In the last few weeks, there have been some very encouraging signs that the economy may have turned the corner. Figures for the June quarter suggest that the economy grew marginally over those months, the share market has been rising, the housing market has stabilised at levels not much below the peak, and business confidence has reached the highest level in a considerable time. With a bit of luck and a fair wind, perhaps the worst is behind us and we can look forward to some real economic growth next year.
Alas, “perhaps” is the operative word. The pessimists (or are they the realists?) point out that unemployment is still rising, that the Government is having to borrow $250 million every week to cover the gap between spending and tax revenue, that the very serious fiscal situation facing both the United States and the United Kingdom suggest that several major economies will have to cut back on their stimulus before long, and that, most worrying of all, none of the imbalances which have bedeviled the New Zealand economy for so long has been fixed.
For me, this is the most serious issue. For more than three decades, New Zealanders have spent more overseas than we have earned overseas, with the result that today we have a level of net international indebtedness which is higher, relative to the size of our economy, than that of any other developed country in the world with the exception of Iceland and Hungary. Borrowing overseas is not in itself a bad thing to do – Singapore borrowed overseas very heavily for years to finance a high level of investment. We have borrowed heavily overseas to finance a high level of consumption, while our investment has been low relative to the standards of other developed countries.
Economists look at this from two angles. One way of looking at the issue is by looking simply at the deficit in the balance of payments. That measures how much we spend on imports of goods and services (including interest and dividends on money we have borrowed overseas in the past) compared to how much we earn from exports of goods and services (including interest and dividends on money we have invested overseas).
Unfortunately, for too much of the last four decades investing in the production of exports (or the production of things which compete with imports) hasn’t seemed nearly as attractive as investing in producing stuff for the local market. There have been many reasons for that, including the strong growth in government spending over that period, a tax regime which has encouraged investment in property rather than in “production”, and an exchange rate which has moved up and down in a way which makes investment in export production seem a very risky proposition.
Another way of looking at the same issue is to look at the gap between what we save in New Zealand and what we invest – in farms, factories, houses, roads, schools, and all the rest. I won’t bore you with the proof, but the deficit in the current account of the balance of payments is identical to the gap between what we save in New Zealand and what we invest.
For quite a long time, I had assumed that we New Zealanders invest too much in building ourselves more and more luxurious houses. But that’s not the case. Compared with other developed countries, we invest a bit less than average in housing, and certainly less than Australians do. No, the problem is not that we devote too many real resources to building ourselves houses; the problem is that we don’t save enough to cover the other things we want to invest in. And as a result, we have to borrow those extra resources from more thrifty foreigners.
The reasons for our poor savings performance are not entirely clear.
Because we have a generous social welfare system, free hospital care, and heavily subsidised tertiary education, we don’t need to save for the risks which people in countries with a strong savings culture save for (such as China and Hong Kong). But many of the countries of Western Europe also have generous social welfare systems and free hospital care, and their citizens save a lot more than we do.
Perhaps we tax the income from savings more heavily than other developed countries do, and there is some evidence for that. And perhaps because we have conspired (through tight zoning rules) to create huge increases in the price of residential land, those who already own homes have seen very large increases in the value of those homes, and have seen no need to save additional funds for their retirement.
But whatever the reason, we have not saved enough to fund the investments which we want to make and have borrowed from thriftier foreigners to cover the gap. Logically, we can’t indefinitely go on increasing the net amount we owe to foreigners relative to the size of our economy. At very least, the more heavily dependent we are on the savings of foreigners, the higher the proportion of the total output generated within New Zealand we will have to devote to servicing that debt.
A trend which can’t go on indefinitely will of course eventually stop. The only question then is whether the trend will stop gradually – with a gradual increase in our own saving and a gradual reduction in our dependence on the savings of foreigners – or abruptly, with foreigners deciding rather suddenly to stop lending additional funds to us and even demanding back some of what they have already lent us.
We know from looking at what happened during the Asian crisis of 10 years ago that foreigners sometimes panic and want their money back in a hurry. Thailand was a good example: when foreigners rather suddenly decided to take their money out of Thailand, the Thai currency fell very sharply and Thai interest rates (for those who could still borrow) went up. Thailand’s balance of payments moved quite quickly from deficit to surplus. But the economic and social cost of that adjustment was brutal, with a huge increase in unemployment and companies serving the domestic market collapsing in significant numbers.
In the last issue of FundWatch, I wrote about the challenge which the Government faces in adopting policies which will help to raise productivity in New Zealand, so that our living standards equal those in Australia by 2025. That is a huge challenge, and it is made all the more difficult because of the significant imbalances in our economy as we start that process. A few minor policy tweaks here and there will not, unfortunately, cut the mustard.
Copyright © 2024 Don Brash.