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New Zealand Engineering 1998 October
So
What Happened?
 One
minute everyone's talking about the coming "Pacific Century", the next,
Asia's a basket case; after a year of crises the president of the United
States is calling for a G7 finance ministers' meeting; and money for engineering
projects around the region has evaporated. From a "correction" New Zealand's
past two quarters have become a "technical recession" with others still
gloomily predicting the worst is yet to come. Even the "D" word ("depression")
seems to be being bandied about with unusual ease lately. Looking at covers
of the usually bullish BusinessWeek the reoccurrence of the word "crisis"
on the 14 September edition, a year after the initial 28 July 1997 "crisis"
edition, suggests this isn't a "crisis" at all but something far more pernicious.
Are politicians the world over to blame? From President Clinton to President Yeltsin to Prime Minister Hashimoto world leaders are hardly instilling any bustling sense of confidence. Is George Soros, the financial guru to the trillion dollar Quantum fund, to blame? He took aim at Britain and Italy and forced them out of the European currency arrangements in 1992, forced the Thai devaluations in 1997 and caused a capital panic when he suggested the rouble should devalue. Is financial Armageddon upon us? Who should be doing something ? What will happen next? How should New Zealand and New Zealand businesses respond? 
Welcome to global markets, the subject for the premiere forum at next February's IPENZ Congress '99. For engineers, whose task is to generate wealth by efficiently solidifying liquid capital or by extracting cashflows from intellectual capital, this forum will come as a "heads up" affair. A chance to take stock of where we are, where we've been and where we're going. It will also present an opportunity to re-examine our performance, as a nation, and as individual firms. That New Zealand has taken a hammering from a year of the Asian "crisis" is certain. The Economic and Fiscal Outlook published by the Treasury1 (8 September 1998) said that economic growth for 1998/9 is expected to be -0.5 percent while unemployment rates may reach 8.5 percent of the workforce. These figures are similar to those in the New Zealand Institute of Economic Research's2 11 September Quarterly Report which averages three forecasters' quarterly growth predictions into a "consensus forecast". Since June forecasters have sliced back annual GDP growth estimates from 2.1 percent to -0.5 percent while export growth predictions have gone negative from 1.7 percent to -0.2 percent. Their view of the domestic economy predicts a rise in unemployment from an estimated seven percent to 7.8 percent in the year 2000, while domestic construction is forecast to contract rapidly this year but come back with a vengeance in the year 2000. It should be noted, however, that consensus forecasts have so far failed to predict the depth and length of the current recession. In its first take on the crisis the Treasury, in a paper by Treasury Secretary Dr Alan Bollard and Jim Rose ("Responding to the Asian Crisis - A New Zealand Perspective", 11 August 1998) quotes from the June 1998 OECD Economic Outlook which estimates the crisis will cost Australia and New Zealand one percent of GDP. Worse, the International Monetary Fund Direction of Trade and International Financial Statistics quoted in the paper show New Zealand as being more exposed to the troubled Asian nations of Indonesia, South Korea, Thailand and Malaysia and to Japan, than Australia. Sectors which have taken the biggest hit include tourism (where 30 percent of 1997 visitors came from East Asia with a huge 96 percent fall off from South Korea), farm products (which have also suffered from the dry summer) and commodity exports. The Treasury, however, takes heart from the big dipper ride our dollar has followed with a 15 percent decline in the Trade Weighted Index and 25 percent decline against the US dollar since early 1987. This has boosted export competitiveness, particularly for non-commodity manufactured goods, and tourism. There are, however, big caveats. In particular, the biggest concern is the stalling of the Japanese economy with retrenching by domestic consumers and the knock-on effect of a weaker yen and our reliance on Australia as an export market for manufactured goods. In short, Australia dominates New Zealand's economic future just as Japan (the world's second largest economy) dominates the whole region. In short, as most people already know, times is tough all over. The question on those people's minds is "what does it all mean?" From an ideological perspective there has been a tendency to see the Asian "crisis" as a kind of divine retribution for those governments foolish enough to arm wrestle the "invisible hand" of the market. The suggestion is that the "Asian way" has been "proved" a false idol compared to the hands off, unregulated "truth" of laissez-faire capitalism approach taken by our own Government. While this may make for good rhetoric there are some pretty hefty commentators who beg to differ. Among those who have certainly not been lining up to put the boot into the "East Asian model" is Joseph Stiglitz, chief economist and senior vice president of the World Bank3 . In February Mr Stiglitz, speaking at the Chicago Council on Foreign Relations, argued that East Asia had done extremely well precisely because of government intervention but that "even with the best economic management, small open economies remain vulnerable. They are like rowboats on a wild and open sea. Although we may not be able to predict it, the chances of being broadsided by a large wave are significant no matter how well the boat is steered. Though to be sure bad steering probably increases the chance of disaster, and a leaky boat makes it inevitable even on a relatively calm day". Less poetically, Mr Stiglitz pointed out that the East Asian economies had: laudable domestic savings rates (over one-third of GDP); government surpluses (1.6 percent and 1.4 percent of GDP for Thailand and Indonesia respectively); shared the wealth reasonably well (despite charges of crony capitalism it should be noted Indonesia's poverty levels fell from 64 percent in 1975 to 11 percent by 1995 which compares well with places like Zaire); and had developed formidable "human capital" assets by emphasising high levels of tertiary education "especially for engineers and scientists". So if they were so good what went wrong? Careless deregulation of financial markets allowing foreign capital to wash away some of the vital supports that were keeping the system operating: in particular very much higher debt/equity ratios than the Western norm. Mr Stiglitz says East Asian economies did not really need foreign capital because they were growing well anyway but by throwing open their doors to the world, relying on outdated exchange rate pegs and failing to monitor borrowing/lending they were sowing the seeds of their own destruction. More fundamentally some believe Southeast Asia was caught in the crossfire between China and Japan as they used exchange rates to compete in manufacturing. When Japan let the yen slide back from its all-time high of 80 yen to the dollar in 1995 the pressure started to go on the rest of Asia's manufacturers, particularly South Korea, Thailand and Malaysia. With the absorption of Hong Kong in 1997 pressure also went on Chinese authorities to devalue the official rate of the yuan. All of this left Thailand, the latest and most dubious of the Asian Tigers, high and dry and gradually currency speculators began to realise that a devaluation was inevitable. The storm broke on 2 July 1997 and the baht crashed 23 percent. Emboldened by easy pickings speculators went after other Asian currencies with weak foreign reserves. One by one they were hammered. What nobody realised, Quantum fund adviser George Soros4 included, was how much, once exposed to foreign exchange and stock market adversity the East Asian financial system would begin to unravel. One by one bastions of Asian respectability began to crumble and in short order 60 percent of East Asia's asset valuations disappeared. Remaining capital flew to the security of American stocks. Then slowly it began to dawn on United States investors that many US corporations had based profit projections on now non-existent Asian demand. A cold chilly wind of panic began to envelop financial markets such that even the Russian devaluation last month affecting a relatively small $40 billion in German government guaranteed loans and the recent Brazilian austerity programme spooked the markets again. New Zealand Institute of Economic Research director Alex Sundakov says the most interesting thing about the crisis was not that it would happen but that it has continued for so long. He believes that it is now not a matter for governments to manage (other than to avoid big deficits) but rather central banks, who will have to get over their historical missions to deliver price stability and now tackle the difficulties of managing money supply in a potentially deflationary environment. The biggest danger in a deflationary environment is unemployment. The reason for this is that some prices are not as flexible as others (they go up but don't go down) most notably salaries and wages. If the prices companies can obtain for their assets or goods and services must decrease worldwide but costs such as wages are kept level, then either people will be laid off or whole companies can go under. Many economists blame the mass unemployment of the 1930s on central banks maintaining tight monetary policies in a deflationary environment, restricting the amount of money in circulation. While far from alarmist Mr Sundakov believes the Reserve Bank here, knowing that monetary policy changes typically take 12 to 18 months to flow through into the rest of the economy, could certainly assist by being less cautious about inflation and follow a much steeper curve to improve monetary supply (and therefore effectively reduce interest rates). Worldwide, a sudden shortage of consumers rich enough to buy goods and services does nobody any good. Equally, a rush to drop prices could see commodity suppliers scrabbling for pennies at the bottom of a deep dark market. The 21 September issue of Forbes magazine5 "Is it Armageddon" looking at deflation, tracks a downward spiral for common United States commodity prices and places the probability of recession in the United States at year end at 75 percent. The same magazine also prophesies the end of the incredible bull market in American stocks, and warns that buying "on the dips" in a bear market could simply mean throwing good money after bad. With 39 percent of American households wealth in stocks that could mean that "supertanker America" may be slowing down. It's at times like these nations open their top drawers and start flicking nervously through their portfolios. That's when one notices that New Zealand has issued $18 billion worth of New Zealand denominated "Eurokiwi" bonds in the past three years compared to only $1.5 billion in the five years previous to that, mostly to fund fixed interest mortgages. While there is no exchange rate risk (offshore investors are wearing that) there is an interesting point that the banks borrowing this money will have to pay it back from late 1999 on. This is not considered a problem, all things being equal, by the Reserve Bank6 as banks typically hedge their borrowings. But what it does mean is that New Zealanders are borrowing the savings of foreigners into order to pay for their houses, and if all things were suddenly not equal that might become a serious problem. This is when it's good to have, as many developing economies such as Malaysia do have, a solid set of export industries and markets to rely on. Unfortunately, for all the years of restructuring that New Zealand has been through, we are only just reaching the stage where manufactured goods earn us more than farm products. In many respects our export profile is not hugely different to the one we had ten years ago. Mr Sundakov thinks at core New Zealand has a worrying streak of anti-development culture and a backward approach to international marketing. "You see it all the time. Like these conferences devoted to finding markets for timber. It's the typical way New Zealanders do things. Grow heaps of something and then try to work out how to sell it. It's completely the wrong way around, a sort of 'producers enthusiasm'." Similarly he believes the anti-development culture enshrined in the Resource Management Act is selling the country short. "This latest business from the Environment Commissioner about reducing the size of the 'urban footprint' is simply madness. What it effectively says is that if Auckland's economic influence was reduced to its borders that would be a good thing. Why ? Just imagine what would happen to all the peasants in Southern China if Hong Kong or Shanghai did that." Confining cities such as Auckland to specific borders is another example of the same mentality. Its only real effect is to boost the price of land in the city to internationally ridiculous levels. In short, the ghost of the pioneer land speculator Edward Gibbon Wakefield still walks our land. But for an example of a country similar to our own which has extracted itself from the bogs of rural depression, one has to travel half-way around the world to the Republic of Ireland, the home of Congress '99 keynote speaker, Deputy Prime Minister, and Minister of Enterprise, Trade and Employment, Mary Harney. Ireland's achievement has certainly not been lost on officials in this country. A working paper by Sarah Box on the Treasury web site demonstrates in 40 pages that the policies developed by Ms Harney and her government has certainly led to success for Ireland. This paper follows on a 1991 study by Treasury secretary Alan Bollard which also examined the Irish approach. In brief, Ireland's GDP per capita which was 85 percent of New Zealand's
in 1985 has grown to 108 percent by 1995. That growth can be broken
down into the following averages as follows:
Which is a polite way of saying the Irish are working smarter and attracting more investment while we are getting more out of our workers. The author points out that the Irish have targeted long-term investment in specific industries, in particular: electronics, engineering, healthcare, consumer products, financial and international services. Half of the employment and 75 percent of the output in the industrial sector has come from United States, Japanese and European firms. The benefit for foreign firms is low taxation (10 percent, shortly to be 12.5 percent across the board), a pool of highly educated English-speaking workers (thanks to Irish education investment), and other targeted grants of cash, training and facilities. The spin-off benefits for Ireland have been employment, some tax rather than none, and growth. This is not to say Ireland does not have problems. It still has a higher unemployment rate than New Zealand, largely because of "structural unemployment", ie. people who will never be computer programmers. Its state sector is also fat and sloppy by New Zealand standards - although in some ways this is an asset because it is easy to generate profits by saving than going through the hard business of attracting investment - and Ms Harney has indicated in recent speeches she intends to begin a process of rationalisation of the public service. Ms Box concludes: "What can New Zealand take from Ireland's growth experience? Our location and demographic structure are given, so perhaps New Zealand has to be twice as smart as other countries to achieve the same gains.According to the OECD, New Zealand will fall further and further behind the OECD average if our current performance is maintained. If anything, this study of Ireland has suggested that our potential may be much smaller given our location. Therefore New Zealand must put extra energy into improving the environment for growth and getting our policies right." Assuming a sponsor can be found in time Congress '99's Global Markets Forum should prove an interesting platform to determine what exactly those policies should be. References
Congress '99
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