Labour’s unexpected economic conundrum
The economy has serious capacity constraints that pre-date Covid and haven’t been fixed. Building back better could turn out to be a mirage.
Luke Malpass Political editor
Stuff NZ Newspapers
New Zealand’s political economy currently seems in a state of disconnection. All headline economic figures Governments traditionally use to tell stories are running hot: The jobless rate is very low at 3.2%. Annual GDP growth is high at 5.6%. Wages growth of 3% is at its highest level since 2009. But in a world dominated by social media echo chambers, there is a feeling that, politically, macroeconomic indicators no longer matter, because they do not reflect each individual’s experience. The numbers might seem good, but if I am going backwards, or there is more injustice in the world, they must be bad. It’s all rather rather post-modern. Yet beyond the social media milieu, those numbers matter very much, because they reflect what is happening out in the world – primarily that there are lots of jobs. But they are also being hijacked by a new reality – that there is one indicator that, politically, rules them all: inflation. At 6.9%, while it is rolling forward, most New Zealanders are going backwards. Businesses and households are feeling the pinch. Consumer confidence is at rock bottom, and there is a Budget coming up on Thursday, which is unlikely to furnish much relief. The Reserve Bank is beginning an interest rate hiking cycle and on May 25 the official cash rate is expected to go up another 50 basis points. Whatever happened to building back better? Remember the refrain from Labour as we went into the GFC and into the budget last year? It seems like there’s a lot of movement, from the Government, but not a lot of concrete achievement. A lot of reforms are still in progress. There is an increased feeling that Labour won the Covid war, but is losing peace. At present, the priorities for the Budget are health and climate change. Health is a perennial black hole for money – there is always more demand for care than cash available – but the health reforms and settling DHB deficits are overdue changes. Ditto for climate. All this speaks to an unusual set of political and economic circumstances, not seen in New Zealand for a long time. There’s a significant portion of nontradables (essentially domestic) inflation, but also a good deal of inflation driven by shortages originating overseas: of goods, services, labour and an economy that was already hitting up against labour shortages, even before the pandemic. Then there’s the additional pressures created by Vladimir Putin’s war in Ukraine. ‘‘The big challenges – if you ask business – tend to be on the supply side, they can’t get staff, costs are going through the roof, that kind of thing,’’ ANZ chief economist Sharon Zollner says. ‘‘The issue for the central bank is that it’s all a very inflationary environment – no matter what’s causing that stretch: hampered supply or stretched demand.’’ Zollner thinks it is a mixture of both factors but that, in the end, the central bank has only one choice. ‘‘The only solution is to reduce demand.’’ That means interest rate hikes. Zollner says that the Reserve Bank’s signals, along with the clearly slowing housing market, are already causing the economy to slow. She contrasts it with 2007, when the OCR was boosted four months in a row to a giddy 8.25%, yet it seemed to have little effect on consumer behaviour or house prices until the GFC and accompanying credit crunch washed up on New Zealand’s shores. ‘‘They will feel comfortable they can take things a bit more cautiously. This is not 2007. They are getting traction, house prices are down, confidence is down and . . . there’s no reason to think that the Reserve Bank will have to raise interest rates to those levels. Zollner also says there are good signs for the back half of the year, for example, to do with the cost of shipping, which the IMF said in March has increased sevenfold since the beginning of the pandemic. ‘‘There are good reasons to think global inflation will come off – by the second half of this year shipping lines should be competing for business again, and there are early signs of commodities coming off as concerns mount about the growth outlook in China in particular,’’ she says. Yet in the interim, there is still consumer pain to go through and a Government that, in common with others across the world and with the benefit of hindsight, kept the money spigot open for too long. Politically, the challenge for the Government is making the case for long-term investment – especially in health, climate and infrastructure – while convincing voters it understands and will do what it can about the cost of living crunch. Finance Minister Grant Robertson on Wednesday again defended spending money on longer-term priorities. ‘‘If we decided against reforming our health system, we would not see lower petrol prices; we would just have both high petrol prices and a health system that was not set up to meet our needs.’’ But Robertson has a problem: The economy is already constrained. ‘‘There is rampant inflation and capacity constraints are far worse than they have been in living memory,’’ BNZ head of Research Stephen Toplis says. Yet Toplis thinks Robertson is a minister determined to deliver surpluses and that the new promised spending in health and climate probably need to be made at some point. ‘‘Environmental and carbon issues are going to be front of mind. The big question is how much does it add to costs for everybody, can we withstand that and ensure the distribution of the costs is appropriate. With regard to labour, how do we get the people we need?’’ he says. Despite one of the key criticisms of Labour being its big increase in spending those years – some $6 billion added on to the annual operating allowance – Toplis says that with both climate and health the money probably needed to be spent, the question was just when. At the root of a bunch of problems is the capacity constraint within the economy, he says. There isn’t enough labour to support the economic activity that is being demanded – especially around infrastructure. ‘‘While we are very focussed on Covid and its impact on the labour force – largely through what’s happened across the borders – people shouldn’t forget that prior to the word Covid entering our lexicon, we were already starting to experience labour shortages,’’ he says. ‘‘Covid has not caused but exacerbated a trend that was well and truly in place.’’ Toplis says it’s a moot point whether we enter a technical recession or not ‘‘but we have to prepare ourselves for a protracted period of slow or negative growth. Even if you are an optimist ... then growth will still be constrained by capacity. In this environment who is going to be willing or able to invest and hire to allow the economy to grow?’’ ‘‘The question is . . . whether the slowdown can be achieved without a marked downturn and how much pain inflation delivers until the moderation is achieved.’’ But for the Government, and Robertson, this economic conundrum throws up a series of challenges that Labour never thought it would confront a couple of years ago. When Labour first came into office it clamped down on foreign direct investment while maintaining a suspicion about high levels of immigration. Yet, as with New Zealand’s history since the first European settlers arrived, both things will be needed more than ever over these new couple of years. Without it, building back better may be a mirage, mired in slow growth, higher-than-desirable inflation and real incomes going backwards.