By Bryan Gould On 18 July 2009 In New Zealand Politics Tags economics, productivity

The Productivity “Puzzle”

The Prime Minister was surely right last week to identify low productivity as being at the heart of our economic problems. Low productivity has been a constant feature of our economic performance for at least the two decades leading up to the current recession, and it will remain our biggest headache as we face a post-recession future.

The bad news is that the Prime Minister’s statement is not a brilliant new insight. If talking and worrying about low productivity was a cure, we would have solved it long ago. The difficulty has never been in identifying the problem – it has been in knowing what to do about it.

There have of course always been those in denial. I remember being challenged in 1994 by Roger Kerr of the Business Roundtable to substantiate my assertion that New Zealand productivity was lagging badly. I think he assumed that the “reforms” of the preceding 10 years must have dealt with the issue. When I produced the figures (which have continued to be depressing ever since), I heard no more from him.

It is not as if we haven’t tried the usually touted solutions. Privatisations, tax reforms, removing “labour market rigidities”, strict adherence to monetary policies, have all been tried – and none have worked. Nor is it that we are lazy; so bad has been our productivity performance that we have continued to lag in the OECD tables, despite working longer hours. As a result, the average New Zealand family is now up to $80,000 a year worse off than its Australian counterpart – no wonder the grass on the other side of the ditch looks greener.

The Prime Minister’s statement has been given added weight, of course, by the credit rating downgrade applied to us last week by Fitch. The credit rating agency rightly pointed, not to the government’s deficit which they said was par for the course (prompting doubts about the priority given to it in framing the Budget), but to the indebtedness of the country as a whole. Our need to borrow at such high levels – one of the highest per capita levels in the world – is surely a function of our overall economic failure of which low productivity is both a symptom and a cause.

If we really want to address the problem of low productivity, we need to do more than wring our hands and repeat the failed nostrums of the past. That is not to say that the Prime Minister’s list of initiatives is not a good one. As a former university Vice-Chancellor and current Chair of the Foundation for Research Science and Technology, I am the last person to cavil, for example, at the emphasis on increased investment in higher education and research, but these are necessary rather than sufficient pre-conditions for better productivity.

If we really want to solve our problems, we need to take a broader view. A broad economic failure is likely to have an equally broad economic cause. But that is the one possibility that our policy-makers have resolutely refused to contemplate. If low productivity is both a consequence and a cause of poor economic performance, should we not at least be asking whether our economic policy settings over recent decades have been correct?

Productivity is a function of many factors, almost all of which cost money. To improve productivity, New Zealand firms need to spend on new skills training, new technology, new product development, new equipment, new market development, new research and development. The truth is that the New Zealand productive economy has not been competitive or profitable enough to invest in international standards of productivity growth.

Has this happened for reasons beyond our control? No, we have done it to ourselves. Our insistence on exclusively targeting inflation and on using interest rates and the exchange rate to restrain economic activity has meant a built-in and continuing bias – over decades – against growth, profitability and investment. Number 8 wire has its uses, but as an alternative to a macro-economic policy that focuses on good and sustained profits that are re-invested in new productive capacity, it falls somewhat short.

Some recent research about New Zealand productivity is most instructive. It shows that, as expected, our export firms are our most productive – typically, it is only the most competitive enterprises that will venture into export markets.

Less expectedly, however, it also shows that our export firms did not increase their productivity any faster than others. They did not, in other words, “kick on”, to take advantage of bigger and more profitable markets overseas. One can only conclude that there was something in the domestic environment that inhibited them – that the burdens of high interest rates and therefore expensive borrowing to finance expansion, and of an over-valued dollar that reduced price competitiveness and cut profit margins, had meant that New Zealand exporters had simply been unable to invest in the productivity growth that was needed to maintain and improve competitiveness against overseas rivals. They were, at best, hanging on by their fingernails. Some, like Fisher and Paykel, gave up, and moved their operations overseas.

Isn’t it time that we removed our ideological blinkers and applied some common sense?

Bryan Gould

18 July 2009

By Bryan Gould On 28 June 2009 In New Zealand Politics Tags economics, gdp, recession

Too Late for Complacency

Reality is beginning to catch up with complacency. We have consistently underestimated the severity of the recession; our forecasts have constantly had to be adjusted to take account of the ever-worsening outlook, but they still lag behind the true dimensions of the downturn.

A sign of the times is the fall in GDP for the first quarter of the year. What this figure tells us is, that despite the optimism expressed by the Treasury and others in the months before Christmas, the recession is well into its second year and is still building momentum. No one now believes that the second quarter of 2009 will show any reversal of the trend, and that means that we are now about to enter our seventh quarter of recession, with little or no relief in sight.

Why have our forecasts so consistently understated what has been happening, with the result that our policy response has been dangerously inadequate? The answer is a complex one.

The first part of the answer lies in the fact that we are experiencing a different recession from the one that has afflicted most of the rest of the world. Our recession has come in three phases; the first began at the end of 2007 with our own home-grown recession, when our domestic economic policies hit the buffers and the constant use of ever-higher interest rates and an over-valued exchange rate in a failing attempt to control inflation had done enormous damage to our wealth-creating sector.

Long before the rest of the world, we had already become accustomed to living with recession. We were therefore less panicked by the onset of the second – global – phase of recession, in the third quarter of 2008, when the world’s financial institutions were in free fall. We felt that we were already grappling with the problems, and we were in any case less affected – in the short term at least – by financial failures than most other countries. There was a sense of “phoney war”; people began to believe that the recession was not so bad after all.

But what they had not reckoned with was the third and most dangerous phase of recession – the price paid by our small, vulnerable, open economy when the financial crisis impacted the real (and not just the financial) economy around the world. What we are now discovering is that as growth turns negative, unemployment rises, credit becomes more difficult and expensive, and investment plummets on a global scale, there are very nasty consequences for our export markets and for the prices we are paid for our goods – and that is to say nothing of the increased cost of the international credit on which, in our indebted state, we are so greatly dependent.

The worst of our recession, in other words, is yet to come; as I warned in these pages in December “we are still looking to the early end of a recession that has barely begun.” We are likely to be first in to the recession, but last out. Our share of the pain from the global downturn will follow – at the end of the causal chain – as a consequence of the pain felt by others, but we are still behaving as though the measures thought adequate to deal with the first (home-grown) phase of recession will carry us through. Part of the reason for this, sadly, seems to be a continuing predilection for relying on monetary policy, and an ideological reluctance to accept the value of government intervention.

Our so-called “stimulus” package has been piecemeal and small-scale – scoped to deal with recession in early 2008 but inadequate to respond to what is now in store. And, it has been less effective than it might have been because it has been misdirected, taking the form of tax cuts for the well-off (who may or may not spend them) rather than direct investment in economic activity and in lifting demand.

We still seem to pay inordinate attention to the OCR, but that bolt has largely been shot. Monetary policy, once interest rates have been cut to low figures, is largely ineffectual to stimulate the economy. The Governor of the Reserve Bank’s insistence on keeping further minor cuts up his sleeve does have one consequence however; it is read by the foreign exchange markets as an invitation to pile in to the New Zealand dollar, so that a once again over-valued currency will ensure that any nascent recovery will be still-born. And, when we eventually do turn the corner, the odds are that we will be back on the same debt-fuelled treadmill that ran us into the buffers in the first place.

There will be some developments to help us – net migration figures and a stabilising housing market perhaps – but the most important factor depressing our immediate economic future is rising unemployment. We have only now started to see the full potential of job losses. The actuality and the fear of unemployment is only just getting under way. If we don’t want to see the recession deepen into 2010, we should be acting now.

Bryan Gould

28 June 2009

By Bryan Gould On 28 May 2009 In New Zealand Politics Tags budget, credit rating, economy, treasury

A Standard and Poor Budget

We may never know what passed between Standard and Poor’s and our Finance Minister on the eve of the budget. And only time will tell whether the “primary focus” of the budget was – as the Prime Minister claimed – the avoidance of a credit rating downgrade and whether, in the long run, that goal was achieved. But the episode does raise a number of interesting questions.

Eyebrows were understandably raised at the explicit acknowledgment that the government’s budget strategy has been shaped by the need to please an overseas credit rating agency. How did we, as a sovereign country, become so powerless to decide our own destiny?

We don’t have to look far for the answers. After decades of poor economic performance and – as a consequence – of living beyond our means, we are now one of the world’s most indebted countries. On some measures, only Iceland had a greater overseas debt in proportionate terms than we have – and we know what has happened to Iceland.

The size of our debt means that we are dangerously dependent on the willingness of others to lend to us. In times of plentiful and relatively cheap credit, borrowing (at a price) was not a problem. But the global crisis has changed all that. Credit is now in short supply and countries like New Zealand, with substantial deficits to finance, will have to pay an interest rate premium to borrow – if they are able to borrow at all.

The level of interest we must pay will depend crucially on our credit rating – and that is why the government is so concerned about the view taken of us by Standard and Poor’s. According to the Treasury, a downgrade would cost the country $600 million and interest rates could rise across the board by 1.5%.

But is this all as stark as it seems? Are the threats of a credit downgrade and its consequences as serious as they sound, and – even if they were – would they be a price worth paying for gains that are even more important?

We should note, first, that the Treasury and others have been very relaxed over a long period about interest rates that have been much higher and more damaging to our economy than anything currently contemplated. And we should also note that many of the more frightening Treasury forecasts of the likely level of government debt seem to be simple extrapolations of the short-term and recession-induced deterioration in the government’s financial position, and to pay little attention to the beneficial impact of an effective counter-recessionary strategy. And no one – least of all Standard and Poor’s – could overlook the fact that our government’s financial position is, by both our own historical standards and in terms of international comparisons, reassuringly strong.

Let us assume, in other words, that the credit rating agencies are not lacking in intelligence and know their own business. The government may be obsessed by the projected level of government debt but Standard and Poor’s know that the government’s relatively healthy debt position is only a small part of the real problem – the huge amounts that we as a country (and that includes all of us, banks, businesses, individuals as well as the government) have to borrow overseas if we are to keep our heads above water.

That is the real issue of credit-worthiness – not the government’s debt but the country’s indebtedness. That can be corrected only if we reverse the long-term failure of economic policy and performance and it will only get worse if we fail to use the spending power of government to rescue us from recession. That, surely, is what a credit rating agency should be focusing on.

The best and quickest way, after all, of bringing both the government’s debt and the country’s borrowing requirement down to manageable levels is to make the recession as short and as shallow as possible. The buoyant tax revenues produced by a recovering economy will quickly bring the deficit down, and repay the $600 million supposed cost of a credit downgrade (if it should happen) several times over. Just how rapidly that can happen can be seen from how fast the government’s finances travelled in the opposite direction once the recession struck.

No one would welcome a credit downgrade. No one can cavil at the government’s insistence on value for money in public spending. But our over-riding goal should surely be recovery from recession. In giving priority to a temporary increase in government debt as we face the worst recession in generations, we may be taking our eye off the ball. There is a bigger game in town, and that is the health of the economy as a whole.

Bryan Gould

28 May 2009

This revised version of an earlier piece was published in the New Zealand Herald on 1 June.

By Bryan Gould On 15 May 2009 In New Zealand Politics Tags budget, credit, debt, economics

The Country Not The Government Should Be The Budget Priority

Even as they prepare their annual budgets, governments don’t always enjoy the freedom of action they would like. The intervention of outside agencies like the IMF is all too familiar to many governments whose economies have run into the buffers, and even at the best of times New Zealand governments have been content to hand over major decisions about the economy to an “independent” (for which read “unaccountable”) bank.

In terms of democratic accountability, however, we seem to be plumbing new depths in this country with the tacit acknowledgment that the government’s budget strategy is being shaped by the view taken of us by a mid-level desk officer in an overseas credit rating agency. How did we, as a sovereign country, become so powerless to decide our own destiny? Why, at a time when the economic crisis has called into question so much of what was the prevailing orthodoxy, are we still so dependent on the opinions of bean-counters who are focused on only one small part of our economic landscape?

We don’t have to look far for the answers. After decades of poor economic performance and – as a consequence – of living beyond our means, we are now one of the world’s most indebted countries. On some measures, only Iceland had a greater overseas debt in proportionate terms than we have – and we know what has happened to Iceland.

The size of our debt means that we are dangerously dependent on the willingness of others to lend to us. In times of plentiful and relatively cheap credit, borrowing was not a problem, though even then the high interest rates we had to offer crippled our productive economy. But the global crisis has changed all that. Credit is now in short supply and countries like New Zealand, with huge debt to finance, will have to pay an interest rate premium to borrow – if they are able to borrow at all.

The level of interest will depend crucially on our credit rating – and because our debt is proportionately so big, the cost of even a small hike in interest rates as a consequence of a credit rate downgrade will be damagingly high. That is why the government is so concerned about the view taken of us by Standard and Poor’s, and why this month’s budget will be framed to please them.

This, then, is the long-term outcome of the economic policy we have pursued for twenty-five years – that our government feels that it must dance to the tune of a credit rating agency rather than address the worst recession in living memory with the policies that stand the best chance of bringing it to an early end.

There is, however, a mystery at the heart of the government’s acceptance that it must toe the credit rating line. The focal point of economic strategy appears to be the over-riding priority given to the size of the government’s debt. The scope for stimulating the economy through, for example, investing in much-needed infrastructure (which most commentators agree is the best way to deal with a recession) is said to be greatly constrained by a government debt that threatens to shoot into the stratosphere within a few years if public spending limits are relaxed.

But is this really the case? Let us leave to one side the argument I have advanced on other occasions – that stimulus now through public spending is the best way of reducing government debt in the medium to longer term. Let us instead register that even pessimistic projections of how far and fast the deficit might grow would still leave government debt at levels that in both our own historic terms and in terms of international comparisons would be comparatively low.

It is not government debt that is the problem. Careful management over the past decade has left the government’s finances in pretty good shape. We can afford, more than most countries, to allow the government deficit to grow a bit, if that is the price to pay for prudent investment in our economic future and for getting on top of the recession quickly.

Our real problem is not the government and the role that it might play in putting in place a counter-recessionary stimulus package. The underlying problem is the country’s indebtedness – what banks, businesses, individuals as well as the government need to borrow to fund our failure to pay our way. That problem is a function of the long-term failure of economic policy and performance – and it will only get worse if we fail to use the power of government to rescue us from recession.

This is a time for keeping our eyes firmly on the ball. There is a bigger game in town, in other words, than the government’s debt and the risk of a credit rating downgrade. The budget strategy should focus on the country’s accounts, not just the government’s. The best way of looking after the latter is to get the former right.

Bryan Gould

15 May 2009

By Bryan Gould On 23 March 2009 In New Zealand Politics Tags deficit, deflation, economics, jobs summit, recession

Spend Now, Prosper Later

The global recession dominates the thinking and writing of the world’s best economists – and not surprisingly, they exhibit a wide range of views as to what is really happening. There is not even a consensus about how deep and how long the recession will be, let alone what should be done about it.

In New Zealand, we are now reaching a more sober assessment of how we will be affected. After an early period that was somewhat akin to a “phoney war”, we are now beginning to realise that the worst may be yet to come.

We must of course be careful to avoid undue pessimism. Deflation feeds on itself, as people prepare for hard times by battening down the hatches and thereby make the times even harder. But we must also be alert to the policy measures that could help – and there is at least an emerging consensus that the earlier such measures are put in place, the more effective they will be.

We also know now that the “jobs summit” – however well-intentioned – may have succeeded in creating a sense of pulling together but has not managed to produce much by way of measures to stop the slide into further recession. If we are to be effective, we need to decide now on what needs to be done.

The time may be right, in other words, to rehearse the arguments for government intervention. Virtually all of the world’s economists agree that the central feature of recession, and of threatened depression, is a deficiency of demand or purchasing power. In New Zealand, we are being hit by a double whammy in this regard; our export markets are contracting at the same time as unemployment and a deflated housing market mean that consumers at home are also spending less.

Left to itself, an economy will take a long and damaging time to correct this deficiency. But, it will be asked, what can governments do about this, when their own finances are being hard hit by recessionary factors? And if the government spends money it doesn’t have, isn’t this just building up problems for the future?

Our own Treasury is not immune from this kind of thinking. Its projections show – even without further interventions – a sharp rise in the government deficit in the next year or so, and they then extrapolate that rise so that the deficit appears to soar into the stratosphere over the next decade. This, they say, means we should be cautious about boosting government spending further.

This is not, however, an accurate way of looking at the issues. There is a good deal of evidence, supported by a growing number of economists, that the key is timing. A dollar spent now to boost the economy could save several dollars in government deficit later on.

The argument runs as follows. The government deficit rises and falls in line with the fortunes of the economy as a whole. A buoyant economy will generate a large tax revenue so that -as has happened over recent years – the deficit can actually be reduced by paying off debt. A flat or shrinking economy, on the other hand, will increase the deficit, as the government struggles to maintain essential services with falling tax revenues; and if the government does respond by trying to cut the deficit by spending less, this will make matters worse by dragging the economy even lower and making the deficit bigger in the long term.

If, on the other hand, the government has the courage to intervene now with carefully judged spending so that economic activity is boosted, the recession will end sooner and government finances will improve quicker. What might look like a frightening short-term deficit may well be the best protection against a bigger deficit in the long term. The priority is to spend the government dollar now, when it is most needed and will be most effective in correcting what would otherwise be a growing deficiency of demand.

Government spending now would of course depend for its efficacy on exactly what it was spent on. If increased government spending went mainly on consumption, little would have been achieved; that is why many believe that tax cuts are not necessarily the most effective means of boosting the economy and countering the recession.

If, on the other hand, the government spends now on investment projects that will strengthen our economy in the long term, we not only counter the current recession effectively, but will be better equipped to prosper in the future. Investment for this purpose need not be limited to physical facilities in areas like transport, communications and energy, but could also include programmes for improving our research effort and the skills of our people.

The ideologues and the faint-hearted will quail at the sight of a rising government deficit at this particular juncture. But common sense is our best guide. We are all familiar, in our personal lives and in our businesses, with borrowing now to invest in a more prosperous future. Let’s do it for our country too.

Bryan Gould

23 March 2009

This article was published in the NZ Herald on 26 March.