Christchurch Rebuild: Dominick Stephens: Let's not go blindly into the 'danger' phase

Dominick Stephens.

This rebuild is a huge task to be undertaken in a tiny economy.

The Canterbury rebuild is almost in full swing - construction work in the province is now running at 150 per cent of the peak pace reached during the mid-2000s building boom, and is still accelerating.

This rebuild is a huge task to be undertaken in a tiny economy. So it was always going to create waves.

At present the rebuild is acting like a giant economic stimulus. The influx of money from overseas reinsurers or released by the Earthquake Commission (EQC) is not only boosting the construction sector, but is percolating across the whole economy. Unemployment is falling, business confidence is at a 20-year high, consumer confidence is strong, and GDP growth has accelerated. The number of migrants coming into New Zealand has surged, and the number of people leaving the country has fallen. All this extra economic activity has benefited the Government's tax take, allowing it to potentially ease up on the spending side of the ledger.

This has been the "easy gains" phase. The economy was fairly depressed before the rebuild began, so there were plenty of spare resources to draw on - the unemployed could be brought back into employment, under-utilised machinery could be worked harder, and so on. Economic growth has been able to occur without much inflation or wage growth (aside from cost escalation in the Christchurch construction industry itself).

By our reckoning the economy and the rebuild are now transitioning to a more dangerous phase. The spare capacity has been used up, meaning further increases in economic activity are more likely to generate inflation pressures from here. Unemployment is not far from its non-inflationary limit, below which wages really start to rise.

To keep inflation in check, the Reserve Bank is going to have to lift interest rates and this has already begun. We expect that the Official Cash Rate will have to rise by three percentage points over the next three years, which could take floating mortgage rates to around 7 or 8 per cent. The Canterbury rebuild won't be the sole reason for lifting interest rates, but it will probably be the single most important contributing factor. This serves to illustrate the downside of the rebuild. Canterbury is effectively hogging the country's limited economic resources, leaving other regions and industries less to work with. Firms not connected to the rebuild - particularly exporters - will find they are facing higher construction costs if they want to expand, higher wages if they want to hire, and higher interest rates if they want to borrow. At the margin, some firms will find that they have to cancel investment projects that would have gone ahead had the Canterbury rebuild never happened. The rebuild will prevent New Zealand from investing as heavily in new infrastructure or export industries as it otherwise would have.

Perhaps the biggest danger of the rebuild is that we set ourselves up for a boom/bust cycle due to overconfidence during the upswing.

New Zealanders might mistake this temporary construction boom for a new era of prosperity. Firms might base investment decisions on the rebuild economy, only to find they have overinvested for the post-rebuild world. Employees may be surprised to find that their roles are not required when the rebuild is complete. People might overpay for assets in the mistaken belief that the economic good times will last forever. If we do go down this path of economic hubris, we may find the process of reorienting the economy away from construction more painful than it needs to be - something Australia is now experiencing as it comes to terms with the end of its mining construction boom.

• Dominick Stephens is chief economist at Westpac.