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War Economy

Dependent or Independent Economy?

Dependent or Independent Economy?

In pre-war years the United Kingdom was taking four-fifths of New Zealand's exports and supplying nearly half of her imports. Nearly another quarter of New Zealand's imports came from other Commonwealth countries. Commonwealth trading arrangements had been formalised in 1932 in the Ottawa Agreement, and for New Zealand this meant, in the main, the exchange of tariff and quota preferences with the United Kingdom. In effect it gave New Zealand an assurance that the United Kingdom would continue to absorb the bulk of her exports free of duty and quantitative restrictions, while New Zealand agreed to maintain a 20 per cent tariff preference on most imports from the United Kingdom.

These arrangements, while ensuring a market for farm products, gave New Zealand no protection against price changes on a United Kingdom market which was from time to time affected by over-supply.

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In its 1935 election campaign the Labour Party had promised to insulate the New Zealand economy against external economic fluctuations. In the first two years of Labour administration, insulation would have involved siphoning off increases in export earnings. The Coalition Government had left the country with substantial overseas reserves. Then in Labour's first year of office export prices rose 14 per cent, and by a further 15 per cent in the second year—truly a most favourable start for any Government's term of office. But in these years the only steps towards insulation were some diversification of the economy and the accumulation of £0·6 million in the special account set up under the guaranteed price scheme for dairy produce.

Between 1936–37 and 1937–38 export prices fell by more than 5 per cent, and Labour's promise was put to the test. The fall in export prices continued into 1938–39, with a further reduction of 3 per cent. These falls were serious but still left export prices at 19 per cent above their level in 1935 when Labour took office. In 1938–39 the dairy farmers' guaranteed price insulated their incomes against the fall, the Dairy Produce Account going into deficit by £1·9 million for the purpose. But the most serious price fall was in wool, which in 1938–39 realised 35 per cent less than the peak prices of 1936–37. Here there was no insulation.

The Government carried on with its expansion policy as if the economy were in fact insulated.

Fortunately import prices were still below their pre-depression levels and the purchasing power of a given quantity of exports increased by 23 per cent between 1935 and 1937. Between 1937 and 1939 this purchasing power, or terms of trade, decreased by 8 per cent, but this still left it 13 per cent above the 1935 level.

However, it was soon to become apparent that insulation would require either unlimited overseas funds or irksome internal restraints.

In 1936 the value of exports had moved above the 1929 level for the first time, when £57 million was earned. The next year earnings increased to £67 million but fell away again to £58 million in 1938 and 1939. Meantime imports, stimulated by increased internal purchasing power and augumented by extra orders of heavy equipment for the public works programme, had increased rapidly up to 1937. The rapid mechanisation of farming also added to the expansion of import requirements.

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Imports and exports are shown in Chart 5. Export receipts have to pay for a substantial unfavourable balance of invisible items, such as debt servicing, as well as to meet the cost of imports.

chart of import and export

Chart 5

When export earnings fell in 1938, imports remained high, leading to successive falls in the overseas reserves of the banks. This influence, combined with some flight of capital as a result of a loss of public confidence, resulted in the overseas reserves in December 1938 falling to the dangerously low level of under £7 million. The Labour Party's promise to insulate the New Zealand economy was now under a most exacting test. Disaster was avoided by resort to exchange and import controls at the end of 1938, but, even so, New Zealand entered the war with overseas reserves still at an extremely low level. They were only £16 million in December 1938, £20 million below their December 1935 level. Changes in net overseas assets of the banks are shown in Chart 6.

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chart of bank assets

Chart 6

Import controls were a direct restriction on the freedom of action of a considerable economic group and must have seemed a high price for them to pay for the attempt at insulation. But the Labour Party seems to have been tolerant to this form of control.1 It offered secure protection for the rapid expansion of manufacturing which would be essential if the production base of the economy was to become broad enough to make insulation practicable.

Whether the electors would have tolerated import controls was not really put to the test at this stage. Before there was another election, import controls, along with many other controls, were to become necessary to protect the war economy.

Insulation against overseas economic disturbances had not proved so easy. The country had been subjected to import restrictions and, even with these restrictions, there was still considerable danger of financial disaster in New Zealand's external relations. It may not be fair to say, as some have said,2 that the war saved the Labour Government from financial disaster externally, but it is certain that a very crucial testing period was avoided when war came and completely changed the influences on the external economy.

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1 Some members had advocated it for many years.

2 NZPD, Vol. 256, p. 446.