Changes needed, but care essential lest truth emerge

A coalition deal could expose the fragility of our economy, writes Peter Lyons.

Let's hope any coalition deal does not expose several economic trip wires that could spring some nasty outcomes. There are several that come to mind. They could erode the tired myth of our rock star economy.

We are a small open economy that has embraced the concepts of free markets and free trade in the past few decades. A particular aspect of this has been opening our economy to international capital flows.

Many of our listed companies have substantial foreign ownership. It is estimated that more than 50% of our sharemarket is foreign owned.

Our housing market also has a degree of foreign ownership. The extent of this ownership has not been fully researched because of the lack of political willpower.

That is a concern.

There are certain trip wires which could expose the fragility of our economy if there are major policy lurches as a result of a coalition deal. They include our exchange rate and housing market. A sudden change in either could reveal an unpalatable truth about our economy.

We have been living beyond our means as a nation for a long time. We have been able to do this because we have borrowed large amounts of money from overseas and sold assets such as property and businesses to overseas interests.

The evidence of this is our continued current account deficits despite our apparent booming economy. The current account measures what we earn and spend as a nation in our dealings with the rest of the world. It has been negative for a very long time.

A coalition deal that suddenly curbed migration or clamped down on foreign ownership of New Zealand assets could expose the faultlines in our economy. This is not to say such changes are not needed. Rather they need to be managed very very carefully.

They could reveal some unpleasant truths about our economic wellbeing. Many New Zealanders have treated their houses as cash-friendly ATM machines in recent years.

Our political leaders accommodated this illusion. Private debt levels have increased dramatically as a result. This private sector debt mountain is a very ugly aspect of our economy.

We have been living beyond our means as a nation for a long period. We have been protected from this reality by an overvalued exchange rate and rising house prices because overseas interests have been willing to lend to us and buy our assets.

If our exchange rate was to drop because of an exodus of foreign capital, things could get unpleasant. The prices of tradeables such as oil, foodstuffs, cars and electronics would rise. Inflationary pressures would increase leading to the Reserve Bank raising interest rates. It would get much harder to pay the bills.

A sudden change in key factors affecting the housing market would also reveal unpalatable truths. A clamp on migration or an exodus of foreign buyers could deflate the housing market. No country in history has become wealthy off housing inflation. Houses are for people to live in.

We have been treating them as speculative assets that can only increase in value. Nations become wealthy by increasing their output of saleable goods and services. This is what generates higher incomes for workers. Debt-fuelled housing inflation is not a route to national prosperity. It never has been.

There is a huge amount riding on the outcome of these coalition negotiations. Any sudden policy lurches could quickly expose the faultlines that underlie our fragile economy.

-Peter Lyons teaches economics at St Peter's College in Epsom and has written several economic texts.