article published by NZ Herald (4 Oct) as: Land is our best hope for revival 

 Fixing the Balance of Payments

 Keith Rankin, 10 September 2000


Policymakers in New Zealand have been in denial about the balance of payments problem. Before 1984, the opposite was true. The balance of payments used to be the central issue that determined whether macroeconomic policy would be growth-accommodating or growth-inhibiting.

New Zealand's indebtedness to the rest of the world is simply the accumulation of 26 years of capital inflows. Indebtedness is a problem to New Zealand because we have accumulated liabilities at a much faster rate than gross national product (GNP) has increased by.

The years in which we messed up the most were 1985-87 and 1995-97. Foreign investment only makes economic sense when it is used to raise GNP. In those years, New Zealand's debt-to-GNP ratio suffered simultaneously from rising debt and a lowering of GNP [1] due to an overvalued currency.

Before 1984, economic growth always led to a disproportionate growth of imports. New Zealand then had a protected manufacturing sector producing 'wage goods', and an export sector based solely on our land, a fixed resource. For nearly 40 years we had pursued a macroeconomic policy that targeted the balance of payments.

Consumers with growing incomes wanted to spend much of their extra incomes on imports. So, even when our export revenues grew at the same pace as our incomes, there was always a tendency for import demand to grow faster than GNP.

Import licensing was used to ration imports. And stringent currency controls were imposed on New Zealanders travelling abroad. In the 1960s, only exporters who retained some of their earnings in British bank accounts could get unimpeded access to foreign goods.

In addition to these controls, New Zealand governments used Keynesian growth-inhibiting monetary and fiscal policies. People's banks - especially the Post Office Savings Bank - were used to soak up liquidity that might otherwise have created a demand for imports. Savings banks had very strict lending rules. Interest rates were fixed.

The 1958 Black Budget was a classic example of a fiscal policy response to an import blowout. New taxes on tobacco, alcohol and petrol soaked up the extra demand that was fuelling an import boom. In those days of unemployment rates below one percent, there was some logic to creating a mini-recession to avoid an import blowout.

Between 1967 and 1984, our world started to change. Increasingly the balance of payments problems were induced by the prices of our imports rising faster than the prices we were getting for our exports. Our instinct to apply the brakes whenever import payments became unsustainable simply aggravated externally-induced recessions. Struggling to pay for our imports, we could not afford to lay off workers.

In 1985, in order to get the balance of payments monkey off our back, the New Zealand dollar was floated. There was to be a market solution. The textbooks of the 1970s had suggested that a currency would adjust to whatever exchange rate ensured import payments would equal export revenues.

The theory of free trade that underpinned early Rogernomics was developed in the 1810s while Britain was at war with both Europe and the United States. Reflecting those conditions, the theory simply assumed that there would be no exchanges of capital or labour between countries. Only goods would cross borders. Such naivety!

After the 1985 float, we soon found out that it was offshore capital and not export success that determined the value of our dollar. The textbooks were rewritten, suggesting that investment rather than trade determined the exchange rate.

What was not well understood was that capital flowed into nations for two very different reasons: (i) as a recognition of the strength of a nation's economy, and (ii) in pursuit of high interest rates. Until 1997, the interest rate effect dominated. The Reserve Bank could raise interest rates as a surefire means of both appreciating our currency and funding excess imports.

That's all changed now. The Reserve Bank has become impotent. Today capital flows into nations with strong economies. The raising of interest rates is now interpreted by financial markets as a sign of weakness. Monetary policy announcements in the USA (August) and New Zealand (May) have had the opposite effect on currency values to what they would have had three years ago.

In this new century, exchange rates now work much like the handicapping system for the Melbourne Cup. A good horse is acknowledged but also handicapped by a rising exchange rate. Past losers, on the other hand, are given a low weight to carry, thereby improving their chances of prospering.

The New Zealand dollar has been devalued more than other currencies because the balance of payments problem is at last being recognised. What we don't know yet is whether the exchange rate has fallen far enough to fix that problem.

We now import many of the wage goods that we used to produce for ourselves. And we export more 'luxury' products than ever before.

In the past, a devaluation led to fewer imports and higher priced exports. Today, it's more likely to be the opposite. We will pay higher prices for the imports that we cannot do without, and adjust through higher export volumes.

We cannot rely solely on the growth of 'knowledge economy' exports. Our educated labour force is internationally mobile. The outflow of 'human capital' is likely to continue, meaning that many New Zealand educated knowledge workers will generate income for other nations.

Only our land is fixed. Our recovery will most likely arise therefore from our ability to raise export receipts by adding value [2] to our land-based products (which include tourism and film-making) while holding the line on imports. With an exchange rate approaching $US0.40, our export sectors are leading us into a decade of productivity growth.


[1] Ceteris paribus. That is, GNP fell relative to what it would otherwise have been. We might note, however, that real GNP growth per capita might have been negative. We cannot be sure, because Statistics New Zealand has at times included foreign income reinvested in New Zealand as a part of New Zealand's GNP.

[2] That is, adding knowledge to our land-based products. The knowledge economy is fully compatible with an emphasis on the land.


© 2000   Keith Rankin

Rankin File | 2000 titles