Friday, April 19, 2024

A chance to re-engineer our economy

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More lending into the productive part of the economy is a necessary part of that, says Cameron Bagrie.
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We are entering the difficult stage of the economic cycle when cyclical challenges need to be addressed but structural change is needed at the same time. 

This is where the real pain starts, but also opportunity – where pain brings more appetite and need for change.

The recent financial results of Briscoes Group highlight a critical point. When you face macroeconomics headwinds you are reliant on microeconomic tailwinds. We are starting to find out which organisations have the better microeconomic credentials. Eyes will be on the red meat industry.

Last year was the appetiser for the macroeconomic main course. Non-performing loans are 0.7% of all loans. The proportion of loans in agriculture that are defined as non-performing is 1.6%  Back in 2010, they were more than double that. 

This coming year will be dominated by two variables and one variability. Inflation, the economy’s productive capacity to meet demand – the money line for the economy that needs to be repaired – and geopolitics.

You do not get rid of inflation if the economy is going well. Good times are inconsistent with people tightening their belts, a prerequisite to businesses discounting or pricing sharper to get business.

The world is trying to get rid of inflation, so the global economy is not going to be strong. Core inflation in the United States is starting to level out, still considerably above the 2% target. 

There is a growing risk that central banks and the US Federal Reserve will need to resume tightening. That could drive the New Zealand dollar lower. 

Locally, the earnings reporting season was not good news overall with big hits to Fletcher Building, and The Warehouse Group ejecting Torpedo 7 for $1. 

Building consents continue to fall, some consented projects are being paused or cancelled, and retail sales volumes have fallen eight quarters in a row. 

We are seeing more tourists, though, and migrants.

Improving business sentiment post the election has not been matched by reality. Business optimism is probably hope that we’ve seen the worst of it and that the new government will fix it.  Good luck on both counts.

Demand needs to remain weak, and that will be concentrated and worst felt in interest-sensitive parts of the economy such as construction (outside of infrastructure) and discretionary spending. Parts of the government will suffer too as the spending tap gets turned off.

Can we lift the anaerobic capacity of New Zealand?

The economy’s productive capacity is the combination of labour, capital, natural endowments and the efficiency of resources. It is the economy’s anaerobic capacity to grow without generating inflation.

The chief economist of the Reserve Bank noted a few weeks ago that “the productive capacity of the economy was lower than previously assumed”.

That is a fancy way of saying the economy has suffered extensive structural damage in recent years and we are poorer than we thought we were. It will take time to fix the structural damage. Roading is an example. 

Fixing something reduces time and resources to invest and grow something.

Geopolitics is the major variability. Geopolitical tension could exacerbate the persistence of inflation.

China and Taiwan. The US election. Gaza. Ukraine. What region is next? How seriously could democracy be challenged this year?

We live in a world where the rules-based system that we have been used to is being challenged by exercising power; the economics of trade is now morphing into the security of trade; and resilience is usurping efficiency with more just-in-case as opposed to relying on just-in-time. 

The International Monetary Fund’s October forecasts, titled Navigating Global Divergences, dedicated a whole chapter to fragmentation and commodity markets.

How do agriculture and the wider primary sector fit into all this?

Global demand conditions will be challenging, but we can take some encouragement from the resilience of dairy prices during China’s woes of late.

Agriculture is not construction, a sector with three gears: fifth, neutral and reverse. Food is an essential, though the more value-add components are more sensitive to economic conditions.

The primary sector’s productive capacity has been hit directly by a combination of costs, policy, and sustainability needs. Some can, and should be, corrected quickly, an example being ceasing requiring employers to pay regional seasonal employer (RSE) workers 10% above New Zealand workers.

But “carcinomic” takes you only so far and we need “growthnomics”.

Water has been noted by the government as a priority. We await the action.    

The geopolitical environment carries risk, but also signals opportunity. NZ needs to quickly define how it can take advantage of international needs for security in food and sustainability. Countries with less, or better managed food production cycle variability that can show sustainability credentials stand to benefit.  

The economic environment we are in is offering opportunities, and appetites to ask serious questions, and define solutions as opposed to kicking the can down the road.

An example is the inquiry into banking, which needs to go beyond retail banking. Banks price for risk but are they taking a lot compared to the alpha returns they have made in recent decades? We do not want irresponsible lending. But overly strict conditions stifle growth and innovation.

More lending into the productive part of the economy is a necessary part of the re-engineering of NZ, with our old growth model of selling more expensive houses to each other, relying on migration, and cheap imported products (boosting our term of trade) being exposed. 

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