Opinion: Are we out of the woods yet?

By Neville Bennett New Zealand is casting about for direction. There is an air of confidence, bolstered by news that GDP increased into positive territory in the last quarter, albeit at a rate of 0.1%. Can a strong recovery now be expected? One newspaper headline last week: "Recession done and dusted" prompted this response. While the economy is strengthening over previous quarters, there is no evidence of a recovery towards strong growth. Several commentators are picking 3.5% growth next year though 2011 and onwards. This optimism is misplaced. It worries me because it assumes that New Zealand is a closed economy, capable of prosperity based on better house and some retail data (like lipstick and fast foods) indicating we can get rich by taking in others people's washing.

Actually, we live in an international economy where many markets are subdued, capital is tight, and debt bedeviling budgets. The stimulus is wearing down and now must be paid for. Our growth is limited by that of our customers, and the USA, the EU (including the UK) and Japan foresee very low growth. My main argument, however, is that the past crisis has been minimised. It is not a mere blip, and it may not be over. A point I will stress is that the latest research by the IMF into 88 banking crises over the last four decades, shows that after a crisis, on average, "the output level is still around 10 percent below its pre-crisis trend seven years after the crisis". In other words, our output may still be 10% below that of 2007 in 2014. I am not saying this is certain, but Japan's experience of no growth over nearly 20 years is a reality. Moreover, some indicators are consistent with poor performance. As Michael Coote wrote income growth in the US cannot be expected to grow for 4 to 5 years, wealth loss will crimp consumer spending, credit is tight (the Bank of England is considering negative interest rates to force banks to lend rather than deposit money with it) and most economies with be subject to fierce fiscal drag from 2010. There are strong headwinds in the medium term. New Zealand Basically, growth can only come from more activity than is presently occurring. Some extra activity is always necessary because economies are in a state of creative destruction. Some parts are growing very quickly but others are in decline or have gone out of business.  The slowing element is obvious in growing unemployment and falling investment. Many firms are stable, with negligible profitability. Where can extra income come from? Exports are the main hope, but most markets are fragile and exports dived in August. The outlook is diminished by a high dollar. The trade balance is quite good only because imports have dropped 21% for the month, and the downward trend is the worst since the statistical series began in 1988. Imports of goods for consumption are much stronger than investment goods - which bodes ill for future growth. Other external sources of growth include tourism but that is also down and not certain to recover strongly. Fortunately immigration is very positive. Growth can also come from internal demand, either from the public or private sector. Greatly expanded government expenditure is impossible owing to National's ideology and the scrutiny of the credit raters. There is, however, significant stimulus in road construction. But, business is not investing significantly. As incomes are not rising strongly, stimulus from household expenditure must come from savings or credit. Retail spending will not be sufficient to power a growth surge. The outlook in the next 2-3 years is little better, with growth perhaps occurring in the 1%-2% range, according to BERL. IMF Viewpoint The IMF's World Economic Outlook, October 2009 argues that banking crises have a long-lasting impact on the level of output, although growth eventually recovers. Lower employment, investment and productivity all contribute to sustained output losses. Obviously, there is variation across countries and with the nature of the crisis. But this recession is much greater than the other 88 which the IMF studied, and presumably did more damage and will be harder to recover from. For the average country, the output level is "still around 10 percent below its pre-crisis trend seven years after the crisis". This is applicable for both developed and undeveloped countries. Depressed output comes roughly equally from three sources: reductions in employment, the capital-to-labour ratio and productivity. Initially, the greatest loss in output comes from a loss in total factor productivity, but this recovers in the medium term. But capital and employment suffer enduring losses because the crisis depresses investment as the supply of credit is more limited. Moreover, unemployment tends to endure for a long time which erodes working skills. Many workers have to change their type of work. Less credit, persistent unemployment and a weaker capital-to-labour ratio weaken productivity. The most surprising finding is that a high pre-crisis investment-share is a good predictor of large medium"“term output losses. Normally one associates high investment with productivity and innovative products. Nevertheless, it was noticeable that manufacturers, especially in motors cars, have suffered inordinately in this crisis. The Asian Crisis also impacted adversely on societies which devoted a high proportion of their national income to investment. The good news for Australia and New Zealand is that initial conditions have a strong influence on output loss: their loss of GDP is much less than the average country, which facilitates a revival. Some counties avoid an output loss and achieve growth subsequent to the crisis. The key appears to be timely stimulus and a readiness to reform. This research is rather sobering. Most counties will suffer an output loss in the medium term. Stimulus measures may mitigate this, but the IMF sees merit also in reforms to help to raise output and facilitate the shift of resources across sectors. This is not music to my ears, readers may recall an earlier column in which I lamented the drive to de-industrialise and rely on services. ____________ * Neville Bennett was a long-time Senior Lecturer in History at the University of Canterbury, where he taught since 1971. His focus is economic history and markets. He is also a columnist for the NBR where a version of this item first appeared. neville@bennetteconomics.com www.bennetteconomics.com