Recovery? What Recovery?

It is surely beginning to dawn on us, nearly three years after our recession began, that anything approaching a full recovery is still a long way off.

It is now clear that unemployment remains stubbornly high, that the housing market is depressed, and that property values have fallen sharply so that most people no longer feel as wealthy as they did. Lower housing values and employment uncertainties explain why domestic demand is sluggish so that – barring an unlikely pre-Christmas boom – we can expect to see increasing numbers of empty retail premises in our high streets in the New Year. Little wonder that confidence in the economy is ebbing and that employment and investment intentions are at low levels.

As a consequence, the exodus across the Tasman has resumed. Australian living standards continue to rise faster than our own, as both demonstrated and assisted by the growing strength of their dollar against ours.

Yet a great deal is going right for our economy. Our major export markets in Australia and China are performing strongly and demand for our goods is buoyant. Commodity prices generally and dairy prices in particular are at historically high levels. Our trade figures mean that a trade imbalance is not so much a constraint on expansion as it has been over such a long period.

Inflation is not an immediate problem and the Reserve Bank governor has signalled his intention to keep interest rates at low levels. Our banks are in good shape (though, sadly, the same cannot be said of our finance companies). The warnings of the “bond vigilantes” that increased government borrowing to fund their deficits will mean rapidly rising long-term interest rates around the world have not materialised. Our own government’s finances are stronger than forecast and are in any case among the healthiest of any advanced country; most European governments can only dream about our relatively and historically low levels of government indebtedness

In these unusually favourable circumstances, there is something wrong with us if we cannot make a good fist of coming out of recession in good order. So, what is going wrong?

What we are seeing, I believe, is a simple failure of analysis. An economy in recession is by definition an economy in which there is a deficiency of demand. If we want to recover from recession, we have to see somewhere a lift in demand. The question is, therefore, where is it to come from?

For once, a partial answer is provided by the export sector. The improvement in export prices is helping to re-balance the economy towards exports and away from domestic consumption –something the government is keen to see and a process that could be made even more beneficial by a more competitive exchange rate.

But is the relatively strong performance of the export sector enough to counter the impact of lower levels of activity in the other two sectors – the private sector and the government? If the answer to that question is no, then we have our answer as to why our recovery is so sluggish.

It is of course only too evident that activity and confidence in the private sector have suffered during the recession. Consumers are keeping their wallets closed, and businesses are cutting costs rather than taking on employees and investing in new capacity.

So, if we are to lift ourselves out of recession, we need the government sector to be playing its part in stimulating the level of demand, so as to offset and eventually reverse the current depressed state of the private sector. Yet, when we look to what the government is doing, we see priority given to the government’s finances rather than the health of the wider economy – to getting the government’s deficit down, rather than on using fiscal policy to stimulate the economy as a whole. The effect is that depressed demand in the private sector is reinforced rather than offset. The government is not, in other words, helping towards a solution but contributing to the problem.

The government says of course that it must cut back because it has to borrow just to maintain current spending, let alone spending at a higher level. But that is simply to re-state the problem rather than resolve it. The government has a deficit because a depressed economy means that its revenues are down. If the government is not helping but hindering recovery, then it will take longer to reduce the deficit and the recession will drag on for longer. And the longer it takes, the greater the risk that less than optimal levels of employment, investment and output will become permanent features of our economy.

The government is quite right to insist that it must, like the rest of us, get value for every dollar it spends. But isn’t it time that ministers took a wider and longer view of the role they must play if we are to shake off the shackles of recession?

Bryan Gould

2 October 2010

This article was published in the NZ Herald on 12 October.