Growing Pains

If we want to promote economic growth, we need a big rethink.

Listener: 13 November, 2010.

Keywords: Macroeconomics & Money;

The global financial crisis is not over; it just keeps morphing into new phases, without leaving the old ones entirely behind – and so the risk of financial institutions falling over remains. The world struggles with crises over government debt, because some countries have too much of it.

Turbulence may arise in the foreign exchange markets, as countries depreciate their currencies to encourage exporting. Except not every country can do this; we could end up with economic warfare between the great powers. New Zealand would be part of any collateral damage.

We have not yet reached the stage of businesses crashing as their cash flow diminishes. (And although we have assumed East Asia will continue to grow, it could stall – from political disruptions or poor economic management.) Every%thing is so uncertain we cannot accurately predict what will happen and when. The advice – to your household and to the Government – is be prudent and maintain a reserve for the unexpected. It may have to be used.

It is likely we will have a longer recession – with stagnant production and high unemployment – than many expected. There may be short bursts of growth %followed by offsetting downturns.

Two kinds of people promise high economic growth that never happens. Those in the first group have a political agenda – perhaps ineffective policies they want implemented. But the real danger is the second group: pseudo-forecasters with careless thoughts.

To think about it more carefully, consider where the expenditure that drives growth might come from. Its largest component is public and private consumption. The Government is insisting on restraining public expenditure, partly because it grew faster than incomes over the past decade and partly because of the need to be prudent. And there’s an ideological component: National is less committed to public spending than Labour.

But private spending also grew faster than incomes. We may be spending less of our income in an effort to reduce debt, reinforced by higher unemployment, lower real incomes and the savings wiped out by finance company crashes. It is difficult to see consumption pulling up New Zealand’s growth rate.

What about investment? The Government has a big infrastructure programme, but is not expected to increase it. New house building is in the doldrums. The post-earthquake reconstruction of Canterbury will provide a boost, but the Napier precedent was not enough to pull New Zealand out of the Great Depression.

Business investment? Most businesses are cautious about adding to capacity when the economy is stagnant. Technological innovation offers opportunities, but these usually involve expenditure switching – as we move to faster broadband we give up other spending – so some businesses will invest and others will contract. (Businesses running down or building up their stocks can cause a double-dipper contraction, but the effect is not significant through a long %recession.)

The economy gets boosted from any reduction in imports resulting from a switch to home production, but this is easier said than done. Which leaves exports.

If exports grow fast, they drag the rest of the economy along, too. Favourable primary export prices from strong sales in East Asia provide a boost, but many farmers will pay off their debt, so there will be only a little extra consumption and, hopefully, a bit of investment. Primary production takes time to expand, but we should not neglect it.

The immediate prospect is the secondary (manufacturing) and service sectors. Are there overseas markets for them? Sometimes, in Australia and East Asia. Is it profitable for them to sell there? A high exchange rate means low profitability. (If there is a rise in export profitability, we may first see a rise in investment in production for exports, including offshore market development – but don’t hold your breath.) Are we going to do anything about the exchange rate? We have not been very successful in the past. If we want to promote economic growth, we need a big rethink.

Not an optimistic prospect; at the heart of any success will be the export sector. If there are international exchange-rate wars, disruptions to export markets will make economic growth even more %difficult.