a little.
However my expectation is that the government cannot be as phlegmatic over this borrowing as it is about the earthquake – that financial markets will be less forgiving. As a result the government may, to some extent try to offset some of the borrowing by expenditure restraint.
One could argue that the restraint need not be that great. Suppose we thought of amortising the $600m over ten years,. Then aside from interest it would need to cut spending by only $60m a year (but it would have to convince the financial markets that too). This is because these are capital transfers not expenditure injections.
So my feeling is that the SCF receivership will speed up the resolution of the asset valuation a little, and probably lift economic activity a little, but it will add to the government’s funding difficulties.
Again there are second order effects such as prices in other markets may be aligned faster (e.g. farm prices may get more realistic quicker).
In summary, both events will lift economic activity. My expectation is the because of the earthquake by a bit, but only to offset its destruction; the receivership a little – really only a second order of magnitude. What it really complicates is the government fiscal situation.