How can such a small tumble hurt so much?

It’s official – New Zealand experienced its first recession in a decade over the first half of 2008.   According tothe official statistics the quarterly level of economic activity is down 0.5%on its peak in December (adjusted for seasonal differences).  

However, over this period New Zealand has experienced a severe drought, a sharp increase in petrol prices, and asignificant increase in the cost of getting credit – a series of events thathas been compared to the 1991 recession, and even the Great Depression.   Thisbegs the question: why has measured economic activity "only" fallen 0.5% when,to many of us, the decline feels much greater?

This point has been illustrated by the WestpacConsumer Confidence survey, which fell to its lowest level since the 1991recession in June.   The decline in confidence far exceeded anything seen duringthe Asian Crisis or the bursting of the dot com bubble, when larger declines inGDP were recorded.

One factor that may explain thisdifference is population growth.   If New Zealand experienced a big increase inour population then the amount produced in the economy (GDP) may rise, even ifeveryone in the county is becoming poorer.   Taking this into account tells usthat economic activity per person is down 0.9% since December.  

However, this is smaller than the declineover the second half of 1997, when the initial shock of the Asian FinancialCrisis dragged economic activity per person down 1.1% per person.

An alternative way of looking at thenational economic position is to look at real gross national disposable income(RGNDI).   As well as taking into account domestic production, this measurecaptures the impact of the price of exports and imports, as well asinternational income flows, on our nation’s income position.   

In other words it tells us what we canbuy rather than how much we make.

The RGNDI measure declined by 1.3% in theJune quarter as petrol prices rose and the profitability of New Zealand firms’ activities overseas fell.   When we look at RGNDI in per person terms thedecline in income appears even greater, with a 1.7% fall recorded sinceDecember.   This is significantly worse than the start of the Asian Financial Crisis,when RGNDI actually rose 1.9%.

Even so, compared to some other episodesof slowing growth, this fall in income is relatively small.   As recently as thesecond half of 2005, RGNDI per person fell 2.4% perperson over the nine months to March 2006.  

Furthermore, both of these declines palein comparison to the 10% fall in income recorded during New Zealand’s last major recession over the nine months to June 1991.

The reason that the current situationfeels so much worse than late 2005, and many other periods of negative nationalincome growth, stems from the fact that it coincides with a substantial declinein asset prices – specifically house values.  

The 4.5% annual decline in house pricesexperienced over the three months to August was the largest nominal decline inthe value of property on record.   When the sharp decline in asset prices is combinedwith a rapid fall in national real income it is understandable why thisrecession has felt more painful than our headline GDP number suggests.

All in all, the decline in NewZealander’s wealth and income over the first half of 2008 has been substantial,and this has led some commentators to state that we are now in a terribleeconomic situation – an attitude that exaggerates the severity of our situation.  

Looking at a longer term context, theprice of what we sell overseas, relative to the price of what we buy, has gonethrough the roof, hitting a 34 year high in March.   This shift pushed RGNDI perperson over the 2007 year up 3.8% on 2006 – the largest increase since theeconomic boom times of 2004.  

As a result, even with the decline inRGNDI over the first half of the year, our income as a nation is still higherthan at any time prior to September 2007.

Furthermore, house prices increased by anaverage of 14%pa between 2002 and 2007 (or a cumulative 68%), indicating that thepossibility of a 30% decline over the next five years would simply seehousehold’s lose some of the extravagant wealth gains that they have beengifted by rising house prices.

In reality, the decline in activity feelsso intense because the recent increase in income and house prices has beensimilarly rapid.   New Zealander’s may not be as rich as they thought they werelast year, but as a nation we are still in a much better position than we wouldhave expected five years ago.  



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