Former Economics Editor of the NZ Herald

Brian Fallow: What could possibly go wrong?

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As NZ basks, a host of dangers await in the global economy. Illustration / Anna Crichton
As NZ basks, a host of dangers await in the global economy. Illustration / Anna Crichton

The economic cycle is in the Goldilocks zone - not too hot, not too cold, just right - to judge by the latest quarterly survey of business opinion by the New Zealand Institute of Economic Research.

Business confidence is strong and activity indicators point to output growth well north of 3 per cent, but there is scant sign of inflation and the way seems clear for a further cut or two in the official cash rate. The NZIER's own forecast is for GDP growth of 3.5 per cent this year and around 3 per cent a year over the next five years.

In the fairytale, when the bears come home, Goldilocks, the larcenous blonde intruder, escapes into the forest with nothing worse than a nasty fright. Will we be so lucky?

As usual, the main threat to the cheerful domestic outlook is that we will be sideswiped by some shock from the other 99.8 per cent of the world economy. As the grandees gather in Washington for the annual meetings of the International Monetary Fund and World Bank, it is unlikely the mood is one of serenity and mutual back-slapping.

But first, the good news. The QSBO found firms' views of the general business situation and of their own prospects to be up on the June survey and well above their long-run trends.

Investment intentions for plant and machinery are steady at historically high levels, while hiring intentions are at the highest level for 40 years.

Actual hiring over the past three months, on the other hand, declined. That stark divergence between the expected and the experienced may be explained by the fact that firms reported a high level of difficulty finding the skilled labour they need.

At a time when the net migration gain is exceptionally strong, what is wrong with that picture?

"The surge in net migration has expanded the labour force but the increase in work visas has been largely for labourers, tradespeople and personal service workers," the institute says.

"In Auckland, where migration inflows are concentrated, firms report greater ease in finding unskilled labour but greater difficulty in finding skilled labour."

But even if a tightening labour market presages higher wage growth down the track, there is little evidence of inflation in this survey.

Despite strong experienced and expected demand for what they do, firms seem to lack pricing power. They report increased costs, but a net 4 per cent report cutting their own prices in the past three months, while a net 7 per cent (down from 11 per cent in June) expect to raise their prices in the three months ahead.

The rise in business confidence is evident across most regions, the institute says. The prospect of a higher dairy payout has seen optimists outnumber pessimists in dairying regions like Taranaki and Southland, while confidence is strongest in tourism-intensive region such as Auckland, Otago and the Bay of Plenty.

But the high dollar is a headwind for exporting manufacturers, whose export expectations (which in any case tend to be optimistic) have declined.

And little wonder. The international context is one of sluggish economic growth and even weaker growth in world trade.

New Zealand economy may be whistling a happy tune but it sits inside a world economy which resembles a boat with an underpowered outboard motor.

The IMF, in its world economic outlook released this week, has cut its forecasts yet again. It now expects world gross domestic product to grow by 3.1 per cent this year, which is only about three-quarters of its average rate in the two decades before the global financial crisis.

The advanced economies are collectively projected to grow by just 1.6 per cent this year, down from an uninspiring 2.1 per cent in 2015.

World trade is expected to eke out growth of just 2.3 per cent this year, the weakest pace since the recession year 2009 and only about a third of its annual pace in the 20 years before the GFC.

And in its global financial stability report, the IMF says the risks are building.

"The continued slowdown in global growth has prompted financial markets to expect an extended period of low inflation and low interest rates and an even longer delay in normalising monetary policy," it says.

"The political climate is unsettled in many countries. A lack of income growth and a rise in inequality have opened the door for populist and inward-looking policies. These developments make it even harder to tackle legacy problems, further expose economies and markets to shocks, and raise the risk of a gradual slide into economic and financial stagnation."

Not exactly a heartening message.

But it is clearly justified in the wake of the Brexit vote and polling which indicates millions and millions of Americans look at Donald Trump - a man clearly unfit by any standard of knowledge, experience, temperament or character for that high office - and see a potential President.

But even if next month's election removes the shadow of Trump from the outlook, other risks remain.

One is that in the advanced economies a protracted period of sluggish growth and weak inflation (excluding asset prices bloated by extraordinarily loose monetary policy) will drive down inflation expectations "causing expected real interest rates to rise and spending to decline, eventually feeding back into even weaker overall growth and inflation".

Meanwhile, in China it has become clear that Beijing gives a higher priority to its growth target than its reform agenda, even if the cost of the former is a potentially toxic build-up of debt in the financial system. This raises the risk of, in decorous IMF-speak, "a disruptive adjustment".

We are left with a picture of a New Zealand economy that may be whistling a happy tune but sits inside a world economy which resembles a boat with an underpowered outboard motor, and is lying low in the water when the swells are rising.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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