The New Zealand economy is undoubtedly in good shape but not all the factors behind the boom can or should be sustained indefinitely.
This raises two questions: How much is temporary? What are the prospects once these one-off factors disappear?
The main growth factors are:
- the Canterbury rebuild estimated to be worth $40 billion;
- export prices relative to import prices have risen dramatically;
- exports to China as a percentage of GDP have more than quadrupled since 2008.
- interest rates are still around 50-year lows;
- net migration has returned; and
- the housing wealth effect translates into higher confidence.
The first factor to go will be low interest rates. The rate hikes may begin in the next few months and once under way could be quite substantial. An increase of 200 basis points or more over the next couple of years is not difficult to imagine.
The next factor to fade away will be the Canterbury rebuild. This will probably peak around 2016/17. After that, the building and construction sector will return to a more normal development path.
One factor likely to remain positive for the foreseeable future are favourable terms of trade.
The Asian appetite for dairy products will continue to grow but this is no guarantee the terms of trade will stay up forever.
A similar word of caution is appropriate about trade with China. While the growth rates since the 2008 freetrade agreement have been phenomenal, the relationship will mature and the pace of growth will inevitably slow.
Finally, the housing market could also slow down. Even in severely constrained housing markets prices cannot only go one way as the UK demonstrated during the financial crisis.
As interest rates return to more normal levels, a correction remains a real possibility. The Reserve Bank’s double-whammy of macroprudential regulation and rising interest rates could take some of the steam out of the housing market.
Most booms contain the seeds of their own destruction. While I certainly do not want to spoil the party, it is evident there are elements about the upswing that do not lend themselves to being a long-term foundation of prosperity.
One would not usually build a country’s economic business model on a recovery from natural disaster, ultra-low interest rates and rising house prices.
We should use the good times to hedge bets by preparing for the time when the positive one-off factors run out. Improving our openness to trade and foreign capital, reforming public services, reducing red tape – in short everything that can make the economy more productive – are what we should do.
The other thing is to continue the path of fiscal consolidation. Finance Minister Bill English has been absolutely right with his insistence on returning the budget to surplus. He should not stop there once he has reached this goal. Repaying government debt now is the best preparation for the next downturn.