Brian Fallow: Time is ripe to learn the lesson of recession

As business people turn their minds to life after the recession they need to beware the assumption that it is some kind of aberration and the economy will snap back to the way it was before.

The lesson of the recession is that in New Zealand, as elsewhere, much of the growth we enjoyed earlier in the decade was phony, unsustainable and based on people thinking they could borrow their way to a standard of living their incomes could not support.

Even when conditions normalise the trend growth rate will be slower, economists warn, perhaps 2.5 per cent instead of 3 per cent.

And there will be the long-awaited rebalancing, with resources focused more on the industries that earn the country a living as a trading nation, and less on those which are about domestic consumption.

This is already under way. Bank lending to households in March was up just 2.8 per cent on a year earlier, while lending to the farm sector was up 21.7 per cent.

But because New Zealand has had some factors which have moderated the recession it is easy to underestimate the severity of the global slump and therefore what tough going an export-led recovery will be.

Across the OECD, economic output shrank by 2.1 per cent in the first three months of this year, the steepest fall since OECD records began in 1960. The December 2008 quarter had been almost as bad, a 2 per cent contraction.

Only 61 per cent of our trade is with other OECD countries. But it is hard to see life getting a lot easier in export markets generally so long as the advanced economies, and world trade, are shrinking.

Export commodity prices, as measured by ANZ's index, have fallen by a third from their peak in the middle of last year in world price terms. Half of the fall has been offset by a fall in the lower dollar.

In March and April the index rose, however, a cumulative 3.5 per cent, and the rise was broad-based. Sheep meat prices did not enjoy the spike dairy did but have been rising steadily for a couple of years and are at a two-year high. But the dollar is also rising. It may be more a case of US dollar weakness, but the effect on export returns is the same. And now the US has joined the European Union in reinstating export subsidies on dairy products.

The trade balance is improving, though it remains deep in the red on an annual basis. The improvement reflects the fact that domestic demand is so weak, imports are falling. This is part of the rebalancing of an economy which had got badly out of kilter.

The housing boom, which saw house prices double between 2002 and 2007, turbocharged consumption to the point that by 2007 households were collectively spending $1.13 for every $1 of income. In the process it drove the country's overseas debt to a level where it has become a real constraint on the Government's financial options.

It also pushed house prices to nearly six times incomes, when the long-run average is less than four, and mortgage payments as a share of income to 40 per cent, when the long-run average is 30 per cent. This raised concerns about social effects - the ability of young couples to afford both a mortgage and children.

The subsequent fall in the housing market has reduced the multiple of house prices to incomes, but it is still above five and well above its long-run level.

The market is showing signs of renewed life. Turnover in March and April was markedly higher than any time in the previous year and the average number of days it takes to sell has come down.

Prices tend to lag turnover by about six months, which would suggest the bottom may not be far off. But that conclusion - positive as it would be for consumer sentiment - may be premature. Nationally, house prices are some 10 per cent lower than their peak at the start of last year, but that is only about half the fall the Reserve Bank reckons would be necessary to unwind the overvaluation which has built up.

And the housing market, like the rest of the economy, has yet to feel the worst of the employment cycle. Some forecasters expect the unemployment rate to climb from 5 per cent now to 8 per cent by the end of next year. That will be felt well beyond the families directly affected. It has a chilling effect on consumer confidence and will limit wage rises.

Some offset comes from a rising trend in net immigration, largely the result of fewer New Zealanders leaving for Australia. The net gain in April was 2200, the highest since January 2004. The last three months annualised would represent a gain of 22,000, about twice the long-run average but half the previous peak in 2003.

A surge in net immigration boosts both the demand and supply sides of the economy: more consumers and people needing to be housed, more workers and more entrepreneurs.

The net effect of all these influences is expected to be little growth in household consumption which makes up about 60 per cent of demand in the economy. It shrank by 0.7 per cent over 2008.

The Reserve Bank expects it to remain very weak this year and stage only a feeble recovery thereafter, to the point that by 2012 in per capita terms it will be lower than it is today. The consensus among private sector forecasters is, if anything, gloomier at least about the next two years.

Businesses which depend on chasing the consumer's discretionary dollar are in for a tough time for a while yet.