Economist sounds growth rate alarm

The economy's sustainable growth rate may be weaker than policymakers have assumed, with implications for interest rates, debt levels and, potentially, New Zealand's credit rating.

The Reserve Bank currently estimates the potential growth rate - the rate the economy can sustain over time without inflation becoming a problem - as about 3.25 per cent.

It is a vital calculation for the bank to make when setting interest rates, but 3.25 per cent seems high to ANZ National Bank chief economist Cameron Bagrie.

He points to the fact that the economy's resources remain stretched even when the economy is growing at less than 2 per cent and has been for some time.

The unemployment rate is at historic lows and last week's quarterly survey of business opinion found little spare capacity in the rate at which manufacturers and builders are running their plant.

Gross domestic product growth averaged 3.2 per cent between 1995 and 2005, but only 1.3 percentage points of that was higher labour productivity. The rest was due to population growth and a higher proportion of the population working.

"Certainly population growth continues to provide at least 1 percentage point to growth, thanks to steady net migration gains.

"But ultimately an economy's long-term potential growth has to come from sustained productivity gains - something which is glaringly absent from the economy at the moment," said Bagrie.

The potential growth rate does not only affect monetary policy decisions. It affects the value of companies, which depends partly on how strong the whole economy is going to grow. It affects bank decisions about how much debt borrowers can prudently undertake.

And it affects the Government's fiscal forecasts. "If trend growth, the key driver of tax revenue, is indeed lower, the fiscal forecast will be over-optimistic and a credit downgrade will be one step closer." Bagrie admits he has more questions than answers. He wonders:

* Are years of underinvestment catching up on us? Despite a surge in business investment over the past few years, the country's productive capital stock has been on a trend decline since 1993. Is the fixation with housing leading to underinvestment in more productive areas?

* Why has the average number of hours worked per employee been on a falling trend over the past few years? Is it a reflection of tax bracket creep, and the high effective marginal tax rates as family tax credits and welfare payments abate?

* Is the gradual re-regulation of the economy having a material impact? Is the growing size of Government crowding out the private sector as both compete for scarce resources?

"When [Governor] Alan Bollard first came to the throne he made comments about the potential growth rate maybe being closer to 3.5 per cent than to 3 per cent and that it was time to give growth a go. That experiment has not been that successful," Bagrie said.

Not so fast

If the economy has less ability to expand without getting the speed wobbles:

* It will take a longer period of slow growth to dampen inflation.

* Company valuations will be lower.

* The "fiscal headroom" for tax cuts will be lower too.