Alan Bollard, New Zealand Listener
New Zealand is at a turning point in its response to the global pandemic. As government debt soars and GDP plunges, former Reserve Bank governor Alan Bollard considers lessons from past crises.
During the Covid-19 lockdown, many people bought Colombian author Gabriel García Márquez's classic book Love in the Time of Cholera. But as New Zealand is isolated by continuing waves of pandemic and closed borders, we might instead look for guidance to his earlier classic One Hundred Years of Solitude, a story about our inability to learn from the repeated lessons of history.
Where did This come from?
Only six months ago, the world suffered a pandemic shock: sudden, unexpected, highly contagious, not particularly fatal, but nevertheless causing global health concerns. The pandemic hit the world's economy in a devastating way, causing an unusual synchronised contraction. The International Monetary Fund notes this is the first time that most of the world has gone into recession.
Where the world's economies go next depends on our success in containing Covid-19. The OECD has forecast the possibility of a second wave causing even more economic damage.
We must accept there is much we still do not know about the virus and its future economic effects. We are learning as we go along and this is going to be uncomfortable.
The shock has been so unusual that we cannot interpret current economic data in a conventional way. Most countries have now recorded a jarring second quarter of recession. Even the strongest economies are vulnerable – Singapore contracted by almost 40 per cent in the period ended June 30.
Perversely, next quarter's economic data will show a record rebound but not enough to get us back where we were. Unemployment figures have not looked too bad, but that is mainly because of temporary government support. If there was ever a good time for a pandemic, this is not it, with high global debt, slowing trade, worsening climate-change worries and serious US-China tensions.
Our early lockdown was quite stringent by OECD measures, and consequently caused significant short-term economic damage, with almost all business activity suffering. Our second-quarter gross domestic product contracted by 12 per cent, worse than the OECD average. Some of this impact has been cushioned by fiscal policy: speedy Government support for jobs and businesses.
The $62 billion of Covid-19 funds announced in the Budget has now largely been committed. Some of the job subsidies, business support and infrastructure spending will probably ultimately prove to be of low quality, but importantly, it has been a speedy stimulus to the economy and to confidence.
Monetary policy has been supportive but cannot do a lot more: interest rates are already near zero and the Reserve Bank has tweaked several macro-financial tools. It is offering quantitative easing by financing government bonds in the secondary market. There have been calls for this to go further, by directly financing government debt (a risky and radical move) or by sending interest rates negative (but this will not stimulate spending).
In my view, the most important role of the Reserve Bank now is to ensure the banking system has plenty of liquidity as it comes under strain from non-performing business loans and mortgage defaults that lie ahead.
We expect improvements in Covid-19 identification, tracking, treatment and inoculation. But contrary to some of the breathless media accounts of new vaccines, it seems likely that the disease will continue to haunt the world for several more years, there will continue to be border controls, there may be further sporadic lockdowns and our economy will have to adjust.
It is clear the world is going through a major recession. However, New Zealand is fortunate to be more economically dependent on East Asian economies than on the slower-recovering European and American ones. Consequently, our commodity prices are still relatively healthy.
Some locked-down services have now recovered. But other sectors of the domestic economy are seriously troubled: the hospitality industry is in deep strife, particularly those parts dependent on international tourists that cannot re-adjust to domestic demand. Some parts of the retail industry on high streets and in shopping malls are being displaced by digital ordering, and they will close when their leases terminate. Some office space is now in oversupply as a result of work-from-home technologies, and we will soon see valuation write-downs of commercial property. The construction industry is suffering higher costs from Covid-19. And some other traditional businesses that are being digitally challenged are facing closure.
New Zealand will return to economic growth, but it is unclear when and whether this will be a rapid V-shaped recovery, a slower U-shaped one or even a second-wave W-shape. The latest Treasury pre-election forecasts are for two years of contraction, then a reasonably strong bounce-back.
Compared with what we were expecting at the beginning of the year, this implies that we have lost several years of growth and that after that, our growth path may be slower than in the past because of lower productivity. We are not going to be as well off as we had expected.
Cost of the Stimulus
Allocating $62 billion of extra expenditure means that government commitments are a third bigger than a year ago and we face a large fiscal deficit ahead. This is the time to acknowledge that various ministers of finance and the Treasury have done a good job in preparing the public accounts for an emergency.
Commencing from very low levels, our net government debt will grow rapidly over the next few years to about 55 per cent of GDP. Financing this in international sovereign debt markets will be a challenge but probably a manageable one.
However, the massive sovereign borrowing that will result from the US$10 trillion of Covid-19 stimulus worldwide means some less-well-managed countries are going to face funding disruption. At the moment, New Zealand can borrow at very low interest rates, but these rates will probably rise thanks to world demand for funds, and our debt-servicing costs will mount.
Over the next few years, governments will need to reduce this debt. The least painful way is by encouraging strong GDP growth, but this will be difficult as long as Covid-19 cases continue. The other ways are to repay debt from general taxes (which may slow growth), special Covid-19 levies (which will be politically difficult) and inflation (which penalises savings). Some have even suggested we renounce the debt, but that would mean we would never borrow on good terms ever again.
None of these options look attractive, and they all have distributive implications – meaning different parts of the population will pay. Following the difficult experiences of countries in the global financial crisis, economists have been calling for austerity to be avoided and debt to be reduced very slowly (government forecasts say a decade). But this is equivalent to sentencing the next generation to pay for this generation's pandemic mistakes. It will be a hard choice.
Paying for the Recession
If the fiscal cost of our Covid-19 relief is about $62 billion, the full economic costs from disrupted activity and forgone growth are going to be many times higher. Who will bear these costs? They will probably fall unequally across New Zealanders.
Some examples: younger people are already affected because of restrictions on schooling, tertiary education and mobility. The 2020-21 cohort of first-time job-seekers will be especially hard-hit by employment cutbacks.
Those in marginalised, low-skilled and casual jobs are particularly at risk, meaning there will be particular effects on Māori and Pacific people in the labour force and also on some migrant groups – this at a time when government social expenditure will be stressed. Those who retain their jobs may face pressure to accept wage cuts, with the lockdown increasing pressure for faster automation.
This is a services-sector recession and that affects female workers more heavily. (On the other hand, those in the public sector have been relatively protected.) There has already been a sharp reduction in labour-force participation, mainly borne by women and those nearing retirement age. Older people have been affected by pressures on health and mobility.
Who stands to gain?
So far, the housing sector looks reasonably buoyant, which is important for confidence, because housing constitutes most of the wealth that households hold. Demand for housing has been lessened by the loss of tourists and the emigration of many visa-holders but stimulated by the return of around 50,000 overseas New Zealanders so far, and we do not yet understand what broader economic effects this might have.
With the subsidised entry arrangements these returnees enjoy, New Zealand taxpayers are starting to look at them as fair-weather free-riders. But some may use their savings and business experiences to help generate the predicted wave of new business start-ups. Already there are many technology-driven entrepreneurs here who are seeing interesting new commercial opportunities in a digital Covid-19 world.
Shouldering the Burden
Covid-19 is presenting us with the largest economic challenge in a generation. To find economic parallels, we might look back to World War II, with its big growth of government, authoritarian controls and heavy debt burdens. As John Maynard Keynes pointed out in his radical 1940 publication How to Pay for the War, these economic costs can be moved to different parts of the population, but they cannot be avoided.
This article is about the economic effects of Covid-19. But the waves of pandemics and the isolation of borders remind us to heed García Márquez's lessons of history: we should expect social and political problems ahead, led by those most affected by this.
Economist Dr Alan Bollard chairs the Infrastructure Commission.