Brian Fallow has some extraordinarily good analysis of the economic situation in his piece today. Here’s some important passages (and my, unfortunately, extensive comments):
“We are really talking about two recessions back to back,” AXA Global Investors chief economist Bevan Graham said. “Last year it was a domestic one, that we needed to have. There were excesses in the housing market and consumption that needed to be worked out. But then we get hit by this global storm.”
We had a very strong period of growth from 1999 to 2007. While policy was part of the reason for this (Labour’s full employment policy, for example, bedded in high domestic demand) there was an underlying demographic reality – the baby-boomers have been middle aged for the last decade, this means they’ve been at their peak earnings without dependents and looking to build a retirement nest-egg. And what’s safer than houses?
The wealth effect created by all this investment in housing added to high employment and high wage growth to fuel demand, which added inflationary pressure (leading to higher interest rates) and caused the trade balance to worsen as we imported more. You’ll recall that during this period National was demanding Labour throw more fuel on the fire through tax cuts, which would just have been more inflationary, while at the same time complaining that interest rates were too high because the Reserve Bank was trying to contain inflation. The real solution would have been to try to deflate the housing bubble and the accompanying wealth effect early and slowly with a capital gains tax on second homes but neither National nor Labour would go there. They were fixated on keeping the good times rolling forever. But you can’t remain at above-trend growth forever, eventually there needs to be a correction, and although that point had been put off both by good fortune and Labour policy a small, short recession primarily caused by the collapse of the housing bubble (and the drought and oil prices) was inevitable.
“For much of last year it was hoped that by now the economy would be in an export-led recovery. Instead world trade is shrinking.”
Unfortunately, the rest of the developed world had also been in a long-term boom and it came to a crashing halt with the collapse of other housing bubbles and record prices for oil and commodities (the relationship between the commodities spike and the housing collapse will be an interesting topic of study for economists). The global finance sector was greedily geared towards permanent boom times. When things started to go bad, people couldn’t afford their mortgage payments which underpinned the value of trillions in investments. The finance sector went into meltdown sending the broader world economy into recession (we had earlier seen something similar on a small scale with the collapse of finance companies here).
In theory, with low interest rates, a lower dollar, lower house prices, ‘spare capacity’ in the labour market, and stimulus from Labour’s tax cuts and 2008 Budget spending, we should be set for recovery but the international situation, particularly the shortage of credit and falling demand for our exports is blocking that. Instead, all the money we borrowed from overseas on the back of the housing wealth effect so we could buy more imports leaves us dangerously exposed now the lending has dried up, and we have a negative wealth effect from people seeing the value of their assets (houses, shares) fall. This is leading to more people becoming unemployed.
“The year started with 105,000 people or 4.6 per cent of the workforce unemployed. Forecasters expect it to be closer to 7 per cent by the end of the year [the New Zelaand Insitute is saying up to 11.2%]. Every percentage point increase represents around 23,000 people. The effects spread beyond those who lose a job or cannot find one, and their families. The fear of losing their jobs encourages people to spend less and reduce debt or build up precautionary savings. The risk is a vicious circle where cautious consumers spend less, leading businesses to invest less and employ fewer people, leading to a further contraction in spending.”
We need to head off this secondary round of contraction by stopping unemployment reaching high levels (the current 4.6% is still lower than we ever had between 1987 and 2003 but hours worked are falling sharply). That’s what the rest of the world is trying to do with massive stimulus programs like the trillion dollars and more the US, the EU, and China are each injecting into their economies this year and next. It might work (frankly, if those economies do start to grow as a result of their packages, I suspect it’ll just spark another oil spike, slamming the world back into recession). What won’t work is doing nothing, which is essentially what National is doing – sure it has moved forward by a year or two a few roading projects but it also reduced its tax package, slashed Kiwisaver and R&D tax credits, has signalled spending and wage freezes for the public sector, and made only a token increase to the minimum wage, all of which are de-stimulatory compared to business as usual.
During the election campaign, Helen Clark said her focus if re-elected would be “jobs, jobs, jobs” and the new Government has picked up the mantra. But we’ve yet to see any action; any actual net stimulus to create jobs. It would be straining optimism to the point of foolishness to expect anything out of this week’s Jobs Summit but something needs to happen and it needs to happen quickly. While the rest of the world works over-time to protect their economies, we’re sitting on our hands and watching the jobs evaporate.