Lowest Unemployment Rate on Record for New Zealand - Essay Example

1. Introduction. New Zealand being the only OECD country to have 14 quarters of unemployment below the 4% mark has prompted some to label it as an “unemployment miracle”. Despite this low unemployment rate, the country has failed to experience tremendous economic growth in recent years. More so, New Zealand has maintained an inflation rate well above its target limit of 3% not withstanding its five years of tight monetary policy. This has prompted analysts, economists; policy makers, educationists, etc to ask whether the above facts are interrelated. In particular, is New Zealand’s low rate of unemployment related to its slow economic growth, or is the low rate of unemployment related to its high rate of inflation? Is tight monetary policy contributing to the slow economic growth of the country? Is the high inflation contributing to low economic growth? These and many other questions remain unanswered. This paper aims at providing answers to the above questions. The paper intends to do this by gathering relevant information on unemployment, economic growth, inflation and monetary policy in New Zealand and evaluate it in relation to relevant theories so as to gain a reasonable basis for explaining seeming controversies identified above. The rest of the paper is organised as follows: section 2 provides information on economic growth, inflation, unemployment, monetary and fiscal policies in New Zealand; Section 3 provides a discussion of the facts outlined in section 2 in relation to relevant economic theories; and section 4 provides some conclusions and recommendations. 2. Economic Growth, Inflation, Unemployment and Monetary Policy in New Zealand. 2.1. Economic Growth According to Evans et al. (1996) New Zealand launched into a sequence of economic reforms following a constitutional and foreign exchange crisis in 1984. These reforms have been described by David Henderson (1995) cited by Evans et al. (1996) as “one of the most notable episodes of liberalisation that history has to offer”. The economic reforms included macroeconomic stabilisation and structural change. According to the OECD (2007) New Zealand began economic reforms 2 decades ago, which have laid the foundations for entrepreneurship and innovation in the country. The country maintains a well functioning product market, as well as a flexible labour market. In addition, the economy has been very open. (OECD, 2007). New Zealand also maintains world-class Public research organisations in many areas, especially in education and health. (OECD, 2007). Despite these positive aspects of the economy, the country has failed to maintain record levels of economic growth as the GDP per head continue to lag behind the OECD average. In addition, the country has failed to embrace technology given that most of its growth is driven by increased labour utilisation. New Zealand is yet to fully seize the opportunities of globalisation. In addition, its geographical isolation and the small size of many of its firms have made it difficult for it to compete in many fast growing areas of the global economy, such as services and technology. It is also lagging behind the OECD in terms of investments in business research and development (R&D), which is less than a third of the OECD average. (OECD, 2007). New Zealand’s per capita income has not quite doubled in the 51 years from 1947 to 1998. (Galt, 2000). New Zealand witnessed significant growth in real GDP in the 1990s. However, per capita GDP witnessed very slow growth during this period. (Galt, 2000). Compared with the OECD New Zealand has remained behind other OECD countries since the 1960s. Although the country has managed to measure up to the rest of the OECD countries in the 1990s following the major economic reforms, its performance witnessed a sharp decline in 1996. (Galt, 2000). Nahar and Inder (1998) suggest that all OECD countries are converged to U.S income levels over the period 1950 to 1990 except New Zealand and Australia. The forgoing indicates that New Zealand has been very slow in terms of economic growth and development as compared to other OECD countries. Source: Reserve Bank of New Zealand Monetary Policy Statement September 2008 Figure 1 above shows the movement of New Zealand’s GDP over the last 8 years. One can observe that the figure has been on a decline over this period. 2.2. Unemployment New Zealand has the lowest unemployment rate on record. The country has recorded the lowest rate of unemployment of 3.5 per cent following the birth of the Household Labour Force Survey 2 decades ago. (Working In Ltd, 2008). This has created a tight labour market and a strong need for skilled workers. The number of people unemployed decreased from by 2.1 percent from 81,000 in June to 79,000 over the September quarter. (Working In Ltd, 2008). As at September 2007, 2,150,000 New Zealanders were employed ranking New Zealand second among countries with the highest level of employment. (Working In Ltd, 2008). According to the Social Development and Employment Minister, Ruth Dyson, the country has recorded unemployment rates below 4 per cent for more that 3 years and has the fifth lowest unemployment rate in the OECD. (Working In Ltd, 2008). 2.3. Inflation New Zealand currently runs an inflation rate of 3.4 percent, which is well above the 1 percent to 3 percent target. (International Herald Tribune, 2008). This higher rate of inflation has been attributed by the Finance Minister of New Zealand to higher global gasoline prices, as well rising food prices. (International Herald Tribune, 2008). 2.4. Monetary Policy The reserve bank of New Zealand has as its main policy tool of monetary policy the adjustment of short-term interest rates. The Reserve Bank of New Zealand has maintained tight monetary policy over the last five years as witnessed by rising figures of the official cash rate (OCR). Source: Reserve Bank of New Zealand Monetary Policy Statement September 2008 The figure above shows the OCR for New Zealand over the last 9 years. One can observe that the rate has been on the rise for most of the time indicating tight monetary policy by the Reserve Bank. 3. Evaluation in Relation to Relevant Economic Theories One can observe from above that New although New Zealand enjoys low levels of unemployment, its economic growth has failed to improve. Macroeconomic theory posits that the output of a country depends on three factors. These include labour, capital and technology (CFA, 2008). That is, output is a function of labour, capital and technology. This can be stated mathematically as: Y = f(L, K, T). (1) The quantity of labour and capital are fixed at any given time while labour can be varied. (CFA, 2008). When the economy reaches full employment, that is at the natural rate of unemployment, it is difficult to increase productivity without increasing capital and technology. New Zealand seems to depend much on labour for its productivity and it appears the country has reached full employment. It is therefore impossible for it to witness economic growth because there is currently no investment in technology and capital. The issue of high inflation and low unemployment can be explained using the Philips curve. The Philips curve is a relationship between inflation and unemployment. The Philips curve posits that as inflation increases, unemployment decreases. Figure 3: The Philips Curve An economy that as just witnessed a recession will have a high rate of unemployment resulting from an excess supply of labour. (http://www.econ.iastate.edu/classes/econ102/bishnu/short_note.pdf). As the economy begins to recover from the recession, there will be an increase in aggregate demand which will stimulate the demand for labour. As employment increases in the short-run, there will be less pressure on firms to increase wages. However, in the long-run, as the economy grows faster and more people are employed, wages will start to increase. (http://www.econ.iastate.edu/classes/econ102/bishnu/short_note.pdf) This increase in wages will lead to an increase in price levels as firms try to transfer the increased cost of production to consumers. The Philips curve as shown in figure 3 above therefore in effect says that when the rate of unemployment decreases, the rate of inflation rises. (http://www.econ.iastate.edu/classes/econ102/bishnu/short_note.pdf) We can therefore explain New Zealand’s case from the perspective of the Philips curve. Since more people are employed, there is greater pressure for higher wages, which are passed on to consumers in the form of higher prices and thus the higher rate of inflation. 4. Conclusions and Recommendations. Based on the above discussion, we recommend to New Zealand to make more investments in Technology and Capital so as to boosts exports and thus economic growth. Bibliography Working In Ltd (2008). Lowest unemployment rate on record for New Zealand. Available online at: http://www.workingin-newzealand.com/info/715 CFA (2008). Economics, CFA Program Curriculum Volume 2. CFA Institute, Pearson Custom Publishing. Galt D. (2000). New Zealand’s Economic Growth. Treasury Working Paper No. 00/09 OECD (2007). New Zealand Economic Growth According to an OECD Report. Available online at: http://www.ibls.com/internet_law_news_portal_view.aspx?s=latestnews&id=1854 International Herald Tribune (2008). New Zealand inflation hits 3.4 percent annual rate; interest cut unlikely. Available online at: http://www.iht.com/articles/ap/2008/04/15/business/AS-FIN-ECO-New-Zealand-Inflation.php Reserve Bank of New Zealand (2008). Monetary Policy Statement, September 2008. Available online at: http://www.rbnz.govt.nz/monpol/statements/sep08.pdf Nahar, Syfun and Inder, Brett (1998) “Testing Convergence in OECD Countries”, Monash University Department of Econometrics and Business Statistics, Working Paper 14/98, (October 1998). A short note on inflation, unemployment and Philips Curve. Available online at: http://www.econ.iastate.edu/classes/econ102/bishnu/short_note.pdf Read More