Let’s not go bananas over the Covid recovery

Published in the New Zealand Herald, 27 May 2020

It was in 1986 when Paul Keating, then Australia’s Treasurer, made a famous remark: “If this Government cannot get the adjustment, get manufacturing going again, and keep moderate wage outcomes and a sensible economic policy, then Australia is basically done for,” Keating warned on the John Laws radio programme. “We will just end up being a third-rate economy, a banana republic.”

In hindsight, Keating might have exaggerated. Still, it was remarkable for a finance minister to warn of a dramatic economic decline caused by poor choices in such blunt language.

Today’s Covid-19 crisis is in many ways more severe than the economic adjustment Australia faced in the 1980s. Yet no politician has the guts to speak like Keating.

Whether it is Rishi Sunak in the UK, Josh Frydenberg in Australia or indeed Grant Robertson here in New Zealand, finance ministers are talking up the prospects of recovery. More than that, they pretend what lies ahead will be a better version of the past.

A bit of ambition and optimism is fantastic. However, it would be more honest to spell out the cold harsh reality that the world’s risks are now heavily tilted to the downside.

The global pandemic is not over yet and the economic crisis has only just begun. The shifts in business, government finances and geopolitics triggered by the crisis will take years to unfold.

Before we can even talk about a better future, we must ensure this crisis does not wreck the economic and political foundations upon which this future could be built and create a banana republic.

A small economy like New Zealand should be cautious. Being small has some obvious advantages, not least that smaller countries can be nimbler in changing circumstances. But that tiny size also limits the ability to get away with bad policy.

To illustrate this point, consider the United States. As the world’s largest economy, it has a greater ability to retreat from the rest of the world. To be clear, even a very large country like US must exploit its comparative trading advantages. But because the US’ market is huge, it could withdraw from international trade and still keep the impacts on its consumers and businesses moderate.

The same is true for monetary and fiscal policy. The US is not just the largest economy on the planet. It also has (at least for the time being) the luxury of being able to print the world’s de facto reserve currency. Or, as John Connally, the Treasury Secretary of the Nixon Administration, once said, “The dollar is our currency, but your problem.” As a result, the US can run massive fiscal deficits and money printing programmes without much restraint.

As a small country, New Zealand simply does not have the ability to withdraw into its shell like the US can. Reducing New Zealand’s participation in global trade would be a catastrophic outcome of this crisis. For a start, too many products are not made in New Zealand. Cars, specialist machinery and pharmaceuticals are all imported. For lack of scale, import substitution would be a disastrous choice.

Given New Zealand’s small size, the percentage of its economy traded internationally has been relatively low for some time. As a percentage of GDP, imports and exports are just over 50 per cent, a remarkably low number by comparison with other small economies like Denmark (103 per cent), Switzerland (119 per cent) or Ireland (208 per cent). New Zealand is trade-dependent but not nearly trading as much as expected or hoped.

The same is true for monetary and fiscal policy. The NZ dollar may be the world’s 10th most traded currency, but that ranking overestimates our dollar’s importance. It is only involved in about 1 per cent of global trades and is not regarded as a reserve currency. To paraphrase Connally, the Kiwi dollar is our currency and nobody else’s problem.

New Zealand cannot debase or inflate its currency as much as other countries. It is dependent on other countries having faith in the stability of the NZ dollar, so any political moves to undermine it are potentially dangerous. If New Zealand or its dollar disappeared tomorrow, the world would barely notice.

The general picture for New Zealand is becoming clear: this country is too small to be a must-have in anyone’s portfolio. Against this background, the political direction of travel in the Covid-19 crisis is worrying.

Since March, New Zealand First ministers have announced a wish to reduce New Zealand’s trade engagement. Shane Jones openly toyed with a tariff on log exports and is now rushing through legislation to redirect forestry towards national manufacturing. Winston Peters has talked about onshoring manufacturing even when goods are more expensive to produce in New Zealand.

The Government is also making it harder for international investors to come to New Zealand. Minister David Parker is pushing through changes to the overseas investment rules requiring Government approval for buying 25 per cent of Kiwi businesses, regardless of the dollar value.

None of these initiatives will improve New Zealand’s international trading position. Combined with the inevitable decline in the country’s export revenue from the shuttering of tourism and export education, serious problems are emerging for both New Zealand’s current account and net international investment position.

On top of this is the slow merging of fiscal and monetary policy. The Reserve Bank has signalled it would monetise government debt if it is asked and it has already started a large quantitative easing programme, which Governor Adrian Orr has indicated could be expanded if needed.

None of this will improve international confidence in the NZ dollar. Nor will ratings agencies appreciate hearing about plans for the Reserve Bank to take on large chunks of government bonds.

New Zealand must be careful not to look like it is pursuing anti-trade, anti-investment, anti-monetary and anti-fiscal stability policies. Otherwise, international markets may conclude that Paul Keating’s warning applies to New Zealand.

New Zealand must remain clean, transparent and solid in all its economic institutions. We are not a banana republic, and we do not want to become one.

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