Brian Fallow: Edge of mire closer than we think

Everyone is stuck in the same mud and no one is on firm ground to tow the rest out. Photo / Mark Mitchell

While it may be valid to describe the global slump as the worst since the Great Depression of the 1930s, it seems the local version is not exceptionally severe.

The Treasury and the Reserve Bank have recently offered views of how this recession compares with others New Zealand has had over the past 50 years.

They may be tempting fate. This is necessarily based on their forecasts of how the rest of the recession will play out and we are not out of the woods yet.

But both the Treasury and the Reserve Bank expect the economy to begin growing again in the December quarter, after seven straight quarters of contraction.

That would make it twice as long as the average recession of the past 50 years and longer than any other in that period apart from the one which began in 1976.

It is also expected to be deeper than any recession in the past 50 years except the 1970s one.

The Reserve Bank expects the final peak-to-trough fall in the level of gross domestic product to be 3.3 per cent. That is deeper than the average 2.7 per cent, but not quite as bad as the 1970s' 4 per cent.

However, the Treasury makes the point that in per capita terms the current downturn would be the deepest. The reason is that this time net migration has behaved differently.

Normally net migration flows are pro-cyclical. They amplify what is happening to the economy. When it is doing well there are net inflows and when it it is not there are net outflows.

In 1976, net migration turned negative and by 1979 the net outflow reached 43,000, enough to cause the overall population to shrink.

By contrast, net migration has remained positive through this recession and has picked up markedly this year as pastures-new abroad no longer look greener.

Net inflows of migrants have served to underpin the housing market. This recession has already seen a steeper fall in real house prices than any of the previous six - again, apart from the one starting in late 1976.

The Reserve Bank expects real house prices to fall 20 per cent this time round, the Treasury 28 per cent. But either would be less severe than the 38 per cent fall recorded in the late 1970s.

In one key respect, however, this recession is more like that of the early 1990s, in that it was triggered by a financial crisis.

Then it was the 1987 sharemarket crash, whose flow-on effects included the need to bail out the Bank of New Zealand and left the economy vulnerable to the much milder global downturn of the early 1990s.

This time the wealth shock was the bursting of a housing bubble in 2007, reinforced by a global credit crunch as the same thing happened in the United States and elsewhere.

No bank bailout has been required this time, but households are much more exposed, having increased their debt from around 60 per cent of disposable income in the early 1990s to 160 per cent by 2008.

Combined with falling house prices and tougher lending criteria on the banks' part that is curbing households' scope to fund consumption through additional debt.

Add feeble wage growth as firms retrench - shedding, the Treasury estimates, another 100,000 jobs over the next couple of years - and you end up with its picture of four straight years of shrinking private consumption, stretching out until 2012.

The Treasury is, admittedly, at the gloomy end of the range of forecasters on this point.

But the Reserve Bank's forecasts also have a very weak outlook for consumer spending over the next three years.

It is the same story in other Anglo economies: the need for a prolonged period of payback for the excesses of the boom years with households reining in spending, reducing debt and increasing savings.

Reserve Bank forecasts for the four years 2008 to 2011 inclusive have New Zealand faring significantly better than the United States, Britain or Japan.

Australia does somewhat better but the stellar performance, relatively speaking, is by "Asia excluding Japan", a group including China, Malaysia, South Korea, Taiwan, Singapore and Hong Kong.

That is fortunate because nearly half New Zealand's export trade is with Australia and non-Japan Asia.

Overall, though, the bank expects the pace of recovery to be "quite gradual" relative to past ones (with the exception, once again, of the 1970s).

"The pace of recovery is constrained by the impact of weak global activity on exports, and low income growth and lower asset prices on household spending," it said in last week's monetary policy statement.

"As a result the level of real GDP does not return to its pre-recession level until the end of 2010."

Three years, in short, with no net growth to show for it.

It would be worse still but for three factors.

One is that compared with the early 1990s, and even more so compared with the late 1970s, the economy is more flexible and better able to cope with the kind of strain it is now under.

The banking system, in contrast with many of its Northern Hemisphere counterparts, is in good shape.

Across the 20 largest advanced economies as a whole, governments have had to spend as much on propping up their financial sectors as they have on fiscal stimulus, the International Monetary Fund tells us.

New Zealand has escaped that.

Fiscal policy has also been seriously stimulatory, boosting the economy by 3.3 per cent of GDP in both the 2008/09 and 2009/10 years.

This has been possible because at the start of this recession gross government debt was around 17 per cent of GDP, about a third of where it stood in 1976.

In previous recessions, the post-Asian crisis one excepted, government debt was typically around 60 per cent of GDP, Treasury says.

At such levels IMF research has found that fiscal stimulus can have negative impacts on growth because of concerns about the sustainability of rising debt.

And orthodox monetary policy - official interest rate cuts being transmitted to the real economy via the banks - has by and large continued to work, despite what one think from the current jawboning and finger-wagging.

So we are left with a picture of a recession that is somewhat deeper than average but not the worst we have seen and relatively mild by international standards.

But the recovery phase looks like being a tediously slow and gradual affair.

That is because the globally synchronised nature of this recession means that everyone is stuck in the same mud and no major part of the world economy is on firm, dry ground and able to tow the rest out.

We have to wait for the mud to dry out and that is a slow business.

In the deficit countries like New Zealand households need to reduce debt and curb consumption, and the weight of economic activity needs to shift more towards earning a living as a trading nation.

The surplus countries, too, need to rebalance but in the opposite direction, with more of a focus on domestic consumption.

Both adjustments are easier said than done.