The New Zealand Institute has published a paper outlining four factors that it says could lead to a structural downward shift in global growth over the next decade and heavily impact on New Zealand's economic outlook. The paper titled 'The End of the Golden Weather' argues that the current recession will be a protracted, 'L' shaped recession from which "the recovery will be weak and subdued." "We cannot rule out the possibility that this recession will be the largest in the post-war period, as global financial markets have not yet returned to normal and the continuation of the financial crisis into 2009 is likely to deepen the impact on real economies and delay a recovery," the Institute said. New Zealand's external position in the world and its small size make it particularly vulnerable to a global recession, the paper argues, as:
- households are forced to reduce spending and focus on reducing debt;
- the availability of credit contracts;
- the cost of government interventions will heighten tax burdens;
- the US, without an alternative engine for growth, grows slowly over the medium term.
The paper puts to one side the regular question currently being asked on when the recession will end: "will the economy begin to recover in late 2009 or early 2010?"
This is a question based only on the technicality of what constitutes a recession - two consequent quarters of negative growth - the paper states. Instead, what should be asked is: "what will the growth profile of the next decade be like?" "The next decade will be a period when some of the structural factors that led to high and sustained growth in the last decade unwind," author of the report Benedikte Jensen said. "It seems plausible to expect the next ten years to be quite different to the period of generally sustained, low inflationary growth we've experienced since the early 1990s." Unwinding of household indebtedness across advanced economies The paper points to household debt at historically high levels in the world's leading economies. The burst of the housing bubble in New Zealand and other OECD countries had the flow on effect of home equity values declining, and has led to the need for more "financial innovation" to service mortgage debt. With unemployment set to rise, households are now contributing more income towards debt reduction, and away from retail spending, Jensen said. New Zealand will be hit directly by this as it relies on commodity exporting. "More generally, export-led growth for the New Zealand economy will be challenging because of sluggish demand in overseas markets despite a weaker New Zealand dollar," Jensen said. Ongoing financial market disturbances produce a lengthy period of credit contraction leading to heightened risk aversion The paper calls upon research done by the Boston Consulting Group estimating that losses made by global financial institutions will lead to a US$19 trillion decline in credit capacity, or 7% of current global credit levels. Risk taking is set to decline: "The downswing is likely to be more than a process of re-balancing, moving to a period of risk averseness that is sub-optimal for the global economy. This reverse risk cycle is likely to place a drag on productivity and growth for some time." "New Zealand may find it increasingly difficult to attract foreign investment as multinational investment decisions become more risk averse." Worsening fiscal positions in a number of advanced economies leading to higher tax burdens with a negative impact on growth Jensen's paper argues that the costs of financial stimulus packages from governments around the world, such as the US$700 billion bailout fund, will not be fully realised for some years to come. With the ageing baby-boomer population set to place spending pressures on governments, Jensen states that "the next five years had been considered the golden opportunity for economies to get government spending under control and thus limit the impact of rising age-related costs on their economies. However, the financial crisis and global recession look set to delay spending adjustments, which may lead to taxes around the world being forced up in the next 10 years to cover costs incurred by present day interventions. The United States is looking increasingly like Japan in the 1990s and an alternative engine of global growth is not apparent US households are some of the most indebted in the world; asset values and confidence have eroded; and US will be among the most heavily indebted countries in the OECD within a decade, Jensen said. He points to similarities between the US now and Japan in the 1990's, notably that "businesses are focused on minimizing debt rather than investment", and that "monetary policy is relatively ineffective in this environment." But Jensen also pointed out that the US has been given the chance of learning from Japan's mistakes. This has been most notably evident with the US government using capital injections and introducing financial stimulus packages much quicker than the Japanese did. Impact on New Zealand With the Baltic Dry Index (measuring the cost of global freight shipping) and the CRB Commodity Index (measuring globally traded commodities) at their lowest levels in five years, Jensen argues that "the outlook for New Zealand's commodity exports is suddenly extremely uncertain." The tightness of credit criteria, and a move by foreign investors to seek 'safe-havens' such as US government bonds will lead to a decline in foreign investment in New Zealand, Jensen argues. Also, as multinationals deleverage and practice higher risk aversion, the outlook for foreign investment in New Zealand is looking weak. With risk aversion on the rise, coupled with the fact that New Zealand is highly indebted to the rest of the world, it will become harder for New Zealand "to use foreign savings to finance our current account deficit," Jensen said. However, there are opportunities for New Zealand to benefit over the next decade, but these rest heavily on government policy. "The key is to use the fiscal position and the Government's balance sheet to support policies that ultimately enhance productivity and bring New Zealand back to a sustainable growth path in the medium term."