Solid growth, solid business confidence don't tell the entire story

The economy starts the year with a fair head of steam up and business confidence high.

The gross domestic product data released just before Christmas recorded growth of 1.1 per cent in the September quarter, making 3.6 per cent for the year.

And this week's quarterly survey of business opinion (QSBO) from the New Zealand Institute of Economic Research found a net 26 per cent of firms confident about the general business situation.

Manufacturers, builders, retailers and services firms all reported higher output in the December quarter.

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Businesses continue to plan for expansion, NZIER senior economist Christina Leung said. Hiring and investment intentions remain high by historical standards. Overall, the survey "indicates continued solid momentum in the New Zealand economy which should provide a buffer against the downside risks from unexpected results both here and abroad," she said.

The institute expects some moderation in economic growth this year, but for it still to remain above 3 per cent.

But a couple of caveats need to be borne in mind.

One is our tendency to insularity. If you live in New Zealand and it stretches to the horizon, it is easy to forget about the other 99.8 per cent of the world economy and its capacity to sideswipe us with some external shock. The risk is ever-present but it is especially elevated right now, not least because of what is being celebrated in Washington tomorrow (NZ time).

The other cautionary note is that while sentiment surveys like the QSBO convey valuable information, so do the hard data that emerge, albeit with a lag, from the statisticians.

If you drill down into the components of GDP, the picture that emerges is less cheerful than the headlines suggest.

It is all well and good that in the QSBO a net 16 per cent of firms expect to increase investment in plant and equipment over the next 12 months, and a net 11 per cent in buildings.

But the survey does not establish whether they follow through with that.

And the national accounts tell us that in the 12 months to last September, business investment of all forms rose just 1.2 per cent compared with the year before. For plant, machinery and equipment, the annual average increase was 1.5 per cent.

That does not look like the sort of increase needed to transform the country's sluggish productivity performance.

If you drill down into the components of GDP, the picture that emerges is less cheerful than the headlines suggest.

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In the latest September year - when the economy's output grew 3 per cent compared with the year before - the total number of paid hours worked according to the quarterly employment surveys rose 3.1 per cent, indicating output per hour was essentially flat.

Comparing the latest September quarter with the same period a year earlier tells a similar story: output up 3.5 per cent but paid hours up 3.4 per cent.

The largest component of GDP on the expenditure measure is private consumption. It was 5.4 per cent higher in the September quarter than in the same period a year earlier.

Over the same period the population grew 2.1 per cent. Even so, a 3.3 per cent rise in real per capita consumption is not bad.

Partial indicators for the December quarter suggest a similar rate of expansion.

Electronic card transactions, which account for more than 60 per cent of retail spending, were 5.2 per cent higher in the last three months of 2016 than in the same period a year earlier. And while that is a nominal increase, retail sales data in recent quarters have indicted deflation in the sector, with volumes growing faster than dollar sales.

The question is, how is this increase in consumer spending being financed?

Labour market incomes rose 1.3 per cent in the September quarter, making 5.3 per cent for the year.

But that was mainly the result of more people working.

The average wage rate rose just 1.6 per cent over the year, or 1.7 per cent if you include overtime and 1.8 per cent including the public sector.

With CPI inflation running at 0.4 per cent, that still represents reasonable real wage growth (and more than productivity would justify).

But the December statistics due next week are expected to record an inflation rate back above 1 per cent.

And the CPI does not include mortgage rates, which are expected to rise over the coming year, driven not by the Reserve Bank but by rising interest rates offshore putting upward pressure on banks' cost of funds.

In the year to November, household mortgage debt rose 9 per cent to $229 billion - outstripping income growth at a time when the debt-to-income ratio is already at a record high - while household deposits rose 7.5 per cent to $160b.

ANZ economists argue that such a gap between deposit growth and lending growth is unsustainable and that without a further ramping up of banks' offshore borrowing - undesirable from a financial stability perspective - retail interest rates would have to rise to attract more deposits and to slow lending.

As for the other components of GDP, government spending in the September quarter was 2.4 per cent higher than a year earlier. This does not include transfer payments like super and welfare benefits but it does include local government spending. At that rate it barely exceeded population growth of 2.1 per cent.

Finally, net exports. With imports consistently exceeding exports by the best part of $2b a quarter over the past two years, net exports subtract from GDP. That is despite terms of trade which, dairy notwithstanding, have been at historically favourable levels.

It is hard to be encouraged by the outlook for trade. World trade volumes have been growing much more slowly than world output for some time, reversing the previous trend.

And the United States is about to have a President with a primitive, protectionist, bilaterally focused, zero-sum view of international commerce.

President-elect Donald Trump has a lot more discretion in this area of policy than others.

Whether talk from team Trump of an across-the-board tariff comes to anything remains to be seen. In any case he seems determined to pick a fight with China.