Debate hinges on how to earn living

By Brian Fallow

We are living in a fool's paradise, says Bank of New Zealand chief economist Tony Alexander.

New Zealand is still struggling with the same fundamental problem it has had since the "Britain's farm" era ended -- how to earn a good living as a trading nation.

Neither regulation nor deregulation has yielded the huge investment in new export industries needed to sustain the standard of living we want.

We are left, says Mr Alexander, with a growth rate that is not particularly flash by world standards.

The central issue is clear: we have been poor at developing a broad range of export goods and services to reduce our reliance on primary products. Meanwhile, those primary goods, such as agricultural and forestry products, will continue to suffer from declining prices and market access problems.

"We have shown that we will not voluntarily cut back on our private consumption in order to free up money for investment. Eventually it will be forced on us by the international markets."

He is talking about a currency collapse, but he does not think one is imminent.

"I think it's five, 10 or more years down the track. But I think it is the only way we are going to get massive investment in export industries, and import prices going to a level where we do start cutting back on a standard of living which we cannot afford."

Economic statistics reveal three troubling trends. Much of the political debate is about what the Government can or should do about them:

* We are increasingly reliant on other people's savings to fund the level of consumption and investment we want to undertake.

* While the new reformed economy has resulted in stronger economic growth than we have seen since the 1960s, that has done little to lift real household disposable incomes.

* Despite a lot of rhetoric about the knowledge economy, spending on research and development is low by developed country standards.

Combined, the three trends are badly hurting the economy, summed up in one number: New Zealand's large and growing current account deficit. It shows that we spend more than we earn internationally. We bridge the gap by borrowing abroad or selling more assets to foreigners.

The Treasury forecasts the deficit will blow out to 8.3 per cent of gross domestic product by March next year before recovering to about 6 per cent.

These chronic deficits, which have to be funded by a net inflow of foreign capital and credit, add to a mountainous stock of non-residents' claims on the New Zealand economy.

Foreign investment in New Zealand, both debt and equity, had hit $126 billion by last March. It exceeded New Zealand investment abroad by $86 billion and was equal in value to about 86 per cent of the annual output of the economy.

These figures are very high for a developed country.

The current account deficit can also be seen as a measure of the extent to which savings within New Zealand fall short of investment in New Zealand, as analysed in an article on Page D2.

Part of the reason lies in the stagnation of household incomes.

New Zealand's economic growth record over the past seven years does not look too bad.

It has averaged around 3 per cent a year, a better performance than we have managed since the 1960s.

But what is that worth in terms of household disposable incomes - the money households have available, after tax, to spend or save?

According to Statistics New Zealand, average household disposable incomes rose 2.6 per cent in real terms (after allowing for inflation) between 1991 and 1996, or about 0.5 per cent a year. Treasury forecasts for the coming fiscal year suggest a little improvement in that rate to about 0.6 per cent a year.

Why are real incomes growing so much more slowly than the economy as a whole?

First, the figure is diluted by population growth, which has averaged 1.4 per cent a year since 1991.

Second, one consequence of our continuing reliance on other people's savings to fund investment in New Zealand is that the share of the national economic cake which is not ours to eat has been growing. More dividends and interest payments to foreign investors mean less money for domestic investors to spend or save.

But ultimately the sluggish growth in real incomes reflects relatively poor labour productivity, the efficiency with which labour is used.

Two-thirds of the economic growth over the past nine years is explained by an increase in hours worked. Productivity, by this measure, has increased by only 0.8 per cent a year.

The 0.5 or 0.6 per cent annual growth in household disposable incomes is an average and masks the fact that income growth has been spread unevenly. A disproportionate share of income growth has gone to the top 10 per cent of households.

A Statistics NZ study of income distribution between 1982 and 1996 showed that only the top 10 per cent had enjoyed significant real income growth. It also showed households in the middle had lost ground compared to high income earners. They had also lost ground in absolute terms after adjustment for inflation.

As well as raising politically highly charged issues about tax policy, this trend helps to explain why household savings rates have been so low.

Indeed, over the past two years households collectively spent more than they earned. It suggests that for many saving falls in the "chance would be a fine thing" category.

That creates a chicken-and-egg dilemma for policy makers: To lift our economic game we need to lift investment and savings. That would be more likely if economic growth and incomes were higher.

Finally there is an intangible component in all this: confidence.

New Zealand seems to be going through a period of gloomy introspection. It has become commonplace to express doubts that New Zealand has much of a future except as a larger version of Tasmania - a great place to be from or to visit.

Two indications of faltering confidence are net emigration and the behaviour of foreign investors.

Since mid-1997 more people have been leaving New Zealand than arriving on a permanent basis. Although the outflow is slowing, it is not forecast to turn positive until 2002.

Meanwhile, foreign direct investment (FDI) has been dwindling. FDI, where the non-resident owns at least 25 per cent of an enterprise, is seen as a more stable form of inward investment than debt or portfolio investment in shares and bonds. After running at over $4 billion a year in the mid-1990s it dropped to $1.9 billion in the year to March 1999.

At the same time the owners of existing FDI companies have of late seemed to have better things to do with their New Zealand profits than reinvest them here. Over the past three years they earned $10.2 billion in profits, of which $9.5 billion was paid out in dividends and $700 million retained in the companies concerned.

Some of these factors are cyclical, cautions National Bank economist Brendan O'Donovan. The last three years, after all, straddle a recession.

"Navel gazing is not always that healthy when we are just coming through the bottom of the cycle. If we hadn't gone through these reforms, how would we have come through what have been big shocks to the economy - two droughts and the Asian crisis? The economy has weathered it very well."

If there is a sense of malaise and doubt about the near term, there are also grounds for optimism when we look through the top half of the bifocals, at New Zealand's longer-term outlook.

A comparative advantage in pastoral farming and plantation forestry may prove more durable in the long run than other countries' edge in manufacturing, given how mobile industrial technology and capital are these days.

And when wedded to the still-infant science of biotechnology, the potential can only be guessed at.

Meanwhile, the capacity of the internet and e-commerce to boost efficiency and to overcome some of the disadvantages of being small and remote remain largely untapped.