What the election means – outlook for the New Zealand economy
Dominick Stephens started his career at the Reserve Bank of New Zealand, where he was involved in forecasting and modelling the New Zealand economy. He joined Westpac as a Senior Economist in 2006 and became Chief Economist in 2011. His most well-known research concerns the roles of taxation, interest rates and inflation on the New Zealand housing market. He has also published research on the exchange rate, New Zealand’s labour market, and macroeconomic modelling.
Since the announcement of the new Government, we have seen the New Zealand Dollar drop quite sharply, due to some uncertainty about what markets will do.
The Kiwi dropped 7.5 percent between before the election and the first week of November. Some of that is due to the stronger US dollar but most is market reaction to the change of government. Business confidence has fallen, but other factors may also be contributing to that.
Different fiscal trajectory
The new government is planning a different fiscal trajectory, including in its approach to tax and spending. Tax cuts planned for 2018 will be cancelled and there will be a lot more spending on education and health. Some of this will be paid for through tax but there will be borrowing too.
Cancelling the tax cuts could weaken the economy in 2018, but by 2019/2020 we should expect to see that spending resulting in fiscal stimulus coming through, and higher GDP growth.
The biggest impact on the economy will be from the new government’s plans for housing, including a ban on foreigners buying existing homes and changes to tax rules for property investors.
This will have an immediate negative effect on house prices. The government also plans to convene a tax working group and that could ultimately result in the introduction of a capital gains tax. In New Zealand, this is likely to have a dampening effect on economic activity for many years.
The new government is also planning to introduce its KiwiBuild programme, building 100,000 new homes. This type of approach tends to lead to ‘crowding out’. The government builds more houses, the private sector finds there is a government bidder and cannot participate anymore – which means that, overall, the number of homes being built doesn’t change.
What will happen is that more small homes will be built but fewer large homes. This will make smaller homes cheaper and larger houses more expensive. That will mean more affordable housing, but it might not affect average house prices.
Approaches to migration
The proposed new approach to migration will also have an impact. Net migration is already turning. A lot of people came into the country on temporary visas three or four years ago – either for work or education. Those visas are now expiring, the first cohort is leaving, and natural forces will take net migration down by 2020.
The current rate of population growth in New Zealand is 2.1 percent. This could slow to about 0.7 to 0.8 percent by 2020, and that will affect the rate of economic growth. Fewer new people means the economy will grow more slowly.
Much of the growth we have seen recently has been because there are more people on the ground, so businesses have had more customers. If population growth slows, that source of easy business growth will diminish. For individual households, though, lower population growth won’t make much difference.
Emissions trading scheme
Another important factor is the potential impact of the new government’s approach to climate change and the Emissions Trading Scheme.
It is committed to having a net zero carbon economy by 2050. That means forest growth must absorb as much carbon from the atmosphere as we emit. That is a much more ambitious target than that set by the previous government.
An independent climate change commission is to be established, but the broad brush will be an Emissions Trading Scheme which includes agriculture.
Overall, this is a fairer approach. At present New Zealand’s climate change commitments are being borne by only half of the emitters. A scheme which excludes agriculture is costly to the economy. A comprehensive Emissions Trading Scheme, which includes agriculture, is more efficient, fairer and the best way to meet our commitments.
Farmers will have to pay for their businesses to emit greenhouse gases. There will be incentives for farmers, and other businesses, to find ways to emit less carbon, such as using solar panels and electric vehicles – however, these are all costly.
Ultimately, this could really change the way the New Zealand economy works and the way we use land. The likelihood is that, by 2050, we will see more land in forestry and less in dairy than we would in the absence of a climate change commitment.
Increasing the minimum wage
Another way in which the new government will impact the economy is through a large increase in the minimum wage. This will incur costs for businesses and, to some degree, businesses will find less costly ways of getting work done – for instance through increased automation. There will be some substitution of workers and loss of employment but that is expected to be quite small. The biggest effect by far will be to transfer money from businesses to low-earning workers.
The Reserve Bank
Some concerns have been raised about the potential impact of the new Government’s policy plans on inflation, and how the Reserve Bank will react. People are asking if interest rates will go up. My answer to that is ‘no’. The biggest influence this government is likely to have is on the housing market. If house prices are falling, then New Zealanders will respond, and the Reserve Bank will not have to change its plans.
Finally, the government has recently announced plans to review the Reserve Bank Act. Currently, the Reserve Bank focuses on inflation. The proposal is for it to focus on both inflation and employment and for Official Cash Rate decisions to be made by a committee, rather than by a governor.
This is in line with what many other countries do. However, you cannot create more jobs by manipulating the OCR. If the new approach is designed well it is not likely to have any impact – however, if it is designed badly, it will give the Reserve Bank an impossible target.