“Sustainability” and “Unsustainability” are becoming increasingly overused words in the economic and Government lexicon in New Zealand . There is one very disturbing and clearly unsustainable trend emerging in our economy that has nothing to do with climate, energy and the environment. The productive sector, which has always been the backbone (and remains the backbone) of the New Zealand economy has been contracting over the last eighteen months. The remainder of the economy, consisting of retail, services and Government sectors continues to party-on like there is no tomorrow. The party might continue for a bit after the booze runs out, but eventually it dies. Most know that the economic reality is that these sectors are ultimately dependent on the productive sector for their jobs, income and foreign exchange. The expansion of Government itself, Government spending and debt-fueled retail spending has allowed this situation to occur, but it is unsustainable. The tax-take will reduce with a weaker economy and debt limits will be reached.

Splitting our GDP growth performance over the last six years into the two component parts highlights our problem.

Note: “Productive Sectors” consist of:- Construction (approximate economy-wide weighting of 5%), Manufacturing (16%), Electricity, Gas & Water (2%), Agriculture (5%), Fishing and Forestry & Mining (2.5%). Approximate total Productive Sector weighting of 30.5%.

Note: “Retail and Services Sectors” consist of:- Wholesale Trade (approximate economy-wide weight weighting of 8.5%), Retail, Accommodation & Restaurants (8%), Transport & Communication (10.5%), Finance, Insurance & Business Services (26%), Government Administration & Defence (4.5%) and Personal & Community Services (12%). Approximate total “Retail and Services Sector” weighting of 69.5%.

Understanding these fundamental trends in the wider economy will be vital for the Reserve Bank of New Zealand as they recast their GDP growth and inflation forecasts for release within their 8 th March Monetary Policy Statement. The interest rate markets are pricing-in an 80% probability of further tightening in monetary policy by the RBNZ lifting the OCR from 7.25% to 7.50%. Bank economists say this action is needed because the economy is re-accelerating. The RBNZ seems to be saying that a late-cycle tightening is warranted because the annual inflation rate, after plummeting to a forecast 1.5% in June 2007, will increase again back up towards 3.00% in 2008. They see “medium-term” inflation risks as being on the increase. For that higher inflation forecast to be accurate, GDP growth this year would need to increase from the current 1.5% p.a. to near 3.00% p.a. Given the damage the “high interest rate/high currency” policy is doing to the export sector and the tough trading conditions for most of our major industries, a GDP growth rate for this next year of 1.5% might be overly optimistic in my view. The RBNZ concerns about medium term inflation risks arising in late 2007 and 2008 are just as unlikely to actually eventuate as has been the case with their 2006 warnings about wages growth, high capacity utilisation, higher inflationary expectations and second-round price increase from oil pushing inflation higher. There is no evidence that any of these factors are causing the CPI to be increasing today.

The RBNZ's sole focus is that only negative or slower growth in the retail and housing sectors of the economy can control inflation within their prescribed 1%-3% band. They still want to reduce consumer spending as they see this demand as causing medium term inflation risks. The hard cold facts about our inflation track-record over the last six years does not support the RBNZ position that strong consumer demand is pushing up prices, now or in the future. The goods that consumers are buying in the retail stores are generally falling in price. That is why the retail demand remains steady. The high NZ dollar value makes the goods even cheaper.

Outside of oil price impacts, which are now unwinding, the inflation we do have is sourced from the non-competitive or Government sectors of the economy. The lack of market price-disciplines and financial control in these sectors is the root-cause of most of the inflation, but the RBNZ Governor seems very reluctant to confront these inflation perpetrators. It is not good enough for the RBNZ to lamely admit that interest rate changes have been ineffective to control inflation and other control measures touted all have limitations. The Governor should be directly challenging the Government sourced inflation and forcing change.

That is his job. If he does not succeed at that he should ask the Minister of Finance to widen his 1% to 3% band as he cannot be accountable for what is out of his control. If he cannot persuade the Minister to do that, he should resign in protest. Someone has to bring the “out of control” public sector to account; it is causing major economic dislocation. What is happening under the high interest rate/high exchange rate policy setting is that farmers, exporters and borrowers are paying a subsidy to the non-competitive/Government sectors who are the real culprits causing the inflation.

Note: “Competitive Sectors” consist of:- Food (economy wide weighting of 17.5%), Alcoholic Beverages & Tobacco (7%), Clothing & Footwear (5%), Household Contents & Services (5.5%). Total “Competitive Sector” weighting of 35%.

Note: “Non-Competitive Sectors” consists of:- Housing & Utilities - predominantly property rates & energy costs - (economy wide weighting of 20%), Recreation & Culture (10%), Education (2%), Health (5%), Miscellaneous Goods & Services (7%) and Communication (3.5%). Total “Non-Competitive Sector” weighting of 48%.

Note: “Oil Related Sectors” consists of:- Transport (economy wide weighting of 17%). Total “Oil Related Sector” weighting of 17%.