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Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: Time to take stock of $40b rebuild

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Activity good news for construction and manufacturing industries, but could hinder rebalancing of economy.

The construction industry is expected to run at full capacity for longer than previously thought. Photo / The Star
The construction industry is expected to run at full capacity for longer than previously thought. Photo / The Star

The Government's latest estimate of the cost of earthquake-related rebuilding work in Canterbury is an arrestingly large number - $40 billion.

That's twice the estimate on Budget day a year ago and $10 billion more than was built into the Treasury's forecasts at the half-year update last December.

It is equivalent to nearly 20 per cent of the economy's annual output. It is $9000 for every man, woman and child in the country. It is, in short, a lot of money.

So it may be timely to reflect a little on where the money comes from and where it will go, and on how much it is a positive and how much a negative for the economy - because it is both.

One of the things that has softened the financial blow of the earthquakes is the high level of foreign reinsurance cover.

Statistics New Zealand estimates that, as at the end of 2012, total international insurance claims for all the Canterbury earthquakes amounted to $17.9 billion. Of that sum, $8 billion had been settled with overseas reinsurers, leaving $9.9 billion of claims outstanding (and counted as foreign assets in the meantime).

But the buck does not stop there.

A claim of this scale is conspicuous by global and historical standards and will have consequences for the pricing and scope of insurance in the future.

Premiums are rising.

The deductible or excess which property owners, especially of commercial buildings, have to bear has risen. And open-ended full-replacement policies are being phased out.

Insurance will represent a significantly higher share of the cost of living and the cost of doing business from here on.

The next biggest share of the earthquake costs falls to the Government, including the Earthquake Commission.

The estimate of that is now $15 billion, up from $13 billion a year ago and $9 billion in Budget 2011.

Most of that the Government has to borrow.

EQC's natural disaster fund, to which households contribute through a levy collected with their insurance premiums, stood at just under $6 billion when the first of the Canterbury earthquakes struck.

However, the lion's share of the fund was invested in Government stock, which the Government has to buy back if EQC needs the money, as it certainly does now.

The Government has yet to decide how EQC is to be recapitalised.

Right now the Government can borrow relatively cheaply. Its most recent tender of 10-year bonds got away at an average yield of 3.2 per cent.

But servicing and repaying that debt will be a charge on future taxpayers.

And like higher insurance costs, it will divert spending from other things.

Between them, the reinsurance inflows and the fiscal cost account for most of the $40 billion projected rebuild cost.

Nevertheless it still leaves a hefty cost to be borne by the people of Canterbury, both directly and as ratepayers.

As for where the money goes, the first sector to benefit is, obviously, construction.

Building consents data released this week recorded the highest monthly total for Canterbury dwellings in six years.

But we ain't seen nothing yet. So far, since the first earthquake in September 2010, the statisticians reckon just $910 million of earthquake-related building consents have been issued, the majority of it ($570 million) non-residential.

Westpac's economists in their quarterly forecasts released yesterday expect double-digit growth in housing construction nationwide over the next two years, led by the Canterbury rebuild but with an upturn in the under-supplied Auckland market as well and modest growth elsewhere.

The most likely implication of the recent increase in official estimates of the scale of the rebuild is that the construction industry will run at full capacity for even longer than previously thought, they say.

"That will mean more sustained pressure on the nation's resources, more persistent increases in construction costs, and ultimately a more persistent uptick in domestic inflation."

The rebuild is also a welcome fillip to the manufacturing sector, much of which is devoted to supplying inputs to the construction sector.

The Reserve Bank estimates that a 1 per cent expansion in construction activity requires a 0.38 per cent expansion in manufacturing activity.

In addition, as ASB chief economist Nick Tuffley points out, the rebuild will provide work for all sorts of services - from engineers and architects, through transport and logistics, to financial services and recruitment agencies.

Some of the rebuild spend will "leak" overseas, as machinery, material and workers are imported.

But as far as the workforce recruited overseas are concerned, it is only that part of their wages either saved or remitted home, that is lost to the New Zealand economy.

Economic forecasters are struggling to quantify the effects as the money spent on the rebuild spreads out to regions other than Canterbury and sectors other than construction. We have, fortunately, no experience of recovery from a natural disaster on this scale to go on.

ANZ chief economist Cameron Bagrie expects the rebuild effort to peak in 2015 or early 2016 in terms of adding to growth. There will still be an awful lot of work there, in terms of the level of activity, for another 10 years, he says.

"But in terms of incremental additions to growth it will probably peak around 2015/16, which is ironically when the fiscal screws are on the most intensely as well."

To the extent that the economy's resources are drawn into rebuilding Christchurch, or relieving housing shortages in Auckland for that matter, it gets in the way of the rebalancing of the economy towards more effort going into earning our living as a trading nation.

That rebalancing is something that badly needs to happen.

The Reserve Bank will be alert for signs of inflationary pressures from the rebuild spilling over into the broader economy.

Westpac chief economist Dominick Stephens believes the inflationary consequences of the rebuild and rising house prices will be greater than the Reserve Bank or the financial markets currently expect.

"Construction cost inflation in the Canterbury region is now quite intense, and could begin leaking to other regions. And house prices show no sign of slowing their ascent," he says.

"Over history, construction activity and rising house prices have been important sources of domestic inflation pressures, and we believe that pattern will repeat."

The result may be a combination of both higher interest rates and exchange rates, which is the last thing we need from the standpoint of rebalancing the economy.

- NZ Herald

Brian Fallow

The Economics Editor of the NZ Herald

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