Brian Fallow: Growth of jobs best among the positive pointers

The economic backdrop to this week's Budget is a lot brighter than it was a year ago or even at the time of the half-year update last December.

The economy has been growing again for a year now and that is finally being felt where it counts, in the labour market. Unemployment fell in the March quarter, when for seasonal reasons it usually rises. On that front it looks like the worst is over.

But Finance Minister Bill English has warned that the recovery in the economy's fortunes won't bring any dramatic changes to the Budget's fiscal forecasts.

When it comes to the economic outlook it is, as usual, possible to paint either an optimistic or a pessimistic picture.

The happy story goes like this: not only is the economy recovering, it is the right sort of recovery - export-led, rather than one based on a return to the domestic borrow-and-spend binge of the last boom.

We have has just recorded the first quarterly trade surplus for eight years.

Asia and Australia, which account for nearly half our trade, are going strong and this is reflected in export commodity prices which are at all-time highs, even when converted back into New Zealand dollars.

Manufacturing is expanding again after two horrible years, aided by the most favourable exchange rate with Australia in nearly 10 years.

Meanwhile households' financial position has largely recovered from the devastation of the global financial crisis; their net wealth rose $47 billion last year, after falling $58 billion in 2008.

The less sanguine view goes like this: the global economic recovery is fragile, a picture more of convalescence than rude good health. Most Western economies are heavily debt-laden, some perilously so, while China is showing many of the symptoms of a bubble economy.

And for firms chasing the New Zealand consumer's dollar, it is all about what is happening to incomes and the claims on those incomes.

The job market may be moving in the right direction again, but the improvement could be slow.

During the recession employment fell less than output.

Instead, average hours worked per employee fell and output per hour fell too.

This lessened the social impact of the recession but it also means firms are expected to restore hours and rebuild productivity before making deep inroads into unemployment.

While unemployment may have peaked, it remains high by the standards of recent years. This is not an environment where rip-roaring growth in wages and salaries can be expected.

No wonder retail spending remains subdued.

While house prices are back to within 3 or 4 per cent of their all-time highs in late 2007, the cost of servicing the associated mortgage debt is set to rise relentlessly. Reserve Bank governor Alan Bollard is expected to start next month the process of pushing interest rates back to normal levels, and the financial markets expect the official cash rate to be 2 percentage points higher by this time next year.

Meanwhile petrol, diesel and electricity prices are set to rise after the emissions trading scheme kicks in on July 1.

April's increase in ACC levies has already quietly pre-empted about half of the income tax cuts people can expect in the Budget.

And the expected increase in GST will lead to a one-off rise in prices of 2 per cent.

Overall the Budget's tax changes are supposed to be "broadly revenue neutral" which means that they will not, on a net basis, increase households' collective spending power. Indeed, part of the point of switching the tax burden from taxing incomes to taxing consumption is to encourage people to spend less and save more of their incomes.

On the Government spending side belts are being tightened. Mr English has been very clear that the cap of $1.1 billion of new money heralded in last year's Budget will be adhered to.

Most of the public sector will have to fund any new spending by "reprioritising" - code for scrapping or scaling back existing programmes. This, Mr English has warned, is going to be a fact of bureaucratic life for years to come.

"It would be futile to launch a one-off package of big-bang reforms that pleases a few commentators, but sparks an overwhelming public backlash," Mr English said in a recent speech.

"We've seen this happen in New Zealand before. History shows this approach has been followed by extended periods of economic policy inertia and - most damaging of all - economic underperformance."