Interest rate relief will not come until inflation is under control and we have a way to go with non-tradable (domestic) inflation still at 5.8 per cent, and broad-based.
The path to lower inflation and interest rates has not been helped by fiscal policy continuing to be stimulatory in the coming 12 months. This is because populism has resulted in a front-loaded stimulus with cost savings back-loaded.
The economic outlook and associated tax revenue is inversely proportional to inflation. Sticky inflation requires continued tough times to break pricing power which dampens profits and wage growth.
This will not come easy in a country beset with pricing influence and lacking competition in key areas.
We are a long way from 2 per cent inflation.
The importance of productivity
If there is one thing we should be able to agree on is the importance of productivity. Without it we are going nowhere when it comes to living standards. Cost-cutting, spending reprioritisation, or if you are a local authority, jamming up local authority rates, is not sustainable.
Forget about economic indicators that gauge demand and how fast or not the economy is growing. The issue is supply. The availability and efficiency of resource utilisation such as labour and capital. They define the economic base on which our wellbeing is premised.
The Reserve Bank downgraded its projected estimate of the productive capacity of the economy in 2027 (what we call potential growth) in the May Monetary Policy Statement. This is down 3 percentage points in the last six months. Slower potential growth inhibits actual growth.
A recent Treasury paper on productivity noted that: “Productivity for the whole economy averaged 1.4 per cent per annum between 1993 and 2013 but averaged only 0.2 per cent per annum over the past 10 years.”
Based on an analysis of current trends in productivity drivers, the Treasury paper concludes that productivity growth is most likely to remain slow over the coming years. Capital productivity is consistently negative.
Look no further than Auckland’s unsustainable and unviable four stadiums mix as an example.
The 2024 Budget stated: “The key reason for Treasury’s downgraded economic growth forecast is a reassessment of the future productivity growth in New Zealand. This results in forecast potential GDP being 2 per cent lower by 2026 while labour productivity levels are around 3 per cent lower than in the Half Year Update.”
The latest OECD Economic Survey of New Zealand noted “the decline of almost 29 points in New Zealand’s average PISA [Programme for International Student Assessment] score between 2006 and 2018 will eventually reduce aggregate productivity levels by close to 4 percentage points”.
Four percentage points is equivalent to 20 years of multi-factor productivity growth at the current rate – or six years of labour productivity growth, and we have yet to see the education outcomes from 2019 to 2023.
Less growth means lower tax. Lower tax means less money to reinvest in wellbeing, that overused phrase that took over in recent years. Now that the torch has been shined more and more on productivity, we need to see substantive action in some critical areas that are productivity enablers.
Here are some examples.
Education is the primary battleground we need to get right
When the OECD states that declining school education performance and ongoing inequity are a “serious threat to New Zealand’s prosperity”, we are all on notice – households, business, and the Government.
Action is under way on some initiatives, including OECD recommendations to establish a more detailed national curriculum that specifies by subject the learning outcomes, competencies, core concepts and knowledge children should have acquired by years of education and to provide high-quality assessment and teaching materials.
There are two missing links.
The first is that school under-achievement is not just a function of schooling. Wider society ills such as poverty impact outcomes. The 2024 Budget painted a disturbing mismatch between the poverty aspirations/targets and the projections for poverty. Can someone explain why a benefit is linked to inflation and New Zealand Superannuation to wages?
The second is teacher remuneration. If we accept the basic principle that New Zealand’s economic future is critically dependent on education, a pathway to lifting teachers’ pay substantially and measuring outcomes needs to be implemented soon.
Competition
International evidence shows that competition is one of the most important drivers of long-term growth in productivity, according to the OECD.
Stop dilly-dallying around was the message from the OECD which recommended “a strategy of gradual escalation of intervention, from reducing barriers to entry to light-handed regulatory approaches and structural solutions such as the break-up of dominant players”.
This has thrown down the gauntlet to the Government. Look at retail electricity, ports, airports and, relatedly, airlines (domestically and on transtasman routes) and retail financial services. And re-examine retail building supplies, retail fuel and groceries. The scorecard (so far) in terms of Government action is zero.
Actually, more like minus two because the Commerce Commission just had its budget reduced.
The Government cannot have tigerish productivity aspirations and be a tabby when it comes to competition.
A more dynamic banking sector
The OECD’s Economic Survey of Australia said empirical research suggests that the productivity benefits of financial deepening are realised via business lending, rather than household lending. That is, you do not get wealthier selling more expensive houses to each other.
Home lending has gone from 50 per cent of total bank lending to 63 per cent in just over 20 years, accelerated of late by requiring banks to hold more capital. This has encouraged a shift to mortgage lending – the low productive asset.
The recent ding-dong between the Reserve Bank of New Zealand and the Commerce Commission – over whether banks holding more capital inhibits competition – missed the bigger picture. That is the channelling of more money into less productive areas.
Banks are making alpha returns but take little risk with high margins, elevated return on equity and low standard deviation of returns relative to international peers. The evidence was laid out in the Commerce Commission’s preliminary findings regarding bank competition.
The finger can be pointed at the Reserve Bank’s wider compliance requirements, bank leadership and a Government that seems oblivious to the evidence, appearing to be captured by the lobbyists and industry.
If you accept the basic proposition that the current financial intermediation model and approach is not conducive towards growing a productive economy built on substance, the next question is: when will the Government bite the bullet and look beyond personal banking?
It is time for the Commerce Commission to unleash fully and look at the business side of banking and reach beyond the retail examination they are currently undertaking.
Business investment is one of three pillars (the others being productivity and natural resources) we need to extract more out of over the coming years and that will require a reassessment of the credit intermediation regime.
A worrying trend for exports
Deteriorating trends for goods exports are weighing on productivity and economic performance as resources have moved from high productivity areas such as agriculture into others.
There has been an alarming decline in exports as a share of gross domestic product (GDP). This has fallen to 25 per cent of GDP. The previous National-led Government had an aspiration for exports to reach 40 per cent of GDP. We got to 31 per cent and it’s been downhill since.
The Reserve Bank’s latest Monetary Policy Statement had a feature on exports noting unwelcome trends.
Environmental restrictions, the economic cycle and a more fractured world does not bode well for doubling exports by value, which is the coalition Government’s stated aspiration. Yet our prosperity depends on it.
The Government is focused on market access when the real inhibitor is supply. That’s the factors of production; labour, capital, and our natural endowments. Addressing on-farm cost pressures. Port capacity. Unlocking the power of water/irrigation. State Highway 29. Hamilton’s Southern Links start date is four to 10 years.
The bottom line
The Government and business are not going to turn the dial in a meaningful way on productivity unless we are bold and forced to change. We need tough times to cement some real boldness and look at numerous perceived untouchables.
A shake-out is getting under way within central and local government, management, and boardrooms. It’s overdue.
