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    The Unfolding Economic Crisis
    Peter Harris on what NZ should do

    from The Jobs Letter No.80 / 18 June 1998

    There is a lot of interest and confusion about the unfolding economic crisis in NZ. In recent weeks the kiwi dollar has crashed to a twelve year low, short term interest rates surged to over 10%, and the sharemarket has slumped.

    In this special feature The Jobs Letter presents an essential summary of recent commentaries by Peter Harris, economist to the Council of Trade Unions, on the effect of the crisis on workers and employment.

    Why are we in the middle of an unfolding economic crisis? The government and the finance markets have closed ranks behind a stock excuse: individual New Zealanders haven't been saving enough. But this "save more" message is a political cover, not an economic explanation.

    The "crisis" is not only an economic one. It is a crisis of direction, a crisis of policy, a crisis of credibility and a crisis of consistency. Part of the problem has been the government's persistent denial that there is any weakness in the structure of the economy, and its failure to take corrective action in time.

    Ironically, the economic recovery predicted in the Budget was itself dependent on a boost to spending flowing out of the tax cuts and looser monetary settings, not a boost to savings. The government is trying to face in two opposite directions at the same time: spend to get the economy moving; save to bring the foreign accounts into balance. People can't do both!

  • Very simply, the problem is only partially the fall-out from Asia. Asia made financial markets nervous. What made them particularly nervous about New Zealand was that it was running a very large deficit in its transactions with the rest of the world, and covering that by a combination of selling assets and borrowing. Neither can go on forever.

    That, though, begs the question. Why did this deficit emerge? It is a direct result of defective economic policy, not of the savings habits of New Zealanders.

  • Four key beliefs that underpin economic policy have led to the current difficulties.

    Firstly, there is the belief that monetary policy only affects the rate of inflation, not production and employment. This has led the Reserve Bank to maintain a generally overvalued dollar and a high interest rate for most of the last seven years. That has been kind to the finance sector but ruinous for exporters.

    This monetary mix has led directly to the so-called overconsumption that the architects of the policy now complain about. Under these conditions, banks could borrow abroad to finance mortgage lending. They didn't lend to the export sector because exporters were made non-viable by the very same policy.

    The proportion of bank loans to the household sector rose from 31 percent of total bank loans in 1990 to 52 percent in 1997.

  • Secondly, the new economic lunacy is based on a belief that exports don't matter. Official economic policy accepts that the aim is economic efficiency - and that market mechanisms will determine where resources go. If money went out of applying fertiliser on farms and into yet another café bar, that was simply economic rationality.

    Hence the government dismantled all supports to exporting. The economic growth that occurred in the 1990s was essentially based on an expansion of domestic consumption. The very core of the growth strategy is now being held up as the reason for current problems, yet it is individuals, and not the strategy that get the blame!

    Ironically, the economic recovery predicted in the Budget was itself dependent on a boost to spending flowing out of the tax cuts and looser monetary settings, not a boost to savings. The government is trying to face in two opposite directions at the same time: spend to get the economy moving; save to bring the foreign accounts into balance. People can't do both!

  • The third principle underpinning policy is the official view that as long as it was not the government doing the borrowing, foreign debt was a private matter and of no concern to the government. Commerce Minister John Luxton repeated this nonsense as recently as two weeks ago at the Northland Province of Federated Farmers annual conference.

  • Finally, the theory about the dead-weight losses of taxation inspired policy to cut government spending and direct more money back into the private sector through tax cuts. That fuelled consumption, and led to under-investment in infrastructure, skills and industry development. The theory led directly to a pattern of activity that demolished the international competitiveness of New Zealand producers, and to the balance of payments deficit.

    There is an external deficit. It is large. But any deficit can arise either because spending is too high, or because earnings are too low. In New Zealand's case it is that external earnings are too low. Having collapsed the export sector, the government asks people to lower their consumption to accommodate the defects of its own programme. But it needs them to spend if the economy is to grow! It's a mess.

    Saving the tax cuts doesn't make sense. The money that is to go out as tax cuts has already been saved -- by the government! It is taking a 100 percent level of savings and distributing them into private hands where at least some of them will be spent. The tax cuts themselves automatically reduce the level of national savings, so exhorting people to do what the government is already able to do but has decided not to do is rather pathetic.

    Besides, the government's whole growth plan for the next year depends on people spending those cuts, not saving them. It can't have it both ways.

    What do a sliding dollar and rising interest rates mean for workers? There are three possible impacts: rising costs of living, reduced value of the equity they have in their houses or pension funds, and less job security.

    Workers generally did not benefit from the expansion of the 1990s. They look set to bear the brunt of the contraction caused by its excesses.

  • The rising cost of living is the immediate and obvious effect. The economy has been opened up to imports as tariffs have been cut or eliminated. A lower NZ$ means higher prices. The even greater fall in the value of Asian currencies might mean that some goods that come from Asian countries (electrical goods, clothing etc) do not rise in price.

    However, items traded in US$ - like petrol - certainly will go up. And, of course, interest rates have devastating effects on the cost of servicing the mortgage.

  • A more direct worry is the loss of wealth (the value of the equity in the family home, the value of the insurance policy). For some years now, banks have been borrowing offshore, but in NZ$. They have found willing lenders who have been attracted by the high NZ interest rates, and the prospect of a windfall gain when the NZ$ appreciated between loan being taken out and when it was repaid. These offshore loans have serviced the fixed interest home mortgage market.

    Now, as the NZ$ depreciates, the bonds are not so attractive to foreign lenders. When loans mature, there will not be the pool of willing lenders. Either credit becomes scarce, or interest rates have to be cranked up to lure the lenders. The rates people pay on their mortgages go up, and the inevitable result is that the value of houses goes down. Again, how far is the only question to be answered.

  • There has been some comment that the "silver lining" could be that a lower dollar creates an extra flow of money to exporters, and that jobs there expand. Overall, the net effect on jobs is likely to be negative.

    For a start, most jobs are in sectors that sell in the domestic economy, not in foreign markets. As money dries up, (more spent on imported items, higher mortgage repayments) those jobs become more precarious.

  • With exporter industries, it is not all good news. The key market for manufactured exports is Australia, and the NZ$ has not declined markedly against the AU$. Asia is the key destination for timber, fish and wool -- and the currencies there have collapsed.

    The gains are only from North American and European markets, and therefore mainly for beef, sheep and dairy products. But as with other exporters, those selling there need to borrow a lot of working capital. Rising interest rates take back on the roundabout much of the gain had on the devaluation swing.

  • It is also likely that the fall in the dollar has come too late for many exporters. They have either closed up, relocated to Australia, or borrowed heavily to stay afloat. Extra cash will rebuild their balance sheets before it finances expansion.

    Workers generally did not benefit from the expansion of the 1990s. They look set to bear the brunt of the contraction caused by its excesses.

    Peter Harris recommends....

    Moving back towards international competitiveness and international solvency will not be quick. But it demands four new initiatives. All make employment and export growth the top priorities for economic policy.

    1. Change the way monetary policy is managed. It relies too much on an export and employment unfriendly interest and exchange rate mix. This doesn't mean using inflation or tolerating inflation. It means controlling inflation more by increasing productivity than by dampening spending, and it means controlling inflation in a way that is more sensitive to the needs of the real economy.

    2. Upgrade the infrastructure. (Roads, power, water supply, wastewater treatment, communications etc). It is not possible to get the best results from modern technology and smart production if it is applied inside an outdated and creaky infrastructure.

    3. Improve the skills base. Too much of New Zealand's recent past has involved boosting service sector production by using cheap labour. That is no route to export led growth, let alone internationally competitive exporting.

    4. Introduce an industry policy. This does not involve excessive regulation, subsidies or the introduction of Fortress New Zealand. It does recognise that there are some things private businesses cannot do by themselves, particularly in exporting. It means an active partnership for the development of competitive industry.

    There are ways out of the crisis. In many ways the government is like an economic alcoholic. Before starting the cure it has to get past denial and blame. And when it is cured, don't ever go back to the mischiefs of the 1990s!

    Source -- "Backgrounder on the Economics Crisis" by Peter Harris 11 June 1998

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