Brian Fallow: Little cheer in new-found prudence

The recession may have been over for more than a year, but it was big enough to cast a long, cold shadow. Photo / Dean Purcell

Lately there has been little in the economic news to cheer people up.

The labour market and housing market are torpid, at best. The cost of living is rising and interest rates are rising too.

Business confidence is slipping and business investment is weak. Credit growth is flat-lining. The net inflow of migrants has dwindled to a meagre and exiguous trickle.

Even the bright spot - export commodity prices - is getting dimmer.

Statistically the recession may have been over for more than a year, but it was big enough to cast a long, cold shadow.

The news is not all bad, of course.

At 6.8 per cent, the unemployment rate is down from its peak of 7.1 per cent in the December quarter last year, just not very far down.

Full-time employment and hours worked per week rose in the June quarter even if the headcount measure of employment fell.

This is the flipside of a notable feature of the recession, which was that the economy's output dropped more than employment did. Firms and workers opted to reduce hours. Productivity, or output per hour, was also sacrificed.

It is only to be expected that as the economy expands again firms look to restore hours and productivity before making significant inroads into the jobless numbers.

The household sector's collective income from wages and salaries grew 4.6 per cent in the year to June, up from an imperceptible 0.4 per cent the year before, according to the latest payrolls data.

But the level of household debt grew just 2.4 per cent over the same period, as people set about the process of reversing the pattern of the mid-2000s boom when borrowing and spending grew much faster than incomes.

This new-found prudence is an essential part of getting the economy back on an even keel but it makes for hard going for businesses that depend on chasing the consumer's discretionary dollar.

The Bank of New Zealand's economists forecast gross domestic product growth to average 2.7 per cent over the next five years. That is in line with the average of the past 10 years.

But the bad news is that it may be more growth than the economy can handle without inflation getting out of hand. The last decade was very much a game of two halves, with most of the scoring in the first half.

Over the five years 2005-2009, the economy expanded by a cumulative 5.5 per cent (or not much more than 1 per cent a year) but prices rose 15 per cent, or just under 3 per cent a year - barely within the Reserve Bank's target range.

Partly that reflects the lags between economic activity and prices; the recession occurred towards the end of that five-year period.

But it also testifies to a troubling propensity towards inflation in the non-tradable sectors of the economy where prices are immune from international competition or the influence of the exchange rate.

The Reserve Bank has revised down its estimate of the economy's potential growth rate to around 2 per cent from something close to 3 per cent before the global financial crisis.

Sometimes called the economy's speed limit, the potential rate is the trend rate at which the supply side of the economy is expanding and therefore the rate at which actual growth can be sustained before inflation and a blowout in the trade balance become problematic.

The difference between 2 and 3 per cent may not sound like much but over time it mounts up. Over the past 30 years Australia's growth rate has averaged just 0.7 percentage points more than ours, but the cumulative effect on output and incomes is now conspicuous, and from New Zealand's point of view very challenging.

The International Monetary Fund's estimate of New Zealand's medium-term growth potential is slightly higher than the Reserve Bank's, at around 2.3 per cent.

That is pretty good by advanced-country standards, comparable to the IMF's estimates for the United States and better than the major European economies or Japan - but less than Australia's 3 per cent.

For both countries, the main impact of the financial crisis on medium-term growth is likely to come through a higher cost of capital, partly offset by a higher return to capital from strong demand for commodities in emerging economies of Asia, the IMF says.

As capital importers, neither is immune from such global developments as the dramatic widening of risk margins in interest rates, and the heightened competition for the investor's dollar from debt-laden governments.

We can think of the potential growth rate as driven by growth in the labour force and growth in labour productivity. Both have been declining.

Statistics New Zealand estimates that over the 10 years to June next year the labour force will have grown by 460,000.

Assuming medium rates of fertility, mortality, migration gain and labour force participation, it expects the labour force to grow by less than half that in the following decade, or just under 200,000.

And on the productivity side the trend is also sobering.

Between 2006 and 2009 labour productivity declined at an average annual rate of 0.3 per cent. But that period is only part of a cycle and included a recession.

In the complete peak-to-peak cycle before that, 2000 to 2006, annual labour productivity growth was 1.3 per cent, less than half its rate in the 1990s and lower than it was in Muldoon's day. By 2006 New Zealand ranked 22nd among the 30 OECD countries in labour productivity and in GDP per capita.

The problem, in short, is capital shallowness - too little capital invested per worker by firms in plant, equipment and software, and by the country in infrastructure.

When it comes to multi-factor productivity - how much output is extracted from given inputs of capital and labour - New Zealand has in fact significantly outperformed Australia over the past 30 years.

Australia's faster growth over that period (an average of 3.1 per cent a year compared with New Zealand's 2.4 per cent) reflected significantly higher inputs of both labour and capital.

The cumulative effects of that on the transtasman income gap and migrant flows are well known.

Migration has been falling all year, and by June the monthly net inflow could have fitted in two airport buses - 70 people.

Until New Zealand households save a lot more, and New Zealand businesses invest a lot more, it is hard to see those trends reversing.