Obstacles to Trade
A few eyebrows were no doubt raised when the Prime Minister said on television news last week that his four or five-day visit to the Gulf – unsuccessful though it proved to be – was a better use of his time than spending the same time in Wellington.
We should not perhaps have been surprised at the Prime Minister’s order of priorities. Third-term leaders across the globe often find that the opportunity to stride the global stage is a welcome boost to the ego and an equally welcome diversion from the tedious business of domestic politics.
And, as John Key pointed out, his goal – a free trade agreement with the Gulf States – was, although unattainable for the present, a prize worth seeking. When a prize of that kind is won, as was the case a few weeks ago in the case of South Korea, the dollar value of the deal is immediately talked up. The Korean deal was said to be worth $65 million in its first year, and much greater figures are of course attached to a possible “success” in the talks aimed at a Trans Pacific Partnership Agreement.
Let us put to one side arguments about the price that we might have to pay for such arrangements and acknowledge that no one could fail to welcome the boost to our trade as the result of the removing tariffs in our export markets. But this still leaves a major puzzle about the Prime Minister’s and the government’s attitude on such matters.
If reducing tariff barriers against our exports so that we can sell at more competitive prices in individual markets is so beneficial, and so easily quantifiable in terms of the boost to our economy, why are we so relaxed about the tariff we impose on ourselves – not just in respect of particular markets but in every market, including our own, and on everything we try to sell?
If, as is widely accepted, our dollar is over-valued, and has been for a very long time, that simply means that we are charging too much for our goods and service in export markets – and, for that matter in our own market when we are competing against foreign imports. We ask buyers, in other words, to pay 20% more than the goods are really worth. We are in effect demanding a premium, or imposing a tariff, on our own goods. And if a tariff of, say, 20% in an export market damages our trade, then that trade is equally damaged by an over-valuation of 20%. And over-valuation applies of course across the board, and not just – as a tariff does – to particular products in a particular market.
So, if we can so easily calculate the benefits of reducing tariffs, why cannot we apply the same calculation to the benefits of reducing the over-valuation? If the Prime Minister finds it worthwhile to travel the globe in search of the odd success in getting deals to reduce tariffs on particular goods, wouldn’t it be worthwhile him staying at home for a few days to work out ways that we can escape from the damaging over-valuation treadmill?
As it happens, we don’t need to be statistical whizzes to work out the cost of over-valuation. We can make an initial estimate by looking at our continuing failure to pay our way in the world. We have run a perennial trade deficit – that is, buying more from overseas than we sell or, in other words, consuming more than we produce. It is that deficit, and not the government’s, that really measures how well we are doing.
That trade deficit is now on the rise again, as happens every time we have a consumer-led boom, and as our over-valued products fail to keep pace with cheap imports. We are rapidly heading back to danger territory, when we could spend up to five cents in the dollar more than we earn; and when we need to cover the shortfall by increased borrowing and selling assets, that represents a typical rake’s progress that cannot be sustained.
The longer it goes on, the worse it gets. Every time we borrow more, at high interest rates, the cost of repayment increases. And every time we sell off assets to foreign buyers, the greater the size of the income stream we lose as profits are paid into foreign hands – and, of course, the less control we have over our own economy.
Yet the government, and most New Zealanders, seem completely unconcerned, and in most cases completely unaware, that this is our true situation. And it is not just the direct cost of the trade deficit that penalises us. The fear that the trade deficit will get completely out of hand and can no longer be financed by borrowing means that we are frightened to grow as fast as we could and we fail to diversify and invest in new capacity – as witness our increasingly dangerous dependence on the unreliable price of a single commodity.
Wouldn’t a few days’ attention to these issues, rather than knocking one’s head against Saudi intransigence, be a good use of time?
Bryan Gould
2 May 2015
Which Deficit?
So, the much-touted and long-awaited government surplus looks unlikely to arrive this year. Is that a surprise? No. Does it matter? Not much.
The only reason for sparing much time on the failure to eliminate the government deficit is that it relates to a target that the government itself identified as the crucial test of its ability to manage the economy. In doing so, it exploited the confusion in most people’s minds – and that includes the minds of many media commentators – as to what deficit we are really talking about.
Just a few days ago, in reporting the probability that the government would remain in deficit, Radio NZ news described it as “the country’s deficit” as though the two deficits were the same thing. Sadly, the government deficit, about which so much fuss is made, is only a minor factor in an economy which continues to remain in substantial deficit in its total operations.
Far from running the economy in a prudent fashion, the government presides over a New Zealand economy that continues to chalk up foreign payments deficits, year after year. We continue, in other words, to go on spending well beyond our means. We fill the gap by selling assets to foreigners and by borrowing at high interest rates to overseas lenders – a classic instance of a rake’s progress that makes a day of reckoning eventually inevitable.
That foreign payments deficit is about to get a lot worse, as the overvalued dollar (about which so much jingoistic celebration was enjoyed) makes it more and more difficult for us to pay our way. Those cheaper Aussie holidays today are bought at the cost of Kiwi jobs and living standards tomorrow.
So, let us be clear about the deficit we are talking about – the country’s deficit, the one that matters, the one that is getting worse all the time, or the government’s deficit, that simply defines how much the government takes in tax revenue from the rest of the economy by comparison with how much it spends.
Is there are any link between the two? Yes – the priority given by the government to its own deficit has almost certainly made the country’s deficit worse. This is because, in a recession, which by definition arises when people (that is, households and corporations) are earning and spending and investing less, the slow-down can only deepen if the other major sector – the government – also cuts its spending.
Our recession was longer and deeper than it should have been, in other words, because the government gave priority to balancing its own books, and ignored what was happening to the whole economy. An economy that went backwards for several years was even less able than usual to pay its way in the world when the world economy began to improve.
But surely, many will say, it must be a good thing for the government to tighten its belt when the economy slows down? That would be true if the government were a business, but running an economy is not the same as running a private business. The paradox is that the government’s preoccupation with its own finances has meant a more sluggish economy and reduced tax revenue so that it becomes more and more difficult for the government to balance its books.
This is the lesson taught by both history and recent experience. It is a lesson that has now been painfully learnt all over again by the world’s central banks, some of which – the European Central Bank, in particular – wasted six or seven year insisting on austerity as the proper response to recession. The people who paid the price for that mistake were Europe’s poor and unemployed; we were saved from worse only because our Australian-owned banks remained relatively stable and because our main export markets in Australia and China remained until recently reasonably buoyant.
If the government’s finances are only a small part of the picture, why have they attracted so much attention? It is worth noting in passing that, while the Labour government of 1999-2008 recorded a surplus in eight of its nine years, the current government has now chalked up six successive deficits. So why focus on this particular factor?
The answer is that focusing on the government deficit has been driven by political rather economic considerations. It has served the government very well as the justification for policies that come straight from the neo-liberal handbook. We can be sure that the next round of cuts in the level of public services will be misleadingly explained as “necessary to eliminate the deficit”.
In the end, in any case, facts cannot be denied. As any accountant will tell you, borrowings and lendings must, as a matter of accounting identities, match each other. Our perennial foreign payments deficit – what we need the rest of the world to lend to us – must be matched by the borrowings our economy makes in total. If the focus is entirely on achieving a government surplus, that makes it inevitable that the private sector (households and corporations) must borrow even more.
The truth is that, by looking only at the government deficit and ignoring the country’s deficit, we create an unbalanced and broken-backed economy that will survive only as long as overseas peddlers of “hot money” are willing to go on lending to us.
Bryan Gould
12 April 2015
A Fool’s Paradise?
The pre-election, headline-grabbing, so-called “rock-star economy” may be less in evidence today, but there is still a good deal of self-congratulation about an annual GDP growth-rate of over 3%. There is general agreement that the New Zealand economy is doing pretty well, particularly when compared with what is happening elsewhere.
It is only when we look behind the headline figure that doubts begin to emerge. Unpacking the figures and the trends is an important corrective to unjustified optimism.
First, the current growth rate – a welcome relief from an unnecessarily protracted and slow recovery from recession – owes very little to merits of our own or to the way we have managed our economy. We emerged relatively unscathed from the Global Financial Crisis largely because of the stability of our Australian-owned banks and the buoyancy of our major export markets in Australia and China – both powerful and welcome factors but well beyond our control.
The belated post-GFC stimulus to our economy came from another factor beyond our control and one which on other grounds we could well have done without – the Christchurch earthquake. A government that had set its face against using its powers to get the economy moving again – indeed, that had focused on reducing its own spending so that the economy as a whole was smaller than it need have been – found its hand forced by a natural disaster.
No one doubts that the Christchurch re-build has been a major factor in lifting economic activity, particularly in the construction industry. We would not have had that stimulus to spending, employment and investment if the government had been left to its own devices.
And much of our current optimism rests on a 2014 surge in international commodity prices, particularly for dairy products. Again, we are the beneficiaries but can claim little credit for it, and its effect already seems in any case to have been short-lived.
A fourth factor that has lifted our economy and encouraged a spending spree is the asset inflation in the Auckland housing market, something that is a function of the banks’ willingness to go on creating new credit to lend on house purchase rather than of government policy. Indeed, the government professes itself to be unhappy with what is happening – and the Reserve Bank agrees that it is a problem, not a success.
These factors that underpin and explain our relative success do not in any case come without a price. The increased lending by our banks, for example, simply adds to the billions of dollars in bank profits that are repatriated every year to Australia and that accordingly enlarge the burden on our foreign payments balance.
The consumer spending spree makes inevitable a worsening of our perennial trade deficit, as we suck in more imports to meet our insistence on spending five cents in the dollar more than we earn.
The prices people must now pay for Auckland housing must come from somewhere. They are not matched by any increase in real output and therefore reflect new money created by the banks and placed in the hands of existing home-owners at the expense of those who can’t afford to own their own homes, so that the inequality gap is thereby widened.
The rise in dairy prices throws the spotlight on our increasingly dangerous dependence on a single commodity and on the Chinese market, carrying with it the risk that we are gradually being absorbed into a greater Chinese economy.
But it is when we look to the future that the doubts really begin to grow. The government makes great play of its efforts to reduce its own deficit, without apparently concerning itself at all with the deficit that really matters – that of the country as a whole.
How many of those who are inclined to congratulate the government on its prudence in “reducing the deficit” understand that we continue as a country to live well beyond our means and that the current consumer boom can only make that deficit worse?
How many understand that the government deficit is only a small part of a much wider picture – that of an economy that cannot pay its way – and is in any case virtually inevitable for as long as we have a substantial foreign payments deficit?
How many understand that the current emphasis on high interest rates and an overvalued dollar make it impossible for us to earn enough to pay our way? Or that the price we pay for the continued foreign payments deficit is that we must sell more assets and borrow more as a country to make up the gap – that we are quite literally spending away our future?
Do we understand that, despite all the talk about broadening our economic base, we are more dependent than ever on the price of a single commodity and that our power of self-government is being constantly eroded as we become more dependent on just one customer for that commodity and as more and more of our economy passes in to foreign ownership?
Should we not ask – is New Zealand the paradise we think it to be, or is it becoming a paradise for fools?
Bryan Gould
21 March 2015
A Fair Deal for Christchurch
The Christchurch earthquake was a catastrophe that was national in its impact and significance but that required the people of Christchurch to pay its terrible price. In the four years that have since elapsed, they have had to shoulder the burden of rebuilding shattered lives and a devastated environment.
There has been no shortage of sympathy and encouragement from the rest of the country, and the government has played its part in financing the restoration of essential infrastructure. But the government’s help – provided to Christchurch on behalf of all the people of New Zealand – has been limited by a hard-headed and largely artificial distinction between what is seen as properly the responsibility of central government and what falls to be dealt with by Christchurch itself.
We now see the impact of that distinction. It means that the people of Christchurch must face a substantial financial burden on their own, in addition to the other losses they have suffered. They are to face substantial rate increases over the next three years and their city’s finances will suffer from a further loss of income as a result of the forced sale of up to $750 million worth of city assets – assets built up over many years.
They are faced with the need to shoulder these burdens because the law, as presently defined, takes no account of their special circumstances and requires them, come what may, to balance their books. The people of New Zealand, through their government, may in other words offer sympathy, but when it comes to costs, Christchurch must – from this point on – take responsibility for re-building the city on its own.
The government’s position on this issue is hard to fathom. No one doubts that the national economy has benefited greatly from the investment that has been made and will be made in re-building the city. Our GDP growth, and the level of economic activity, have been stimulated by the increase in public funding; the earthquake forced the government’s hand to increase public spending that they would, for ideological reasons, not otherwise have undertaken.
The re-building of Christchurch, however funded, will continue to provide great benefits to the national economy in terms of employment and output. But the priority given by the government to the short-term problem of reducing its own deficit means that it is unwilling to invest in gaining the further benefits potentially available to the national economy from not leaving the people of Christchurch to find the money on their own.
There must be the suspicion that the government is not unhappy at the prospect of asset sales and the opportunity thereby offered to private investors to make a profit. But, setting aside issues of fairness and national solidarity, the government’s stance is in any case hard to justify in purely economic terms.
We can see this clearly when we examine the responses of governments around the world to crises of various sorts. In the aftermath of the Global Financial Crisis, and the threat then posed to the stability of the banking system, governments like those in the US and UK had no hesitation in creating new money to bail out the banks and to get the economy moving again.
The US Federal Reserve has created no less than $3.7 trillion of new money – so-called “quantitative easing” – and the Bank of England has done likewise to the tune of £350 billion.
The Bank of Japan, at the behest of the Japanese government, has created huge quantities of credit directed to productive investment and even the European Central Bank – so long demanding austerity and reduced government deficits – has changed course dramatically.
In New Zealand, we saw our own smaller version of the willingness to bail out financial institutions in the $1.6 billion help provided to South Canterbury Finance. If it can be done to help the banks and finance companies, why can’t it be done to help the people of Christchurch – especially when that investment would provide such a good return to the economy as a whole and wouldn’t just disappear into the balance sheets of financial institutions?
There is, after all, a powerful economic pedigree for such an approach. John Maynard Keynes famously articulated two great insights. First, he said, while there are obviously intrinsic reasons for a scarcity of land, there is no intrinsic reason – in a country that is sovereign in respect of the creation of money – for a scarcity of capital. And secondly, he observed, the creation of credit for productive purposes will not be inflationary if the increased production it is designed to bring about actually materialises.
And, for those who are still nervous about the government stepping in to help in this way, consider this. If we don’t object to the huge volumes of new credit for housing purchase created for their own purposes by the banks, why should we be so reluctant to see the government act on a much smaller scale in the public interest to help the economy as a whole and the people of Christchurch?
That would be the proper response on a national scale to what is a national and not just a Christchurch issue.
Bryan Gould
1 March 2015
Solving the Housing Crisis – Facts or Ideology?
The scale of the housing affordability crisis, particularly in Auckland, is now unmistakable. Not only do individual families suffer as home ownership increasingly moves beyond their reach, but the impact on social cohesion and on the fair distribution of resources is becoming more and more damaging.
The rising cost of buying a house is without doubt the most powerful driver of inequality in our country. Those who already own their own homes can watch the rise and rise in house prices with equanimity – even satisfaction. They can comfort themselves with the knowledge that the increased price they would have to pay for a new house will be offset by the rise in value of their existing house and that, in the meantime, their wealth will – at least on paper – grow week by week without any effort of their own.
Those who are not property-owners, however, can only watch helplessly as the inexorable rise in house prices leaves them further and further behind. They would feel an even greater sense of despair if they realised that, because the rate of increase in house prices far exceeds any percentage growth in national wealth, it does not represent real resources, and can therefore only come from a net transfer of wealth from non-home-owners in favour of those who own their own homes.
Little wonder, then, that our policy-makers have at last been forced to confront the issue. Sadly, though, their response reflects political and ideological preoccupations, rather than the real reasons for the crisis.
The government has seized the chance to offer yet another goodie to their friends in business. The Resource Management Act has long been a serious bugbear for property developers. Life would be so much simpler for them if they did not have to worry about environmental issues and the interests of neighbours. The government has duly obliged. The growth in house prices, they discover, is all the fault of the RMA and, for good measure, of local government bureaucracy, and they have promised action to discipline both of these supposed culprits.
This diagnosis is also consistent with the government’s ideological preferences. The housing market in Auckland is obviously misbehaving. Since the market is, according to neo-classical economics, by definition infallible, its malfunctioning must be the result of “rigidities” that must be removed so as to allow supply to rise to meet demand.
But this is completely to ignore the fact that the housing market is not like any other market. Not only do houses maintain their value as units of accommodation over a long period of time, but in what other market is it possible for those on ordinary incomes to meet the purchase price by borrowing many times their annual income? And where else do the lenders meet any increase in the purchase price by simply offering to lend more?
And since we have now had confirmation from the Bank of England that bank lending on mortgage is created out of nothing (and that the notion that banks lend only what others lend to them is entirely false), we can now begin to see where the pressures for asset inflation in the housing market really come from.
Bank credit-creation for the purposes of lending on mortgage is in fact the single greatest factor in increasing the money supply and is therefore the source of the most significant inflationary pressure in our economy. And since it is not matched in any way by a corresponding growth in real resources, it is not surprising that it manifests itself as asset inflation (or rapidly rising house prices) in the very market into which it is almost entirely directed.
The most reliable statistics for bank lending on mortgage go back only as far 1998. In the period 1998 to 2014, the value of such lending rose fourfold, from $52 billion to $196 billion. Can we be surprised that Auckland house prices have risen over that same period at the same rate – that is, they are now four times higher than in 1998.
The Auckland housing market, in other words, is a function of the cumulative effects of that $196 billion of new bank-created money. Where else could it have gone? And the herd mentality that is typical of markets means that rising asset values attract speculators and investors seeking capital gains, thereby making the problem worse.
The Auckland housing market survives at its present level only for as long as the banks will go on lending. Each rise in prices in the Auckland housing market requires more lending to sustain it. Each new loan helps to create a new price structure which then provides the basis for yet more lending. But if, as some are beginning to realise, the bubble should burst, it is not just the housing market but the banks themselves that would be at risk.
To its credit, our own Reserve Bank is one of the few central banks to begin to perceive the truth about the housing market – hence its initial and timid attempt through tighter loan-to-value ratios to restrain bank lending for housing purposes.
There may well be measures – not just in housing but in areas such as transport – that could usefully be adopted to better align supply and demand in the Auckland housing market. But until the ideologues understand what is really driving the upwards price spiral, there is no real solution in sight.
Bryan Gould
26 January 2015