Economics for extraordinary times
Published in the New Zealand Herald (Auckland), 9 December 2022
The first principle of medicine is “do no harm”. It should be the first principle of economic policy, especially heading into an election year.
Even in ordinary election years, rational and calm policymaking is the exception. Yet these times are anything but ordinary.
In the coming year, New Zealanders will face the toughest set of economic circumstances in a generation. Politically, we can expect the Government to have its back to the wall, facing not only a defeat but a potential landslide loss.
The combination of economic turmoil and the Government’s political weakness may be a toxic combination.
The Government will be tempted to engage in bribery and populist gimmickry while avoiding tough but necessary reforms.
Inflation and the fight to control it, rising mortgage rates, falling house prices, and a shortage of workers will dominate our economic debates next year.
These issues are all connected. You can hardly fix one of them without tackling the others. Still, the Government will promise the impossible in 2023. After all, this is an election year. What we can expect are policies that will tackle symptoms rather than causes.
Cost-of-living-crisis? Gift another cost-of-living payment to households. Extend the fuel excise rebate and dictate petrol prices. Force the supermarkets to lower their prices with threats of expropriation.
Shortage of workers? Fast-track visa applications for preferred employers (most likely government entities and favoured businesses). Pay subsidies to companies who cannot find staff. Maybe offer tax cuts for people working longer hours and pay people to defer retirement.
Rising mortgage pain? Force banks to offer mortgage holidays. Have a subsidy programme for households suffering mortgage stress. Allow KiwiSaver withdrawals for homeowners facing negative equity. Even rent controls could be on the table.
To be clear, none of those policies would make any sense. But they are the kinds of policies that a desperate Government might consider.
Not only would such measures be unhelpful, but they would also violate the “do no harm” principle. Yes, it is possible that they might provide temporary relief. But they would cause yet more economic damage and distortion in the medium term.
If it was not for electoral considerations, and if sound economics were a guide, the response to New Zealand’s economic crisis would look very different. Rather than treating symptoms, we would deal with the underlying causes. Yes, that would be painful, at least for a while, but it would work.
At the root of our problem lies the failure of monetary policy. In trying to support and stimulate the economy over the past years, the Reserve Bank has overdone it.
This brings to mind two famous quotes by two famous economists. It was Nobel laureate Milton Friedman who taught us that “inflation is always and everywhere a monetary phenomenon”.
He meant that price increases result from central banks expanding their money supply faster than economic output grows.
New Zealand is now bearing the consequences of earlier monetary stimulus. This does not only apply to consumer prices. Asset prices became more volatile as well, heading up and down with monetary moves.
That brings us to the second quote, this one from Austrian economist Ludwig von Mises: “There is no means of avoiding the final collapse of a boom brought about by credit expansion.”
In other words: what goes up must come down. When you create a massive boom out of thin air (read: freshly created money and, in the current case, high government deficits despite an overheated economy), then — sooner or later — you end up with a bust.
Again, we are witnessing this now. Having printed money to spur a boom, that boom is now ending in tears. High inflation, negative equity fears, and falling living standards are all consequences.
The right thing to do would be to rein in inflation as quickly as possible, and indeed that is what the RBNZ now says it wants to do. And it is the right thing to do.
With each month that prices remain high, inflation expectations become more entrenched. Those expectations make it increasingly difficult to treat the cancer of inflation.
The Government should avoid all policies that would make it harder for the RBNZ to do its job.
So, no subsidies to households or companies; no expensive pet projects; no election bribes. Instead, the Government ought to implement policies that help the economy grow and become more productive.
Such policies would include immediate changes to immigration settings.
The Reserve Bank acknowledges that the labour market is overheated, making the unemployment rate unsustainable. These pressures could be relieved by bringing in more overseas workers and allowing those who are already here to work. Instead, the Government is proposing to make it even harder.
We would also benefit from rapid changes to our foreign direct investment rules.
It is way too hard for foreign companies to invest in New Zealand, cutting us off from international value chains. For this country, overseas investment rules have been a spectacular own goal. We should abolish them.
Finally, we have hurt ourselves by making land markets uncompetitive. This is especially true for urban land markets.
New Zealand needs proper planning and infrastructure reform. These would strengthen property rights, streamline planning processes, and provide financial incentives to councils to go for growth. But will we see any of this next year?
Well, I believe I already mentioned that it is an election year. Have turkeys ever voted for Christmas? No, and neither have Governments.
Whoever takes over from this prodigal Government will inherit an almighty economic mess in 2023. Or an even bigger one in 2026.