Irrational exuBerance

Business lobby reactions to the Budget
gave no reason to suppose this sentiment would be reversed in the foreseeable future, although business lobby leaders typically grumble that governments – especially left-wing ones – have done them too few favours.
But why was sentiment so sour? There were many possibilities. First, the economic forecasters are wrong in predicting modest growth over the next year or so.
Second, there’s something wonky with the business psyche. The exchange rate’s slump below US50c should provide strong stimulus to growth, but Bank of New Zealand chief economist Tony Alexander believes falling currency can spook business people: they will interpret the depreciation as sign of something wrong with the economy and so will shy from investment, at least in the short term.
This time round, worries about the currency slide and rising interest rates have been exacerbated by government plans to enact measures like the Employment Relations Bill. Alexander spoke of companies laying off contractors simply because of their concerns about how the Bill will affect the relationship between contractors and businesses.
Third, variant of the second, is that businesses are going on strike – in effect – in corporate protest at the Labour-Alliance policy programme. Alternatively, they are threatening to go to Australia in campaign to force the Government to back down on legislation regarded as hostile to their interests.
Those three possibilities were on my list of suspects when I chatted about the confidence slump with economic consultant Brian Easton.
For example, the economy is good in some sectors but not so good in others. Because of rising interest rates and price pressures from competitors, the non-tradeable sector by mid-year would have been feeling the pinch as domestic activity slowed while the tradeable sector increasingly became the engine of growth.
Easton also mentioned the notion of “irrational exuberance”, or the belief that markets can over-talk themselves into over-optimistic assessments. This shows up in over-inflated share prices, for example. The obverse side of this coin, by definition, must be “irrational non-exuberance” – or should that be “rational non-exuberance”?
Whatever the expression, it describes markets talking themselves into over-pessimistic assessments. It’s not deliberate, like businesses taking political strike action, but results from market judgements being so ephemeral that often they come to bizarre results.
Easton threw in variation of this theory. It’s that for some time, the markets have been overvaluing the performance of the New Zealand economy, although growth has been poor on an array of measures. What little expansion we have had has been at the expense of the balance of payments.
So maybe the election of Labour-Alliance Government caused people to reassess our economic strengths and weaknesses.
Low inflation stands out on the positive side of our accomplishments. After that, however, there’s daunting list of negatives: poor productivity growth; falling incomes; our overseas debt has climbed above 100 percent of GDP; last year our economy was propped up by overseas investors loaning us sum equivalent to eight percent of GDP.
If business people apprehensively observed the new Government settling down to modify some National Government “fundamentals” at the same time as they realised the economy is in bad nick, the response would have been like that of farmers in the famed Toyota ad. They would have cried “bugger” and the confidence bubble would burst.
Another thing about confidence of surveys, of course, is that we should appreciate what they measure. Easton is former director of the Institute of Economic Research and was involved in at least one rebuilding of its quarterly survey of business opinion. Even so, he questions the worth of confidence surveys.
If you ask business people for their opinions about the economy in general, he contends, their responses are not very important. Much more meaningful are their responses when they are asked about their plans for investment, employment, sales, and so on. These measures of their activity levels distinguish between what they think of the economy and what they are actually doing.
The issue, therefore, should not be whether businesses feel more or less “confident” about general economic conditions in the six months or 12 months ahead, but whether they intend to expand.
Cullen has good reason to closely watch what business people say they intend doing, in the months immediately after the presentation of his first Budget. He hoped the Budget would be perceived as business-friendly, encouraging more investment and employment. If surveys show business people don’t intend to expand, his growth projections will be threatened and it will be his turn to cry “bugger”.