A close analysis of the Treasury assessment of the Medium Term in its PREFU 2023 suggests the economy may be entering a new phase.
Last week I explained that the forecasts in the just published Treasury Pre-election Economic and Fiscal Update (PREFU 2023) was similar to the May Budget BEFU, except that it showed weakening in the fiscal position. A summary might be that the commentary on the Treasury forecasts should have happened four months earlier.
What I did not discuss was the PREFU 2023’s medium term outlook which presents the economy returning to track after wobbling last year and this. A serious forecaster always has a medium-term view although there is always a high degree of uncertainty (fan) around it.
I should not be surprised if Treasury is currently reviewing its medium-term outlook. A group of diverse macroeconomists with which I am associated are. Some of their issues are too technical for a column but here is my response to their discussion.
I focus here on the external sector, asking whether there has been some structural change in the last few years. The possibility is there in the PREFU 2023 forecast of the Net International Investment Position (what we owe overseas less what is owed to us) rising from about 50 percent now to near 60 percent in 2027. That suggests that a substantial element of our economic growth in the next few years will be the result of overseas borrowing.
The forecast rising net debt is largely driven by the current account deficit (i.e. import payments over export receipts). Currently they amount to about 8 percent of GDP. The deficit comes down but remains higher than in the decade before 2022, which is the arithmetic cause of the rising net debt. The high current account deficit seems to come from three causes:
First, there is some reduction in our export prices, especially for dairy products. The Treasury forecast expects no significant recovery. This suggests a structural change probably arising from the slowing down of the Chinese economy and their consumption of our food exports. Lower export prices mean lower export revenue, and that increases the current account deficit. It also reduces the prosperity of the farm sector.
Second, while the volume exports of goods has continued to expand, there has been a falloff in service exports, particularly tourist receipts. I have not seen a thorough account of what is happening here so I must be cautious. There are two major possibilities. One is that the post-Covid recovery has not worked through to the tourist sector yet. Rather, after two years of restrictions, Northern Hemisphere tourists are visiting nearby destinations, and when they have exhausted them they will move on to more distant ones. The other possibility is that there has been a structural change in the international tourist industry – perhaps airfares are going to be permanently higher – so our tourist industry is on a lower growth track. Given the importance of the tourist industry’s generation of foreign exchange, the latter scenario would represent a major structural change, as would lower export prices.
The third possible structural change is the fiscal stance. To go back to last week’s PREFU column, the big change seems to be the falloff in corporate tax receipts. PREFU 2023 gives no account of why this has happened and expects the receipts to be back on track in a couple of years. Let’s hope it is right.
Even so, public debt continues to rise faster than GDP. PREFU 2023 expects net public debt (excluding the NZ Superannuation Fund) to be near 40 percent of GDP over the next few years, in contrast to 20 percent or so before COVID, with no expectation of a significant fall.
(There are a number of measures in the PREFU 2023 forecasts. I am not fastening on a single one in the way the election ‘debate’ does but looking at them all. As I said, the issue is technically complicated.)
If the government is borrowing more, then someone has to be lending to it. Generally that ‘someone’ is overseas, although the channel through which the loans flow is complicated. As a rule, the New Zealand Government borrows in New Zealand currency, but further along, the lender to the government is, typically, converting foreign currency into New Zealand dollars. Suppose the public borrowing is used for diesel to fund capital investment. Ultimately, the diesel has to be paid for with foreign currency.
(This is a severe omission in explanations like Modern Monetary Theory when they ignore the foreign sector. The index of Steve Keen’s The New Economics: A Manifesto – which, by the way, is a much better exposition of MMT than his earlier book – does not mention the balance of payments, exports or imports. Were modern economies so simple.)
Forgive me if I don’t give here the details of the complex analysis. What seems to be happening is that we are not adjusting our economic behaviour for the expected reduction in the terms of trade. Over the next four years, consumption and investment are expected to grow more slowly than total production (GDP) – public consumption is actually forecast to decline – but the production is less valuable because imports are more expensive relative to exports, so what we can afford to spend is growing slower than consumption and investment. (PREFU 2023 does not publish sufficient tables to be sure of this.) To maintain our desire for growing national expenditure, we have to borrow more overseas so that foreign debt rises.
The good news is part of that borrowing is for business investment, which is expected to rise faster than consumption, and will, presumably, add to productivity. Even so, it is not obvious that national consumption should be rising quite as fast as expected. A neutral observer, observing that public spending is already constrained might suggest that the restraint should be on private spending, although those with political agendas might argue differently. (Remind me of the economic case for general tax cuts.)
This conclusion is not the outcome I expected when I first began analysing the medium-term PREFU 2023; facts have a bad habit of getting in the way of preconceptions. Ultimately then, PREFU 2023 seems predicated on a structural change in our terms of trade with slower economic growth prospects in the medium term. Oh dear.