Phil O'Reilly: Better productivity may beat our exchange rate monster

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The past few weeks have seen a lot of talk about the best way to resolve our exchange rate interest rate problem.

This is positive. I can't recall as much thoughtful discussion on any economic issue, even the reforms of the 1980s or the issues surrounding the 1987 crash.

The problem is complex. Inflationary pressures, most obvious in the housing market, drive the Reserve Bank to raise interest rates, making the New Zealand dollar more attractive to overseas investors and raising the exchange rate, making our exports less competitive.

Resulting lower growth reduces confidence and investment in the productive sector, prompting us to invest in housing and on it goes. It's a bit like the hydra in Greek mythology; the giant snake-like beast with seven heads - every time one head was chopped off, another appeared.

Our exchange rate/interest rate problem has many monster heads too: uncompetitive exports, under-investment in enterprise, over-investment in housing, over-gearing, housing unaffordability and more. It's becoming ever more obvious that the single weapon of interest rates is insufficient to deal with them all.

Some suggested remedies - capital gains taxes, trade-weighted exchange rates, mortgage levies, mortgage restrictions, interventions in the rental market and so on - are focused on a single aspect of the problem.

Instead, I'd like to focus more on the underlying health of the patient. How could we improve the general health of the environment for enterprise in New Zealand?

First, we could stop the growth in government spending - central and local. This wouldn't mean cutting spending, just restraining its growth. High government spending brings high tax. High tax puts a burden on New Zealand businesses and reduces the incomes of New Zealand families, reducing our living standards and making us poorer than citizens of other countries.

Lower incomes increase the need to borrow, part of the reason for increased interest rates. So there's a direct connection between high government spending and high interest rates.

We should also try for better quality spending. Poor spending decisions include interest-free student loans, Working for Families, and untargeted spending on items like rates rebates and superannuation (of course we should have policies that support students, working families, ratepayers and older citizens, but these should be of a much better quality).

Interest-free student loans encourage students to spend beyond their means without incentives to retire the debts as quickly as possible when they graduate. Working for Families effectively turns three-quarters of working families into welfare beneficiaries. Tax cuts would make them better off.

Lack of targeting in payments for things like superannuation and rates rebates means some receive assistance they don't need, and those in greatest need don't get enough.

In all these areas, better policy work could lead to better spending decisions.

Over-regulation makes it harder for our businesses to compete against overseas companies that are not so burdened with red tape. Proposed legislation and regulation should get proper cost-benefit analysis.

Productivity growth is fundamental to retaining international competitiveness - if resources can be better utilised offshore and used more efficiently, they will be. Strong productivity growth brings significant rises in real incomes without imposing added inflationary costs.

Of course, productivity grows best when there's competition. Selling assets in areas where public sector ownership is not essential would reduce government debt, get more commercial activity, discipline and efficiency, and counteract the tendency for SOEs to be subject to political interference.

Central government does not have to be a monopoly service provider to meet social and economic objectives, and local government would be able to reduce the rates burden through savings from contracting out services.

We also need to get the housing market working better. Some factors making housing unaffordable include artificial restriction of land near urban centres, delays and uncertainty in getting resource consents and building permits, and over regulation of the Building Act.

These are all elements needed to make the New Zealand business environment healthier. Some, like better spending decisions and less regulation, lie squarely with government, while productivity is an element that the business community must tackle. It's a problem worth tackling because a better business environment could well drive the many-headed monster away.

* Phil O'Reilly is Chief Executive, Business NZ

For a full consideration of specific policy tools, see Business NZ's publication OCR: The Sharpest Tool in the Box? Giving interest rates some help to control inflation, www.businessnz.org.nz, under commentaries.

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