CTU Economic Bulletin No 114 - On the Way Up or a Third Depression?

June 2010

Paul Krugman, a heavyweight among world economists, wrote on 27 June:

We are now, I fear, in the early stages of a third depression. It will probably look more like the Long Depression [of the 19th century] than the much more severe Great Depression [of the 1920s and 30s]. But the cost – to the world economy and, above all, to the millions of lives blighted by the absence of jobs – will nonetheless be immense.

To all appearances here in Australasia we are on the way up. New Zealand is slowly climbing out of a deep hole, unemployment has peaked, manufacturing is starting to find its feet again, exports are increasing and the economy growing. But sustained recovery is very dependent on seeing no more surprises from the world economy. So why is Krugman so pessimistic?

The crisis was triggered by irresponsible risk taking and woeful regulation of the financial system, mainly in the US and the U.K. There is a story to tell about how the finance sector is obstructing attempts at financial reform in the US, and how division among the major powers (those resisting being driven by their finance sectors) is preventing reform internationally. If the obstructers win, another crisis is inevitable. But that is not what Krugman is referring to.

The much more immediate problem is to cope with the effects of the crisis.

The Greek situation has been well publicised. Greece and others were already running big government deficits or economies (like Iceland’s and Ireland’s) that were vulnerable to financial instability. But it was the global financial crisis that turned these into national economic crises. Governments had to borrow to stabilise the economy and bail out banks.

Greece’s government had a budget deficit of 7.7 percent of GDP in 2008, which shot up to 13.5 percent of GDP in 2009. Even those figures were called into question when it was revealed that merchant bank Goldman Sachs had helped Greece to use financial tricks to hide some of its deficit. Greece’s financial system came under attack by money market dealers claiming they doubted its government could ever repay its debt, estimated at 129 percent of GDP in 2010. Credit agencies downgraded Greek government bonds to junk status – even though they admitted the risk of default was low.

Though Greece is a relatively small economy, its situation became systemically important for the European Union, because it has adopted the Euro as its currency. It had breached rules limiting Euro country deficits to 3 percent of GDP. Bailing out Greece would set a precedent for bailouts of countries in a similar situation and effectively change the rules of the Euro currency area. However the EU was in a no-win situation. If they didn’t bail out Greece, the Euro was at risk of falling apart. That risk remains.

In the end, the EU and the International Monetary Fund jointly agreed to provide up to 860 billion Euros for the EU members in trouble, but this was conditional on draconian austerity measures. The Greek government has announced widespread privatisations, pay cuts and a freeze in hiring in the public sector, and a 2 percent increase in value added tax (their GST). Unemployment is forecast by the OECD to soar from 11.7 percent now to 14.3 percent next year. Unionists and others have been on strike and marching in the streets. Greece’s economy is expected to contract by 3.7 percent this year and 2.5 percent next year. It could take years to recover.

Others with quite different economic records face similar measures. The new U.K. government has announced cuts to welfare, housing, disability, and retirement benefits. There is a two-year freeze on most public sector salaries. All government departments bar health and overseas aid have to cut spending by 25 percent over the next four years. Unions say it will cost 750,000 jobs.

In Ireland, unemployment is expected to reach 13.7 percent this year. Social welfare payments and public investment have been cut. Public sector salaries have been cut by 5 to 15 percent. In Spain, unemployment has reached 20 percent. The government has reduced spending and frozen pensions. Public service pay is being cut by an average 5 percent with a pay freeze next year.

Millions of people in these and many other countries are suffering enormous disruptions to their lives. They are paying for the irresponsibility of the financial sector and of deregulators like the Bush Administration and its predecessors.

The problem that Krugman points to with all of these measures is that they are doing exactly the wrong thing: they will put those economies further into recession before they have begun to recover. The EU is the world’s largest economic bloc. If it goes deeper into recession, it will affect the world. It could drag down its trading partners with it, including the US and Japan (which have their own huge government deficits and debt problems). There is also a risk of further financial instability. Though only 10 percent of New Zealand trade is with the Euro area, we will undoubtedly be affected if world trade begins to contract again or financial markets return to turmoil.

Perhaps Krugman was just trying to frighten the policy makers into more sensible action. But unfortunately he may well be proved right.

Bill Rosenberg

NZIER Consensus Forecasts¹

These consensus forecasts were published on the 22nd June 2010. Items marked "*" are actuals from Statistics New Zealand rather than forecasts.

Economic Snapshot

• Gross Domestic Product (GDP) increased by 0.6 percent for the March 2010 quarter. But In annual terms has still declined 0.4 percent.
• The Consumer Price Index (CPI) rose by 2.0 percent for the year to March 2010 and by 0.4 percent for the quarter.
• Food prices fell 0.7 percent for the month and fell 0.5 per cent for the year to May.
• Unemployment was at 6.0 percent in March 2010. M?ori unemployment was 14.2 percent, Pacific unemployment was 14.4 percent, Asian unemployment was 9.8 percent and European/Pakeha unemployment was 4.4 percent. Youth unemployment (15-19 year olds) was 25.2 percent. In March 2009, 60,211 people were on an unemployment benefit.
• The total number of people in employment decreased in the year to March 2010 by 0.1 percent to a total of 2,177,000.
• The minimum wage is $12.75 an hour and $10.20 an hour for new entrants aged 16 or 17 in their first 3 months or 200 hours, whichever ends first.
• Ordinary time hourly wages, as measured by the Quarterly Employment Survey (QES) for March 2010, were up 2.2 percent in annual terms (1.6 percent in the private sector and 3.7 percent in the public sector). The average hourly wage is now $25.27 ($23.35 in the private sector and $32.56 in the public sector). The average female wage is $23.50 which is 87.7 percent of the male wage of $26.79. The Labour Cost Index (LCI) shows that ordinary time wages went up by 1.5 percent in the March 2010 year (1.3 percent in the private sector and 2.3 percent in the public sector). For those workers who received a pay rise in the year, the median increase was 3.3 percent and the average increase was 3.9 percent.
• On 10 June, the Reserve Bank lifted the official cash rate by 25 basis points to 2.75 percent. The next review will be on 29 July 2010.

Gross Domestic Product

GDP increased by 0.6 percent in the March 2010 quarter, down slightly on the 0.9 percent increase in the previous December quarter. However, GDP for the year to March 2010 was still 0.4 per cent lower than the year to March 2009. At an industry level there was growth in fishing, forestry and mining (3.2 percent), manufacturing (1.6 percent), wholesale trade (1.4 percent) and construction (1.0 percent). Investment moved into positive territory with growth of 0.8 per cent, having contracted 0.9 per cent in the December quarter. This improvement continues to be driven by investment in intangibles linked to oil exploration which was up a further 10.3 per cent from the December quarter. Annual investment in fixed assets is at its lowest since 2004 and when we see a sustained revival, it will be an important sign that a recovery is really under way.

Food Prices

Food prices fell by 0.7 percent in the month of May and are down 0.5 percent on May 2009. This is the first time since July 2004 that food prices have fallen over a 12-month period. Lower prices for the year were recorded for meat, poultry, and fish and fruit and vegetables (both down 4.5 percent). However, butter and cheddar cheese prices have been on the rise increasing 51.1 percent and 13.6 percent, respectively, over the past five months.

Overseas Goods Trade

In May 2010, the New Zealand enjoyed a trade surplus of $814 million (19.4 percent of exports), an increase of $158 million on the surplus for April. Overall exports were up $238 million on the same time last year (6.0 percent) Exports of milk power, butter and cheese were up 12.6 percent ($102 million) and exports of crude oil were up 44.5 percent ($71 million). On the other hand, exports of fruit were down 16.7 percent ($53 million). However imports are also up on the same time last year by $330 million (10.8 percent).

Balance of Payments

New Zealand's seasonally adjusted current account deficit was $1,291 million in the March 2010 quarter. This was $1,628 million less than the December 2009 quarter. This change was the result of a $989 million fall in the investment income deficit, a $624 million rise in the goods surplus and a $137 million rise in the transfers surplus, but $122 million growth in the trade in services deficit. For the year to March 2010 the deficit represents 2.4 percent of GDP, compared with 2.9 percent for the year ended December 2009. New Zealand’s international liabilities fell to $166.7 billion, equivalent to 88.9 percent of GDP, a reduction from $168.3 billion (90.6 percent of GDP) in December 2009.

Manufacturing Sector

Statistics New Zealand’s Economic Survey of Manufacturing recorded a rise of 0.9 percent in value and a fall of 2.7 percent in volume of seasonally adjusted manufacturing sales for the March 2010 quarter. Meat and dairy product manufacturing still recorded a 1.0 per cent rise in value of production despite a 10.1 per cent decline in volume. Petroleum and industrial chemical manufacturing recorded a 8.4 percent increase in the volume of production, and a 10.3 percent increase in its value.

For May 2010 the Performance of Manufacturing Index (PMI) fell back slightly, but is still showing expansion with an index of 54.5³. Of the 5 sub-indices, only the employment index was in contraction (49.3), with production (55.3), new orders (56.4), deliveries (58.7) and finished stocks (52.4) all still positive. Textile, clothing, footwear & leather manufacturing (63.7) and machinery & equipment manufacturing (59.7) were the only industry subgroups showing expansion. Northern was the only region to show contraction (48.3). In international terms, New Zealand was a little behind the global PMI of 57.2.

Service Sector

The Performance of Services Index (PSI) remained positive for May 2010 at 53.3³. All five sub-indices were positive ranging from new orders/business at 55.7 to employment at 50.8. Regionally the North Island continued to expand while the South Island continued to contract. At an industry level, property and business services showed the greatest expansion at 59.1, and accommodation, cafes and restaurants fell even further to 39.4.

Property Values

Quotable Value residential property indices for May 2010 show that property values nationally were 5.6 percent higher than they were a year ago but the average sales price for the three months to May was slightly below April’s level. This is the first month since March 2009 where the rate of annual growth has slowed. Regionally only Whangarei and Rotorua recorded an annual decline in values, while Auckland recorded the highest growth at 8.8 percent.

Building Consents

The number of building consents issued for new housing units excluding apartments fell 9.5 percent (in seasonally adjusted terms) in May. This follows a 15 percent rise reported in April. In May consents were given for 1,333 new housing units and 27 new apartment units. The value of those consents was $481 million, 15 percent less than the value of those issued in May 2009. There was $289 million worth of non-residential building consents issued.

Migration

Seasonally adjusted net migration increased by 250 people in the month of May, with 6,370 permanent and long-term arrivals and 6,120 permanent and long-term departures. Net migration for the year to May was 17,900, up 6,800 on the year to May 2009 but down on the most recent peak of 22,600 for the year to January 2010. The biggest net inflows for the year continued to come from the United Kingdom (7,600), India (5,500), and China (3,600). The largest net outflow continues to be to Australia (15,200). This is the result of almost 31,000 PLT departures to Australia offset by almost 16,000 PLT arrivals. Of those arrivals from Australia, two-thirds were returning New Zealand citizens.

Retail Sales

Seasonally adjusted retail sales excluding the vehicle-related industries were down 0.2 percent ($8 million) in April 2010, reversing a 1.0 percent increase in March. Including vehicle-related industries, the decline was 0.3 percent ($18 million). Sixteen of the twenty-four retail industries recorded decreases. The largest decreases were recorded by department stores (down 3.3 percent or $11 million) automotive fuel retailing (down 1.1 percent or $6 million) and chemist retailing (down 3.6 percent or $6 million). The largest increases were in accommodation (7.0 percent or $15 million) and supermarket and grocery stores (0.5 percent or $6 million).

Online Job Vacancies

The Department of Labour's job tracking tool, Jobs Online, reported a 7.5 percent rise in vacancies over the three months to the end of May 2010, and an 8.2 percent increase in skilled vacancies for the same period. Christchurch saw a 1.0 percent decline in advertised skilled vacancies, but the rest of the South Island saw 12.2 percent growth. Auckland recorded 8.6 per cent growth and Wellington 11.3 percent, but this was still behind the 11.6 percent increase in the rest of the North Island. On an industry basis, construction saw the biggest rise in advertised skilled vacancies (17.1 per cent) and accounting, HR, legal and admin the smallest (2.6 per cent). Despite this growth, skilled advertisements are still down 34.2 percent on the peak of March 2008.

Government Accounts and Debt

The Government accounts for the 10 months ending in April 2010 showed a deficit in the Operating Balance before Gains and Losses (OBEGAL) $636 million less than in the 2010 Budget forecast, at $5.2 billion. The Operating Balance was $820 million better than forecast at $1.4 billion. However, gross debt, at $51.9 billion and 28.0 percent of GDP was $353 million higher than forecast and net core Crown debt (excluding student loans and other advances) at $27.8 billion and 15.0 percent of GDP was $458 million higher than forecast. Both debt measures are still below Budget 2009 forecasts. The New Zealand Superannuation Fund is now $610 million ahead of forecast, and ACC’s investment fund is $437 million ahead. ACC payouts this year have fallen, presumably due to tightening of the criteria for paying on claims. This is shown in the comparison between "insurance expenses" of $2.329 billion during the 10 months to April 2010, compared to the 50 percent higher $3.495 billion paid out in the 10 months to April 2009.

Australian Minimum Wage

The Fair Work Australia specialist Minimum Wages Panel has raised the Australian minimum wage to A$15.00 per hour from 1 July 2010, a nominal increase of 4.7 percent and a real increase of 1.2 percent over the two years since it was last set. This is 42 percent higher than the New Zealand minimum wage of $12.75 in purchasing power parity terms. The announcement also included changes that improve wages for approximately 1.45 million workers on minimum award wages under the Modern Award system.

For further information contact Bill Rosenberg  or Andrew Chick

Notes

1 The consensus is made up of the average of forecasts from NZIER, Berl, ANZ- National Bank, ASB Bank, BNZ Bank, First New Zealand Capital, Deutsche Bank, UBS, Westpac, Reserve Bank of New Zealand and Treasury. Because the consensus forecasts are done only every 3 months, some of the more recent forecasts will be more accurate.

2 As measured by Statistics New Zealand’s Quarterly Employment Survey (average ordinary time hourly earnings).

3 A figure under 50 shows the sector is contracting; above 50 shows that it is growing. The index is an early indicator of business activity.