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Salient: Victoria University Students' Paper. Vol. 30, No. 14. 1967.

Prof Holmes looks at recent trends in the NZ economy

Prof Holmes looks at recent trends in the NZ economy

It Will by now be fairly evident to most people that New Zealand has run into some pretty serious problems in her overseas transactions. Most of us will also be conscious that the action which is necessary to deal with these problems is having an adverse effect on our ability to maintain the standards which we have come to accept— not only our standards of living in terms of the consumers' goods and services which we can afford to buy, but also our rate of capital development and our ability to provide gainful employment for a rapidly rising number of workers.

My main objective will be to examine the nature and causes of these problems, and to provide some background for discussing what are the most appropriate methods open to us to deal with the problems in a manner which will enable us to sustain as far as we can progress towards such objectives as high living standards, rapid growth, full employment, stability of prices, and reasonable freedom of choice for the consumer and producer.

In growth of output, and in improvement of productivity, the country considerably improved its performance between 1963 and 1966 in comparison with that of the previous decade or so. The volume of production grew by about 20 per cent between 1962-63 and 1965-66, in contrast to the 12 per cent or 13 per cent growth achieved in the two (probably three) preceding three-year periods. The growth of manufacturing production was particularly rapid, an increase of 37 per cent being achieved in the three years. Part of the increase in output was attributable to more rapid increases in employment than in the '50s and early 60s, but productivity—output per worker—also showed a significant improvement over the record of the 1950s which had caused concern to the Monetary and Economic Council in its earlier reports.

The growth of GNP in constant prices in the first half of the 1960s was comparable with that of Australia, and the growth of productivity more rapid than Australia's, in contrast to the position in the late '50s. Official figures are not yet available for 1966- 67, but it is evident that the growth of output slowed down, probably to about 3 per cent, compared with 5.7 per cent and 6.6 per cent in the two preceding years. It is slowing down further this year.

The rise in output was associated with an improvement in living standards, the volume of consumers' goods and services having risen by about 16 per cent between 1962-63 and 1965-66, while population rose by just over 6 per cent. Capital formation appears to have risen even more rapidly in this period, reaching 24 per cent of GNP in 1965-66 or 28 per cent if investment in stocks is added to the spending on buildings, plant, equipment and public facilities. Some economists believe that these official figures understate the true level of capital formation which was achieved during the period. Personal and Government spending on goods and services continued to rise relative to the Gross National Product and in real terms in 1966-67, but private capital expenditure began to decline absolutely. This trend is continuing in 1967-68, accompanied by a levelling off of Government's spending on the works programme.

The rate of growth of spending on consumers' goods and services is also slowing down not only the growth of personal spending but also and, more appreciably, of Government's own current expenditures. And most of the extra personal expenditure which takes place this year will be to cover the requirements of a larger population and higher prices. The Government will in turn take a good deal of this through its higher taxes, higher charges for public services and savings on subsidies. Our consumption per head —which constitutes the material standard of living of the average Kiwiis falling slightly.

The expansion of the economy created jobs for many more New Zealanders. The total labour force grew by nearly 115,000 between October, 1962, and October, 1966—more rapidly than population as a whole, the ratio of labour force to population rising from 36.4 per cent to 38 per cent during the period mentioned. Rapid increases in the labour force were, until 1967, accompanied by very low unemployment and employers were confronted with a pronounced shortage of labour. Vacancies for males, for example, rose from 20 per 1000 employees in October, 1962, to 37 per 1000 in October, 1965 (the peak) and 33 per 1000 in October, 1966. The turnover of labour was substantial in many industries.

The employment situation changed appreciably in the second quarter of this year, when the numbers of notified vacancies fell away from the figures of between 7000 and 8000 which had been typical of the previous two years to about 2750 in June and July. At the same time, the numbers registered as unemployed began to climb from figures near 600 at the beginning of the year to over 5000 in June and between 6000 and 7000 in July and August, with the Government providing special work for others. This was the first time in the postwar period that registered unemployment had exceeded notified vacancies. Although, at 0.6 per cent of the labour force, the percentage registered as unemployed is low by comparison with that prevailing in any other country, it represents a marked change from the 0.1 per cent or less to which we had become accustomed for so long.

As would be expected in a situation of very buoyant demand and labour shortage, costs and prices rose between 1962 and 1966. On average, the increase in prices of consumers' goods and services was about 27 per cent per annum. Given the extent of the labour shortage, indeed, it surprised many overseas economists that the rise of prices was not more pronounced. However, the increase in New Zealanders' costs of living, while not among the slowest in the world, could be classed as moderate by present international standards: our increases in the '60s being somewhat more pronounced than those experienced in the United States and Canada but less pronounced than those of most countries of Western Europe, for example. As I indicated earlier, we have seen a more pronounced increase in living costs than usual in the first half of this year, Government action designed to reduce our consumption being a major contributor to the change.

You can see that the years 1963 to 1966 were years of achievement in respect of the goals of improved living standards, additions to our stocks of productive capital and full employment of a rapidly rising labour force, marred by some inflation of prices, labour shortages and rapid labour turnover. However, in 1967, while the labour problems have taken on a different complexion, we are obviously struggling to sustain the achievement which we have recorded in respect of the other goals.

Our problems stem partly from an inevitable need to pay for past excesses in which we had indulged and partly from misfortunes which have descended upon us from overseas, mainly in the form of a sharply reduced demand for our wool. They centre around our inability to continue to finance the expansion of imported supplies which has made such an important contribution to our expansion of output and employment.

Unfortunately, the achievements of 1963 to 1966 were not entirely due to our own efforts. Between 1962 and 1964, we enjoyed a bonus in the form of a rise of over 20 per cent in export prices. Although export prices fell by about 4 per cent between 1964 and 1966, on average they remained buoyant last year by comparison with those prevailing in the late '50s and early 60s, Moreover we greatly increased the volume of exports. Despite the rise in export receipts thus achieved, the pace of our rapid expansion of incomes and spending, including spending on imports, made it necessary to supplement our high overseas earnings very substantially indeed by drawing on our accumulated reserves of overseas exchange, and by borrowing overseas.

The official estimates of the balance of payments published by the Government Statistician, for the year ending March, 1966. put the deficit between current receipts and current payments at $186 million. This represents the extent to which the country had to increase its overseas liabilities or reduce its overseas assets during the year. No official estimates for the year ending March. 1967, are yet available, but the available statistics suggest that a similar or slightly higher deficit was incurred during that period.

Slightly [unclear: low] part payments and slightly lower [unclear: rt] receipts for the year were [unclear: offes] considerable rise in "net [unclear: invis] [unclear: yments]" i.e. the amounts [unclear: accn] o foreigners in interest and [unclear: div] and payments for other services [unclear: h] they have provided for Net [unclear: landers.] This rise in "net invisib [unclear: ments"] was a continuation of a [unclear: trend,] arising mainly [unclear: beca] higher freight charges, a number of New Zealanders [unclear: overseas,] increased [unclear: remit] of interest and dividends, and promotional expenses and [unclear: ents] for technical services by [unclear: Ne] land firms.

Deficits of [unclear: th] [unclear: gnitude] incurred in 1965 and 1966 [unclear: reat] strain on the country's [unclear: reser] overseas exchange, and necessits [unclear: large-scale] official borrowing to [unclear: ment] the inflow of private capital [unclear: far] as foreign private capital is [unclear: erned], New Zealand has not [unclear: recent] joyed any substantial net [unclear: inflo] funds through the banking [unclear: ost] of the private investment [unclear: ken] by foreigners has taken the [unclear: o] of reinvestment of profits by for [unclear: or] enterprises or the supply of good [unclear: cr] credit to New Zealand affiliates [unclear: es] is investment, plus New Zealand [unclear: ringing] cars and other things [unclear: th] the country on a no-remittance obtaining certain and local be [unclear: ave] probably dealt with between [unclear: an] and $70 million per annum of the which I have mentioned. [unclear: est] has had to be met from the [unclear: ves] of the banking system and [unclear: fr] [unclear: fficial] capital transactions.

The Govert [unclear: t] or the Reserve Bank [unclear: borrowe] $106 million in 1965-66 and $68 million and $108 million [unclear: or] ort-term e.g. draw-the loans wer [unclear: rnational] Monetary ings on the [unclear: ad] advance from the Fund ($50m), [unclear: m)] and loans from Midland Bank [unclear: o] of Australia ($24m) the Reserve [unclear: B] of International and from the [unclear: gi]; given the prevail-Settlements [unclear: ($] ; policies in Britain ing conditions [unclear: ion]States, longer-term and the [unclear: Un] difficult to arrange.

The Govern [unclear: Govern] depleted its holdings of [unclear: inves] overseas by $10 million during [unclear: during] same period. However, despite substantial official supplements [unclear: t] country's high ex-change [unclear: ch] the net exchange reserves of [unclear: mi] million during the also depleted [unclear: review.] At the sea-two years [unclear: un] December, 1966, they sonal low [unclear: a] million for too low were as low [unclear: a] with the country's when [unclear: compar] overseas payments level of [unclear: curr] been not far short which have [unclear: re] of $1000 million.

The [unclear: forego] external difficulties, already [unclear: obvio] serious, were aggravated in 1967, [unclear: ch] worsened as the wool prices, for the rela- wool prices, [unclear: ogressed] for the relatively coarse [unclear: w] the effect of this deland specialise [unclear: e] country's exchange velopment on [unclear: ensifled] wool [unclear: commis] that the new [unclear: orde] support its declared that the new [unclear: p] support its declared sion in order, [unclear: 000] bought and floor price of [unclear: c] of over [unclear: the] million season at a [unclear: ool] in wool prices and ($60m), the [unclear: in] from the market withholding [unclear: of] to a substantial re- has naturally [unclear: to]

Professor F. W. Holmes has recently taken up an appointment with the Tasman Pulp and Paper Company. Formerly Head of the Economics Department at Victoria, he was this year made a Life Member of the Students' Association. This commentary is a slightly abridged version of an address given last week to the Royal Society.

Professor F. W. Holmes has recently taken up an appointment with the Tasman Pulp and Paper Company.
Formerly Head of the Economics Department at Victoria, he was this year made a Life Member of the Students' Association.
This commentary is a slightly abridged version of an address given last week to the Royal Society.

page 11

duction in exchange receipts for wool. For the year ended August. 1907, they were down by nearly a third, to $167 million, compared with $253 million in the previous year.

Continuing low prices for wool of course greatly complicate the already serious problem of restoring a better balance in the country's overseas transactions. For the first eight months of this calendar year our export receipts for wool were $80 million less than in the same period last year; our total current receipts from overseas were about $70 million less. Imports are now falling appreciably, but for the first eight months of 1967 they had fallen by only $40 million compared with last year, while other current payments had risen by $16 million. Accordingly, the balance to be financed by borrowing increased in this period. Given the trend in imports and orders for imports, and my present informed guess for exports receipts, I estimate that the total net borrowing required for the year ended March, 1968, might be kept to slightly below the levels which it was necessary to undertake, on average, in the two previous years. We should see a further reduction in the deficit as 1968 proceeds. But unless we see a significant improvement in export prices, which regrettably does not seem a likely prospect in the near future, our external position will remain difficult for some time yet.

The foregoing analysis indicates that the effects of falling wool prices, not evident in the statistics till recently, were superimposed upon an already difficult external position, the causes of which were clearly to be found in the speed with which spending by New Zealanders grew in response to the welcome, very substantial rise in export receipts which began in 1962-63. In the three years ending March, 1966. annual expenditure on consumers' goods and services rose by over $640 million and annual expenditure on capital formation (including increases in stocks) by about $300 million, a total increase of about $960 million or a third.

It is obvious that such a high rate of increase of expenditure is well in excess of our longer-run capacity to increase the supply of goods and services, which seems to be a rate of increase of between 4 and 5 per cent per annum. As indicated earlier, with high imports, we did better in production than our long-run average in the period we are discussing, but even so our spending out-distanced our productive achievement.

Until the late 1930s the New Zealand economy was very much a slave to the influence of the fluctuations of export prices. Changes in institutions and policies have diminished that influence in the past-war world, In particular, when export prices fall, the internal impact is dampened by stabilisation schemes which have been devised to set a floor to farm incomes and, more impatiently, by the determination of governments through fiscal, credit and overseas borrowing policies, to avoid unemployment.

But the influence of external fluctuations on the economy is still substantial-in my view more substantial than it need be-because when export prices rise substantially we as a nation like to treat the rise as permanent and rapidly increase our internal expenditures and incomes to a degree which cannot be sustained when export prices level off or fall away.

Improved export receipts not only increase the incomes and expenditures of formers and those satisfying their requirements. They engender feelings of optimism throughout the community. This is reflected quite quickly in an expanding desire to spend both on capital and consumers' goods and services in the private sector. Financial institutions, their cash reserves swollen by the improved balance of payments, are able and willing to help their customers to satisfy this desire by expanding credit. Demands for labour and resources grow, and wages and prices rise.

The Government, with revenues rising as incomes and expenditure grow in the private sector, is frequently prepared to accede to increasing pressures for it to spend more or to grant tax concessions. The rise in spending outpaces the capacity of the economy to meet it with goods and services; imports are brought in in increasing quantities in an endeavour to fill the shortages. If export receipts stabilise or fall away, the desired imports can be paid for only by extensive borrowing or drawing on reserves of overseas exchange. Deficits in the balance of payments drain liquid funds away from the community and make credit more difficult and expensive to obtain. They also oblige the Government eventually to restrict imports and, usually, to reinforce the developing tightness of credit by more restrictive credit and fiscal measures of its own.

It is clear that if New Zealanders want greater stability of economic expansion than they have experienced in recent years, they must recognise that this will not occur automatically. It will require Governments to intervene continually in the economic process with a view to trying to keep our total spending and money incomes rising more or less in step with our long-run capacity to increase production. This means not only that Government must stand ready to stimulate spending and incomes if indicators such as a rise in unemployment, excess capacity in factories, slow retail sales, etc, demonstrate that our demands are inadequate.

It also means that they must be prepared to exercise some restraint on spending and incomes when they are obviously rising more rapidly than longrun output, as indicated by labour shortages, rising prices and substantial increases in overseas payments. However, the policies required in these circumstances are not popular policies, and consequently politicians are naturally most reluctant to introduce them. This reluctance accentuated when the parliamentary term is relatively short, is one of the major obstacles to the achievement of stability and efficiency in a democracy.

I do not intend to look back this evening to try to answer the question "What sorts of policies could have been adopted to prevent our getting into our present position?" Suffice it to say that I hope that our experience will have indicated that there was some sense in the co-ordinated stabilisation policy advocated by the Monetary and Economic Council from 1962 onwards, and by others, and that, before the next upswing occurs. Government will gear itself to avoid a repetition of excessive increases of national spending. To this end, it would, I believe, have to be prepared

(a)to make changes in present arrangements for the stabilisation of farm incomes, with the general objective of basing payouts to exporters of farm products on a moving average of realisations, so that the peaks, as well as the troughs, of realisations would be smoothed out so far as their impact on local incomes and expenditures were concerned.
(b)to vary deliberately the rate of growth of Government expenditure and/or of tax rates to offset excessive (or inadequate) spending in the private and local body sectors of the economy.
(c)to control the rate of expansion of credit, not only through the control of trading bank advances, but also by using variations of official borrowing and interest rates to control the flow of funds to all financial institutions.
(d)to engage in a greater measure of medium term economic planning, not only of the Government's own operations, but also of the development of the economy as a whole.

Let us review the significant changes of Government policy which have occurred during 1967.

The effect of the unexpectedly severe deterioration in the woof market on the balance of payments outlook, and the continuation of high levels of spending and imports, rising prices and labour shortages, finally provoked the Government into taking firm fiscal action to curb demand in February. 1967. Following the general line of action recommended by the Monetary and Economic Council, it removed consumer subsidies on wheat, flour and butter (compensating most social security beneficiaries by 2/6 per week); terminated the milk-in-schools scheme; raised State house rentals and Post Office charges; announced its intention to make lending by the State Advances Corporation more restrictive and expensive; extended capital issues control to cover finance companies; tightened hire purchase regulations; reduced overseas travel allowances; and announced plans for the gradual elimination of the noremittance imports scheme.

In addition to these measures announced in February, rail charges were raised in January and February and the levy for loan repayments and capital requirements charged to authorities distributing electricity was increased from 25 per cent to 50 per cent (though the effect on consumers was to be felt later in the year).

A further series of measures was announced early in May. again primarily designed to reduce internal demand, the Government arguing, with justification, that the tightening of import licensing alone would be inadequate to deal with the country's balance of payments problem if demand remained excessive. Sales taxes on motor vehicles and some other means of personal transport were increased, duty on petrol was lifted by 4d a gallon and vehicle licence fees were raised, the proceeds to go to the Consolidated Fund rather than to the National Roads Board. Excise and import duties on spirits, cigarettes, tobacco and cigars were also increased.

It was decided that the banks should be asked to reduce advances to about the level of the previous year and, to this end, they were directed to reduce each customer's overdraft limit by 10 per cent by July, 1967. After allowing for exceptions to be made for farming and other "essential" industries, it was estimated that this should reduce limits by £25 million. A slight offset to these restrictive measures was provided by a widening of the existing range of incentives for the tourist and fishing industries and an increase in the rate of deduction for tax purposes for increased export sales of manufactured goods from 15 per cent to 20 per cent.

After these so-called "mini-budgets," the real Budget of June 22 appeared to many to be an anticlimax, in that no new tax restraints were announced and some relaxations were announced in building programming and in credit for housing in the face of indications of slackness in the building industry. However, the Government indicated that its previously announced intention to restrain severely the growth of its awn spending had been no mere gesture, and that an increase in total expenditure of only £9 million or 1.4 per sent was provided for in the Estimates. Even though the reduced subsidies previously mentioned made an important contribution (£10 million) to effecting this restraint, nevertheless, specially when account is taken of the increases which have occurred in public service salaries and other costs, the estimated rise of only £19 million or just over 3 per cent in other expenditure in total represented a significant slowing up in the Government's demands on the real resources of the country. The appearance of three sets of budgetary measures In the first half of the year also represented a complete change of outlook on the flexible use of fiscal policy.

These firm budgetary measures were ' introduced in a situation where private expenditures on building, plant and equipment were already beginning to subside from the high levels reached in the previous boom years, and where farmers were also starting to lose some of their capacity and enthusiasm for expenditure on development.

As we have already seen, the effects of the combination of dampening demand and restricted supplies of some imports are being felt in the nation's output, employment, investment and consumption.

The essence of the problem for the nation is to restrain spending, especially overseas spending, with the minimum adverse effect on production, especially production for export.

Some disinflation was an essential part of the prescription for the country's ills. The luxury of serious labour shortages as well as of inflated import spending could no longer be afforded. it was vital that stocks of imported supplies (fortunately high) should be made to last longer than they would have done if spending had not been checked. Import control on its own would not have corrected the problem if inflation had continued. (Nor, for that matter, would other correctives operating more directly on the balance of payments, such as a devaluation, work satisfactorily in inflationary circumstances.) On the other hand, to rely on dampening down spending alone, even when accompanied by tighter import licensing, could be a mistake.

It can be argued that such a mixture worked without too serious effects on production and employment in 1958 and 1962, when imports fell sharply in response to it, but the deficits then to be corrected were much smaller. Moreover, the fact that export receipts turned up sharply, due mainly to rising prices, in 1959 and 1963. played an important part in the recoveries; there was a smaller problem of short-term debt repayment to be dealt with; and reserves had not fallen quite so far relative to overseas payments.

It is possible that a sharp rise of export prices will help us again, but at present there are no signs of any marked upsurge. Thus we cannot, in the short run, avoid making a substantial reduction of imports. Disinflationary measures, designed to check spending generally, could be carried far enough to achieve this result, but they affect not only imports and other overseas payments, but domestic production, trade and employment as well.

These latter must, of course, suffer some adverse effects if imported supplies must be cut, but it is desirable that these be kept to a minimum. Thus it can be argued that the measures should include some designed to give positive incentives to economise on overseas spending and to get out and earn overseas exchange.

The Government's policies do. of course, already include some measures of this kind—on the one hand, a variety of export incentives, mentioned earlier; on the other, special taxes bearing on selected goods, like cars, petrol and spirits with a high import content. It can be argued that, given reasonable luck with wool prices, these, the stricter import licensing, and the other disinflationary measures taken and developments occurring, will supply the necessary correctives.

Several economists, however, especially those who are least optimistic about the longer-run prospects for wool, see the problem as more fundamental than this and argue that New Zealand must plan for a significant page 12structural change in its economy to reduce its dependence on imported supplies and encourage an expansion and diversification of its exchange earning activities.

Some see devaluation of New Zealand's currency as an essential element in inducing such a structural change. Devaluation would (1) put up the domestic cost of goods and services with a high exchange content, make overseas spending generally more expensive, and thus give an incentive to look for domestic substitutes for imports and to be economical in the use of goods and services with a high exchange content; (2) increase the relative profitability of industries which earn overseas exchange; thus improving the capacity to invest of existing exchange-earning industries, and putting some industries in a position to commence earning exchange for the first time; and (3) possibly encourage some repatriation of funds held overseas.

One cannot, however, ignore the inflationary impact of devaluation—the rise of domestic costs and change in the distribution of income which it involved would lead to pressure from various groups for higher incomes and to attempts to pass on the extra costs in prices. This pressure is the more likely to succeed the more buoyant is the domestic market for goods and for labour. As inflation has eased this year, and the conditions for the successful use of devaluation thus improved, the opposition to it by many economists has diminished.

An alternative to devaluation suggested by some economists, and by the Monetary Council, is a "switch" in the tax structure. Extra taxation could be imposed on purchases of overseas exchange, or on imported goods, and this could be offset (in greater or lesser degree depending on the net expansive or disinflationary effect desired by Government) by a reduction in company tax and/or in the rate of progression of personal income tax and or an increase in some of Government's expenditures, especially those vital to development.

Both the suggestion of devaluation and the "tax switch" proposals, of course, raise problems of judgment about the future of our staple exports which is inevitably shrouded in uncertainty. They raise problems of timing, e.g. even if you believed in the tax switch, you would probably allow the "Ross" committee on taxation, now nearing the end of its deliberations, to deliver its report before you acted; and even if you thought devaluation was likely to be desirable, you would be concerned at the possibility that the United Kingdom might also be contemplating devaluation.

Both suggestions raise non-economic as well as economic issues. The resultant change of the distribution of income, for example, which must be reasonably well sustained if the measures are to be effective, would by no means be politically acceptable to all. The suggestion of an exchange tax might encounter some opposition in the International Monetary Fund and that of an import surcharge would raise some problems in Gatt. However, if they were seen as part of an overall programme designed to restore the conditions for stable growth as rapidly as possible, and to remove the necessity for such stringent controls on imports as now apply, there would be less opposition to them.

Unfortunately, so far, the Government has made only limited progress towards the goal of developing a more comprehensive, longer-term strategy for the country's development. Further progress with" "consultative planning," and an improvement in the present farm stabilisation programmes together with an adherence to the more flexible use of fiscal and credit policies, which the Government has accepted as desirable this year would provide greater confidence in the country's ability to maintain stable growth in the future.

The planning should be concerned not only with the conditions necessary for stability, but more importantly, with the conditions necessary to achieve rapid growth, more diversified exports and markets, and greater flexibility in the economy. Adequate investment in physical capital and adequate expenditure on education and research are obvious necessities in such a programme. But, in addition, I believe, we should work towards the gradual abolition of import licensing and reliance upon a system of moderate tariff protection accorded fairly generally to all industry.

This should be accompanied by Government policies designed positively to improve the efficiency and competitive ability of New Zealand industries. To this end, we would require changes in the tax structure, and policies to ensure that adequate credit is available to industry on reasonable terms, and to prevent the emergence of serious labour shortages. We would need to ensure that the exchange rate was appropriate and that adequate supplies of skilled manpower became available through local training and selective immigration.

More emphasis would have to be placed on research into means of improving productivity, and so on. Moreover, since capital must be more fully and efficiently utilised than in the past, workers, employers and Government should explore management and labour practices which impede effective utilisation and try to agree on means of ensuring that the fruits of changes designed to increase output per unit of capital are fairly shared among shareholders, workers and the public.

We must accept that we are in a position which is bound to cause difficulties in maintaining employment due to shortages of imported supplies, and that we cannot afford to maintain the labour shortages which have characterised our recent past. Furthermore, if we want a more dynamic and flexible economy, this will require more changes of employment and re-education of employees of most grades and categories than in the past.

For these reasons we should be exploring the adequacy of the provisions which have so far been made for the payment, retraining and resettlement of displaced workers, and the adequacy of education facilities available to workers and management. In my view, a great improvement of such facilities is desirable, not only to help managers and workers better to foster and protect their own interests, and that of their enterprises, but also to equip them to participate in the formulation of a national strategy for stable growth.