Riding The Economic Bi-CycleKeith Rankin, 6 June 2002
The New Zealand dollar has risen 22% in just over 8 months. The agent that revived the New Zealand economy - the low dollar - is no more. The New Zealand economy is switching from one cycle to another.
This is the bi-cycle (or counter cycle) economy.
The revival of the tradable sector has been in large part responsible for the rising dollar, much as a racehorse with a light weight on its back expects to have that weight increased when it starts to win. However, it is Reserve Bank's "stabilisation" policy that has converted a small problem into a very large one. In signalling to the world - through rises in its official cash rate - that betting on the $NZ is a sure thing, the number of punters backing the $NZ have multiplied several-fold.
There are two kinds of damage I want to comment on.
First, the most spectacular growth industry in New Zealand at the moment is educating Chinese students. New Zealand has a price advantage over its rivals, and - since 11 September 2001 - a substantial non-price advantage.
Auckland is probably close to its limits in catering to international English-language students. (Although, given the size of mortgages in Auckland, the supply of homestay accommodation may be quite elastic.) It is appropriate that some signals are given that will slow down the rate of growth of this sector. But the last thing we want is a collapse of this service industry that is as dramatic as its rise.
The demand in China for foreign education is what economists call both 'price elastic' and 'income elastic'. ('Elastic' just means 'sensitive'.) Hence the growth of incomes in China has enabled many more Chinese to consider foreign education. But then a possible 30% rise in the price by the end of this year compared to October 2001 may be just too much for those at the price sensitive end of the market that come to New Zealand.
Perhaps more importantly, many of the students already here may have to return after just one or two semesters; ie just as they are settling down. The exchange rate is likely to do more harm to this 'golden goose' than any stories about sub-standard schools or scrooge-like homestays. Teaching Chinese students about the $NZ exchange rate is much more than an academic exercise for them. These students are very vulnerable people whose insecurity is exacerbated every day that the kiwi dollar continues to rise.
If too many of these students are forced to leave because their parents can no longer afford to send money, then a large proportion of the new language schools would fail, possibly creating a huge scandal in Asia, especially but not only in China.
This brings me to my second more general point. The 'counter-cyclical' monetary policy of the Reserve Bank stabilises nothing, and destabilises much. The Reserve Bank creates a counter-cycle which is as destabilising as the business cycle that it is trying to counter.
Aggregate data such as GDP (gross domestic product) may well neither rise nor fall as much as it would if the Reserve Bank adopts a non-interventionist policy. Close examination however shows that the two halves of the New Zealand economy - the tradable sector and the non-tradable sector - each experience cycles. These cycles work like a see-saw; when one sector is up, the other is down. At the moment we are on the fulcrum; the boom in the tradable sector over the last 4-years is giving way to a boom to the non-tradable sector, and a bust to the tradable.
The tradable sector is anything that is produced for the world market; ie exportable products, and goods and services produced in New Zealand in competition with imports. The non-tradable sector includes wholesaling and retailing, most professional services, government, most healthcare and education, and most of the finance sector. Importers (eg The Warehouse) are not part of the tradable sector. They are not in direct global competition with, say, Walmart, the biggest chainstore in the world of its type. In fact, importers' interests are diametrically opposed to exporters' interests.
We have become quite used to these destabilising countercycles. In the middle of each decade since the 1980s, the urban non-tradable sector (read Auckland and Wellington) boomed as the $NZ went up. At the cusps of each decade, the reverse happened, with the rest of the country shifting into overdrive and Auckland stagnating.
It is now different. At last, through its dominance of New Zealand's international education industry, Auckland is paying its way. It has joined the tradable sector. It may not only be our Chinese guests who will get a nasty shock if the dollar continues to rise in the way the Reserve Bank has virtually promised punters that it will.
It would be more useful for the New Zealand economy if the Reserve Bank acts to stabilise interest rates and the exchange rate, and forgets about using them as pawns in the process of stabilising the price level and the GDP.