Brian Gaynor: Kiwis spend up as Germans hold back

One of the great mysteries of the modern world is why do some economies perform better than others. The answer should be relatively simple, but it isn't.

The general consensus is that the German economy is much stronger than New Zealand's, that it has a higher rate of growth and is wealthier on a GDP per capita basis.

This widely held view is totally incorrect, as the New Zealand economy has outperformed the German economy in most areas in recent years.

The only similarities between New Zealand and Germany are that they have proportional representation and held general elections on the same weekend last month.

These elections, which ended in stalemates, focused a great deal of attention on the performance of the two economies.

The biggest differences between New Zealand and Germany are that we have a huge current account deficit, low unemployment and individuals are on a huge spending spree. Germany has a large current account surplus, high unemployment and consumers are keeping their hands in their pockets.

The combination of these factors has resulted in New Zealand achieving a higher rate of economic growth than Germany in each of the past six years.

Breaking this down into even simpler terms, the big difference between the two economies is consumer confidence.

The German export sector is doing extremely well and the country's current account surplus is expanding rapidly. As the accompanying table indicates, the Organisation for Economic Co-Operation and Development expects Germany to record a current account surplus of US$120.8 billion this year compared with US$105 billion last year and US$51.5 billion in 2003.

But the strong export performance is not flowing through to the domestic sector for several reasons, including the unwillingness of successive governments to initiate structural reforms.

Marginal tax rates are high and the labour market is highly regulated. It is difficult and expensive for businesses to lay off workers and this has resulted in low productivity growth.

The ageing population is also placing a major drain on the health sector and on Government expenditure. The business sector argues that the Government's large deficit is partly because of an inefficient public health sector.

There is also intense debate over the level of support for the area that was formerly East Germany.

Right-wing political parties argue that there is little incentive for the east to improve its economic performance. They claim that unemployment remains high and productivity is 30 per cent lower than the West.

There is no incentive for easterners to become more self-sufficient because of the high level of subsidisation. The OECD agrees that the high level of support from Berlin, and inefficient labour market policies, are a major impediment to the eastern states and has reduced their ability to adapt to market forces.

Although German consumer confidence picked up in August, it is still fairly anaemic. Germans are not borrowing and retail sales, as reflected by the real consumption figures, are flat.

The result is that the German economy is dead in the water and its strong performance during the 1970s and 1980s is a distant memory.

This makes it all the more surprising that Angela Merkel and her Christian Democrats (CDU) were unable to defeat Gerhard Schroeder's Social Democrats (SPD) in the general election.

Meanwhile, the New Zealand economy is booming, mainly because of the high level of consumer confidence, high because of the buoyant housing market and the ability and willingness of individuals to borrow against the rising value of their homes.

Although the Westpac McDermott Miller September 2005-quarter survey of consumer confidence was unchanged from the June quarter, it is still remarkably high. The latest index stood at 120.2. Any number above 100 is considered positive.

The index has fallen from a high of 130.2 in the December 2004 quarter, but gives no indication that consumers are going to materially curtail their spending.

Nevertheless, the latest survey noted that the slower economy is impacting on sentiment and the higher fuel prices are beginning to bite.

The main contributor to consumer confidence in New Zealand is the booming housing market.

The latest Real Estate Institute of New Zealand figures show that the August 2005 median national house price was $290,000 compared with $248,000 in August last year, $215,000 in August 2003 and $185,000 in August 2002.

That translates into a gain of 17 per cent in the latest year compared with 15 per cent in the August 2004 year and 16 per cent in the year ended August 2003. Housing markets have been particularly strong over the past 12 months in Taranaki, Northland and Waikato/Bay of Plenty/Gisborne.

A total of 8537 dwelling units were sold in August compared with 8143 in August last year and 10,222 in August 2003. These figures are well in excess of the number during August in the 1998 to 2001 period, and indicate that the market remains relatively strong.

The combination of rising house prices and aggressive lending by banks and other financial institutions has encouraged individuals to borrow against the increased value of their homes. Retailers report that consumers are using this to purchase big ticket items, particularly plasma televisions, other home entertainment products and appliances.

Total mortgage borrowings increased by 16.4 per cent in 2003 and 15.9 per cent last year compared with only 11.5 per cent and 0.3 per cent in Germany in the same periods.

Up-to-date figures show that New Zealand residential mortgage debt rose by 15 per cent in the July 2005 year compared with only 0.7 per cent in Germany in the June 2005 year.

The increase in mortgage debt is a powerful driving force behind the New Zealand economy.

There are two clear statements we can make about the New Zealand economy.

The first is that it is extremely difficult to predict the performance of the residential housing sector over the next year or so. The second is if a downturn in house prices occurs, it will have a marked impact on consumer confidence, consumer spending and GDP growth.

One of the more important influences on the housing market is migration and that is slowing. There was a net inflow of only 6620 in the August 2005 year compared with 19,290 in the August 2004 year.

There has been a negative outflow in five of the first eight months of the current year and a paltry net inflow of only 350 during this period.

A contributing factor to the poor German performance has been a steady reduction in net migration.

Although consumer spending plays a more important role in the economy than the current account, we cannot disregard New Zealand's burgeoning overseas deficit.

The deficit has been fuelled by the high level of offshore borrowing by the major banks, which is then loaned on to individuals and secured against residential property.

It is widely accepted that consumer confidence and spending is the main driving force behind a successful modern economy, even if some of this is funded by debt.

But New Zealand's strong economic performance would be on much more solid ground if a higher percentage of this borrowing was sourced from domestic savings rather than overseas lenders.

Disclosure of interest: Brian Gaynor is an executive director of Milford Asset Management.