Ahead of the Half Yearly Economic and Fiscal Update (HYEFU), Brian Easton looks at economic prospects - particularly in respect to unemployment and the fiscal position

This is a re-post of an article originally published on pundit.co.nz. It is here with permission.

By way of prologue, the closest parallel to the current economic situation may be when Ruth Richardson became Minister of Finance in late 1990. The economy had been contracting, although there were signs of a fragile recovery. She was an Austerian and cut public spending savagely.

The economy plunged a further 5% in GDP per capita terms. Unemployment rose to above 10% of the labour force. Richardson could claim she achieved her Austerian goal of lowering relative government spending.

But National only narrowly won the 1993 election (because the left was severely divided – this was before MMP). Richardson was sacked. While she could point out that the rate of inflation came down under her watch, it was not really her win. World inflation was falling and in any case, as the legislation she supported clearly states, inflation was the responsibility of the Governor of the Reserve Bank (then Don Brash) not the Minister of Finance. (Perhaps one should add that the National Government also suffered electorally from its attempt to commercialise the health sector.)

This is not to say that this will be the political fate of Nicola Willis, nor of the Luxon Coalition Government. But the memory of the effect of heavy cuts to government spending on a weak economy hangs heavily over today’s policy stance.

Treasury’s 2024 Half Yearly Economic and Fiscal Update (HYEFU) is due for release on Tuesday 17 December – an awkward time of the year, which precludes serious analysis published before Christmas. Helpfully on 21 November, Treasury’s Chief Economic Advisor, Dominick Stephens, gave an indication of what is likely to be in the macroeconomic forecasts – not the numbers, but the way they are shaping up.

He observed that the economy has been doing worse than the central forecast of May’s Budget Economic and Fiscal Update (BEFU), pointing out that since the September quarter of 2022, per capita GDP has fallen by 4.6%, making this already a larger per-capita recession than the Global Financial Crisis of 2008-10. Recent economic data suggests the downturn has been deeper, and the recovery will begin later, than the May BEFU forecast (which was already pessimistic compared to the December 2023 HYEFU):

– in the June quarter GDP fell 0.2%, compared to the Budget forecast of a 0.2% increase.

 – as of October, spending on electronic cards at retail stores remained 1% lower than a year ago.

– indicators of manufacturing and service activity remain at contractionary levels, suggesting little or no growth in the economy over recent months.

– Despite improvements in firms’ expectations of future trading activity, the Quarterly Survey of Business Opinion reported that firms are more pessimistic about their current trading conditions than they have been since 2009 (apart from the pandemic).

In fact the economy seems to have been tracking nearer the downside economic forecast which was also set out in BEFU2024. I look at two aspects of what this may mean: unemployment and the fiscal position.

Unemployment tells us something about the shape of the output (GDP) track although it tends to be a lag indicator. BEFU2024 had its rate at 4.0% of the labour force in December 2023, rising a third to 5.3% at the end of 2024 (about now). Then it was to fall sluggishly so that in December 2026 it would still be at 4.6%. There is no downside forecast for unemployment, but a reasonable guess is that it would have peaked near 7% sometime in second half 2025 and would be correspondingly higher about the time of the next election (even 6% in December 2026). Recall that after the GFC it took the economy almost five years to return to its previous GDP peak.

The fiscal forecasts are gloomy too. Treasury’s Chief Economist reported that ‘Treasury has been revising its revenue forecasts lower. Tax revenue has proven lower than expected given the state of the economy in recent economic and fiscal updates. ... If this trend continues, there could be further downside risks to the Treasury's revenue forecasts.’ One of his Associate Ministers, Chris Bishop, was less discreet, announcing that it is unlikely that the fiscal position will return to surplus by 2027/8 as forecast in BEFU2024.

The Treasury did not foreshadow anything about the public spending track. That is a ministerial prerogative; ministers are indicating they expect more public spending cuts. A group of 16 economists led by Ganesh Nana have argued there should be no more spending cuts or delays to infrastructural spending because they will ‘needlessly exacerbat[e] the current recession’. In effect the economists are arguing for a bigger government deficit – that it is not necessary to pursue as rigorously the debt-to-GDP target. Bishop may agree; he said the government was ‘not going to be a slave to a surplus’ (not mentioning one can get enslaved by debt). Prime Minister Christopher Luxon said ‘I'm not going to chase a surplus at all costs.' We await HEFU2024 to learn the new date.

One should not quibble with public spending cuts whose purpose is to reduce over-staffing, while arguments about cuts of programs which the government does not like are political, although there will be technical consequences. The offset to this position is that the government should increase expenditure where there is under-staffing or on programs which it favours. The technical issue is whether the government should be cutting overall expenditure (or restraining it below population and related demands) to return to surplus. (There is a parallel discussion around raising taxes.)

What Nana et al. are arguing is that not only are such cuts unnecessarily harsh but they are compromising long-term economic growth. On the other hand, there are Austerians who think that the state sector is still too big and are using the crisis to cut it back. (The exception is that they prove to be big spenders in their own portfolios.)

This is likely to be a major debate from now to the next election. In the interim the economy is contracting and is likely to stagnate a bit before it recovers. I withhold an explanation until we have the detailed Treasury HYEFU2024.

*Brian Easton, an independent scholar, is an economist, social statistician, public policy analyst and historian. He was the Listener economic columnist from 1978 to 2014. This is a re-post of an article originally published on pundit.co.nz. It is here with permission.