Thursday, December 23, 2010

Reflections on the challenges facing the New Zealand economy

The traditional pre-Christmas release of key New Zealand GDP and Balance of Payments data contained a few salutary reminders of the challenges facing the New Zealand economy as we head into 2011. Add in the half-year fiscal update from last week and the messages are even more clear…and worrying.

In particular:

* This is a non-traditional New Zealand recovery. Consumption and residential construction, the more traditional drivers of recent growth, are subdued and will, in our assessment, remain subdued for some time.

* This recovery needs to be driven by real productive effort. That productive effort needs to be export oriented. If exports don’t drive the recovery, nothing else will.

* We need a positive contribution from net exports. Recent strength is export values has been price driven rather than volume. There is nothing in this for us to pat ourselves on the back for.

* Our recent export success is more due to the vagaries of global commodity prices. We remain of the view that if we don’t have an export led recovery this time around, we simply won’t have a recovery.

* The structural nature of the recession (and the recovery) means that potential GDP, or the rate at which the economy can grow without generating upward pressure on inflation, is now lower. In particular we believe the higher unemployment rate includes a higher level of structural unemployment – skills shortages and upward pressure on wages will emerge earlier in the cycle this time around.

* We continue to look for a strong business investment cycle to drive the next wave of the recovery and to build the capacity of the economy to produce stuff the world wants to buy. In that regard the increase in plant and equipment in the September quarter was the only really good bit of news.

* We cannot rely on just the economic cycle to close, what is in the Treasury’s own assessment, a large structural budget deficit. Higher savings is part of the answer and we look to the Government to make its contribution in Budget 2011. There are structural changes required to government expenditure, especially entitlements such as New Zealand Superannuation and Working for Families.

* Monetary policy can’t solve this for us. I find it fascinating that whenever we have a conversation about economic growth in New Zealand, we very quickly end up having a conversation solely about the Reserve Bank and monetary policy settings.

* The best contribution monetary policy can make is to keep inflation under control. To use an old phrase (thank you Ruth Richardson): Monetary policy needs mates. That support needs to come from fiscal policy. Where the government does spend on growth oriented policies, it needs to be focussed on the strength and interconnectedness of the innovation system.

* Government can’t make businesses more productive or more innovative. The only contribution policy can make is by creating the right environment for businesses to be more innovative or productive, should they choose too.

I think that's about all for now. These are all things to keep thinking about, worrying about, debating and working on in 2011. In the meantime, Merry Christmas!!