New Zealand Economy Report Card

The BNZ publish a report entitled “NZ at a Glance” which summarises the current state of the NZ economy. Here are some of the main points:

GDP – Construction is the main driver of growth over the next couple of years – mainly residential. Net exports is likely to take a hit as import penetration starts to build with as the economy recovers. GDP is forecast to increase to 3.6% in 2014 from 2.9% in 2013.

Unemployment – the current rate is 6.2% and the labour market is tightening with the increase in economic activity. Forecast to fall to 5.2% by March 2015. Tighter labour market will mean higher wage growth but also because of higher inflationary expectations as the economy recovers.

Inflation - quite subdued and the annual rate has been 1% or less over the last four quarters. A strong NZD, weakening commodity prices and low inflation globally are conspiring to offset domestic-demand driven price increases. Low inflation also becomes self-fulfilling to the extent that it moderates inflation expectations and price-setting behaviour elsewhere.

Current Account - The current account deficit appears to be stabilising in
a 4.0% to 5.0% of GDP range. This is thanks largely to a resurgence in the commodity prices of the goods that New Zealand exports. This is a welcome development to the extent that it may appease nervous rating agencies for a year or so.

Overall

The New Zealand economic expansion is gaining in momentum. The rebuild of Christchurch is now building up a head of steam and this is supporting increasingly widespread confidence. Very low interest rates and a booming housing market are playing their part too. Eventually this will necessitate a response from the central bank but while annual inflation remains below 1.0% (and set to stay there for a while) it suggests that any such response might be some time in coming. Meanwhile, the NZD remains supported by money printing elsewhere and the relative strength of the economy here.

New Zealand Merchandise Exports – Milk products the driver.

In the year ended March 2013, New Zealand’s merchandise exports totalled $46,182 million. The breakdown is as follows:

Australia $9,738 million
China $7,414 million
USA $4,338 million
Japan $3,143 million

Exports to the top ten destination countries accounted for approximately two-thirds of New Zealand’s merchandise exports by value. See chart below for percentages. With regard to the composition of exports the breakdown is as follows:

Milk power, butter and cheese products are $11,434 million
Meat and edible offal $5,287 million
Logs, wood, and wood articles $3,274 million
Crude oil $1,767 million

The top ten export commodities accounted for 64 percent of export value in the March 2013 year. With regard what destination it was sent from we can see the following:

34% of are sent from the Port of Tauranga
11% exported from the Ports of Auckland and Lyttleton Port
10% exported from Auckland International Airport

A Level Revision – Floating Exchange Rates

In theory, an advantage of a floating exchange rate is that it will automatically correct any tendency for the balance of payments to move into surplus or deficit. The following sequence of events shows how this automatic correction is supposed to work.

• Assume the NZ balance of payments is initially in equilibrium.
• Assume now that export values remain unchanged, but an increased demand for $ tends to move the NZ B of P into a deficit.
• This increased demand for imports will increase the supply of dollars in the foreign exchange market.
• The external value of the dollar will fall and this will make exports cheaper and imports dearer.
• The changes in the relative prices of exports and imports will increase the volume of exports and reduce the volume of imports and the B of P will be brought back into equilibrium.

In practice it may not work out like this because the supplies of exports and imports may be slow to adjust to the price changes. For example, if the prices of exports fall, it may take considerable time before the increased quantities demanded can be supplied. There are also problems associated with the elasticities of demand for exports and imports. A 10% fall in the prices of exports will not increase the amount of foreign currency earned unless the quantities demanded increase by more than 10%. A further problem is that a depreciation of the pound increases import prices and, since New Zealand imports a large amount of raw materials and manufactures, this has the effect of raising the cost of living and the costs of production in many industries.

A disadvantage of the system of floating exchange rates is the fact that greatly increases the risks and uncertainties in international trade.

For example, an Auckland manufacturer of cotton cloth may be quoted a firm US$ price by his American supplier, payment due, say, in 3 months. He will still not be certain of the costs of his cotton because he does not know what the US$-NZ$ exchange rate will be when he comes to make payment.

If he is quoted US$500 for a bale of cotton and the exchange rate stands at:
NZ$1 = US$0.56, a bale of cotton will cost him NZ$892.86.

If, however, by the time he comes to make payment, the exchange rate has moved to:
NZ$1 = US$0.53, a bale of cotton will cost him NZ$943.40.

Speculators remove some of this uncertainty by operating a forward exchange market where they guarantee to supply foreign currency at some future date at a price agreed now.
A perfectly free market in foreign currency is not likely to be found in the real world. Even when currencies are said to be floating, governments tend to intervene in the market to smooth out undesirable fluctuations. The central bank (Reserve Bank in NZ) is responsible for this type of intervention and the way it operates is explained in the next section.

Advantages of a Strong Dollar

• A high NZ$ leads to lower import prices – this boosts the real living standards of consumers at least in the short run – for example an increase in the real purchasing power of NZ residents when traveling overseas
• When the NZ$ is strong, it is cheaper to import raw materials, components and capital inputs – good news for businesses that rely on imported components or who are wishing to increase their investment of new technology from overseas countries. A fall in import prices has the effect of causing an outward shift in the short run aggregate supply curve
• A strong exchange rate helps to control inflation because domestic producers face stiffer international competition from cheaper imports and will look to cut their costs accordingly. Cheaper prices of imported foodstuffs and beverages will also have a negative effect on the rate of consumer price inflation.

Disadvantages of a Strong Dollar

• Cheaper imports leads to rising import penetration and a larger trade deficit e.g. the increasing deficit in goods in the NZ balance of payments in 2011
• Exporters lose price competitiveness and market share – this can damage profits and employment in some sectors. Manufacturing industry suffered a steep recession in 2011 partly because of the continued strength of the NZ$, leading to many job losses and a sharp contraction in real capital investment spending and the lowest profit margins in manufacturing industry for over a decade
• If exports fall, this has a negative impact on economic growth. Some regions of the economy are affected by this more than others. The rural areas are affected by a strong dollar in that our produce becomes more expensive to overseas buyers.

New Zealand growth prospects looking good through to 2014

Here is a graph from the BNZ which paints a rosy picture for the NZ economy – looking at a 3% increase in GDP this year followed by 3.7% in 2014. Investment is probably the reason for the forecasted growth – with the construction industry especially in Christchurch. However trade will most likely be subdued as demand for imports has been on the increase at the same time the dry summer has affected primary exports. Nevertheless by international standards New Zealand is in reasonably good shape when you consider the problems in Europe and the USA.

Credit Rating Agencies – how countries stack up.

Here is a list of the latest ratings by the three main rating agencies. Notice that Australia and the three Scandinavian countries have top ratings. The UK lost its top rating from Moody’s but maintained the top rating from the other two. New Zealand comes in further down with a top rating from Moody’s but has lost its top grade from the other two. When you get to B status your are talking high risk or junk status and this is quite evident with the PIGS counties.

If you have watched the movie documnetary ‘Inside Job’ you will remember that these 3 credit rating agencies also rated high risk investments – sub-prime mortgages – as AAA, up to a week before they failed. The same could be said about their rating of investment company Bear Stearns.

Ultimately they could have ‘stopped the party’ but delayed ratings reports and made junk status investments AAA rated. But as they testified in front of congress their advice to clients are opinions ‘just opinions’ – I wonder do they share the opinions of those that lost huge amounts of money, including sovereign investments. Recently they downgraded Greece and Spain in the knowledge that the servicing of the debt would now become more costly for those countries and stifle any sort of recovery in the near future.

Global Manufacturing Trends

I picked some interesting statistics from Reserve Bank Governor Graeme Wheeler’s recent talk to the NZ Manufacturers and Exporters Association.

Importance of manufacturing

* share of global GDP fell from 27% in 1970 to 16% in 2010.
* USA 26% in 1970 – 9% in 2008
* Manufacturing employment 62m in 2000 as compared to 45m in 2010

Reasons for the above:

* Offshoring
* Global transfer of capital, investment, and technologies
* Competition from Developing Economies – export processing zones with lower taxes and cheap labour.

This trend of relative decline has been common despite differences in economic structures, size and geography, commodity endowments, and exchange rate arrangements and behaviour. For example, since 2000 the real effective exchange rate of the United States has depreciated by 14 percent and manufacturing employment fell by 31 percent.

In New Zealand manufacturing’s share of GDP has trended down:
1980’s = 25%
2012 = 12%

The two speed primary economy in New Zealand – Dairy and Sheep

2013 has seen the primary sector of New Zealand continuing at a dual speed. On the one hand dairy and beef prices are up, but sheep and wools prices are making it a real struggle for those farmers. The weather hasn’t helped matters and the North Island is currently very dry but for those in the South Island there has been enough moisture in the soil to maintain reasonable grass growth which ultimately keeps farmers happy.

Dairy Farmers have coped well with the mixed weather and the discovery of DCD in milk. Milk powder has increased in price by 9.8%. With the REINZ farm price index showed farm prices fell 14% from January to August 2012 Fonterra had initially forecast a substantially lower payout for the new season. However interest in farm conversions is still strong.

Sheep Farmers haven’t done as well. World lamb prices have been downward mainly because of the increase in lamb exports from Australia – increase in supply. Like New Zealand, Australia is predominately pasture-based and less affected by higher feed costs. Furthermore favourable seasonal conditions in Australia has resulted in extra stocking and it is estimated that lamb production will increase by 15% in 2013.

Confusing signals from New Zealand employment data

You may have heard Stephen Topliss of the BNZ in the media this morning talking about the inconsistent employment data that was recently published. In 2012 30,00 people lost their jobs and there was drop in the number of participants in the labour force by 48,000 as people gave up looking for work – see diagram below for Composition of Labour Force. There are some conflicting pieces of data:

1. The unemployment rate fell from 7.3% to 6.9% over the last quarter but this most probably is due to the fact that the participation rate has fallen.
2. The number of people employed fell by 1.4% for 2012 but the Quarterly Employment Survey suggests that employment grew by around 1.5% over the last year.
3. Business intentions and actions are inconsistent – survey indicate that they expect to hire more labour but ultimately they don’t
4. In surveys consumer confidence is high with the backdrop of so many losing their jobs
5. Housing market usually reflects the state of the labour market – today employment market poor

It begs the question how accurate is the employment data. Lies, damn lies and statistics.

Composition of Labour Force in New Zealand January 2012

To cut, increase or status quo – that is the question.

The BNZ Markets Outlook looked at reasons why Graeme Wheeler, the RBNZ Governor, might keep a ‘steady as she goes’ attitude to Thursday’s OCR review. Below are some thoughts as to why he could be swayed to increase or decrease the OCR rate.

With all that said it is expected that Graeme Wheeler will leave the OCR unchanged at 2.5%.

Monopsony power in the labour market and the minimum wage

In 1894 New Zealand made history by being the first developed nation to introduce a minimum wage. The Economist had an article on minimum wages and the fact that they might in fact be good for an economy. Most economists believe that a higher minimum wages = the artificial increase in labour costs and therefore lower demand for labour.

Some economist have suggested that minimum wages can increase employment and obviously pay. However if employees have monopsony power as buyers of labour and are able to influence wages they can keep the wages lower below its competitive rate – see graph below.

Two economists (David Carr & Kruegger) found out in New Jersey that when the minimum wage was raised employment in fast-food restaurants actually increased. The Economist suggests that if firms are not reducing the number of their employees with higher minimum wages they must be employing a number of strategies such as raising prices of their goods/services or saving money from reduced revenue. The IMF state that a moderate minimum wage (30-40% of the median wage – see graph) doesn’t have a significant negative effect on employment numbers and may do some good.

Monopsony in the Labour Market

A monopsony occurs in the labour market when there is a single or dominant buyer of labour. The buyer therefore is able to determine the price at which is paid for services. Unlike other examples we have looked at, in this situation we are now dealing with an imperfect rather than a perfectly competitive market. The monopsonist will hire workers where:

Marginal Cost of labour (MCL) = Marginal Revenue product of labour (MRPL)

From the perspective of the monopsonist firm facing the supply curve directly, if at any point it wants to hire more labour, it has to offer a higher wage to encourage more workers to join the market – after all, this is what the ACL curve tells it. However, the firm would then have to pay that higher wage to all its workers so the marginal cost of hiring the extra worker is not just the wage paid to that worker, but the increased wage paid to all workers as well. So the marginal cost of labour curve (MCL) can be added to the diagram.

If the monopsonist firm wants to maximise profit, it will hire labour up to the point where the marginal cost of labour is equal to the marginal revenue product of labour. Therefore it will use labour up to level of Eq which is where MCL=MRPL. In order to entice workers to supply this amount of labour, the firm need pay only the wage Wq. (Remember that ACL is the supply of labour). You can see, therefore, that a profit-maximising monopsonist will use less labour, and pay a lower wage, than a firm operating under perfect competition.

In this situation the power of the employer in the labour market is of overriding importance and the employer can set a low wage because of this buying power.

Macro Conflicts in New Zealand

Part of the Cambridge A2 syllabus studies Macro Economic conflicts of Policy Objectives. Here I am looking at GDP, Unemployment, and Inflation (improving Trade figures is another objective also). The objectives are:

* Stable low inflation with prices rising within the target range of 1% – 3% per year
* Sustainable growth – as measured by the rate of growth of real gross domestic product
* Low unemployment – the government wants to achieve full-employment

New Zealand Growth, Jobs and Prices — 3 Key Macro Objectives Inflation, jobs and growth

1. Inflation and unemployment:

From the graph above you can see that low levels of unemployment have created higher prices – demand-pull inflation. Also note that as unemployment has increased there is a short-term trade-off between unemployment and inflation. Notice the increase in inflation in 2010-2011 as this is when the rate of GST was increased from 12.5% to 15%. Also today we have falling inflation (0.8% below the 1-3% band set by the RBNZ) and unemployment in on the rise – 7.3%

2. Economic growth and inflation

With increasing growth levels prices started to increase in 2007 going above the 3% threshold in 2008. This suggests that there were capacity issues in the economy and the aggregate supply curve was becoming very inelastic. In subsequent years the level of growth has dropped and with it the inflation rate.

3. Economic Growth and Unemployment

Usually you find that with increasing levels of GDP growth unemployment figures tend to gravitate downward. This was apparent between 2006-2008 – GDP was positive and unemployment did fall to approximately 3.6%. However from 2009 onwards you can see that growth has been positive but unemployment has also started to rise.

Tourism and the New Zealand Economy

Here are some statistics – from November NZ Parliamentary Review – referring to the importance of tourism to New Zealand – looks at tourism expenditure and the contribution to employment in the economy.

Some points of note:

2012 – Total tourism expenditure by product:
– $5,119 million – other (which excludes fuel and other automotive products retail sales)
– $4,165 million – air passenger transport of
– $2,900 million – food and beverage serving services.

Generally tourism has been consistent with its contribution to GDP and the value in money terms to the NZ economy. However 8.6 was its lowest as a % but highest in dollar value.

The total number of full-time equivalents (FTEs) associated with the tourism industry was 186,900 in the year ended March 2012 – 9.6 percent of total employment.

Export Revenues Year ended March 2012
* Tourism – $9,558 million
* Dairy Products – $12,704 million
* Meat products – $5,389 million

Dairy products the engine of growth for New Zealand.

New Zealand’s White Gold

Fonterra got a mention in the Business section of The Economist recently. Some significant facts about the Dairy industry in New Zealand and the co-operative Fonterra:

* Dairy produces 25% of export revenue in NZ
* It makes up 33% of the world dairy industry
* Fonterra makes up 90% of the dairy industry in NZ
* Fonterra’s annual revenue = NZ$20 billion
* Fonterra opeates in 100 countries and has 10,500 farmer owners.
* 20% of New Zealand Dairy products go to China

Recently Fonterra had made it clear that it is prepared to let non-farmer investors buy in for the first time – they intend to raise NZ$500m with the issue. Why are they looking to non-farmer investor? Although they have made shrewd investments in Asia and Latin America, in more developed markets health worries and higher prices have cut demand. Countries like China are a threat to the Fonterra’s standing on world markets. Furthermore with milk prices down 20% from last year farmers are concerned that non-farming ownership will cut their return further and that there will be a move away from a farmer-owned co-operative.

Unemployment worries for New Zealand economy

Figures out today show that the unemployment rate increased by 0.5% from the previous quarter to 7.3% – see ASB Bank graph.. This was a concern considering the market expectation was a reduction of 0.1% to 6.7%. The main fall was in Auckland where employment fell by 2% and this should mean that new Reserve Bank Governor Graeme Wheeler will hold off on any increase until late next year. A reduction in the OCR is unlikely unless there is further deterioration on overseas markets.

Remember the types of unemployment

Frictional – The unemployment that inevitably results from the process of job-seeking. It will exist under conditions of generally so-called full-employment conditions (see employment, full), but it is not precisely clear what proportion of total unemployment can be called frictional.

Structural - Unemployment arising from changes in demand or technology which lead to an oversupply of labour with particular skills or in particular locations. Structural unemployment does not result from an overall deficiency of demand and therefore cannot be cured by reflation, but only by retraining or relocation of the affected work-force, some of which may find work at low wages in unskilled occupations.

Cyclical – Demand-deficient unemployment occurs when there is not enough demand to employ all those who want to work. It is a type that Keynesian economists focus on particularly, as they believe it happens when there is a disequilibrium in the economy.

Seasonal - Some workers, such as construction workers or workers in the tourist industry, tend to work on a seasonal basis. Seasonal unemployment tends to rise in winter when some these workers will be laid off, whilst unemploymnet falls is summer when they are taken on again.

Productive debt – Agriculture not Housing

Brian Gaynor in the Saturday NZ Herald reinforced the belief that borrowing in New Zealand must be in an area that is going to generate growth. He presented the lending figures over the last 10 years for Agriculture, Business and Individuals and made the following points:

1. Export revenue from agriculture has increased from $7.3bn in 2001/02 to $16.7bn 2011/12.
2. Agricultural debt has made a positive contribution to the economy
3. There are very limited benefits of $102.7bn of residential mortgage debt over the past ten years.
4. Additional individual borrowings have been mainly used to push up prices of existing houses, rather than building new homes
5. Additional debt has to be shifted away from existing housing and into the productive sector – agriculture and house construction
6. The government needs to develop policies with regard to overseas ownership of land.

New Zealand has the potential to be the bread basket of the Asia Pacific region and the financial returns to the economy are significant. However there has to be an increase in investment and lending to the agricultural sector if it is to be successful.

AS & A2 – Global and New Zealand Update for November exams

It is important that you are aware of current issues to do with the New Zealand and the World Economy. Examiners always like students to relate current issues to the economic theory as it gives a good impression of being well read in the subject. Only use these indicators if it is applicable to the question.

Indicators that you might want to mention are as follows:

The New Zealand Economy
The New Zealand economy expanded by 0.6 percent in the June 2012 quarter, while economic growth in the March quarter was revised down slightly to one percent. Favourable weather conditions leading to an increase in milk production was a significant driver of economic growth over the June quarter. The current account deficit rose to $10,087 million in the year ended June 2012, equivalent to 4.9 percent of GDP. Higher profits by foreign-owned New Zealand-operated banks and higher international fuel prices were factors behind the increase in the deficit during the year. Unemployment is currently at 6.8% but is expected to fall below 6% with the predicted increase in GDP. Annual inflation is approaching its trough. It is of the opinion that it will head towards the top end of the Reserve Bank’s target band (3%) by late next year.

The Global Economy
After the Global Financial Crisis (GFC) the debt-burdened economies are still struggling to reduce household debt to pre-crisis levels and monetary and fiscal policies have failed to overcome “liquidity traps”. Rising budget deficits and government debt levels have become more unsustainable. The US have employed the third round of quantitative easing and are buying US$40bn of mortgage backed securities each month as well as indicating that interest rates will remain at near zero levels until 2015. Meanwhile in the eurozone governments have implemented policies of austerity and are taking money out of the circular flow. However in the emerging economies there has been increasing inflation arising from capacity constraints as well as excess credit creation. Overall the deleveraging process can take years as the excesses of the previous credit booms are unwound. The price to be paid is a period of sub-trend economic growth which in Japan’s case ends up in lost decades of growth and diminished productive potential. The main economies are essentially pursuing their own policies especially as the election cycle demands a more domestic focus for government policy – voter concerns are low incomes and rising unemployment. Next month see the US elections and the changing of the guard in China. In early 2013 there is elections in Germany. The International Monetary Fund released their World Economic Outlook in which they downgraded their formal growth outlook. They also described the risk of a global recession as “alarmingly high”.

New Zealand agricultural sector – lowest subsidies amongst OECD

Having just taught the Developing Economies topic at the UNITEC A2 revision course I couldn’t help noticing this graph that was in The Economist last week. This was extremely useful when you look at how developing nations are locked out of the trading system by the subsidies given to those developed nations agricultural sectors. For years the World Bank and the IMF have forced developing nations to stop subsidising their agricultural sector.

Government support for agriculture in the mostly rich countries of the OECD amounted to $252 billion in 2011, or 19% of total farm receipts. Although there is a move away from support linked directly to production, it is still about half of the total. The general trend is downwards: compared with the second half of the 1990s subsidies fell in all countries. But levels of support vary widely. In Norway, Switzerland and Japan, more than half of gross farm receipts in 2009-11 came from support policies; for producers in Australia, Chile and New Zealand, it was less than 5%. Commodity prices will stay high for some time, suggests the OECD, so markets will provide the farm income that many governments have tried to prop up.

New Zealand Dollar in September

Here is a great graphic from the BNZ showing how the NZ dollar performed in September. You could say that it strengthened on the back of notably QE3 from the US Fed and the improving global growth sentiment. Furthermore the NZ economy has performed well under trying circumstances.

June quarter GDP accounts revealed the NZ economy finished Q2 1.6% bigger than where it began the year. That is solid economic growth under ordinary circumstances. But given the ongoing challenging and uncertain global economic environment we should not under sell this achievement. It is the strongest six month expansion we have seen in the past five years. Source: BNZ

High NZ$ expected to reduce lamb & beef revenues by 11% for 2012-2013 season

The New Zealand Farmers Weekly had an interesting piece on the future prospects of farm revenues over the next year. The outlook is not looking rosy mainly because of the high NZ dollar. A NZ$ value of US$0.90 for a full season would slash farm profit to $46,400 according to the Beef & Lamb NZ Economic Service. However the crucial time for the exchange rate is when the vast majority of produce is actually exported namely between November and June.

With regard to destinations for NZ beef they are the following:

- 50% of beef goes to North America
- 9% Japan
- 8% South Korea
- 6% Taiwan

Below are some of the figures that are estimated from the Beef & Lamb NZ Economic Service

NZ rural sector holds its own

The New Zealand Herald last Saturday had a useful article on the importance of the rural sector to the growth of the economy. Brian Gaynor talked of the confidence of the rural environment compared to that of their urban counterparts who are struggling in a very competitive environment. New Zealand’s exports have increased from $7.9bn in 1983 to $46.7 bn today whilst the contribution of meat, dairy and wool have decreased from 53.8% to 37.5%. Although this gives the impression that the rural economy is not holding its own one has to remember that:

Meat, dairy and wool’s contribution has increased from 34.5% to 37.5% during the last 10 years.
If logs, oil, fruit, wine, fish, casein and Tiwai Point’s aluminium are added then exports from the non-urban sector accounts for around 60% of total exports.

The rural sector has a trade surplus with the rest of the world but the urban sector runs a substantial deficit. The increase is residential house prices has been 8 fold but the problem here is that in borrowing to buy a house they are accessing overseas banks. This means that we need to export more and more rural products just to pay the interest on these overseas loans.