The Bennett Newsletter
"Economic Outlook"
While the budget has provided very welcome income tax relief, it has done remarkably little to improve the country’s outlook. The crown’s debt, which was only $5 billion in 2008, will rise to $63 billion in 2014. Moreover, the net worth of core crown assets will decline steeply. The budget will stimulate an inflationary boom next year and add another chapter to New Zealand’s long record of budget deficits, high debt service charges and dangerously high current account deficits.
Treasury’s main scenario is a rosy one of increasing GDP, although that depends in part on rises in GST as nominal GDP is GST inclusive. The rosy scenario includes rising revenue and expenditure, so despite the rhetoric of a smaller public economy, it will wax larger. There may be more investment, but it is the old story of residential investment being the largest and expected to “rise sharply”.
Moreover, prodigal personal over-spending is expected to increase, albeit at a lower rate. In March 2009, the average household dis-saved by 13.7%. That means for every $100 of after-tax income, households spent $113.70. This is expected to fall to $107 per $100 income by 2014. But watch out for this year, when expenditure will surge to avoid higher GST!
I believe that the colossal increase in debt in the next 5 years is a grave risk, which could result in both credit-downgrades and an inability to cope with a possible double-dip recession. According to Treasury’s basic scenario, New Zealand’s total net debt will soar, in the next five years, from 80% of GDP now to 100% of GDP in 2014. This rise is understated as GDP will increase under inflationary pressures. Any further shock, or major difficulty in finding foreign-funders of our debt (and we need off-shore funders as our savings are woefully inadequate) could create the kind of crisis that requires IMF help.
Is mounting debt in our best long term interests? My feeling that it is imprudent is shared by the IMF. It is concerned about NZ’s gross debt, especially in combination with fiscal deficits lasting until 2016. It also believes this will result in a high dollar, partly because interest rates will increase. The IMF regrets also that its advice to Government to cut spending had been rejected.
The IMF also is more pessimistic than Treasury about economic growth rates because of weakness in NZ’s external position and low saving rates. New Zealand’s overseas debt is a “key vulnerability” as 44% of it has maturity dates of less than 12 months.
The OECD backs this up, saying that the recovery “may be weaker than in the past” because of the debt-overhang, sticky unemployment, and uncertainty about investment. New Zealand was in the forefront of those economies which stimulated their economies in the crisis, and both agencies imply that it is time to set the house in order by paying back debt, and regaining footing in case the crisis takes a turn for the worst.
There has been a lot of concern expressed by international economists recently that the world economy could be weakened by the rundown of stimulus measures, increased cost of credit resulting from the sovereign debt crisis, slowing GDP in many counties because of austerity measures in slashing budgets and stimulus, and the USA M3 decreasing as fast as it did in 1929-1933. Much rests upon the emerging markets driving global growth, but there are many question marks there as global capital flows are fickle and the rising cost of commodities imposes undue costs.
Treasury discusses a “downside scenario”. It examines a subdued global recovery lowering growth by around 1% p.a. The main effect is to lower exports and therefore domestic income. Tightening credit would reduce domestic investment. Lower credit and confidence could cause house prices to fall in real terms by 7% in the year to March 2011. Unemployment, even with a 2% growth rate, would remain above 6% for an extended period. GDP could fall by $22 billion over five years.
The “downside scenario” lowers tax revenue and leads to higher debt. This illustrates another element of the budget: the failure to broaden significantly the revenue base by taxing fixed assets like housing and land. The economy is very dependent upon external stimulus and external funding. The budget changes are credited with raising efficiency by about 0.4% p.a. in the short term, but as productivity is very low, recovery from the recession is muted and very gradual.
The budget is credited with giving a permanent lift in the growth rate of 0.45 rising to 0.9%. This must be mainly due to increased labour participation. I question this. There is no convincing argument that additional labour will significantly raise productivity( an inverse relationship is usual) and I would not expect higher productivity without significant investment.
Rising inflation is worrying. Next year the CPI is expected to rise about 5.9%, driven by a GST increase, tobacco excise, ETC and ACC exactions. The rate will decline thereafter, but the Reserve Bank might wish to intervene on the side of caution and raise interest rates. In that case, other things being equal, the dollar might strengthen, causing headwinds for exports and a tailwind for imports.
There is enough stimulus in the budget to boost the economy next year. There will be an air of prosperity as the tax cuts take full effect, residential construction surges, and economic growth rises to the top of its trend. The government should retain its popularity, certainly with most wage and salary earners.
The Treasury’s Economic and Fiscal Update is a very cogent and persuasive analysis. It is should not be treated as gospel because there are many uncertainties, and because economists often get things wrong. Their models give too little idea of the distribution of risk around their most probable outcome.
The Bank of England’s Medium-term macro Model repeatedly caused the Bank to set interest rates too high, its replacement uses 300 equations but its results are contested. The Federal Reserve has made many errors too, even though the board of governors in Washington alone employs 450 economists, most with Ph.Ds. Its predictive power is not impressive.
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