Dialogue: Our fortunes are at a pivotal point

Very occasionally a government hears an observation from a political opponent that must chill it to the bone. Labour, I suspect, has just heard one from Bill English.

Some of us are about to get poorer, he said, and it looks likely to be the Government's constituency.

That might seem a bold prediction in a week that the Coalition has just strengthened the wage bargaining arm of that constituency with the passage of the Employment Relations Bill.

But English was referring to the dollar's foreign exchange rate, a much more powerful influence on everyone's real incomes than the rituals of "good-faith" bargaining that will add to employment costs and deter some job creation for the next few years.

Nobody needs to leave the country now to realise we are getting poorer. The rising world price of petrol, exacerbated by the low exchange rate, is really starting to bite household budgets.

The dollar has been in descent for the past few years, ever since the Reserve Bank found a way to dispel the notion among money movers that it maintained an unstated "floor" under the currency.

The dollar should have fallen a few years before, after we squandered the fruits of the Richardson recovery on residential property and began to set world records with the current account deficit, the measure of the gap between national earnings and our living standard.

Now, with farm commodity prices rising, the deficit should improve and the dollar should be recovering. But it is not.

Some blame popular public policies for that. Certainly the dollar's decline seems more precipitous since the Government set about fulfilling its promises. But we could not count on having good government forever.

The stranglehold on inflation attracted investment despite the external deficit, but it was not alone. The Employment Contracts Act, Budget surpluses, debt repayment, a declining state share of the economy - all contributed to glowing reviews by the middle of the 1990s.

Bill Birch used to call those "the fundamentals" but monetary and fiscal policies, crucial as they can be, are not fundamental. Investment decisions are that - who makes them, how they are made, what they produce.

If those fundamentals had been improving through the 1990s we would have deserved a highly valued dollar and the high living standards that go with it.

Now that the new Government has largely enacted, or programmed, its cheap election commitments, it, too, needs to face the old fundamental: how do we find investments that will pay our way?

For all its rhetoric, Labour does not really believe that grants for research and development, conferences on the "knowledge economy" and central planning generally are going to come up with top-shelf products that can find markets. If Labour really believed so it would stake serious money on the exercise and, thankfully, it is not about to.

But the rhetoric may be transfixing private investors. The Government would do better to take a quiet, dispassionate look at where we've been and the lesson we might have learned.

Go back to the Richardson-Shipley cuts to social welfare and spending control generally. That enabled interest rates to come down as inflation tumbled. The dollar fell at that time, too, and helped exports to pick up, producing strong economic growth from 1993.

The Budget surplus was in sight by the time Richardson was sacked at the end of that year and we were soon attracting not just investment but people - enterprising people, mainly from Asia and South Africa.

Then the lack of improvement in our true fundamentals undid us. When the immigration wave caused an inevitable housing boom we piled in, too. Real estate was still the only investment we trusted.

With Birch handing out tax cuts from Richardson's surplus, and house prices escalating, we squandered the chance to make productive investments and upgraded our life-style instead.

The Reserve Bank, accepting the economic orthodoxy that asset price inflation soon causes consumer price inflation, tightened monetary policy hard, not only killing off the boom but causing the exchange rate to rise to levels that crippled the exporting sectors.

Urban households are still carrying high mortgages from that time and have seen their equity fall. With luck the nation's faith in residential property investment - a relic of an era of high inflation - has been finally punctured.

That would be a truly fundamental improvement. When the rural recovery starts to revive urban activity we might even look for productive investments.

If we find them, we would see a rising exchange rate reflect real economic improvement. In the meantime the lower dollar is going to confront most of us with the country's real condition. Not even the Governor of the Reserve Bank this week dared predict our response.

That depends on unions now.