Address to the Institute of Chartered Accountants on the economic effects of the Budget

25 May 2012

For several decades, New Zealand has faced two big economic challenges:

  • First, productivity growth has been markedly slower in New Zealand than in most other developed countries for many years.  As a result, New Zealand has progressively seen incomes in other countries rise above incomes in New Zealand, and more and more Kiwis are heading overseas.

              GDP/capita US dollars, constant prices, PPPs (reference year 2000)

Source: OECD

More worrying still, according to figures released by Statistics New Zealand earlier this month, production per hour worked last year was just 1.3% higher than it was in 2005, implying average growth in productivity of just 0.2% per annum over that period — that’s the sort of productivity growth which Portugal and Italy achieved in the decade prior to the GFC, and far behind productivity growth in, say, the US over that period.

The National Party has campaigned on the need for faster economic growth for many years — since at least the time Jenny Shipley was Prime Minister, and John Key promised to have New Zealand incomes match those in Australia by 2025 when he was elected in 2008.  The 2025 Taskforce found that Australian incomes were at least 35% higher than New Zealand incomes in 2008, and the gap now is probably nearer 40%.  There’s not the slightest sign, looking at recent productivity growth, that that gap will close any time soon and indeed it is much more likely to continue widening.

  • The other big challenge is the extent to which New Zealand has become dependent on foreign savers.  We’ve run a balance of payments deficit in every year since 1973 — almost 40 years — and we had some net external indebtedness even prior to that.  Now our net external liabilities are among the highest in the world.

                                   National indebtedness (2009)

Source: OECD and IMF


Paradoxically, our net international indebtedness, relative to GDP, is today a bit better than it was two or three years ago, when it peaked at about 85% of GDP, but that’s only because Statistics New Zealand counts among our international assets the amounts owed to us by international insurance companies to cover the disaster in Christchurch.

Last week, I received an email from First New Zealand Capital showing how Credit Suisse is looking at country risk at the moment.  This is what it looked like:

Credit Suisse’s Country Risk Table, based on current account balance, Budget balance, government debt, net external assets, potential GDP growth, CDS spreads and credit rating

Most risky








Least risky






















New Zealand














Hong Kong










Provided by First New Zealand Capital, 17 May 2012


So what do the Budget projections suggest?

First, they show a very gradual increase in our growth rate, peaking at 3.4% in 2013/14 before trending back to “around 3%” thereafter.  The Budget is based on the assumption that productivity per person trends up at 1.4% per annum, and if that’s achieved (and recall that that assumption looks wildly optimistic in comparison to the growth in production per hour worked over the last six or seven years, just 0.2% per annum) that could well be one of the better growth rates among developed countries over the next few years, judging by the economic disaster which is the Eurozone at the moment.  But it’s hardly rapid growth.  It won’t even begin to close the income gap with Australia, and indeed it is very likely to see that income gap continue to widen.    More and more of our fellow citizens will be heading across the Tasman.

What about our net international indebtedness?  The Budget projections suggest that the balance of payments deficit — which of course is what drives our net international indebtedness at the end of the day — bottomed out at just under 4% of GDP and is now heading back up again — towards 7% of GDP by 2015/16.  Imports are projected to grow faster than exports in each of the four years to March 2015.  And I strongly suspect that that projection was done before last week’s further sharp fall in international dairy prices.

It is indeed sobering that, with some of the best export prices in a generation for virtually all our major exports, and with an economy barely growing (and so not consuming too many imports), we didn’t get close to a balance of payments surplus in the last few years.


Well, what did yesterday’s Budget do to increase our growth rate?

Answer: not an awful lot, beyond a continuation of modest restraint in government spending. 

I don’t want to under-estimate the political difficulty of maintaining slow growth in government spending.  The problem which the National-led Government has is that in the last few years of the Labour Government, that Government went mad with the cheque book — interest-free student loans, KiwiSaver subsidies, Working for Families, and all the rest.  And, despite criticising most of those programmes in Opposition, National has left them all largely untouched.  So between 2007/08 and 2010/11, while nominal GDP went up by $17 billion, core government spending went up by over $13 billion — absorbing nearly 80% of the increase in GDP.  And almost none of that increase related to the Christchurch earthquake!

It’s worth noting that, despite what the Government calls tight restraint on government spending, over the last five years New Zealand has had one of the very worst reversals in its structural fiscal position, from surplus to deficit, of any developed country.

So now National is left saving five million here and 10 million there — chicken feed in the overall scheme of things, given core government spending is expected to be almost $74 billion this year.  Indeed, despite this being described as a “zero Budget”, core government expenses rise from $69.6 billion in the financial year just ending to $73.7 billion in the 2012/13 year, an increase of almost 6%, driven by the higher cost of New Zealand Superannuation, higher finance costs, and a transfer of some earthquake costs from this year to next.

But let’s be grateful for small mercies.  Core government spending is projected to gradually reduce, relative to the size of the economy, over the next few years — from 33.8% of GDP in the 2012/13 year to 30.2% in the 2015/16 year — and in principle that should leave a bit more room for the private sector to grow.

And to be fair, the Government has done some other things to assist growth over the last few years:

  • There’s been a modest start made in reforming the RMA, with more reform promised.
  • The state of the road network has been improved markedly in recent years, something particularly noticeable to us living in Auckland.
  • The Government is continuing to negotiate free trade agreements with some of our key markets, with potentially exciting progress being made on the TPP.
  • The Government has changed the law to allow 90 day probationary periods in all employment contracts, and is making some further changes in employment law which should, if the squeals from the CTU are any indication, go some way to allowing further improvements in productivity.
  • The commitment to sell minority stakes in four of the SOEs is a modest step in the right direction, though in my view the complete privatisation of two or three of them would have been greatly preferable to the sale of a minority stake in four of them.
  • The Government has announced some modest steps to reform the welfare system and the intention to trial some charter schools.  There’s even talk of introducing performance pay for teachers.
  • In the 2010 Budget, there were some moves to encourage work and saving, by a reduction in income tax rates and an increase in the GST rate.
  • And in yesterday’s Budget additional resources were allocated to encourage research and development.

But sadly, a huge amount remains to be done.  I don’t want to summarise the two 150 page reports which the 2025 Taskforce prepared to highlight what needed to be done, but let me mention a few of the more important items which should be on the Government’s to-do list if it’s serious about increasing our growth rate:

  • First, the Government needs to make it clear that they have the will not just to solve the fiscal problem in the short-term but also to solve it in the long-term.   Yes, our net government debt is one of the lowest among developed countries at the moment but, as the OECD has recently highlighted, New Zealand has a bigger challenge than any other OECD country except Japan in keeping government debt below 50% of GDP by 2050.1  And that challenge relates to a significant degree to the ageing of our population, and the Government’s refusal to take even the first and most obvious step to start dealing with that situation, namely flagging the inevitability of an increase in the age of eligibility for New Zealand Superannuation.  It seems a tragedy that Parliament can’t reach a broad consensus on this issue, now that even the Labour Party has recognised the inevitability of this change.
  • Second, there is still a pressing need to radically reform the RMA, and the Local Government Act.  The 2002 amendment of the Local Government Act, giving local authorities the power of general competence, no doubt encourages Len Brown to believe that the Auckland Council should be involved in almost every aspect of Auckland’s social and educational life.

    There are some very dedicated and hard-working people working in the Auckland Council, but I get anecdotes all the time about petty, interfering, bureaucratic little dictators, wanting to be involved in far too many aspects of life.

    Most Aucklanders know the story of the woman who’s been arguing with the Auckland Council for over a year because the Council wants to compel her to paint her white villa over-looking the Kaipara Harbour black or brown.

    I’ve recently encountered a similar story of bureaucratic absurdity myself: I wanted to replace a pot-belly stove in a small house on my kiwifruit orchard in Pukekohe with a modern, efficient, wood-burner.  I was told I needed to apply for a building permit, and that that required me to submit a complete plan of the house, showing doors and windows, along with elevation drawings.
  • Third, policy towards foreign investment needs an urgent overhaul.  Some years ago, we were known as a country which had a welcoming attitude to foreign investment.  No more.  That’s not entirely this Government’s fault — blame can be shared with Labour, Winston Peters, and the Greens.  But the OECD now ranks us as one of the least welcoming countries towards foreign investment in the world.  In their latest survey, we were seen as less friendly towards foreign investment than all of the countries in their survey except China, Iceland, Russia, Indonesia and Mexico.  We were ranked as more hostile to foreign direct investment than either India or Japan!  And that survey was taken before the nonsense about whether we should allow a Chinese company to buy some run-down farms from a bankrupt farmer.  Our current policies are marked by uncertainty and delay, with the strong suspicion that the Government will be more interested in placating ill-informed, if well-intentioned, film stars than doing what is best for New Zealand.
  • Fourth, we’ve also created an environment which is actively hostile to many forms of research, particularly any research which might carry even a hint of genetic modification.  Over the last 10 or 15 years, genetically engineered plants have become widespread around the world.  They are currently grown on more than 2 billion acres in more than 20 countries.  More than four-fifths of the soybean, corn and cotton acreage in the US in 2009 used genetically engineered crops, and any product that has beet sugar, soybean, or cane sugar in it in the US has an 85-95% chance of having some genetically modified content.  We have world class plant scientists, but our regulations around genetic modification are driving high value research in this area offshore.  The 2025 Taskforce was told of many examples of New Zealand scientists paying for research to be undertaken in Australia, Europe and the US because doing that is so much cheaper than meeting the regulatory requirements in New Zealand — including the cost of the delays caused by the need for almost interminable consultation.  If we want to make the best use of our productive land, and our world-class scientists, we need to get the regulation of science substantially stream-lined and modernised.
  • Fifth, in my view we need to look at a substantial reduction in the corporate tax rate.  And indeed, a substantial reduction of taxes on capital, and potentially their total removal, is now increasingly recognised in the economics literature as highly desirable if increased economic growth and employment is an important objective.  Yes, the Government reduced the headline corporate tax rate from 30% to 28% in the 2010 Budget, but of course as you know only too well, that Budget made a number of other changes affecting the tax paid by the corporate sector, so that the overall effect of the changes was, according to Treasury, equivalent to a 1% increase in the corporate tax rate.   Countries all over the world are cutting the tax applied to corporate profits.  We are no longer highly competitive on that front.

    (Incidentally, Treasury calculated that the overall effect of the tax changes in the 2010 Budget was likely to be an increase in the level of GDP of just 0.9% after seven years — equivalent to an increase in the growth rate of about 0.1% per annum!)
  • There are many other things needing to be done, but the only other one I’ll mention is the issue which was the focus of the first report of the Productivity Commission, namely the high cost of New Zealand housing.  That report noted that the land zoning policies of far too many local authorities, including those of the Auckland Council of course, not only hugely inflate the price of housing by pushing up the price of residential land but also make it more difficult for builders to get the economies of scale which easier access to land would permit.  If we want improved productivity in this important sector of the economy, land zoning policies need to change.

What about our other big economic challenge, our huge dependence on the savings of foreigners?  This is, of course, a very longstanding problem, as I’ve noted. 

Some see the problem as a function of our reluctance to save, and certainly the balance of payments deficit is by definition the difference between what we save and what we invest.  A greater propensity to save would almost certainly help to improve the balance of payments.

And successive governments have made timid steps to encourage more private savings.   The introduction of the PIE regime was one such step.  Perhaps Dr Cullen saw the introduction of the KiwiSaver scheme as another.  The increase in the rate of GST was a third.  But they have been timid steps, and at least in the case of KiwiSaver almost certainly not a contributor to national savings at all, with any small increase in private sector savings being fully offset by a reduction in government savings as a result of the subsidies.

Offsetting these moves have been policies such as the encouragement for students to borrow, by the waiving of interest on student loans, first while they were actually in study and then completely for students staying in New Zealand.  There’s plenty of anecdotal evidence pointing to this leading to less saving than would have otherwise been the case.

And again, the tight restriction on the availability of residential land, with the consequential enormous escalation in the price of housing over the last 20 years, has almost certainly had a highly negative effect on attitudes to saving: why save, when you’re becoming rapidly wealthier by simply buying as much property as possible with borrowed money? 

Certainly, the latest data show no appreciable increase in national saving, as a share of GDP, in recent years.  The saving ratio remains significantly below its level in the first half of the last decade.

But the problem of our increasing dependence on the savings of foreigners can also be looked at as a function of a lack of competitiveness — our cost structures are too high, measured in international prices, to compete effectively on international markets, or even with imports on the domestic market.  So imports of goods and services persistently exceed exports of goods and services.

In a fundamental sense this is about the strong growth of the non-tradable sector of the economy at the expense of the tradable sector.   And the largest single part of the non-tradable sector is of course the government sector.  So the strong growth of the government sector over recent years has been one factor putting considerable pressure on the internationally tradable sectors.

Perhaps it would have been better if the Reserve Bank had run an easier monetary policy, so that the exchange rate could have been lower?  That’s the cry of a number of ill-informed people at the present time, and it’s a dangerous cry.  All other things being the same, an easier monetary policy would simply have led to higher inflation — and in no time that would have done absolutely nothing positive for exporters at all, as we proved again and again before 1984.

But if the Government had run a tighter fiscal policy in recent years, there would certainly have been scope for monetary policy to have been easier.  That was particularly true at the height of the 2004 to 2007 boom, when the OCR went over 8% and contributed to a strong appreciation of the exchange rate.  And it is probably true at present.  The Reserve Bank dare not simply reduce the OCR if that would threaten an increase in the inflation rate.  But if fiscal policy were significantly tighter than it is projected to be, then it could well be entirely feasible to drop the OCR; indeed, not only feasible, but necessary to avoid inflation falling below the bottom of the Bank’s 1 to 3% target.  Yes, an OCR of 2.5% is the lowest in our history — but it’s also the second highest in the developed world, lower only than Australia’s OCR.  If our OCR were at, say, 1% rather than 2.5%, there can’t be much doubt that the exchange rate would be lower and the prospect for our balance of payments significantly better.

There is another argument gaining considerable support in policy-making circles in Wellington, and that is the connection between New Zealand’s very high rate of immigration (by international standards) and the exchange rate.  The argument goes that, if immigration inflows were sharply reduced — even if this were to result in a substantial net outflow of people taking into account the existing emigration of many New Zealanders — this would result in a marked reduction in New Zealand’s equilibrium interest rate, and lead to a marked reduction in the exchange rate.  The Savings Working Group, which reported to the Minister of Finance in January last year, suggested that if net immigration flows over the last 20 years had been kept at 1980s levels, New Zealand’s net international indebtedness may well be 20% of GDP lower than it now is.  This is such a huge difference from where we are now that it seems imperative that immediate attention be given to this issue.

It’s not hard, therefore, to see the kind of policy package I would like to see, to increase our growth rate and reduce our balance of payments deficit:

  • Reform the RMA and Local Government Act — fundamentally!
  • Streamline the process of approving foreign direct investment
  • Make it much easier to conduct research in New Zealand, and in particular to conduct research vital to our agricultural and horticultural industries
  • Sharply reduce the corporate tax rate — to 10 or 15%?
  • Free up the supply of land around our major cities, and accelerate the approval processes required for sub-division and building
  • Further tighten fiscal policy in ways which would encourage saving and allow the Reserve Bank to reduce the OCR without letting inflation get out of control, and make a clear commitment to get not only the immediate fiscal deficit under control, but also the longer-term deficit by clearly signalling the need to change the age of eligibility for New Zealand Superannuation
  • Urgently review whether the currently high level of inwards migration is one of the factors holding up the exchange rate.

And I suspect that the Minister of Finance understands all that very well.

So why doesn’t he do it?  The problem, of course, is entirely political.  And tragically for all of us, the political problem stems in significant part from ignorance fostered by petty politics and ill-informed media driven as much by selling advertising space as by any desire to inform the public.

The public debate on the sale of the Crafar farms has been extraordinarily depressing, displaying not only crude racism but also profound ignorance of the benefits of foreign investment.

Likewise, the debate over the partial sale of four SOEs.  Some of you may have seen the leader of a small political party interviewed on TV a few Sundays ago.  He was arguing against the sale of shares in SOEs because, he said, some of them made a return on equity of 22%, whereas government could borrow money at 4%.  Why would the government voluntarily give away 22% when they can borrow at 4%?

I would have been shocked by that argument — rather than just depressed — had I not heard the same argument made at an all-day seminar hosted by one of the Big Four accounting firms shortly before the election, not by one of the very small political parties but by the finance spokesman for one of the largest parties in Parliament.   When it was my turn to speak, I pointed out that the argument was totally flawed, because of course the Government is not going to sell its shares to yield an investor 22%.  They’ll sell them to yield, say, 4%, so there is no sense in which the Government is giving away 18%.  I thought that that was so obvious that it needed no elaboration, so I was dismayed to be phoned by a journalist in the evening — and he is a very sophisticated journalist who has been around Parliament for many years — with a request to explain that to him more fully.

Ladies and gentlemen, if New Zealand is to have any future as a prosperous country, a country to which our children and grandchildren will want to return after they’ve seen the world, you, and people like you, have a responsibility to explain some of the facts of life not just to your professional colleagues, but also to your family, your friends, your barber, and indeed everybody else you come in contact with!   If we fail to do that, we should not be surprised if our grandchildren grow up cheering for the Wallabies.

1 Cited by Brian Fallow, Economics Editor of the “New Zealand Herald”, in that paper on 21 May 2012.

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