An economic outlook

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 economy, 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 Productivity Growth
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 monetary policy 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.