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The Economy: An Orthodox View

by Rory O'Malley, Senior Research Officer, N.Z. Institute of Economic Research.

What are the prospects for the New Zealand economy? Whatever one's opinion regarding desirable directions for New Zealand society, this is a fundamental question. My underlying premise is that we hope to, somehow or other clamber back onto a path of increasing material living standards (qualified by the requirements of "fair" income distribution, environmental preservation, personal freedom, etc., which are increasingly demanded of our macro-economic managers with — happily —some success.) Judging by recent electoral behaviour, not to mention resumption of a net emigration situation, this is largely what the community wants. Whether this is an appropriate choice for society is, of course, worth serious analysis, but beyond my intentions for this article. In any case, whatever alternatives might be preferable to maximising economic growth, they are unlikely to be achieved in a climate of endemic balance of payments deficits and presistent inflation, the most prominent signposts of our present economic malaise.

Whether New Zealand is in fact "at the turning point," as the title of the recently published Task Force report suggests, is debatable. I am more inclined to the view that we are again confronting a traditional enemy — the balance of payments. This is inevitable from time to time in a small, relatively open economy with a narrow resource base, and is a recurring and dominant feature of New Zealand's history since European settlement. If there has been a turning point, economic historians may well peg it to the 1967/68 recession rather than the present one. Nevertheless, given that the relative magnitude of the external deficit is now the greatest for at least forty years the sense of urgency implicit in the title is probably warranted. Given also that the deficit is accompanied by a rate of inflation that we only partially understand and seem unable to control, some careful and imaginative thinking about our economic future is certainly timely.

Broad tables such as "external deficit" and "inflation" do not define the economic problems sufficiently rigorously. It is frequently claimed that we are "living beyond our means" in the sense that demand for imports is exceeding the capacity to earn export income — which leads to "belt tightening" as a dominant concept underpinning most suggested remedies. I would prefer to say that the economy is not sufficiently productive to satisfy our consumption and growth aspirations. The difference is more than one of semantics. It is vital to recognise that present import quantities are not particularly high. Admittedly, we did have a bit of a splurge in 1973 and the early part of 1974 which led to the initial growth of the deficit, but this has since died off. Import payments remain high because the prices of imported goods have risen at a phenomenal rate. Export prices recently have more or less held their own, however, so that the core economic problem, and the one which bodes ominously for the future, is that we are unable to supply a sufficient volume of export goods. In short, it is stagnation in export capacity in the economy rather than extravagant importing that is the root of the balance of payments difficulties and pinpoints their medium and long term character.

Thus while some deflation in the economy in the short term is inescapable if totally unmanageable overseas debt is to be avoided, a more important policy objective is to mobilise resources so they can be used more productively. It is unrealistic to expect the owners of those resources (whether they are labour skills, capital, energy resources, or anything else) to respond in a manner consistent with economic recovery if they get nothing out of it. Consequently the policy of restraint should be delicately balanced with a mixture of incentives and higher reward. The difficulty lies in achieving this but not adding excessively to consumption demand in the short term, especially if it has a high import content.

Although I said inflation was not properly understood, we can be fairly sure that it has played a leading and damaging role in allowing the present situation to develop. Its effects are certainly more penetrative than those obvious to the housewife who is conscious of relentless erosion of the buying power of the family budget. The businesses, who are apparently the unworthy benefactors of consumer price escalation, complain that their profitability is under pressure due to increasing costs — and wage costs invariably cop most of the blame. Moreover, it is claimed that the present tax rules, which are based on historical cost rather than replacement cost accounting principles, impair their ability to survive and discourage investment. Likewise, farmers are faced with a cost-price squeeze and cannot, or are not prepared to, finance expansion. It appears, therefore, that inflation leads to reductions in real purchasing power in more than one sector of, the community. Not only are there unwelcome income distribution effects, there may also be reductions in economic capacity and productivity.

New Zealand's economic straight-jacket can possible be described another way. Society today is dominated by what are known as middle-class people and attitudes: self-employed tradesmen and storekeepers, employees of large organisations, salaried public servants, and so on. (George Orwell would would doubtless have insisted that some of these are more middle-class than others!) Most of these expect a level of income from the "system" that will give them a reasonably high material standard of living. Many of these, however, may not be sufficiently productive in their occupations to justify the level of consumption aspired to. Indeed, given the macro-economic position, this must be so. The awkward reality is how to identify which individuals (or groups, or firms, or industries, or institutions) are most in need of reform. Most people probably agree with this somewhat quackish analysis, but, human nature being what it is, there is a tendency to blame a group one does not belong to or of course, the government. This is easy to get away with in a modern economy where complex inter-relationships are involved. The rate of inflation seems to be a catalyst of this kind of squabble and contributes to a weakening of social cohesion.

Government can act to restore the public's confidence in the economic system with appropriate economic policies. It has to be said, however, that these are necessary but not sufficient conditions for control of inflation and resource reallocation. No amount of macro-economic string pulling (e.g. fiddling with the exchange rate, fixing monetary conditions, planning the government budgetry programme, reforming of institutions and regulations) can Guarantee economic recovery. It is true, on the other hand, that poor economic management will certainly prevent it. The necessary accompaniment of economic policy is a joint preparedness to accept the opportunities it provides. With this in mind I presume to suggest some of the directions policy should follow. The problems described are more than transitory and cannot be blamed on the terms of trade. Decisive adjustment of the internal economy is therefore at the heart of my "recipe," which is, I must add, not comprehensive, and may not even be consistent.

The farming sector is currently being neglected by policy makers at our peril. The technology for further increases in farm output is available but not being implemented because farming incomes are static or declining. Another issue facing the rural sector is that of inflating rural land prices. Because these have risen at an unrealistic rate in relation to farming profitiability, the sector is increasingly relying on expected capital gains rather than higher productivity as a justification for owning and occupying agricultural land. Policies are urgently required which will attract innovative labour and capital into the rural sector. This kind of enterprise is currently shifting to the towns where the rewards are higher. Suitable policies will be politically difficult and take courage to initiate because deep-rooted attitudes concerning land ownership could be at stake.

The recent surge in manufactured exports is perhaps one of the reasons the farming sector has had less attention. Great care is needed in assessing the value of this development to the New Zealand economy, as it may also be at the heart of much of our import demand, which has proved difficult to control. I am very much in favour of manufacturing industries if they export because of high productivity and skilful management of resources. I suspect, however, that much of the recent expansion was facilitated principally by an increasinly convenient exchange rate with Australia rather than spectacular productivity gains. Even that would be reasonably acceptable if the recent currency devaluations (New Zealand has formally devalued in each of the last three years; in two of these the justification was explicitly to preserve manufacturers' competitiveness in Australia) led to a lower import demand. This does not seem to happen, and the higher import prices cause inflation rather than demand reallocation. The events have maintained employment nevertheless, and the experience of exporting may in the longer run lead to higher productivity, but it is wrong to claim for them in the meantime virtues they do not have.

Space does not allow a full coverage of policies which might encourage higher productivity in all sectors. It is a question of how to present the carrot and how and where to wield the stick. Tax exemptions for shift work and secondary employment, or tax relief for substantial commitments to medium term saving are the kind of thing that could work in the national interest. Shift work, which is not common in small industry in New Zealand, is synonomous with intense capital utilisation and the sort of productivity gains we are seeking. Tax concessions for genuine saving may be successful in delaying some of the consumption effects of any increased incomes. The Achilles heel of this approach is the state of public sector finance. Because of the deficit, which is very likely contributing to excess demand in any case, the government has very little manoeuvrability in terms of tax incentives. It could only do this if it was prepared to heavily reduce public sector spending. Clearly productivity gains in the public sector are also extremely important if our social services are not to suffer seriously over the next few years.

It is my contention that some form of direct import control is an essential ingredient of any policy mix for the next few years. The arguments against it are well known and do not require repitition, but could well be rethought. Deflation of the economy sufficient to correct the balance of payments would not only be socially undesirable, it would be economically wasteful. It may be less wasteful to put up with some of the administrative arbitrariness and general "messiness" any system of controls would probably bring. It would be different if our import demand showed any marked tendency to respond to the relative pricing pressures that have been manifest in recent years. Import licensing should not become a central element in industrial policy as it has in the past, but is needed as a means of minimising additions to future overseas debt servicing commitments while other resource reallocation strategics begin to operate.