NZ Economy- Landing II

From Tony ALexander's weekly over-view for the BNZ.

The Productivity Problem

One of the measures we should all keep an eye on is the rate of growth of productivity. This is the measure of changes in how much we produce per unit of input. It is usually measured as output per hour worked and it has to be said that data in this area are very poor. Rising productivity is important because it improves the ability of employers to pay higher wages and it means that for any given rate of growth in one’s resources – labour, infrastructure, raw materials, capital – your economy can grow faster without rising inflation. In New Zealand we have enjoyed strong growth for a number of years almost entirely on the back of greater use of existing labour resources and a running down of the spare quantity of resources like roading capacity and electricity. Now we are into what looks like a prolonged period when resources will be in short supply. That means growth will need to be slower than it has been or productivity growth higher if we are to avoid rising inflation.
The fact that inflation is at 2.8% after being suppressed by a 30% rise in the exchange rate, and we are forecasting inflation over 4% soon, should suggest that there is a productivity problem in our economy – and it is a massive and worsening one. We attempt a rough measure of productivity growth by comparing changes in hours worked from Household Labour Force Survey data with output from the production based gross domestic product numbers. When we do this we see that over the past ten years productivity has grown by 1.3% per annum on average. If we look at just the past five years we get growth averaging exactly the same. So there is no acceleration in productivity growth underway using this crude measure. But it is much worse than that.
If we look at just the past year to June we see that with the recently released GDP data thrown in productivity growth was only 0.5%. This is very bad and the number is well below the 1.25% productivity growth assumed by the Reserve Bank for the year to March 2006. The fall in productivity growth implies that our economy’s growth rate has to slow down quite drastically. The fact that this is happening only slowly is where one gets the currently inflation problem from. This has been a key factor behind our strong warnings the past 18 months about inflation this cycle and interest rates, and our continuing view that although the NZD will one day fall out of the sky, this fall is not imminent because the Reserve Bank simply can’t allow to happen until the inflation outlook is much better. That means continued bad news for exporters and increasing pain for the domestic sector as interest rates go up. In fact just sit back and take a look at where these key macro variables are gong at the moment. A lot of attention has gone on the NZD’s fall against the greenback recently to near US 69.5 cents from 71 cents a month ago. But this fall has been minor and comes about mainly because of a rising USD. On the crosses we are appreciating with the NZD now buying 39.3 pence from 38.5 a month ago. This is the highest rate since November 1997. Against the euro we are at 57.7 cents from 56.7 a month ago. Agaat 78.6 from 77.5 a month ago – also the highest rate since late-1997. And against the Australian dollar we remain high near 91 cents.
The pain for exporters is still very strong. This is now being added to by rising financing costs wReserve Bank highly likely to raise its cash rate from the 6.75% they pushed it to in March to 7.0% and then 7.25%. Our target peak for the OCR this cycle has been 7.0% to 7.5% – though we backed away from that a few months ago when it looked like the economy was slowing more than we now know it is, and it looked like the current account blow-out would not be as ugly as it is proving to be. So we have an economy with over-valued property prices, ballooning debt in the household sector with increasing prevalence of 100% financing of home purchases (surely a warning sign), a vastly over-valued oating and fixed interest rates, shortages of skilled and unskilled labour, costly raw materials, rising inflation, declining net immigration, booming dwelling supply, unusually strong sharemarketconsidering the slowing in economic growth – and to cap it all off, the election of a centre-left government with a key policy of middle income welfare and strong influence likely from the Greens.
We fear this downturn in the economy will be harder than earlier thought simply because there are too many imbalances. The chances that we will sail smoothly past so many rocks are very low. Given the problems in place it is impossible to tell exactly where the bulk of the pain will be experienced. But for now we are most concerned about non-pastoral farmers being hit by a continued high exchange rate but not enjoycommodity prices. Then, given the very high probability that the NZD eventually falls away before the Reserve Bank is entirely happy for it to do so the pain will likely shift to the domestic sector and hit retailing and housing. Given the risks and uncertainties prudent investors, business owners, and debt-driven plasma TV/flash car chasing consumers may want to start exercising some caution. And just in case you want to dismiss this and other warnings on the basis that such warnings have been given before this cycle sentence usually tagged onto such past warnings along the lines of “The longer it takes for growth to slow, the greater the risk of a hard landing”. That is where we are at now.
Don’t close up shop – but take care. >snip