Brian Fallow on the economy

Brian Fallow is the Herald's Economics Editor

Brian Fallow: Singing all the way to the Reserve Bank

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The economy hasn't looked so good for decades but skills shortages and low productivity could dent growth

The $40 billion Christchurch rebuild is a bright spot on the rosy economic picture. Photo / APN
The $40 billion Christchurch rebuild is a bright spot on the rosy economic picture. Photo / APN

There has been a consistently cheerful tenor to the economic news of late.

The terms of trade are the most favourable for 40 years, boosting national income.

The $40 billion task of rebuilding Christchurch is well under way.

Business confidence is at a 20-year high and consumer confidence is strong as well.

The net inflow of migrants is at a 10-year high.
Even that cyclical laggard, the labour market, has been delivering better numbers.

But the factors that are cited as propelling the upswing all relate to the demand side of the economy.

That is all well and good and has lifted us out of the deepest recession and slowest recovery since the 1970s. We'll take it.

The longevity of this expansion, however, depends on what happens on the supply side, to the rate at which we can increase the economy's capacity to produce the goods and services in demand or to earn the foreign exchange to pay for those we import.

"That is all well and good and has lifted us out of the deepest recession and slowest recovery since the 1970s.

We'll take it."

Brian Fallow

There the signs and portents are not quite so encouraging.

Estimates of the potential or sustainable growth rate - roughly the rate the economy can grow with full employment and without inflation becoming a problem - are about 2.5 per cent a year.

That is less than the actual growth rate expected over the next couple of years, which is why the Reserve Bank is starting to raise interest rates from the historic lows they have been at for four of the past five years.

Growing faster than potential is fine, indeed desirable, while there is still some slack in the economy.

With 147,000 people unemployed and a further 122,000 underemployed (who want to work longer hours), a shortage of workers would seem unlikely, were it not for the problem of a mismatch between the people available and the skills in demand.

The other big driver of potential is productivity, which historically has not been a strong point in New Zealand.

ANZ's chief economist, Cameron Bagrie, in forecasts released last week, says that while the level of business investment has increased by close to 50 per cent from its trough in 2009, it is only back to where it was in 2007, and is smaller as a share of economic activity. Nevertheless, Bagrie is generally optimistic about productivity gains firms have made during the lean years, using terms like "fighting fit".

Infometrics, in economic forecasts released this week, also notes the rebound in private sector investing and picks it to rise to 20 per cent of gross domestic product by 2016. "We believe the economy has more scope to grow over the next couple of years than some other forecasters are saying before capacity constraints become a problem."

"Meanwhile, much of the North Island is looking pretty dry, suggesting we cannot count on the combination of sky-high export prices and record volumes continuing next season."
Brian Fallow

Much of the upswing is driven by demand for construction. The Canterbury rebuild will ramp up rapidly this year and next year before peaking in 2016.

In addition there is pent-up demand for Auckland housing, the need for seismic strengthening of a lot of commercial and public buildings and still some leaky homes to repair.

The problem is that the building industry, as the Productivity Commission found when it looked at housing affordability in 2012, is hardly a paragon of productivity.

It cited Statistics New Zealand data which had construction recording the second lowest productivity growth of any sector - that is, almost none - and research by the New Zealand Institute of Economic Research that found productivity levels falling well short of its counterparts in Australia and Britain.

"The industry is dominated by small firms that build one house at a time, are unable to generate economies of scale and often lack management capability," the commission said.

"It is fragmented vertically, which presents difficulties in the management of the supply chain."

The commission noted our preference for one-off bespoke designs and suggested building costs could be reduced through greater use of standardised designs and building techniques.

We get some fresh productivity numbers from the statisticians later this month. It will be interesting to see if there is any improvement.

But as far as the building industry goes, consents data continue to record an average area for new dwellings of around 200sq m and an average cost north of $300,000 (and that includes apartments), suggesting not a lot has changed.

The other main factor underpinning the upswing is terms of trade - relative prices of the kinds of thing we export as against what we import - higher than we have seen for 40 years.

To be an efficient producer of the foods of affluence when Asia's middle class is growing rapidly is undoubtedly a reason to be optimistic about the country's prospects.

Fonterra's latest payout forecast suggests an additional $5 billion or so will flow to New Zealand's dairy farmers this season. How much of that they spend and how much they apply to repaying debt remains to be seen but it will certainly boost demand in the economy.

The flipside of the high terms of trade is an exchange rate uncomfortably high for exporters of things other than primary commodities.

This is especially true for manufacturers whose main export market, Australia, is struggling.

"The flipside of the high terms of trade is an exchange rate uncomfortably high for exporters of things other than primary commodities."
Brian Fallow

The adjustment Australia is having to make to being on the downward slope of its mining investment boom provides a bit of a warning of what is ahead when the peak of our construction boom is over.

Meanwhile, much of the North Island is looking pretty dry, suggesting we cannot count on the combination of sky-high export prices and record volumes continuing next season.

It is likely, also, that one reason for the prevailing high levels of consumer confidence has been the combination of rising house prices and low mortgage rates.

But housing market turnover has slowed since the Reserve Bank introduced its restrictions on low-deposit lending last October.

Westpac economists reckon last month's sales, seasonally adjusted, were down 2.4 per cent, making a cumulative 13.4 per cent decline since the curbs were introduced. And fixed-term mortgage rates have already risen in anticipation of the monetary policy tightening to come.

Some partial indicators, like electronic card transactions and truck movements reported this week, suggest some tapering off in the pace of expansion and that last September's rip-roaring 1.4 per cent might prove the peak for quarterly growth.

All in all more a case for quietly humming "Happy days are here again" than launching into a rousing rendition of the Hallelujah Chorus.

- NZ Herald

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