Navigating Global Divergences was the title in the most recent World Economic Outlook from the International Monetary Fund.
The Ministry of Foreign Affairs’ 2023 Strategic Foreign Policy Assessment was titled Navigating a Shifting World.
We now reside in a world were geostrategic and geopolitical considerations are front and centre. That creates uncertainty. The 30-year playbook on most of the world playing nice is being challenged by greater use of power usurping rules amid economic, and social division.
Such considerations are now manifesting at the level of interest rates. Uncertainty commands a risk premium, which is being accentuated by inflation’s persistence and rising concerns over government spending and debt issuance in the likes of the United States.
The backdrop could have profound implications on trade flows, but also absolute (export) and relative (export and import) price changes. New Zealand has been a beneficiary of the latter for the 30 years.
Sub-par growth and a slow decline in core inflation were key messages from the IMF’s projections. Inflation was not projected to return to target until 2025 in most cases. Forecasts for global growth over the medium term, at 3.1%, are at their lowest in decades.
“Medium term growth prospects are weak, especially for emerging market and developing economies,” the IMF says.
“With lower growth, higher interest rates, and reduced fiscal space, structural reforms become key.”
Which governments around the globe are going to lead, be bold, and who are going to play populists? We need the former. The New Zealand election was notable for a lot of populism propaganda.
While risks of a hard landing for the global economy have receded, the balance of risks remains tilted to the downside and the risks include China’s property sector, persistent inflation requiring higher interest rates and more climate and geopolitical shocks that could add to food and energy inflation. The IMF notes “little room for error on the policy front”.
All up, a fair bit of hope things will be okay, among lots of clouds.
Chapter 3 of the assessment focused on how geopolitical fragmentation and disruption to global trade in commodities can affect commodity prices and economic activity.
According to the IMF, commodity markets are particularly vulnerable in the event of fragmentation. Its model simulations suggest that trade disruptions could result in substantial economic impacts in commodity-dependent economies. Fragmentation can cause large price changes and create considerable volatility across commodities and thereby economic variability.
Post the Cold War, commodity markets have become more connected due to a range of reasons including trade liberalisation, technological innovation, and falls in transportation costs through supply chains. Integrated commodity markets have provided cheap inputs, particularly for manufacturing products, including the technological variety such as smart televisions, that have supported global growth and less volatility in growth.
Tradable or imported inflation (roughly one half of inflation) averaged around 1% per year in New Zealand and was low globally for a long time. A 2% target for inflation is not hard to achieve when half of all inflation is that low.
With the world fracturing and offshoring being replaced with near shoring, we are seeing profound shifts and security of supply is a key consideration. Many commodities are essential inputs for manufacturing and technologies covering clean energy, semiconductors and defence; and the availability can be concentrated in a few producers. Commodity production is hard to shift, though, as it reflects natural endowments (minerals), soil quality, or water availability and that creates dependence but also opportunities for those with endowments.
For 30 years, a defining tailwind for the NZ economy has been a profound relative price shift in our favour; the outperformance of export prices (food) relative to import prices (manufacturing), reflected in a 40% plus rise in the terms of trade. Better relative prices meant we needed to export less volume relative to import volumes to stand still.
The price of primary products outperformed manufacturing items; dairy products versus a computer, for instance, or a kilogram of steak versus a new television. Farmers focus on absolute prices. For the economy, it is relative prices that matter.
This relative price shift has deflected attention from weakness in productivity and per capita growth performance.
Security is now an overarching theme. Security in food, energy, and the upland notes of technology. Chips control the computers and computers control the machines. Some essential commodities go into chips.
One of them plays into our strength, namely the production of food. NZ’s strategy needs to be far broader than targeting the likes of India for trade. That will help but we need a strategy that builds around the theme. The use of irrigation as an enabler of growth but also to mitigate production cycle risks is an example.
That is the absolute side of the equation.
The second side is the relativity. This side could be more problematic if relative prices shift in favour of manufacturing goods over primary products and reverses the 30-year trend. If so, it will be another signal of the need for sustained period of a weak currency.
Relative prices do not need to turn down. Even if they flatten out and we see export prices move in line with import prices so the terms of trade are flat, it removes an economic tailwind. Then attention will need to be more squarely on productivity and improving it will require a lot more than tinkering.