A question to all

Why do policy makers care about this graph so much right now? (ht Roger Kerr)

Specifically, my question to people is simply this three parter:

  1. Does this graph show an issue,
  2. If so, what is it?
  3. And if so, are their any changes that could improve matters?

Some small thoughts of my own beneath the fold.

What do we know here:

  1. The amount produced in the non-tradable sector has increased more than the amount produced in the tradable good sectors.
  2. Non-tradable good prices have gone up more than tradable good prices (from the CPI)
  3. Domestic productivity growth has been weak relative to international productivity growth
  4. Our real exchange rate has risen
  5. Our terms of trade has risen
  6. Export prices have risen
  7. Import prices have risen

These are all undeniable facts.  However, when we come to a policy conclusion from it, we need to say “hey, given judgments about what is best and how resources are allocated through the choices of individuals, is this type of outcome appropriate/the best possible”.  Even better than that is when someone explains why there may be an issue – for example Kerr mentioned the fact that high government spending could well have pushed up the real exchange rate.

I don’t disagree with this point – in fact earlier on I wrote about the fact that the equity-efficiency trade-off (and broader costs of policy) were often ignored by Labour in the past, and how this was illustrated in part by the productivity performance of NZ.  However, I would beware focusing solely on government spending, or EVEN the current deficit, as the sole reasons for the lift in our real exchange rate – beware those bearing silver bullets.

A key set of points for me is that:

  1. Our terms of trade has structurally increased
  2. Changes to policy throughout Asia have lead to massive productivity growth among our neighbours – something we as importers benefit from
  3. There was a tax bias towards housing, and potentially other investment vehicles, through the tax system following the introduction of the top tax rate – a matter that has been largely dealt with.

All three of these issue will have pushed up our real exchange rate, and if we assume the third one has now been dealt with, there is no policy recommendation required here.

Now my question to people is simply this three parter:

  1. Does this graph show an issue,
  2. If so, what is it?
  3. And if so, are their any changes that could improve matters?

Any answer if valid, don’t be shy – I would definitely appreciate any thoughts.  I realise I am putting this up before a weekend though, so doubt I will hear back sadly 😛

4 replies
  1. Horace the Grump
    Horace the Grump says:

    Been thinking about this…

    Does the graph show an issue?

    Well it does show something in that the tradeable part of the economy has been in recession for the best part of 8 years and shows no signs of improvement. So while the non-tradeable sector has carried on its merry way the tradeable sector has been in recession.

    What is the issue?

    The issue is manifest is a weak balance of payments situation. Rick Boven and the NZ Institute have pointed out that to catch Australia we need to be exporting a lot more value added goods, rathe than more bulk commodities (infant formula rather than bulk milk powder for example). Compared to the economy of 10 years ago the tradeable sector is not pulling its weight. So we aren’t earning the sorts of incomes we want because we ain’t got the cash coming in from exports.

    As Roger Kerr notes the problem may be excessive Govt spending, which has driven up the real exchange rate and interest rates to boot, making exporting less profitable. I suspect the impact on the cost of capital is also important here rather than just the impact of a high real exchange rate. But then exchange rates are relative… if the US$ is weak then by definition NZ$ is ‘strong’ all other things being equal… So the policy implication may be that the cost of capital is too high because we are sucking in more foreign cash (interest rates go up) to sustain out domestic economy.

    3. Changes that could improve matters?

    Better directed investment and better understanding of savings – there have been numerous calls for the Govt to stop running big deficits… That helps, but getting cash into the right parts of the economy is also necessary. I think that Govt making better use of the capital markets (particularly equity) to fund itself is a good place to start to help lower the cost of capital.

  2. Greg
    Greg says:

    Our pundits love to compare Aotearoa to Australia, Singapore, Finland, Slovenia, etc. How does this chart compare to charts for those countries?

    Following economic geography arguments, how does this chart compare to one for the only economy anywhere near ours in both distance to major markets and internal size: Alaska? Arthur Grimes compares us to South Australia. How about that?

    For the comparative advantage people, how do other economies concentrated in the same tradable industry groups compare? (Is it possible that the measured “terms of trade” are not the whole story?)

    By itself, the chart tells us that something changed markedly in late ’03 or ’04. What?

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