How we connect economically with the world is critical.
The British Labour Government is struggling. Partly it is because they were badly prepared in opposition; the Conservative Government was making such a charlie of itself that Labour expected that it would do better and gave little thought as to how it might. But while it was ill-prepared in opposition – a common problem in New Zealand too – the miserable state of the British economy is not helping.
I dismiss the conventional wisdom that the poor performance of the economy is due to the government. It is more complicated. In the 1930s and 1940s governments discovered that they could make a difference by smoothing out economic fluctuations. Everyone then leapt to the conclusion that governments could make a difference to economic growth as well. The evidence is they cannot – well, not generally; I shall relate one exception below. Despite the evidence, the conventional wisdom insists they can, pointing out that productivity growth is low (usually true) but there is little evidence that the (often ideological) nostrums they advocate will work.
It is true that British economic productivity has been growing slowly. The relative slowdown seems to have started from about 2016, which, not coincidentally, is when the Brits voted by a narrow margin to leave the European Union, their largest trading partner. At the time, Remainers warned that an exit would damage the British economy, but they left the impression that the public would wake up in the morning after voting for Brexit to find an economic disaster. That did not happen. The economists’ forecasts actually were that there would be a reduction in output (GDP) in the medium term.
Britain is now in that medium term; those forecasts have proved broadly correct. There remains some uncertainty as how much the British economy has suffered from the disconnection but the range of GDP reduction following Brexit seems to be between 6 and 10 percent. I take the figure as 10 percent because it’s a round number. It amounts to a substantial loss of annual productivity growth of about 1 percent a year. (New Zealand’s long-run productivity growth has been about 1.5 percent annually.) The indications are that loss will continue.
Imagine the transformation to the standing of the British Labour Government, if its Chancellor of the Exchequer was told the British economy was actually 10 percent larger so that her government could spend 10 percent more, including hiking social transfers by that amount. If she was more restrained, she could add in some tax cuts, although private incomes would already be around 10 percent higher.
The irony is that the beneficiary of the current poor standing of the British Government has been the Reform Party, who, in an earlier guise as the United Kingdom Independence Party, had been a key advocate of Brexit. Reform now has hardly any economic policy ambitions (which is probably a good thing given how inadequate they have been in the past); it is a grievance party with a social agenda including strongly anti-immigration.
Brexit is a natural economic experiment where, for political reasons, an economy withdrew from a close association with its largest trading partner. As such, the experiment provides insights about the role of the external sector in medium and small economies. Much research is yet to be done; here is my take on what it may find.
My In Stormy Seas: The Postwar New Zealand Economy (1996) showed how the performance of a small open multisectoral economy depended upon its external sector. It has to trade its specialised production to acquire the foreign exchange to pay for its imports. It is no different from, say, Te Awamutu, which is a part of a wider economy and has a big import bill (although New Zealand has its own central bank).
The history of the New Zealand economy since the European arrival shows that its performance has been intimately affected by the world economy. Where domestically we can make an economic difference is by engaging effectively with the rest of the world.
Thirty years later, I see no reason to change the book’s theme. Among the things I have since learned is that the broad analysis also applies to medium-sized economies such as Britain (with modifications for the different economic structures).
I have also acquired a more detailed understanding of the mechanisms involved. The engagement of individual firms is not static but intricately dynamic, responding to a changing competitive environment posed by actors in other economies – if they don’t innovative, they perish.
Brexit was not simply a one-off shock. There was a process of adaptation. Initially it was about finding new supply chains and– often costly – ways around the extra barriers to trade. Then firms hunted for alternative markets (with limited success). Increasingly, businesses found better arrangements by moving activity elsewhere. I do not get the impression that there has been a marked increase in import-substituting industries in Britain. (Trumpism may find its tariff walls do not have a great effect either.) Post-Brexit, British tradeable businesses have been moving their investment and activities offshore, reducing the growth of British economy – hence the relative loss of GDP and counting.
Reflecting, I underestimated the importance of supply chains. Thirty years ago they were not so common (but the book has a discussion of the related intra-industry trade). New Zealand is not as well located in the world economy as Britain; we tend to be at the end of chains, not in the dynamic middle.
The Starmer Government is considering further cosying up with the EU with the aim of getting more involved in the business chains of its most significant neighbour. Any agreement is fraught with technical and political difficulties. It is unlikely to generate an immediate boost to the British economy but it may see a growth boost (as occurred to the peripheral economies when they joined the EU). There may not be a total recovery; it is easier to destroy than to build.
What are the implications for New Zealand other than reinforcing those conclusions of thirty years ago? As far as the supply chain lessons are concerned, I am pessimistic. Because of its location, New Zealand will be at their beginning and end, rather than in the middle where the action is.
The big concern must be whether New Zealand’s external sector will be large enough to support the population and affluence to which we aspire. Thirty years ago I was pessimistic about the future of the world food sector. Nowadays, with rising East Asian affluence from industrialisation plus similar prospects in other economies, together with the struggles of other food supply sectors, I am more optimistic. However, ours now faces serious land and water resource constraints; there are limitations of forestry and fishing too. (One gain is to substitute oil imports with local renewable energy.)
What exports can fill the gap? Probably not manufactures to any great extent. We are not large enough to have the economies of agglomeration which are integral to high value manufacturing.
Many services suffer from the same limitations. Tourism – a kind of primary industry – may be capacity-constrained; our distance may not help. Our international broadband capacity may generate a thriving IT service industry, as it has for India, but because of competition, remuneration may not be as great as we might hope.
The point of the last few once-over-lightly chapters is to demonstrate a problem which we are not addressing. Blindly leaving things to the market may as blindly immiserate the economy.