An economic outlook

February 27th, 2008 at 10:31 am by David Farrar

A leading economist did a presentation to the Business Roundtable Retreat on Friday. It was Chatham House Rules so I can report some of the detail – but not who said what. It was an analysis of the trends and issues in the , and then some possible solutions.

  • The 90 day bill rate predicted to drop in 2009 to 6% but then to increase and stabilise at 7%
  • A small increase in the unemployment rate reaching 4% in 2010
  • The equilibrium level of inflation may have increased from 2% to 2 1/4 to 2 1/2 per cent.
  • Migration to Australia would continue and this would be of the relatively “more productive” New Zealanders. This isn’t a judgement on education levels or intelligence as much as recognising they are people with “skills established in this economy” so generally more productive here than any replacements.
  • Mining in Australia is only 7% of GDP and 2% of their workforce so incorrect to credit the minerals boom for their economic growth.
  • The big challenge for NZ is to increase our productivity, and it is hard to do this with a declining talent pool. Hence we have a vicious circle – the more people who leave, the harder it is to increase productivity so incomes can increase to keep people here.
  • Agricultural Protectionism is a real issue and hurting the agricultural sector
  • Multilateral trade deals and plurilateral trade deals are better than bilateral deals
  • NZ needs to shift focus in trade deals from purely agricultural access to also have investment rights in agricultural processes and storage facilities.

He also did a very nice summary of one of the problems with the current macroeconomic model. Basically, if I recorded it correctly, it is:

  1. Increasing Inflation –> Increasing Cash Rate
  2. Increasing Cash Rate –> Increasing Interest Rates
  3. Increasing Interest Rates –> Increased NZ$
  4. Increased NZ$ –> Decreasing Exports
  5. Decreasing Exports –> Decreasing Economic Growth
  6. Decreasing Economic Growth –> Decreasing Investment
  7. Decreasing Investment –> Decreasing
  8. Decreasing Productivity Growth –> Decreasing Aggregate Supply
  9. Decreasing Aggregate Supply –> Increasing Inflation

In one sense it is an argument why it is important to keep inflation under control from the beginning, but it does highlight a weakness in the current cycle. Whether there is a better solution though is the real question.

It was suggested that the RBNZ targets should have the emphasis on targeting inflation over the medium term removed, as it has led to timidity with the RBNZ late to act, with the consequence being inflation and interest rates stay higher for longer than they otherwise would have been.

He also highlighted some ways to increase productivity:

  1. Encourage people to stay in NZ
  2. Increase the returns for effort
  3. Reform and reduce tax levels
  4. Get rid of redistribution policies which just redistribute money back to those who pay it, and adds a deadweight cost to the economy
  5. Reduce the rate of growth in the public sector relative to the private sector
  6. Make it easier for employers to release lower productivity staff

Now people can make arguments against each and every one of these on grounds of social justice or fairness etc. I mean for example I wouldn’t advocate being able to get rid of staff at whim. But the point the economist was making is that if you don’t do these things, you will find it harder to increase productivity growth. So it is all a trade off – if you do not do any of the above you’ll watch the gap with Aussie grow even faster.

There is also a list of what not to do:

  1. Don’t discourage the able from staying
  2. Don’t discourage more effort
  3. Don’t discourage investment
    1. Don’t ignore property rights
    2. Don’t have costly planning requirements
    3. Don’t increase the regulatory burden
    4. Don’t impose climate change policies which have large risks for investors

It was clarified this wasn’t an argument for having no policies to mitigate climate change. It was for uncertainty and risks to be minimised.

And again people can argue for or against each of the above – it was just a reminder that there is a cost to productivity growth if you do discourage effort and investment etc.

To some degree it was a bit gloomy.  The vicious cycle with migration and the impact of monetary policy on productivity growth make it very clear that closing the gap with Australia will not at all be easy.  It won’t just happen by chance without a change in policies.  And there will be no one or two simple things to do – it will only happen as a result of taking action in a dozen different ways, each incrementally helping increase productivity growth.

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30 Responses to “An economic outlook”

  1. milo (538 comments) says:

    “Don’t impose climate change polities which have large risks for investors.”

    This is a very value laden statement. Would that be short term 3 to 5 year risks then? Or would it be long term 30 to 50 year risks? Or would it be the risk of having to pay for the externalities on which there has been, to date, a free ride? Most commentators who say this sort of thing simply demonstrate why they should never, ever, be in charge of the economy.

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  2. pushmepullu (686 comments) says:

    To some degree it was a bit gloomy. The vicious cycle with migration and the impact of monetary policy on productivity growth make it very clear that closing the gap with Australia will not at all be easy. It won’t just happen by chance without a change in policies. And there will be no one or two simple things to do – it will only happen as a result of taking action in a dozen different ways, each incrementally helping increase productivity growth.

    So in other words, don’t expect too much of the first term of a National/ACT government? I think that’s a bit pessimistic David. OK so we won’t be equal with Australia overnight but just removing the corruption from our economy by changing the government will cause an immense boon – people will realise how much dead weight they were carrying.

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  3. Fabt3 (28 comments) says:

    I thought there was only one Chatham House Rule has a new one been included where punching a person you disagree with is now permitted.

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  4. Alces (310 comments) says:

    Forget it, socialists are offended by most of that stuff.

    Better to posture and pretend adherence to Labour political dogmas are NZ’s first duty.

    And speaking of AGW, the comrades are not going to be happy.

    http://www.dailytech.com/Temperature+Monitors+Report+Worldwide+Global+Cooling/article10866.htm

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  5. David Farrar (1,808 comments) says:

    Milo: He didn’t elaborate on that statement, but I did not read it as anti emissions trading or a carbon tax for example. I just saw it as asking for clear policy which won’t change, so that investment decisions can be taken on the best possible information.

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  6. Kimble (4,092 comments) says:

    Let the misunderstanding… BEGIN!

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  7. Paul W (266 comments) says:

    An interesting presentation indeed. No quick fix, no silver bullet. I do think however, the presenter as under-sold the value of mining to the Australian economy. The federal government surplus is increasingly bloated with business tax receipts which themselves are increasingly made of from revenue from mining companies. Not only this but compared with manufacturing and agriculture, mining commands the lion’s share of exports (and mineral export volumes are largely price inelastic unlike STM/ETMs).

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  8. Jim Donovan (2 comments) says:

    Fabt3 is right – there is only one Chatham House Rule, David.

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  9. Waymad (136 comments) says:

    As dear old William Rees-Mogg (still writes occasionally for the Times) has written, in ‘The Sovereign Individual’ (1997):

    “Once-competent governments will no longer be the friends of wealth accumulation, but their enemies. High taxes, burdensome regulatory costs and ambitious commitments to income redistribution will make territories under their control uninviting settings in which to do business.”

    Oh – the chapter heading: The End of Egalitarian Economics.

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  10. gd (2,286 comments) says:

    have a look at productivity in the 90s compared to the last 8 years and you will see the problem As we lose more of the cream of the crop so it becomes more difficult to close the gaps to our trading partners

    Heads and hands are a mobile international trading commodity. Unless you attract enough of the best then you go down the guggler.
    Nice countryside aint enough on its own We need to get over it and get a low flat rate tax environment to attract indiviuals to work and corporate to invest.

    Look at Ireland Yes I know being in the EC helped but that just goes to prove how we have to try even harder than the Irish did. We need a 15/15/ 15 flat rate tax structure and 15% GST and replace WFF with a simpler rebate programme

    bet in 5 years the economy would be booming

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  11. Tamaki Resident (66 comments) says:

    Paul W – agreed.

    I would have interpreted a 7% contribution to GDP for only 2% of the workforce something that could not be dismissed as a contributor to growth as easily as the presenter did.

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  12. Alces (310 comments) says:

    Noticed that many in NZ want to attribute AU’s growing economic prosperity to mining.

    That way they don’t have to confront anything about the mineral-less NZ economic system.

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  13. Paul W (266 comments) says:

    Yeah Alces, that’s one, albeit very simplistic, way to look at it.

    NZ exports are simply not high-value by comparison with many of our trade partners but we can’t magically create a different nation, we have to add-value to what we have and open more and more markets. NZ has low trade-intensity, circa 30 per cent of GDP, I agree that the goal is increasing this which is why recent achievements in opening up new trade arrangements are so significant.

    My point was that the Australian economy is more diverse and currently benefiting from strong regional demand for a commodity for which they are the majority supplier. If you think that’s irrelevant to the discussion it’s only because you’ve already made up your mind. NZ economic system, your words not mine, is world class by almost any and every measure. What David’s presenter talked about was its performance. In fact, NZ GDP growth has been stronger than Aust/OECD averages for a while now but we’re still behind compared with historical standards. I agree emigration to Australia is something worth considering but lets not forget NZ has net migration and that migrants almost always have more skills than the domestic workforce therefore we’re not losing skills even if we’re not attracting or retaining as many as we might wish for.

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  14. vto (1,128 comments) says:

    Nothing really new or outstanding in all that. Unfortunately the current govt of NZ has done virtually NOTHING to make it better for doing business or to improve productivity during the last 9 years. They could have attended to many of those things over time and by now the economy would be a lot stronger. Example – Slowly reduce taxes (putting the top personal rate up to 39% on coming into power when it was unnecessary still really angers me. It was NOTHING MORE THAN ENVY).

    I shake my head at the current govt.

    As for minerals, NZ is actually loaded with them. It’s just too hard to get consents etc. Here’s a thought / fact though. An average sized mine is about the same size as an average sized farm. The farm will directly support 1 or 2 families over its long life span. The mine will directly support dozens, if not hundreds, of families over its much shorter life span.

    Both the farm and the mine take up the same area of land and cause similar enviro impacts (loss of natural habitat. assuming each controls wastes, which mines do today). In fact the mine is better because it reverts once the mine is at an end.

    The mine is significantly superior to the farm on all measures.

    The ONE perception that prevents greater mining activity is that an operating mine looks dirty whereas an operating farm looks clean with its pretty green grass. Both are industrial sites.

    2c (I am an ex-geo/miner)

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  15. Alces (310 comments) says:

    Sort of Paul.

    Outside minerals, AU’s high value income stream is not mostly from elaborately transformed manufactured goods but from financial services, educational services, technical services sectors.
    There is nothing stopping NZ participating fully in this part of the boom.

    The mining industry has always been the driver in WA and QLD. However, agriculture used to nearly match it.

    The NZ economic system seems to do 1st world ok on most infrastructure, but it needs to match AU in that slippery concept of “attractiveness”. The dead hand of socialism is a feeling westward bound Kiwi’s know well and it doesn’t appear in any OECD report.

    The point by gd is well made, you want a booming economy, slash and burn taxes, accept the inflation adjustment and get on with it.

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  16. gd (2,286 comments) says:

    Alces

    Or do you want a stagnating economy going no where with the best and brightest heading offshore leaving the old and infirm and growing numbers of baby boomers who will consume huge amounts of super and medicare

    Of course we know what the Socialists want Maximum numbers depending on them for at least part of their income (WFF etc) and those outside the welfare cage of dependency being bleed dry whilst being laughed at and scorned for their efforts.

    Those in the welfare cage too frightened NOT to vote for the Soicialists lest they lose the comfort blanket that encircles them

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  17. Matt Nolan (73 comments) says:

    “The 90 day bill rate predicted to drop in 2009 to 6% but then to increase and stabilise at 7%”

    Picking the 90 day bill rate to fall to 6% in 2009 seems a bit steep to me. If thats the case the presenter must have expected NZ economic growth to bail over the next two years – that would involve at least a 200 basis point cut in the OCR over this time. It’s entirely possible, but I think issues stemming from global inflation will probably keep rates up for a little while yet.

    “Mining in Australia is only 7% of GDP and 2% of their workforce so incorrect to credit the minerals boom for their economic growth”

    Huh, is this only looking at the mining factor in GDP statistics? Agriculture is only just over 4% of our ‘GDP’ by that measure. I think the important thing about an export industry is that it injects income into the economy, something which heads around the circular flow helping growth around the economy.

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  18. philu (13,393 comments) says:

    and nothing from this ‘expert’ on the approaching economic/environmental tsunamis..?

    whoar..!

    which ‘hall of delusion’ does he reside in..?

    and how can his words have any credibility..?..if/when he excludes these realities..?

    they make everything he says a nonsense..

    phil(whoar.co.nz)

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  19. SPC (4,598 comments) says:

    There is one way to close the gap with Australia. Become the seventh state.

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  20. SPC (4,598 comments) says:

    The most important thing is to create a separation between the RB measures against inflation and the currency.

    The RB has suggested adding a surcharge to mortgage cost (this would allow the OCR to fall while maintaining an anti-inflationary domestic consumption policy) and reducing the amount of interest income that can be taxed (using 2% – as a standard inflation adjusted figure allowance) so more people would still save despite the lower OCR rate. The resulting lower dollar is initially inflationary but higher import costs would reduce consumption and thus also the BOP deficit.

    I support this approach. A benefit is that it allows business greater profitability in the international market (more favourable dollar value) and also lower borrowing costs. I would go further and reduce all tax on interest income to one low rate 20%.

    Originally the idea of a surcharge on mortgages was posed as one for existing mortgages as well. I would apply them only to new fixed rate arrangements and floating mortgages. The irony is that with this occuring in co-ordination with a low OCR, the actual mortgage costs to the public need not increase – but this device allows the lower OCR to take down the currency value.

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  21. Bernard Hickey (19 comments) says:

    Keeping our youngest, most productive New Zealanders in New Zealand is crucial. Making housing affordable will go a long way to do this. This is something the “lucky and selfish generation” who run the country should address. I’ve had a go at this in my blog today. http://www.stuff.co.nz/blogs/showmethemoney/2008/02/27/helens-lucky-and-selfish-generation/

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  22. SPC (4,598 comments) says:

    I agree with what you wrote on your blog. But it’s not just the older generation enabling it, there is also a whole new group of people whose career is just buying up houses who are part of this new “industry” and who will advocate and donate to parties defending it.

    However other younger people could form their own party and insist on their manifesto housing policy being adopted before supporting any coalition government. Perhaps the “House” Party. The new hippies.

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  23. Dismal Soyanz (58 comments) says:

    Hmmm. Perhaps some of the message got lost in translation but as someone who has done a few of these “stand up in front of audiences and waffle on in economic terms” I don’t see a lot of value-add in your summary of the economist’s speech, David. Long on identifying problems that we all know exist and short on new ideas.

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  24. Southern Raider (1,366 comments) says:

    The Government could easily fix this. Rather than spending money on hand outs that just full inflation they could invest more in infrastructure.

    New roads, rail, power stations etc. Also applying tax credits for machinery purchases would help.

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  25. PhilBest (5,112 comments) says:

    Bernard Hickey’s blog entry linked above is a “goodie”. Required reading.

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  26. Alces (310 comments) says:

    Don’t just talk about it phil.

    The money is there for you right now, time to back your US$ dribble-down call.
    It’s not a bad one.

    Following the Aussie up from 88.4 to now with a number of contracts is a profit of AU$47k.

    95 beckons.

    Most socialist wankers don’t like the profits I make while refusing to trade and take the downside risk themselves.
    They want profit without risk.
    Guess that’s socialism in a sentence.

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  27. side show bob (3,660 comments) says:

    After watching Dear Leader on the news calling the Aussies our cousins and saying how Rudd admires our stand on climate change I want to spew. So I take it that Aussie will now sign the kyoto protocol. It would seem Rudd is as thick as our Dear Leader. Both countrys are busy falling over each other in their rush to please the Chiness in the way of mineral sales. China imports billions of tons of iron ore and coal from both countrys. Is it now safe to assume that NZ and Aus will now halt sales to China of minerals given the great concern these two leaders have for the climate, I fucking doubt it. These arseholes should be held to account when they impose carbon taxes on their people but are happy to boost the coffers with minerals that are highly poluting. The carbon taxes will increase inflation but not alter climate one iota. Thats one idea they can take to Chatham house.

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  28. Mike Readman (353 comments) says:

    Why can’t what econmomists say be reported? It seems strange.

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  29. Alces (310 comments) says:

    side show, here’s a tip.

    Rudd is an economic conservative lefty, his mirror imaging of Howards economics is legendary.

    Take this to the bank, any AU govt that pays one dollar of “carbon fines” to Eastern Europe or anyone else, is dog tucker.

    Tho expect him to pretend a lot for the comrades.

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  30. milo (538 comments) says:

    Matt Nolan said “Picking the 90 day bill rate to fall to 6% in 2009 seems a bit steep to me. If thats the case the presenter must have expected NZ economic growth to bail over the next two years.”

    Yes Matt, I think we are headed for a nasty recession. The only thing holding it back at the moment are milk fat prices. But there is a serious loss of confidence in several major areas of the economy, and I predict investment will plummet in 2008. Add into that extreme interest rates and a shaky Chinese economy, and things are looking nasty. If the Chinese have a crisis – due to internal factors (peasant farmers), inflation problems or other economic dislocations, then NZ is in for a very unpleasant period.

    I wonder if Michael Cullen will take the credit for that, too?

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