Recovery lessons

The COVID-19 pandemic has brought extreme economic and social disruption to many countries across the globe. If an economic shock is defined as an unexpected event which has a major impact, COVID-19 certainly qualifies.

The government has adopted a range of measures to address the consequences from wage subsidies to providing many billions of dollars for construction and infrastructure projects. How, though, has New Zealand responded to previous economic shocks?

After the 1918-19 pandemic

A century ago, the end of the First World War and the 1918-19 influenza pandemic saw a short economic boom as wartime restraints eased.

There was a speculative dimension to the boom, especially in land prices: farmers had done well out of the British purchase of New Zealand’s available exports. Export prices slumped in 1921-22 and New Zealand entered a short, nasty recession.

The government response, in tune with the orthodoxies of the day, was to reduce public spending to match the decline in revenue. Unemployment rose.

Bankruptcies doubled in 1921 and doubled again in 1922. Some ministers expressed the view that this was wholesome: a sort of survival of the fittest, whereby failure was proof that the victim should never have been engaged in business in the first place.

Great depression

New Zealand’s economy was fragile throughout the 1920s but the Great Depression was a major shock. Export earnings dropped by more than a third between 1929 and 1931, and per capita income is reckoned to have fallen by nearly a fifth between 1929 and 1935.

Again, the orthodox response was to sharply reduce public spending and although relief work was made available it was notoriously arduous and badly paid.

The impact of the shocks that bookended the 1920s was, unsurprisingly, uneven. Reduced wages were unpalatable enough but prices fell too. While some people remained almost unaffected, predictably, the unskilled, those without secure and permanent jobs, especially labourers, experienced great hardship, often compounded by substandard housing.

In popular memory, the Depression was resolved by the election of MJ Savage’s first Labour government at the end of 1935. This is far too simplistic. The Coalition of the Reform and United Parties, which would in 1936 become the National Party, took some decisive steps in 1932-33 around monetary policy. Gordon Coates, the Reform leader, was the architect of the Reserve Bank, which was established in 1934. Prior to that, monetary policy was effectively run by the trading banks, most of which were domiciled in London or Australia.

The banks had severely restricted credit, restrictions exacerbated by the fact that Australia’s Depression was even worse than ours.

Coates intended to ensure that an independent New Zealand central bank could adjust monetary policy in line with New Zealand conditions. In 1933, Coates pushed the banks to devalue; where they had kept their New Zealand funds at parity with British sterling, there was an effective devaluation of 14%. Additionally, Coates used a mixture of persuasion and coercion to bring down interest rates on existing loans and mortgage securities – a measure of some benefit to farmers as well as to urban business.

Coates’ approach was to facilitate a business-led, and particularly a farming- led, recovery. Farmers, especially, would benefit from lower costs and higher export earnings, and dearer imports would be expected to stimulate domestic manufacturing.

The first Labour government’s approach to recovery went well beyond Coates, emphasising the spending power of wage and salary earners (and their families). Since the early 1920s Labour politicians had been reading and debating new economic thinking along those lines. Most commonly described as Keynesian economics, this approach held that a generally high level of demand created a virtuous circle.

Labour’s chosen instruments were significantly expanded public infrastructure programmes (famously in state housing) and a significant increase in transfer payments and in publicly funded social services.

At the end of 1938, the recovery had become something like a boom, and import spending was tracking well above export earnings. This amounted to a limited kind of shock, but the government’s response of tight import and exchange controls became entrenched, not least as they proved essential to managing the economy under the constraints of war and reconstruction.

World War II

Whether the Second World War and its aftermath can be described as a shock may be debated – it was prolonged and it was not unexpected, but it caused massive disruption.

Labour, which governed until 1949, managed by strict priorities in public and private investment, tight price and wage controls, rationing of goods and maintaining and even expanding the architecture of social services and transfer payments.

The three decades after 1945 were a time of unprecedented economic growth across the world, often described as a long boom. New Zealand shared that prosperity, with occasional interruptions. The boom ended for New Zealand, according to the economist Brian Easton, on 14 December 1966 when the wool sales opened and the price crashed.

Keith Holyoake’s National government, in office since 1960, sought to trim public spending and to dampen domestic demand in the interests of prioritising export growth. A currency devaluation was discussed for some months. While this would have advantaged exporters, Holyoake and his new minister of finance, Robert Muldoon, prevaricated. The British government put considerable pressure on New Zealand not to devalue, for fear that devaluation would undermine sterling. When sterling was devalued in November 1967, New Zealand followed suit. It may have been better if Holyoake had gone early, taking the initiative rather than appearing to react to events.

Limiting wage growth was a key part of the government’s hopes for an export-led recovery. For decades, wage-fixing had been centralised in the Court of Arbitration, which from time to time issued General Wage Orders covering all workers subject to the Court’s jurisdiction. In June 1968, after hearing a union claim for a 7.6% order, the Court issued its infamous “nil order”. There were widespread protests. Subsequently the employers’ and workers’ representatives joined to agree to a rehearing and a 5% order.

The damage had been done. Wage bargaining moved increasingly outside the Court and was frequently accompanied by industrial action. Hindsight suggests that the government should have indicated to the Court that it could have lived with something less than 5% in the first place.

Oil shock

Apparently, New Zealand’s economy had recovered by the end of the decade and moved into the 1970s profiting from an international surge in natural resource prices. That last fling of the post-war boom came to a crashing halt late in 1973. In the wake of the October 1973 Arab- Israeli war, Arab oil producers placed embargoes on Western powers and the price of oil trebled as a result. Recession ensued. New Zealand was affected both by a sharp increase in energy costs and by falling demand for its exports.

The 1972-75 Labour government tried to manage the shock by borrowing in order to maintain public spending and domestic demand while encouraging exports. Unfortunately, the recession was longer and deeper than anyone had anticipated or experienced and the government’s credibility was terminally damaged.

Robert Muldoon led National to victory at the end of 1975 and initially his approach to managing the shock, as in 1967, was to severely constrain domestic demand in favour of exports. Spending cuts were so severe that they intensified the recession, as Muldoon implicitly admitted at the end of 1977. Industrial unrest also intensified, not least because of Muldoon’s frequent recourse to confrontational language. To the extent that wage restraint might have been helpful, there was no attempt to build consensus.

More positively, Muldoon’s government sought to encourage export diversification in areas such as horticulture and fishing while also increasingly subsidising traditional pastoral farming to increase production. This last eventually became counterproductive, not to say expensive.

And now?

It’s always risky to suggest that history has clear lessons for the present but looking at some past shocks suggests a few things.

One important element in a successful response to a shock is shaping a consensus. It’s helpful if responses don’t appear to unduly privilege some while ignoring others.

Decisive action with a clear idea of what is intended is another important element, although it can be very hard to avoid unintended consequences.

Sometimes, shocks arrive in the context of a deeper transition, and it can be helpful if the response also addresses that transition. It’s not always wise to try to preserve a status quo.

All that said, hindsight is a wonderful thing.