As many governments have put their economies into a kind of hibernation in the quest to defeat Covid-19, economists across the globe are also debating whether a post-Covid global economic recovery is likely to be V-shaped (a quick rebound to pre-Covid normality), U-shaped (a longer trough before the rebound to normality) or L-shaped (a prolonged period of below-par performance with some permanent loss of output).
This stylised description over-simplifies possible recoveries, but it does convey a key message: the longer-term economic damage possibilities from Covid-19 range hugely in both size and timescale.
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The Government's economic advisers will already be trying to think through how we could deal with each of those (V, U or L) scenarios and how far New Zealand's recovery might differ from other countries.
There are at least three 'big issues' to address. 1) How might the structure of the New Zealand post-Covid economy differ from before the crisis? 2) What to do about the huge increase in public debt now building rapidly? 3) Can the Government do anything to minimise longer-term post-Covid economic damage?
These questions need deep and careful analysis this article cannot hope to articulate but it can offer a few thoughts on each.
How might the post-Covid structure of the New Zealand economy differ from before the crisis?
The coming recession will be different from the 2008-09 global financial crisis (GFC), which was initially driven by financial institutional collapse.
The new recession will impact real economic activity and international 'people flows' – both migration and tourism. While the post-recession response of global real activity is still uncertain, it is clear there is no foreseeable prospect of people flows returning to anything like past levels.
Among New Zealand's biggest exports are dairy, wine, foreign tourism and students. The first two should recover well but the last two will be severely adversely affected for years, not months.
And, if future New Zealand governments decide to maintain the current 'completely eradicate Covid-19' strategy, that is likely to further stifle tourism and higher education prospects.
For those sectors at least, an L-shaped future probably looms, and replacing their lost outputs and exports will be a major challenge. Might expansion of milk and other sales to China, for example, be capable of replacing lost revenues from Chinese tourists and students?
What to do about the huge increase in public debt now building rapidly?
New Zealand will almost certainly experience the biggest increase in its public debt in decades. Certainly larger than the GFC aftermath that led the National Government to impose strong constraints on public spending for most of its nine years in office. Will the next Government have to do the same, and more?
There are basically three options to restore sustainable debt levels. Each could be pursued to some degree. These are: to rely on future economic growth to steadily reduce, as a share of GDP, the (fixed) amount of nominal debt; cut back public spending and/or raise taxes to generate future surpluses; or allow a higher rate of inflation, which reduces the real value of debt repayments out of higher future revenues.
While even low positive inflation ensures governments benefit from this third option to some degree, it is not a sensible strategy to encourage higher inflation for debt reduction purposes. It is often self-defeating in any case, as interest rates on debt rise to compensate.
Combining both the other two strategies is vital for successful debt reduction. This means, firstly, facilitating a sustainable growth recovery, especially allowing New Zealand's innovative and exporting firms to flourish.
Secondly, while imposing severe austerity on public spending is not advisable, hard decisions about future taxing and spending will be needed. No government can borrow and spend billions of dollars to assist taxpayers through a temporary crisis without rectifying that imbalance at some point in the future.
And it cannot delay too long either – where would public debt be now if Finance Minister Bill English had not been committed to the oft-criticised public spending restraint after the GFC?
In the same vein, massive tax rises after the crisis will simply undermine demand and alienate the kinds of economic activity we need to encourage. So any tax increases will need to be modest, carefully targeted and clearly signalled as a temporary measure to restore the public finances.
All of this means public debt levels will probably need to be reduced more slowly than after the GFC, alongside careful analysis to reassess sustainable long-term debt/GDP ratios.
Can the Government do anything to minimise longer-term post-Covid economic damage?
Before the Covid-19 crisis the Government was planning a massive expansion in its capital spending programme – adding an extra $9 billion over 2020-24, as well as adding an extra $10b to its recurrent budget over the next four years.
These spending plans were built on substantial forecast budget surpluses over the next four years that must surely now be in the bin. The new Covid wage subsidy programme alone is expected to cost around $10b and there will be significant other calls on the public purse before this crisis is over. So what should the government do to help recovery?
First, cut back substantially on its new capital spending plans – they are no longer sustainable.
The Budget Policy Statement (BPS) last December showed that Finance Minister Grant Robertson planned net capital spending over $10b per year for 2020-24; this compares with only $3.2b per year during 2010-17 as debt was brought back down following the GFC. Some of the more immediate capital spending will be an important part of the recession-fighting toolkit, but any longer-term capital projects that are retained should have demonstrably positive and large impacts on private sector recovery.
Secondly, it must become more frugal with its annual funding for new (recurrent spending) initiatives, which the 2020 BPS set at around $2.5b per year till 2023.
This will be the time to consolidate government activity, improve its effectiveness, and even cut back on some existing spending with limited pay-offs.
However, the state will never be the economy's long-term engine of growth. Rather, it should support an innovative private sector to take risks generating new ideas, activities and exports.
This could include a less regulated regime for small business and removing tax disincentives for entrepreneurial risk-taking, recognising not all risky endeavours will succeed.
All of this will be for the next Government– of whatever colour – to deliver after the September election. It could turn out to be a poisoned chalice, making this election a good one to lose.
- Professor Norman Gemmell is Chair in Public Finance in the School of Accounting and Commercial Law at Te Herenga Waka—Victoria University of Wellington. He is a former Chief Economist at the Treasury.