The Economic Effects of the 2012 Budget

7/31/2019 The Economic Effects of the 2012 Budget

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NOTES FOR ADDRESSING THE INSTITUTE OF CHARTERED

ACCOUNTANTS ON THE ECONOMIC EFFECTS OF THE BUDGET ON

25 MAY 2012

For several decades, New Zealand has faced two big economic

challenges:

First, productivity growth has been markedly slower in NewZealand 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 StatisticsNew 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 periodthats 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.


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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 whenhe 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%.

Theres 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 hasbecome dependent on foreign savers. Weve 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


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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 thats only because

Statistics New Zealand counts among our international assetsthe 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 Suisses 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

riskyPortugal Ireland Hungary Romania UK Belgium Australia Russia Switzerland

Greece Spain Italy India Brazil Indonesia Canada Sweden Singapore

Iceland Ukraine New

Zealand

France Argentina Denmark Taiwan Norway

Egypt Turkey Japan Mexico Korea China Hong Kong

Poland USA Finland Germany

Provided by First New Zealand Capital, 17 May 2012


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So what do the Budgetprojections 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 ifthats achieved (and recall that

that assumption looks wildlyoptimistic 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 itshardly rapid growth. It wont 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 ofcourse 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 weeks 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 didnt

get close to a balance of payments surplus in the last few years.

Well, what did yesterdays Budget do to increase our growth rate?


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Answer: not an awful lot, beyond a continuation of modest restraint

in government spending.

I dont 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 GDPwent 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!

Its 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 fiscalposition, 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 lets 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


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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:

Theres been a modest start made in reforming the RMA, withmore reform promised.

The state of the road network has been improved markedly inrecent years, something particularly noticeable to us living in

Auckland.

The Government is continuing to negotiate free tradeagreements with some of our key markets, with potentially

exciting progress being made on the TPP.

The Government has changed the law to allow 90 dayprobationary 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 toallowing further improvements in productivity.

The commitment to sell minority stakes in four of the SOEs is amodest 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 reformthe welfare system and the intention to trial some charter

schools. Theres even talk of introducing performance pay for

teachers.

In the 2010 Budget, there were some moves to encourage workand saving, by a reduction in income tax rates and an increase

in the GST rate.


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And in yesterdays Budget additional resources were allocatedto encourage research and development.

But sadly, a huge amount remains to be done. I dont 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 shouldbe on the

Governments to-do list if its serious about increasing our growth

rate:

First, the Government needs to make it clear that they have thewill 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 ofour population, and the Governments 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 cant 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 theRMA, 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

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


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believe that the Auckland Council should be involved in almost

every aspect of Aucklands social and educational life.

There are some very dedicated and hard-working peopleworking 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 whos 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.

Ive 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 applyfor 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 urgentoverhaul. Some years ago, we were known as a country which

had a welcoming attitude to foreign investment. No more.

Thats not entirely this Governments 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


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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 byuncertainty 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, weve also created an environment which is activelyhostile 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 in2009 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 inAustralia, 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.


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Fifth, in my view we need to look at a substantial reduction inthe corporate tax rate. And indeed, a substantial reduction of

taxes on capital, and potentially their total removal, is nowincreasingly 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 overalleffect 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 thetax changes in the 2010 Budget was likely to be an increase in

the levelof 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 onlyother one Ill 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


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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 Ive 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 greaterpropensity 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. Theres 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


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effect on attitudes to saving: why save, when youre 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? Thats the cry of a number of ill-informed people at the

present time, and its a dangerous cry. All other things being thesame, 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 tighterfiscalpolicy in recent years,

there would certainly have been scope for monetary policy to have


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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 wouldthreaten 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 Banks 1

to 3% target. Yes, an OCR of 2.5% is the lowest in our history but

its also the second highest in the developed world, lower only than

Australias OCR. If our OCR were at, say, 1% rather than 2.5%, there

cant 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 Zealands 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 Zealands 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 Zealands 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.


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Its 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 encouragesaving 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 inwardsmigration 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 doesnt 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.


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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 isnot going to sell its shares to yield an investor 22%. Theyll 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 theyve 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


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come in contact with! If we fail to do that, we should not be

surprised if our grandchildren grow up cheering for the Wallabies.

Don Brash

The Economic Effects of the 2012 Budget

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