This slowdown is real and can’t be ignored

The Government cannot keep denying the economy is slowing. It must do more to stimulate investment and reassure the construction sector, Bernard Hickey argues.

Comment: Construction firms are falling over, businesses' confidence about themselves has slumped to a nine-year low, unemployment is rising and New Zealand desperately needs heavy infrastructure investment to catch up with a 10 percent population shock in the last five years.

So why does the Government think there's not much wrong with the economy and that it's doing as much as it can?

Until a couple of months ago it could realistically say that the slump in wider business confidence after the election was politically biased whingeing by National-leaning business owners and that cashed up and confident workers and consumers would keep economic growth humming at over three percent this year and next year. It could argue the fruits of employment growth, minimum wage hikes, pay equity deals and big lumps of families package money would wash over businesses and put smiles back on the dials of business owners.

That was then, but this is now.

This week's news is the worst economically for the Government since its election and should force it to recalibrate its response. Prime Minister Jacinda Ardern is returning from maternity leave this morning to find an economy mired in a winter of construction and retailing discontent.

Just to summarise this worst week of 2018:

- ANZ's business confidence survey for July showed businesses' confidence about their own businesses fell to the lowest levels since May 2009;

- Quotable Value reported house values are now falling nationally, and not just in Auckland;

- Ebert Construction was put into receivership owing sub-contractors on 15 building sites tens of millions of dollars;

- Christchurch's Maven Interiors was put into liquidation, leaving more than 40 tradies out of work;

- unemployment rose to 4.5 percent in the June quarter from 4.4 percent after the labour force rose 17,000 because of migration and natural population growth and overwhelmed jobs growth of 13,000 in the quarter (economists had expected the jobless rate to remain flat); and

The under-utilisation rate, which measures both unemployment and under-employment, rose to 12 percent from 11.9 percent, with an estimated 344,000 people saying they were either unemployed or would do more work if they could find it.

It's too early to be sure, but the drumbeat of poor leading indicators over the last three months suggests growth is slowing in a substantial way, possibly to under two percent.That is lower than Treasury and Reserve Bank forecasts in May for GDP growth of over three percent in the next two fiscal years.

Finance Minister Grant Robertson pointed this week to headwinds from economies overseas that former Prime Minister John Key himself cited during National's conference over the weekend. He is right about that.

China's economy is slowing, partly because of high corporate debt and partly because of fear about weaker exports to Donald Trump's America. Europe's economy barely grew in the June quarter and Japan's central bank extended its money printing programme by up to a year because growth and inflation there was lower than expected. Only America's economy is firing on all cylinders, and many think it too will slow later this year as the sugar rush of Trump's tax cuts for the rich and corporates recedes and higher interest rates take their toll.

But that is just a small part of the story, especially when the IMF is still forecasting global economic growth of 3.9 percent this year and next year, albeit with mounting risks and some signs that growth has peaked in the major economies. Trump's trade war rhetoric, Europe's political dramas and some signs of slower Chinese growth are fueling those risks.

Retailers and office builders worried

The Labour-New Zealand First coalition's plan to increase the minimum wage by 35 percent to $20 an hour by 2021 has clearly hit confidence among small to medium employers and retailers in particular, while a collapse in commercial construction sector confidence linked to worker shortages and high profile project cost blowouts is also weighing on the outlook.

Fletcher Building's withdrawal from commercial building construction, the liquidation of 14 Hawkins companies and the collapses this week of Ebert Construction and Maven Interiors is hammering confidence there. Tougher lending rules to developers by the big four Australian-owned banks is also a factor. That is driven mostly by the Australian banking regulator's tougher approach, along with local fears the Reserve Bank will soon impose higher capital rules.

The cooling of house price inflation in Auckland caused by the Reserve Bank's tougher LVR rules for landlords, the slowdown in bank lending and expectations of a slowing of foreign buying have also softened consumer spending growth.

'It's all your fault'

Opposition leader Simon Bridges this week laid the blame wholly at the feet of the Government, saying its policies on employment, migration, foreign buying and housing were the sole reasons for lower confidence.

In my view, that doesn't reflect the full picture in both the global and local economies, but some of the Government's policies are partly responsible for the slump, and it is responsible for any response.

'Nothing to see here, move along'

So far, the Government is denying there is a major problem and denying there needs to be a response. It says it is already doing enough.

I asked Robertson if the Government needed to respond with more stimulus, or if it was time for the Reserve Bank to loosen monetary policy. He would not comment on monetary policy and said the Government was already stimulating with extra capital spending and the bigger families spending package, which will start to flow through to GDP figures in the September and December quarter. He denied the Government was to blame or that it was was not doing enough.

But it's worth challenging the claim that the Government is already stimulating heavily, or that the Reserve Bank is also doing as much as it can.

Not much stimulus

Treasury's own figures from Budget 2018 (Table 2.7) show a 'fiscal impulse' or Government addition to economic growth of a net 0.4 percent of GDP over the four years to 2022, including a 1.9 percent of GDP addition in 2018 and 2019, followed by contractions totaling 1.5 percent in the following three years.

Robertson's claim the Government is investing much more in capital is also worth checking. Budget 2018 figures (Table 2.8) show new capital spending (vs the previous Government) totaling $8.1 billion over the six years to 2021/22, including an extra $7.7 billion worth of contributions to the New Zealand Superannuation fund. Most of that will be invested offshore.

The Government's contortions to get the private sector to pay for Auckland infrastructure spending, including two big new light rail lines, shows that its self-imposed debt funding constraints are holding back development at a time when the construction sector desperately needs reassurance.

The Government could easily borrow up to $35 billion more without endangering its credit rating and its borrowing costs are still under three percent.

A self fulfilling slowdown

The Government's determination to stick to its 20 percent net debt target is stopping it responding to the slow-down in the economy, which may in turn also make it harder to achieve that 20 percent debt target in a perverse type of economic catch 22.

Treasury has already acknowledged the risks of a slower economy dragging on the Government's surplus debt reduction track forecasts. It said in its July 2 Economic Indicators commentary that there were 'downside' risks to its Budget forecasts for growth of over three percent this fiscal year and next fiscal year.

"Tax revenue is only tracking slightly below forecast. GST has come in slightly under, reflecting weaker consumption and residential investment, but source deductions (such as PAYE) have provided an offset," Treasury wrote.

"While indicators for exports look positive for the June quarter, the soft consumption indicators and fall in business own activity outlook suggest there is less momentum in the economy, and pose some downside risk to our near-term GDP outlook."

The Reserve Bank can do more too

Currently the Reserve Bank is still forecasting it will next hike interest rates (albeit not until the second half of 2019), even though core inflation is well under the two percent level at the centre of the Reserve Bank's target band. Governor Adrian Orr agreed to "contribute to supporting maximum sustainable employment" in his policy targets agreement with Robertson.

He has yet to specify what that 'maximum sustainable employment' level might be, but the Government has said it wants to get the unemployment rate below four percent. It got well below that the last time Labour was in power, and the under-utilisation rate also got down to 9.0 percent in late 2007.

Orr's last public comment was that he was neutral about whether the bank would next cut or hike, although its formal forecasts were for a hike. His next chance to revisit that stance will be next Thursday when the bank releases its next full monetary policy statement. The weak business confidence, construction sector collapses, global economic headwinds and still modest inflation should nudge him towards an easing bias.

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