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Basic Statistics of New Zealand, 2010
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Even before the latest severe earthquake in Christchurch, the expected gradual economic recovery in New Zealand was being held back by efforts by the private sector to reduce debt as well as a persistently strong currency. Active monetary stimulus and a significant fiscal expansion resulting from decisions taken prior to the global downturn supported the economy through the recession, as has buoyancy in Australia and Asia and large terms-of-trade gains. Households, businesses and farmers are attempting to repair over-extended balance sheets in the aftermath of a property boom. The balance sheets of the non-financial private sector deteriorated markedly as the increase in property prices and perceived wealth prompted additional household spending. The associated widening in the current account deficit was largely financed by bank-intermediated foreign credit, adding to already high external debt. Weak business investment and low national saving have for some time contributed to poor growth performance. Achieving faster growth will require progress across a broad policy front. This includes bolder fiscal consolidation in the form of spending restraint, coupled with tax and pension reforms to boost national saving. These measures would allow interest rates to stay low for longer and create room for the exchange rate to ease, thereby facilitating the needed rebalancing of the economy, boosting output of tradable goods and services.
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Assessment and recommendations
New Zealand’s economic recovery began promisingly in mid-2009, supported by unprecedented policy stimulus. The economy has benefited from growing trade linkages to China and other emerging markets in Asia, which suffered less from the international financial crisis and have rebounded more vigorously. Dairy and other food prices have surged as rising living standards in such populous markets have boosted demand, and droughts in producer nations, including New Zealand, have been more frequent. The country has likewise gained from its high degree of economic integration with a robust Australia. Even so, private domestic demand has failed to bounce back as quickly as in most previous recoveries, and little or no rebalancing has occurred. Growth lost momentum by the second half of 2010 as the global economy slowed and households and firms remained cautious with their spending. This, together with the impact of a strong earthquake that struck the Canterbury region in September 2010, contributed to stagnation in activity in the second half of the year. A second, more damaging earthquake in late February 2011, largely centred on Christchurch, New Zealand’s second largest city, will further retard the recovery in 2011 and makes the outlook highly uncertain. The Rugby World Cup will provide a temporary boost to growth in the second half of the year and high commodity prices will also provide support, but previously expected earthquake reconstruction will be delayed and household spending will probably remain subdued for longer. Reconstruction (officially estimated at 8% of GDP) is projected to get fully underway in 2012 and provide a substantial boost to demand over a number of years. At the same time private investment and consumption should start to recover more surely, though needed fiscal consolidation will start to bite.
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Adjusting towards a sustainable growth path
The 2008-09 recession was moderated by unprecedented policy stimulus and by relatively strong growth in Australia and Asia, New Zealand’s largest trading partners, which also boosted the terms of trade. The subsequent recovery has been unexpectedly weak and patchy, however. A large debt overhang and increased risk aversion following the global crisis have led to a wish to deleverage by households, firms, banks and (soon) by government. This seems a necessary and desirable part of adjusting toward more sustainable long-run growth. The debt-fuelled property boom of the past decade drove down already structurally low household saving rates. Expansionary fiscal measures implemented prior to the recession, together with cyclical revenue shortfalls and major one-off earthquake costs, have now reduced government saving rates as well. With most of the growth in household, business and now government debt funded from abroad, for the private sector mainly through the banking system, net foreign liabilities have accumulated to levels that make the economy particularly vulnerable to sharp changes in investor sentiment. Persistently higher interest rates relative to other countries are symptomatic of low levels of national saving and have attracted significant capital inflows, placing upward pressure on the exchange rate and thereby shrinking the trade-exposed sector. Relatively high interest rates have also driven up the cost of capital, restraining domestic investment and hence longer-term growth prospects. The official objective of closing the productivity gap with Australia will require a re-balancing of the economy away from consumption towards more productive sources of growth. Fiscal consolidation, in particular through paring back public spending, will play an important role in reducing pressure on the exchange rate and improving the external position. This would allow price stability to be maintained at lower real and nominal interest rates. Public transfer cuts and capital divestments could, in a context of broader regulatory reforms to reduce policy distortions, serve to improve private incentives to work, save and invest, boosting potential growth.
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Policies to rebalance housing markets
A considerable housing boom has been a key feature of persistently large saving-investment imbalances in New Zealand over the past decade. Wealth is concentrated to a greater extent in property compared to most other OECD countries, leaving households and the banking system heavily exposed to a correction in land and housing markets. Supply rigidities and tax incentives that bias savings decisions towards property investment have amplified the increase in house prices, widening wealth inequalities in the form of larger homes for those who can afford them, but deteriorating affordability for the rest of the population. Substantial distortions via tax planning have been evident in rental property markets. Although the 2010-11 budget introduced measures to reduce some of these distortions, further reforms are needed to remove the significant tax bias favouring housing. The economic downturn has increased financial pressures on the social housing sector, with a shortage of public dwellings in areas of high demand. Regional supply constraints reflect inefficient land-use policies and long delays arising from an overly complex urban planning system. The adoption of spatial planning frameworks is a positive step forward, but they should include pricing mechanisms for land and road use that are aligned with broader policy objectives.
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How to move product market regulation back towards the frontier
From the mid-1980s, New Zealand was widely considered to be a leader in liberalising product market regulation (PMR). However, the reform of PMR has lost momentum over recent years. Many areas of PMR are still consistent with best practice, but New Zealand is no longer assessed to be at the forefront of regulatory policy making. Although economic geography clearly offers a partial explanation for the relative underperformance of the NZ economy, restrictive policies in some areas are also likely to be constraining growth in GDP per capita. Indeed, it is likely that being small and distant exacerbates the negative impact of restrictive product market policies on New Zealand’s economic performance. This implies a genuine need to shift the regulatory framework back towards the OECD frontier. Ongoing improvements in regulatory governance, minimising the government’s influence in competitive markets and lowering barriers to trade and FDI, including ongoing policy harmonisation and mutual recognition with trading partners where appropriate, would all help in this regard.
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Green growth and climate change policies
New Zealand, as a resource-based economy anxious to protect and promote its clean-and-green image, appropriately sees green growth as a natural direction for future development. The country’s environment is of high quality, and depletion of its abundant natural resources is for the most part not a problem. Nevertheless, there are challenges. With little pricing of water resources, water scarcity is being felt increasingly acutely in some dairy-intensive regions prone to drought. Water-quality degradation is linked to leakage from farming by-products. Agricultural activity also gives rise to nearly half the country’s greenhouse gas (GHG) emissions, though electricity consumption and private transport are growing sources of pressure. New Zealand’s GHG intensity of output is the second highest in the OECD (after Australia’s), not surprising for a resource-rich country. Its unique emissions profile, however, makes for costly mitigation: an exceptionally high proportion of electricity generation is already renewable-based (mainly hydro), and no technology to significantly reduce methane from ruminant animals yet exists. New Zealand is a pioneer in implementing an emissions trading scheme (NZ ETS) covering all sectors and gases. Green growth could best be supported by the greater use of market mechanisms among a range of instruments in natural resource management and by strengthening price signals in the NZ ETS.
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