The real cost of inflation `solutions'

Tuesday, 19 July 2022

Econ Talks - NZ economy stressed as we pay the inflated price for too much stimulus (14 April 2022)

Clint Smith is a former economic adviser to the Labour and Green parties and author of the paper The Next Oil Shock?. He runs Victor Strategy and Communications.

OPINION: The stark truth of the inflation debate is that there’s very little New Zealand can do about an international price spike driven by oil, war, and shipping shortages.

The domestic debate isn’t really about how to reduce inflation. It’s about who bears the cost.

National, ACT and right-wing commentators are saying the Labour Government should do three things to reduce inflation: boost immigration; remove the Reserve Bank’s mandate to keep the economy at maximum sustainable employment; and cut spending.

* Inflation by the numbers - how NZ hit an unwanted 32-year high

* Opposition parties call for tax cuts and slashed spending to fight inflation

Clint Smith challenges the logic that, if there were more people, including more immigrants, competing for hospitality jobs, the cost of dining out would be lower.

First question – how would these things reduce inflation? By increasing unemployment and holding down wages.

The call for looser immigration is explicitly about suppressing wages.

National finance spokesperson Nicola Willis should identify where the spending cuts would come from to tackle inflation if her party was in power, says Clint Smith.

If there were more people competing for hospitality jobs, the logic goes, then restaurants wouldn’t have to pay as much and could keep prices down.

Lower wages for hospo workers and more unemployed workers seems like a high price to pay for a slightly cheaper burger, though.

National and ACT argue that because it now has to consider unemployment, the Reserve Bank hasn’t lifted interest rates as high and fast as it should.

Kent Blechynden/Dominion Post. Unemployment protest outside the Reserve Bank. Taken in 2010.

If interest rates were higher, businesses would borrow less, families would save more, there would be less demand in the economy, fewer jobs, and reduced inflationary pressure.

If the Government were to significantly cut spending (more than it already has – spending is down by $1 billion this year), it would mean fewer teachers, fewer nurses, fewer police officers, fewer firefighters, fewer builders and engineers employed, and even fewer policy analysts, although they make up only a couple per cent of the public sector workforce.

We’re not talking minor cuts, either. National’s Nicola Willis mentioned a figure of 1% of GDP – that’s $3.5b a year. That’s not back of the couch money. It’s not even “cancel a couple of projects you don’t like and scrap climate change action” money. It’s more than the cost of the entire secondary school system – and it would have only a minor impact on inflation.

Clint Smith is a former economic adviser to the Labour and Green Parties and runs Victor Strategy and Communications.

Throw 20,000 or 30,000 workers out of their jobs, and they buy less, and other people will lose their jobs, and total demand in the economy shrinks, reducing so-called “demand-pull” inflation.

And tough luck to the workers who get tossed on the scrap heap in this scenario.

Cutting core public services and increasing unemployment to have a minor impact on inflation seems like cutting off our nose to spite our face.

One of the best things the Government could do for the economy is to wean it off its reliance on oil products, argues Clint Smith.

Instead, we need to support workers through this period of inflation.

Cutting jobs and increasing unemployment just forces the economic pain on to workers and their families. Instead, we need to be boosting wages and supporting incomes so that families don’t have to tighten their belts too much and can afford the basics.

That means fair pay agreements, higher minimum wage, higher benefits, and expanding the cost-of-living payment to more people for longer.

Do higher incomes increase inflation? Marginally. The 6% increase in the minimum wage this year is estimated by the Ministry of Business, Innovation and Employment (MBIE) to have increased inflation by 0.1%, literally a rounding error.

It’s more important that we protect low-income families from the impact of inflation than worrying about marginal effects like that.

It’s entirely backwards that, during this period of very high inflation driven from overseas, our focus would be on holding down Kiwis’ incomes and increasing unemployment.

We are never going to be a high-wage economy if we react with horror every time someone gets a pay rise or if we treat structural unemployment as a desirable tool to keep wages low.

Kiwis getting higher incomes are not to blame for this inflation spike; international oil prices and supply constraints are.

Ultimately, we need to reduce our exposure to oil shocks. In the past 12 months, New Zealand has spent $6.3b importing oil products – up $2b from the previous year. That’s a $1000 a year increase per household.

Getting off oil isn’t just a great move for the climate, it’s vital for New Zealand’s economic security, and will mean we have billions more a year to invest at home.

Government needs to redouble its efforts to get our economy off oil as quickly as possible.

But that doesn’t solve inflation today.

Right now, the political debate on inflation is about whether we increase unemployment and cut public services so that those impacts land on vulnerable families the most, or we protect families from its impacts by increasing wages and incomes.

Neither path is free of negative consequences, but when it’s a choice between throwing people on the scrap heap to try to ease inflation a little or supporting them through this period, I know which I prefer.