O'Sullivan: Old certainties swept away

By FRAN O'SULLIVAN

When BusinessWeek headlines its October 1 cover story "Rethinking the Economy," a sea change has obviously occurred.

The terrorist assault on the US inevitably brought to the fore talk of recession. The US had, in fact, been teetering on the edge of recession since dotmania collapsed and the high-tech industry shrank. Latest forecasts from the International Monetary Fund (IMF) indicate that prospects for world economic growth had also dampened before September 11.

But the economic landscape is now - perhaps irrevocably - changed, challenging many business verities in the US and New Zealand.

BusinessWeek, the weekly business bible for the US, defines a set of new priorities for the US: defending the homeland, fortifying the financial system and critical industries, dealing with recession and strengthening the social safety net. All of which, it says, mean a more activist Government, higher defence spending and budget deficits - fiscal and monetary stimulus is on the way but tough times lie ahead.

In New Zealand, after a lengthy reform period, some of the priorities BusinessWeek has identified would be marginal - particularly the focus on fiscal and monetary stimulus. But the Labour-Alliance Government has moved swiftly to say it will bring forward spending plans. That move, coupled with a realistic programme of interest-rate cuts by the Reserve Bank, might - just - enable New Zealand to remain on the economic growth path.

But if the situation tightens rapidly, the Coalition Government may soon find itself in the same position as its National predecessor, which had to grapple with the prospect of running a fiscal deficit as the Asian crisis deepened. National Treasurer Sir William Birch slashed spending to overcome the crisis, in contrast to Finance Minister Michael Cullen's current approach.

The US has already moved swiftly in this area. Treasury Secretary Paul O'Neill - who just months ago was floating radical proposals to abolish corporate taxes - will be hard-pressed to safeguard what is left of the 2002 budget surplus.

Before September 11, the US surplus was forecast at $US173 billion ($426 billion). O'Neill must now battle to keep spending demands exceeding more than $US500 billion from swamping federal accounts. At the same time, he faces calls to step up the tax-cuts programme.

Inevitably, O'Neill's surplus is heading towards a fiscal deficit as the US steps in to bail out industries ranging from airlines to insurance companies.

Fed chief Alan Greenspan has quickly moved to provide monetary stimulus. He has slashed interest rates eight times in a row. Another cut is expected tomorrow, followed by further easing in November.

Last week, the IMF did not attempt to quantify the effects of the terrorist attacks on world economic growth. But the Washington-based organisation had already been chasing its forecasts down for much of this year (2001) from 4.2 per cent to 2.6 per cent. It has trimmed its forecast for 2002 to 3.5 per cent. Its US forecasts are for 1.3 per cent this year and 2.2 per cent in 2002. Clearly the IMF will have to upgrade its forecasts. But this is a difficult time for all forecasters.

The worldwide effects of the turndown are difficult to quantify - particularly for New Zealand, which exports about one-third of its goods and services. The US is New Zealand's second-largest market and Asia, which provides many markets, is also verging on recession.

But despite the recession talk, O'Neill is optimistic that the US Government can deal with the bailouts and build confidence.

BusinessWeek sees big changes ahead:

* It suggests the private sector will lose primacy as the public sector takes a bigger role in the economy, with the Government having a bigger hand in allocating capital as it bails out troubled industries such as airlines.

* Economic resources will shift from the private sector with higher spending on defence and security, which will lower growth rates.

* Innovations that enhance productivity will take second place as research and development spending shifts towards national security.

* Concerns about terrorism will slow trade flows, with costlier customs controls and higher airfreight costs.

* Immigration and labour markets will tighten through increased border controls.

* The contracting economy and soaring unemployment will lead to increased spending on the social safety net.

Longer term there are implications for the growth of city states - even far-away cities like Auckland.

The biggest concern will be that customers pull in their belts in reaction to the profit warnings; investment cuts and job losses.

Keeping that risk at bay is a challenge for New Zealand - as elsewhere.

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