Speech to ACT Party Members and supporters

Newmarket,

9am Monday 18 August

Dr Jamie Whyte, ACT Party Leader

ACT’s three point plan to respond to the coming global Economic Shock

New Zealand is a small trading nation. This makes us especially vulnerable to global economic shocks or downturns.

How can we ride out the coming global economic shocks? How can we avoid being thrown into recession by international events over which we have no control? This is the big question for the country.

Not that you could tell it was by observing this election campaign. From the petty bickering and name-calling of our politicians and journalists, you might think that everything is plain sailing for New Zealand. There are no serious threats to the nation’s well-being, and the only question is who should get their hands on the tiller.

This impression is reinforced by the National government’s near perfect inactivity. In six years, they have done almost nothing to reform New Zealand’s economy. They thrive on the Prime Minister’s immense popularity rather than the success of any actions they have taken.

Well, I will make you a prediction. I predict that by the next election the gossip in Mr Hager’s book will be forgotten and the real issue affecting New Zealanders will be some global economic shock. Journalists who today are fascinated by the Hager gossip will wonder why they were not asking our politicians about their plans to deal with global economic instability.

Being the bearer of bad news may not make me popular. Persian Kings used to throw the bearers of bad news down a well. That made the bearer go away but not the bad news. It won’t work in a democracy either. Voters who reject parties bringing bad news won’t prevent global economic shocks from occurring. They will just make effects of those shocks more devastating.

I am known as a “philosopher turned politician”, as the Herald recently put it. I was indeed a philosophy lecturer at Cambridge University for several years. However, I have spent a larger and more recent part of my career as a strategy consultant in the banking industry. About half of the projects I led involved advising global banks on how to measure and manage the risks they were taking.

I can assure you that the global economic situation will not provide New Zealand with plain sailing. Our bickering and steady-as-she-goes politicians are being negligent. Those of us advising the banking industry are very concerned about the risks of another economic shock that could have devastating consequences, especially to small exposed economies such as New Zealand.

The global economy is today in a precarious situation. And, since the global financial crisis that started in 2007, developments in New Zealand have made us even more vulnerable to the next crisis.

Why is the global economic situation precarious?

The short answer is that the imbalances that have built up in recent decades and resulted in the financial crisis have not been corrected.

What is an economic imbalance? It is jargon for an unsustainable position. Your personal finances would be described as imbalanced if you have borrowed to the hilt on your mortgage and credit cards so that all of your income is going to repay interest and just a minor increase in the rate of interest would mean you could not make the payments.

A growing number of countries have governments and citizens in just that position. Interest rates today are at historic lows: the European Central Bank’s overnight rate is actually negative – you have to pay to deposit money with it. But, as New Zealand itself has proved this year, interest rates must eventually rise and, if governments and populations remain highly indebted, we will see real carnage.

The global financial crisis of 2008 occurred because banks in the US and Europe lent excessively and recklessly. Why did they do that?

Government regulations designed to make banks safe actually made them take on risks. Deposit insurance and the implicit government guarantee created by banks being “too big to fail” meant they paid no price for excessive risk-taking. This created what is known as moral hazard.

The policy response to the crisis has not solved this problem. On the contrary, necessary or not, the government bailouts of insolvent banks have only reinforced this moral hazard. The banking system of the world’s major nations remains a serious threat to economic stability.

The second underlying problem is excessive government spending and unfunded government liabilities. These problems are well-known in Europe. Governments there have spent so much on their various vote-buying programmes, and promised so much to future retirees, that they are effectively insolvent. Many already have debt greater than 100% of their GDP, and no prospect of honouring their promises to future retirees. If governments were held to the accounting standards of companies, they would be wound up.

The problem is just as bad in the US, where federal government debt is now $18 trillion and, according the American economist Laurence Kotlikoff, its unfunded liabilities created by entitlement programmes exceed $200 trillion. Not $200 billion. $200 trillion.

The government of the USA can continue paying its bills only because the rest of the world keeps lending it money. We do that because the USA has the world’s reserve currency. But reserve currency status is not permanent. Not very long ago Sterling was the world’s reserve currency. Some countries are trying to challenge the dollar’s reserve status. It will not be easy but the challenge itself may lead to instability.

Then there is China. China’s explosive economic growth has been carrying much of the world with it. New Zealand and Australia have benefitted greatly from it. Much of China’s growth has been based on structural economic reforms – notably, on the shift from a planned economy to a market economy. The gains from these reforms are sustainable.

However, some of the growth has also been based on a reckless government-backed expansion of bank lending. Much of this lending has been to poor-quality businesses. The solvency of Chinese banks is imperilled and dependent on their government’s backing. Indeed, if Western accounting standards were applied to Chinese banks, many would now be declared insolvent.

Over the long run, the systematic misallocation of capital in China cannot be sustained. Chinese banks will eventually either fail or contract their lending or suck-up economic resources through more and more government subsidy.

Commentators used to say that Japan had found a new economic paradigm. Japan was going to be bigger than the USA. Japan was different and its imbalances did not matter. Well, Japan has now been in recession for over a decade.

China must at some point tackle the imbalances in its banking system. This will slow China’s economic growth. The knock-on effects for the global economy will be severe, especially when so many other governments’ finances are on a knife-edge. The knock-on effect of a recession in China for New Zealand will be severe. China is now our most important market.

We cannot fix these problems from New Zealand. We can only manage our own affairs, making ourselves less vulnerable to the effects of a global downturn from these sources or the others that may blind-side us.

How can we do that?

ACT has a 3 point plan to prepare for the coming global economic shock.

1. Reduce government debt

2. Liberalise economic regulation

3. Eliminate corporate welfare and economic planning.

Why will these measures make New Zealand more resilient to economic shocks?

Resilience to economic shocks is weakened by three things. The first, and most obvious, is debt. The more indebted you are when things go wrong, the harder it is to ride the storm. We all know this from our personal lives. If you lose your job, your situation is far worse if you are maxed-out on your credit cards than if you have savings.

The same goes for governments. A government that is highly indebted when a downturn strikes will find it expensive or even impossible to borrow the money it needs to keep functioning – to continue providing the education, healthcare, unemployment insurance and other services that governments now supply. This is what happened to Greece in 2011.

The New Zealand government’s debt has increased from about $30 billion in 2007 to $65 billion today, which is 36% of GDP. That is not high by comparison with the US, Japan and European countries. But that is nothing to be proud of. Those governments are outrageously over-indebted. What’s more, small countries have been shown to be able to sustain lower levels of debt, not just in absolute terms but as a proportion of their GDP.

Reducing government debt should be a priority. Even now that New Zealand has emerged from recession, the National government’s efforts in this area have been feeble. No debt will be repaid in 2014.

ACT recommends selling the government’s stake in all state owned enterprises, such as Landcorp (a government owned farming business), the energy generators and Air New Zealand. This would immediately reduce government debt by a third: that is, by $20 billion. And there would be no material loss in government revenue because the government’s portfolio of commercial assets delivers a return of less than 1% on capital – the kind of return that would get any portfolio manager fired.

Risk is also exacerbated by concentration: that is, by having all your eggs in one basket. Again, we all know this from our personal lives. Most of us have just one client: namely our employer. If our employer goes broke or turns against us, we lose our entire income. By contrast, a company with many customers can lose one or two of them without a dramatic loss of income.

The fortunes of a country that produces only a few goods, or supplies only a few services, is more vulnerable than one, such as the US, that produces a vast array of goods and services.

New Zealand’s economy is quite concentrated compared to the many other countries – most obviously, on agricultural output and, for now, on dairy in particular. Alas, such concentration is more or less inevitable for small economies. Divide the US into many little 4.5 million people regions, and you will find that most have more concentrated economies than New Zealand. Taking advantage of comparative advantage means that high-performing small economies will tend to be quite concentrated.

Which brings me to the third factor that exacerbates risk: namely, rigidity. When demand for what you produce falls, you need to start producing something else. Suppose the international price of dairy falls dramatically, perhaps because the Chinese economy goes into recession.

The current concentration on dairy production in New Zealand will not be a big problem if dairy farmers can quickly and cheaply switch production to something where demand has not collapsed. But if dairy farmers are effectively stuck with dairy, then they are in big trouble. And so are the other New Zealanders whose earnings depend on the success of the dairy sector.

The point is not specific to dairy farming. Anything that makes our economy less responsive, less able to adapt rapidly to changes in demand or in the cost of inputs, makes if far more vulnerable to changes in the global economy.

This is where governments do most to exacerbate economic risk – all around the world and here in New Zealand. The most obvious way they do it is through regulation. Governments impose rules that make it difficult to respond quickly and cheaply to changes in the economic situation.

Employment regulations make it difficult for firms to get rid of newly unsuitable staff or to change their terms of employment. And, on account of these restrictions, firms are reluctant to take on new staff. Employment law thus limits firms’ ability to respond to new circumstances. That’s one of the reasons ACT has proposed significant liberalisation of employment law in New Zealand.

Resource consenting also impedes our ability to respond to economic shocks or even to slow-motion developments. It can take many years and hundreds of thousands of dollars to get permission to put your land to a new use. The consenting process is so arduous and uncertain that many people give up before even embarking on it. Good ideas don’t get off the ground. This is one of the reasons that ACT proposes major reforms of the Resource Management ACT. The RMA is an enormous legislative wet blanket lying across the New Zealand economy.

Other political parties seem blissfully or, more accurately, dangerously unaware of the problem. Rather than seeking to diminish the role of the government in the economy, they seek to expand it. For example, Labour has become entranced by forestry. They plan to subsidise an increased production of trees. The Greens, of course, want to subsidize an expansion of “green” businesses. Even National have edged back towards the economic planning of Rob Muldoon, dispensing $1.7 billion a year in corporate welfare for their favoured firms and setting a target of doubling agricultural exports by 2025.

All such interventions simply make our firms less responsive to economic reality. They produce not what there is real demand for, but what the government is willing to subsidize. And the government’s willingness to subsidise certain things and tax others (as it must to fund the subsidy) responds not to economic reality but to political reality.

Politicians are aiming to get re-elected. Unsubsidized businesses are aiming to produce what people are willing to buy. A subsidized and government-directed economy will not respond properly or quickly to changes in the global economy. This is one of the reasons ACT rejects National’s corporate welfare and the other parties’ proposed return to central economic planning. By eliminating all corporate welfare, we could reduce the company tax rate from 28% to 12.5%.

Like other Western economies, New Zealand’s is becoming “sclerotic”: slow to respond to economic shocks and changes in patterns of demand. This is not because people are lazy and dull-witted. People are always ambitious and they are now better educated than ever before.

The recovery from the recent global recession is so slow compared with previous recoveries not because people have slowed down but because governments are impeding them. If New Zealand is to thrive in a risky world, the government must spend and borrow less, it must tax less, it must regulate less and it must not try to decide what we should produce.

ACT is the only party in New Zealand that takes the risks we now face seriously. And ACT is the only party that understands that the answer is not more government, but less.

The current political “debate” in New Zealand – the accusations and bickering and name-calling – reveals a political class who have become obsessed with their own affairs and oblivious to the real risks to the population.

My message to the voters is “ask National and Labour what is their plan to deal with the coming economic shock?”

Then vote the party that has a three point plan. Vote for ACT.

ends

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