• Needless Casualties in the Economic War

    On Anzac Day, we remembered the sacrifice made by thousands of young New Zealanders at Gallipoli – sent to their fate because those with the power to make decisions had neither the wit nor the courage to depart from a course that everyone knew was doomed to disaster.

    A day after Anzac Day, we learned of another kind of sacrifice – of 350 jobs at one of New Zealand’s most iconic enterprises. This time, there was the same inevitability about the outcome of a strategy that everyone knew was failing but there were no incompetent and far-away British decision-makers to blame. This time, we were doing it to ourselves.

    The Fisher and Paykel decision, after all, did not come out of the blue. We have been sleep-walking towards it for a very long time. Nor is it an isolated instance of policy failure. Behind this decision stand many other Fisher and Paykels, all facing the same imperatives, the same inevitability, the same disastrous consequences of a discredited orthodoxy that no one in power has the courage to challenge.

    In theory, the current orthodoxy could not be simpler. Inflation is to be controlled by manipulating the price and therefore the supply of money, a task entrusted to technicians who are immune to political pressure. With the threat of inflation painlessly removed, the economy is free to flourish and investors can make their decisions with confidence.

    We have now had a protracted opportunity to test this attractive theory in practice. We now know that, while increasingly ineffective and possibly even counter-productive as a counter-inflationary strategy, the orthodoxy is profoundly destructive of the high-productivity, export-oriented economy that our business and political leaders say they want.

    Fisher and Paykel’s catastrophic loss of competitiveness as a New Zealand manufacturer represents just the first-order consequences of the high interest rate, high exchange rate regime that monetarist policy makes inevitable. Faced with an over-valued currency, all New Zealand enterprises that seek to do business in the internationally traded goods sector (including our own home market) face an unattractive choice; either they lose market share through declining competitiveness or they try to maintain price competitiveness by shaving margins and risk having to trade at a loss. For most, the outcome will be an even less attractive combination of both.

    The medium-term impact is severely damaging to our economy. New Zealand companies struggling to maintain competitiveness find that shrinking markets and disappearing profits mean that they do not have the money to catch up on foreign competitors by re-investing in new technology or upskilling staff or conducting leading-edge research or mounting an effective sales campaign or offering improved after-sales service. The result? They fall behind in the productivity race, forced to lose yet more market share at home and to give up the attempt to export. If they do survive, they move offshore or are bought up by foreign competitors.

    In the longer-term still, the consequences of an over-valued currency begin to shape our culture. The only people who make money are the speculators, who manipulate existing assets and create no new wealth. The best brains and best resources gravitate to the non-traded sector and we give up the attempt to move them to the traded sector where the real prospects for growth lie. We become risk-averse, preferring to invest in domestic assets, like housing, rather than chance investment in a high-risk productive enterprise where the threat of failure is ever-present.

    In vain do our leaders berate us for our obsession with housing, our predilection for artificially cheap imports, our unwillingness to save. In vain are we urged to improve productivity, to spend less and to save more. Economics is a behavioural science. Like Fisher and Paykel, we each of us make the decisions made inevitable by the policies adopted by our leaders.

    We are now being driven towards what everyone knows is literally a dead end. We have impaled ourselves on the horns of a dilemma of our own making. It is happening in the name of an orthodoxy that cannot deliver even the limited counter-inflationary outcomes that it promises. Ministerial exhortations do nothing but emphasise how far the dream of high productivity has become – by virtue of literally counter-productive policies – an unattainable chimera.

    We cannot escape from this dilemma until we recognise what it is. The more we push up interest rates and the exchange rate, the less competitive we become and the more we fall behind in terms of international competitiveness. The less competitive our real economy, the more entrenched is our inability to pay our way in the world and the more dependent we are on short-term “hot money” to bale us out. The more we need “hot money”, the more we need to push up interest rates and the exchange rate, the more our competitiveness declines still further and the more threatening inflation becomes.

    We must stop relying on interest rates and the exchange rate to perform tasks for which they are not suited. We should instead free our minds of current dogma, restore economic policy to democratic control and ensure that the economy is run in the common interest. That means a more accurate analysis of what is going wrong and what is needed to fix it. It means a better focus – not just on controlling inflation through fiscal measures, more effective controls on the level and purposes of bank lending, and measures to restrain the booming housing market – but on macro-economic measures to improve competitiveness and encourage growth and investment.

    For the moment, however, there is only one question worth asking. How many more needless sacrifices must be made before we say that enough is enough and that a new course must be tried?

    Bryan Gould

    27 April 2007

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