Heading down the wrong-way economy

The most interesting number in the budget was 6.7. It told us that for now the economy is heading in the opposite direction from the one Bill English says is the government’s objective.

The 6.7 was the percentage of gross domestic product (GDP) the Treasury projected the balance of payments current account deficit would be in 2015-16. That is up from 1.9 per cent in the year to March 2010 and 4.8 per cent in the year to last March.

And that 6.7 per cent, many economists reckon, was based on optimistic assumptions about the state of the world and our economy.

The Bank of New Zealand thinks the deficit will climb to 8.3 per cent of GDP next year, close to the 8.9 per cent peak in calendar 2008 in the bad old years when Michael Cullen was Finance Minister.

English doesn’t miss a chance in Parliament’s question time to dump on the 1999-08 Labour-led governments’ economic management. But is he actually turning the economy around?

English’s line, which he began running early in 2009, illustrated with sad charts, is that in the 2000s when money was sloshing around the world and into this economy, the tradables side — exports and import-competing activities — slid sideways and then down. The non-tradables side — consumer spending and houses — boomed on up.

This consumption and house-buying binge was on money borrowed from foreigners. They wanted to lend to households here (through the Australian-owned banks) because interest rates were high. And we wanted the illusion that we were spending real money.

Clark government ministers say the Treasury told them there had been a structural shift — that is, that the illusion was in part real. After 2005 those ministers spent up on Working for Families, interest-free student loans and even tax cuts. (English at the time wanted to spend it all on tax cuts.)

There had not been a structural change — just a change of attitude. Households spent far more than they earned, that is, they dissaved. The peak was 8 per cent of disposable income in 2005-06. Their debt soared from just over half their disposable income (58 per cent) in 1990 to one and a-half times in 2008 (154 per cent). The country’s overall net debt to foreigners climbed to 85 per cent of GDP in the year to March 2009.

Both have come back a bit, the first because households have been saving (just and no more), the second in part due to the huge inflow of reinsurance money to fix Christchurch. But they remain dangerously high. The Treasury itself projected net debt to foreigners at 81 per cent in 2016. The rating agencies hover.

The way back to the economy English says he wants is to earn more from foreigners — in exports of goods and services and in profits from investments abroad — and spend less at home and on imports and so reduce profits foreign firms earn here.

For a time the trajectory looked promising (notably a trade surplus and higher tourism) but that was also in part an illusion: ultra-high commodity prices, lots of grass, a rugby festival. As the prices and growing levels come off their peaks, as the Euromess bumps on and as China’s boom cools to a more realistic growth path, the goods and services trade balance is heading back towards deficit.

The main drivers of economic growth over the next couple of years will not be tradables. They will be construction, to make up a house shortage and to fix Christchurch, and consumer spending on the back of a not-too-bad labour market (online vacancies in May were up 13 per cent from May 2011).

The Bank of New Zealand projects the household saving rate to go barely positive and then to go negative again from 2015. No one expects anything like the 5 per cent or so that would underpin strong investment in the sort of economy English says he wants.

Note: investment — in productive enterprise (not houses). That is the key.

There is some indication in the trade and balance of payments figures of some switch in imports from consumption goods to investment goods. But last week’s National Bank survey of businesses reported cooling investment intentions, from a net 18.0 per cent more planning to invest than not in April to 8.2 per cent in June.

That’s the short term. Maybe over time households will save much more and spend much less and firms invest much more in high-productivity tradables activity to make money abroad despite the overpriced exchange rate.

But if so, “over time” does not mean three or five years. An indication of how long such turnrounds can take was a report by the Bank of International Settlements last week that most advanced economies would need 20 years of budget surpluses above 2 per cent of GDP to get government debt back to the pre-GFC level.

Government debt here is not a big worry. That is going roughly to English’s plan. But household and country debt are big worries and are not going to plan right now. Both were decades building and will take a decade or two to unwind.

Will English’s successors have the necessary nerve?