Andrew Bayly on the economic impact of Covid-19

An interesting analysis by National MP :

I wrote this economic analysis of the impact of COVID-19 ten days ago and thought I might share it with you now to give an indication of my personal thoughts on how events will unfold over the coming months and years.

International Context

Before COVID-19, many countries were already labouring under high debt levels.  For example, the US had a debt-to-GDP ratio of about 107%; the average across the EU (including Britain) was about 65%; and although China’s Crown debt looks low, a significant portion is carried at the non-bank level and is therefore not captured in Government reported levels.  As a result of initiatives to mitigate the impact of COVID-19, many of our trading partners will become excessively indebted (including Australia, even though it had a lower ratio than NZ before this virus).  Added to this is that fact many of these countries have been running huge quantitative easing programmes. 

That means their ‘tanks are empty’.  They have no reasonable prospect of stimulating their economies further.  It also means the world economy will have to depend on a consumer-led recovery to come out of this next recessionary period.  Given the wholesale job losses that will occur – and are already occurring – a full recovery will take years.

What does that mean for NZ?

NZ is better placed than many.  We will suffer significantly and it will likely take up to 10 years to get our debt level back to where it is today. However, the impact across the economy will differ.  NZ is resilient in that many of our exports come from agriculture, fishing and farming.  Broadly, the business landscape will fall into four groups:

  1. Resilient:  With Government spend accounting for just under 30% of GDP and the local government sector accounting for another 7%, this underpins a significant portion of the economy.    The Government has already signalled its financial support to the health and education sectors, which is important.
  2. Strongly positioned: Food producers and retailers, private health, DIY are examples of sectors that will benefit strongly from the current crisis.
  3. Businesses that will recover quickly: These include service businesses such as hairdressers, IT firms and a significant portion of the financial services sector.
  4. Businesses that will go through painful resizing: Big industries badly affected include the international tourism sector, foreign student industry (both universities and schools), airline and airports, and those that depend on discretionary spend such as car yards and parts of the hospitality sector.

At another level, we are going to see significant population change. Projections for NZ’s unemployment rate are mere guesses at this stage but it is highly likely we will exceed 10%.  Again, those affected by redundancy/layoffs will differ within each sector of the economy.  Those most likely to be affected are:

  1. Last on, first off: This will apply in many sectors.
  2. Least skilled: Some industries will apply this approach but, for instance, in the construction sector, many small builders will make do with the lowest cost/apprentice as a way of getting through the downturn. This will also disproportionately affect Maori and Pacific people.
  3. Expensive Labour Units: Previously the most skilled/expensive people were retained because the cost of redundancy was significant.  With moves over the past 15 years to put people on contracts, it is now easier to let go of high-cost people. Certain sectors will have no choice.  For example, a significant number of pilots have already been made redundant.

The result is that migrant labour, our youngest and many of our professional people will be made redundant. Given the projected spike in unemployment, it is probable the Government might actively adopt a strategy of reducing the number of immigrants coming to NZ on work visas in order to reduce the unemployment rate. Another aspect is that over time, we might see the return from overseas of some highly skilled New Zealanders seeking a safe haven here.

One aspect of the forthcoming redundancy rounds is that the middle-income earners who lose their jobs will be most affected.  They will be considered too wealthy to get MSD financial assistance and consequently their household balance sheets will become stretched. Furthermore, with approximately 40% of all houses in NZ owned by Mums and Dads, they will come under further pressure from tenants seeking rent reductions. Expect a large outcry from this group wanting a degree of financial assistance.

What does good economic theory tell us?

The priority of effort during the recovery period should be as follows:

  1. Retain as much as possible of our viable businesses;
  2. Facilitate those businesses to expand and grow; and
  3. Support the creation of new businesses/industries – by far the most difficult option.

Sectoral Review

  • Tourism and hospitality.  In the year to 2019 tourism generated a direct contribution to GDP of $16.2 billion, or 5.8 percent of GDP, making it our biggest export industry, contributing 21% of foreign exchange earnings. Total tourism expenditure was $40.9 billion, and international tourism expenditure was $17.2 billion, and it contributed 20.4 percent to New Zealand’s total exports of goods and services. Before Covid-19, both industries employed about 393,000 people. Many are less skilled and the industries rely to some extent on a large, mobile immigrant labour force.  Given we are heading into the quieter winter months, the prognosis for both sectors is poor.

It is essential we re-orientate this industry to advocating that New Zealanders travel locally, not internationally.  The opportunity is to highlight more bespoke destinations such as Whangamomona (North Island) and The Catlins. This needs a major advertising programme and should be done in conjunction with Air NZ to help the airline re-establish.

Another opportunity is that we should, as soon as practicable, agree protocols to accelerate opening up our border with Australia.  This might extend to extensive testing for COVID-19 at the border, both before travel and upon arrival. This measure alone would improve the tourism sectors (including airports and airlines) for both countries, pending a wider opening up of tourism again. 

  • Agriculture, Forestry and Fishing: Out of a total of $58.3 billion worth of goods exports to June, the primary sector accounted for $46.4b. The dairy industry earned $18.1b in exports and forestry receipts are forecast to be down by almost $1b next year to $5.8b, after a backlog of log and timber supplies in China.  It is essential that in the first 12 months of the recovery we do not allow additional barriers to be implemented – at either central or local government level – to reduce our ability to produce and export products.  This could entail identifying and putting on hold the most pernicious elements proposed in council environmental plans. Forestry should be encouraged to get up and running as soon as possible – particularly as China is picking up.  It is also job intensive (harvesting, transport, stevedoring).  There is no evidence that local millers cannot obtain supply – but they need to pay an export price equivalent.
  • Education: Approximately 135,000 international students were studying in NZ last year, contributing about $4.5bn. The timing of COVID-19 has meant many who planned to attend but were not here physically will now not come – they will enrol overseas where the university year starts later in the year.  It may take some time for enrolments to return to pre-COVID-19 levels.  One option to address this shortfall is to rapidly mobilise universities/ITOs to offer micro-credential courses to those made redundant. (Micro-credential courses are targeted at a particular facet of a job and over time can lead to a trade or profession. The building & construction sector currently operates on this model).  Such an approach would focus on vocational training in those sectors where existing jobs are on offer or where new growth is likely to occur, and could entail a widening of student loans requirements to take into account those looking to undertake studies as part of a second career pathway (eg, a pilot).  Most promising sectors include IT services and health services.  Further support for apprenticeship training is another important area.  For example, the Building & Construction sector (which trains about 25,000 of the nearly 50,000 apprentices a year) wouldwelcome a package where builders receive $2500 per apprentice in the first year of apprentice training, gradually reducing to $1500 in the fourth year.  A similar model should be developed and offered to other sectors.
  • Building & Construction and large property developments:  The Building & Construction accounts for about 7% of GDP and employs about 250,000 people.  It also trains about 25,000 apprentices a year.  It is essential that the sector be allowed to get back on its feet, and we should also encourage developers to proceed with new housing and commercial developments. There is a pressing need now to allow those trades that can operate safely within the COVID-19 requirements to recommence work as part of the move to transition from “essential services” to “those that can operate safely”.  The construction period is dependent on weather and people such as civil constructors (involving diggers, graders etc), must be allowed to work.  Areas to focus on include defining the rules for safe working practices, fast tracking consents, more widely deploying the Artisan system to allow remote inspections/approval of buildings, and ensuring banks are offering funding lines to developers (addressed later in this report). 

Pressing need for banks to provide working capital

By the time the 4-week lockdown period ends, many businesses will have gone through two cycles of rental payments. That’s why there is a pressing need for a business rental package. 

Possibly, in order to address this, the RBNZ has relaxed the capital adequacy ratios (which theoretically mean the banks can lend an additional $57bn) and, more recently, Grant Robertson has announced a scheme whereby the Government will underwrite 80% of the new working capital funding arrangements put in place by banks with businesses. These initiatives need to be tested:

  1. Has the $57bn of additional lending capacity actually been deployed in important sectors such as agriculture and property development?  When I asked Governor about this at the last FEC meeting, he said the RBNZ had no ability to require this but it would be monitoring lending by banks.  The COVID-19 Select Committee should request this information.
  2. How do we know that the additional capital (as a result of the reduced capital adequacy ratios) has not been siphoned off to the banks’ Australian parents for on-lending there?  Again, I asked this question of the Governor and he said they were in close contact with APRA and the RBNZ would be monitoring the situation. The COVID-19 Select Committee should also request this information.
  3. Even though the Government has announced an 80% underwrite, anecdotal evidence still points to banks requiring full 100% PSBR over the business and personal guarantees by owners when offering new working capital facilities.  If this is a widespread practice, it will lead to many directors choosing not to continue trading.  The Governor should be tested on this point.

Infrastructure Investment

There is no doubt that infrastructure investment by central and local government will play a part in the recovery – but it is unrealistic to assume it will play any meaningful role in the first six months due to the time lag to get these projects underway – which is when businesses are most vulnerable.

The nature of this investment needs to encompass both ‘hard’ infrastructure (roads, rail, houses, water and wastewater) and ‘soft’ infrastructure (community facilities etc).

I think one of the findings of the COVID-19 crisis is that our telecommunication/broadband capacity was found wanting.  This problem will continue after the lockdown ends as those made redundant will continue living at home. There are two main issues:

  1. Lack of mobile capacity – this is a spectrum and capacity issue; and
  2. Need to address the issue of the connection “over the last mile’ (i.e., from the fibre to the home).  Telecommunication companies often want to charge exorbitant fees for the last-mile connection and for many the cost is too high.  This means as a country, we are not fully realising the benefits of investment in a modern, high-speed fibre network. I believe we will need to look at different approaches (eg allowing wires to be placed on telegraph poles) and provide an element of funding to reduce this cost to an acceptable level.

Another crucial factor is to immediately pass legislation to extend the type of infrastructure that can be fast-tracked through consent processes.

Should tax cuts be part of the stimulus package?

As discussed earlier, the greatest burden from the COVID-19 crisis will fall on the middle income earners. For this reason, it is essential our proposal to address the bracket creep (fiscal drag) by adjusting the personal tax thresholds is implemented as soon as possible.

There is also a suite of tax measures I have previously proposed to assist businesses.  These include quicker write-off of the cost of new machinery and changes to depreciation rules which will provide some assistance to existing and new businesses to invest in plant and equipment.

The remaining issue is whether wider tax cuts are the best way to deliver a stimulus to the economy. My personal view is that circumstances have changed.  Tax cuts only favour those still working and are only realised progressively through PAYE reductions during the course of a year. And once in place they cannot easily be changed.

Many countries around the world have simply given, say, a $1000 cash check to individuals.  This approach means the benefit is immediate and delivered at the point of most need.  It can also be tailored to go only to those on low income levels.

What additional policies should we advocate?

Other generic initiatives we might consider proposing include:

  1. Promote ‘Buy NZ’.
  2. Consider increasing free hours (from 20 currently) for children at ECE for the remaining part of 2020 to provide parents with increased time to focus on their livelihoods.
  3. We should also think about a window for relaxing foreign investment in demonstrably new projects or in preferred sectors.
  4. Create labour market flexibility (such as reintroducing 90-day trial periods) to let things settle down.

Summary of possible policies initiatives

My view is we need to consider the recovery in stages:

STAGEKEY FOCUSPROPOSED APPROACH
Lockdown – Month 1Assist businesses to survive the lockdown period.  Initiative announced: Wage supportIndemnity for Directors re receivership rulesStrongly advocate for a business rental support package (with rent collections as at 1 April down as low as 28%, it shows that many businesses cannot afford to make their monthly payment)At the conclusion of day 14, strongly advocate a move from allowing essential services to only operate to those businesses that can safely operate. Part of that also means freeing up logistic arrangements at ports, airports and couriers Ensure banks are lending to key sectors (eg, agriculture) and on reasonable termsConsider advocating for price control on supermarkets  
Months 2-3This is the most dangerous time when directors will finally determine how to downsize their businesses or decide to place the company in receivership. Need assistance package to assist many businesses to resume business and survive.Consider additional wage subsidy support packagePass legislation to retrospectively indemnify directors who may be trading insolvently, under the recently announced “stand to” provisions receivership rules clarifiedImplementation of business rent support packageImplement apprentice/employer support packageImplement tax changes to address bracket creep and provide additional tax incentives to businesses to invest in new machineryAnnounce other stimulatory measures (eg, one-off $1000 in cash for low income earners) Pass legislation to extend the fast track consent provisions to include other infrastructure projectsCommence promotion of NZ tourist destinations in association with Air NZ  
Months 4-6Large number of unemployed – consider second career training optionsImplementation of ‘micro credential’ programmes at university/training organisations  
Months 6-12Realistic time for infrastructure projects to occurImplementation of infrastructure investment programme across central & local government. Special importance should be given to addressing telecommunication/ broadband access to homes and businesses  

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