Cameron Bagrie: Ignore business confidence but worry about bumpy times ahead

A lack of skilled employees is acting as a handbrake on the ability of firms to meet demand, writes Cameron Bagrie. Photo / George Novak

COMMENT:

Economic theory says the New Zealand economy is in good heart.

Economic reality says otherwise and needs to be respected.

My view sides with reality.

The coming years are going to be bumpy.

Apart from the obvious global risks, the transitional costs of changing the structure and growth across the economy are being understated.

We are yet to fully identify, and fill the voids being created as some sectors get hit.
The prevailing wisdom is that the economy should perform okay.

The Treasury, Reserve Bank, forecasting community and bank economists are all singing from the same hymn book.

Most economic fundamentals look sound. Inflation is contained. Interest rates are low. The Government books are in a strong position.

Unemployment is low.

Capacity constraints should be encouraging investment.

We don't have the smorgasbord of red lights flashing such as rapidly rising inflation, rapid debt accumulation and sizeable valuation excesses that can typically warn of a correction.

We have some red lights, but it's not across the board.

The economy is not showing the same late cycle excesses we were seeing in 1996-1997 and 2006-2007.

Those excesses ended up in a visit from the Grim Reaper.

Then we were clobbered by global events too; the Asian crisis and global financial crisis.

The New Zealand dollar has fallen, partly because the economic outlook for New Zealand has been reassessed internationally.

Good news for exporters, though not for importers.

The Reserve Bank relaxed loan-to-value ratio restrictions as housing activity softened.

They could do it again.

They could also cut interest rates. The economic framework is working.

Some key old economic drivers are either topped out or are providing less impetus over the coming years.

Construction activity has peaked as capacity constraints bite.

House price inflation is cooling and in Auckland prices are falling. Migration inflows remain strong through easing. A lack of skilled employees is acting as a handbrake on the ability of firms to meet demand.

And some old drivers are still contributing. Tourism numbers continue to lift. Migration figures are still massive. House prices in Auckland might be falling but a lot of regions are still seeing rises, albeit of a moderating nature.

The economic theory is pointing to the combination of lifts in rural incomes via buoyant commodity prices, boosts from government spending (what we call expansionary fiscal policy), lifts in wages and a falling New Zealand dollar to keep the economy trucking along.

A lot of money is being thrown at lifting housing supply and infrastructure.

Voila, the economy (real gross domestic product or GDP) should be growing around 3 per cent.

Happy days should be around the corner.

Then there is the reality.

The economic expansion is old in the tooth.

People are looking over their shoulder and eyeing the global scene.

Closer home, the Australian economy needs watched.

Australian households have a lot of debt, house prices are falling, credit is being tightened and we are seeing out of cycle lifts in borrowing rates.

That's a worrying combination.

Businesses are getting whacked with price increases with wages at the epicentre.

That's not the real concern. The real worry is how to get the productivity growth to accompany higher wages.

The signals for business investment are not great.

Capacity constraints are saying one thing but other signals are saying something else.

Three key drivers of investment are growth (the accelerator channel), tobins q ratio (the market value of assets versus their replacement cost), and the degree of certainty.

Growth is waning, the market values of assets is softening while replacement costs go up (think construction costs or import costs for plant and machinery equipment), and we have uncertainty.

House price inflation is cooling and in Auckland prices are falling. Photo / Brett Phibbs

Investment intentions in the ANZ Business Outlook Survey have ground to a halt.

Signals from the likes of the ANZ Business Outlook Survey need respected.

Ignore business confidence; it's a politically biased gauge.

But the remainder of the survey is warning of bumpy times ahead.

This is not like the 2000 "winter of discontent".

The Reserve Bank thumped the economy with 200 basis points of interest rate hikes that year.

Government policy was only part of the issue.

Hikes in 2000 were followed by interest rate cuts in 2001 and after.

The economy responded.

The Clark government had experience too. The current one does not.

The transitional costs of recalibrating the economy into a more sustainable model is being understated.

Half cut: in a sharp response to ongoing falls in key activity indicators in the ANZ Business Outlook survey, markets are now pricing 50% odds of a 25bp cut in the OCR by mid next year. pic.twitter.com/APX0eY9Loa

— Sharon Zollner (@sharon_zollner) August 31, 2018

Almost all agree a migration, credit, dairy intensification and turbo-charged house price model is not sustainable.

We need to change. That change is taking place.

"Hits" to growth are coming think and fast and businesses are naturally eyeing what is next as 170 odd groups consult and eventually report.

The Government wants to have its cake and eat it too.

Well you can't. Either the economy can grow at 3 per cent on a business as usual basis, or it's going to take time to transition the economy to something new.

Think of it as telling the All Blacks to play with a round ball as opposed to an oval one.

Assume migration halves over the coming years and house price inflation levels out too as government policy shifts and affordability bites.

The wealth effect on spending and growth from rising asset prices disappears.

Small-to-medium sized businesses find it difficult to access credit with house price inflation more contained. Home equity is less of an ATM.

We aren't going to see volume growth from the dairy or non-renewable sectors. It's likely they will contract.

Dairy land prices are falling as peak cow and environmental realities bite. Banks will be wanting money repaid so the boost from commodity prices will be diluted. Credit will become more constrained as the fallout from across the Tasman comes to bare. Boosts to incomes via wages get eaten up by petrol levies and other inevitable pending taxes to pay for things.

These are big economic holes and they aren't one-year gaps to fill. Suddenly 3 per cent GDP growth becomes 2 per cent. Throw in some uncertainty to boot and you have a sluggish economy.

Replacement sources of growth are needed.

The hits and change ledger are abundant whereas the replacement ledger is light.

There is Kiwibuild, more infrastructure spend and the regional growth fund.

None are game-changers to fill growth voids. Two are just one-off fillips.

Successful change management requires a plan and the ability to articulate it and get buy-in. We are short on all counts.

Until that changes businesses are going to remain in a grumpy mood and grumpflation applies. That's soggy growth with pressures on costs.

The onus is not just on the Government.

The private sector is going to have identify the new opportunities too.

It won't happen overnight, but it will happen.

That's not a 3 per cent growth environment in the meantime though. Change takes time and there are up-front transitional costs.

Cameron Bagrie is the managing director of Bagrie Economics.