Former Economics Editor of the NZ Herald

Brian Fallow: Spending caught in a squeeze

  The population is up, the Govt wants debt to go down. Net result: not a lot left to play with.

Budget 2016 represents a collision between the irresistible force of rapid population growth and the immovable object of the Government's determination to cut debt.

That limits how much is left on the table for new initiatives.

Population growth, according to Statistics New Zealand's estimate for the year ended March 2016, was 2.1 per cent or the thick end of 100,000 people, of which the net inflow of migrants (including the coming and going of Kiwis) contributed around 70 per cent.

It is well above the average population growth of 1.2 per cent a year over the past 25 years. As well as contributing to social carnage in the Auckland housing sector, it drives up demand for public services like health and education.

And the population is not just growing, but ageing as well.

The number of people 65 and over grew by 3.6 per cent over the past year, nearly twice the brisk 1.9 per cent growth in the rest of the population.

New Zealand Superannuation payments are set to grow by 5.3 per cent to $12.9 billion over the coming fiscal year.

It outstrips the growth in overall operating expenditure, which is set to grow 4 per cent or $3 billion over the coming year.

To fund that, the Government has had to dip into money it was notionally hoarding for tax cuts in next year's Budget.

The operating allowance for this year's Budget - the pot of money available for new initiatives over and above what it can fund by economies in existing programmes - has been increased from the previously forecast $1 billion to $1.6 billion. Next year's allowance has been cut from $2.5 billion to $1.5 billion.

The other factor that has removed tax cuts from the agenda next year is that otherwise the Government would not get close to its target of reducing net debt to 20 per cent of gross domestic product by 2020.

The Treasury forecasts Budget surpluses to climb to $5 billion by the 2018/19 fiscal year - the sort of number that "gives the Government options".

This will raise hopes that the tax cuts which were pencilled in for next year's Budget but now erased will eventuate then.

But Finance Minister Bill English was downplaying that prospect somewhat yesterday, pointing to other competing claims on the money: the need to reduce debt, resuming contributions to the New Zealand Superannuation Fund and the "pressure to fund good investments in public services". In any case, fiscal forecasts are subject to a margin of forecast error which widens the further out you look.

There is the ever-present risk that the other 99.8 per cent of the world will sideswipe us with some shock that means all bets are off.

Even if that doesn't happen, the fiscal forecasts rest on the Treasury's forecasts for economic growth.

They are quite cheerful, with growth expected to average 3 per cent a year over the next three years, driven more by growth in the labour force and employment than by labour productivity.

And the population is not just growing, but ageing as well.The number of people 65 and over grew by 3.6 per cent over the past year, nearly twice the brisk 1.9 per cent growth in the rest of the population.

The Treasury has wisely slashed its expectations for growth in labour productivity - or output per hour worked - and now reckons it will average about 1 per cent a year over the next three years.

But that would still be an improvement on the recent trend.

Last year, for example, economic output grew 2.3 per cent but that was almost entirely explained by a 2.1 per cent rise in hours worked.

It implies that the contribution from more output per hour worked was meagre.

And that is the trend. The more recent the period you look at, the weaker the growth in labour productivity.

In the 1990s, labour productivity grew at a brisk average pace of 2.6 per cent a year. Between 2000 and 2007 it fell to 1.3 per cent and since 2008 it has averaged 0.8 per cent.

This droopy trend is unfortunate as it is productivity growth that has to underpin, to earn, sustained rises in real incomes and living standards.

And the feeble growth in productivity is off a low base by international standards.

In Australia, for example, they produce one-third more per person than we do, despite our working 8 per cent longer hours on average.

Compared with the average of 33 OECD countries (including Mexico and Turkey) we work 13 per cent more hours per capita but produce around 10 per cent less.

The other arm of the pincer putting the squeeze on public spending is the dominant fiscal objective of bending the net debt curve down from 26 per cent of GDP now to around 20 per cent by 2020.

These are low numbers by international standards.

And these days, the Government can borrow extremely cheaply by historical standards.

Last week it got away a four-year bond issue at an average interest rate of just 2.2 per cent, in contrast to the yields around 6 per cent that used to be the norm. So why the fixation on lowering pubic debt?

There is the ever-present risk that the other 99.8 per cent of the world will sideswipe us with some shock that means all bets are off.

One reason might be that the private sector is piling on debt at a rate - around 7 per cent a year - that is faster than the economy is growing. So it is helpful if public debt is growing more slowly than the economy. But that is a very partial offset as there is at least six times more private sector debt than government debt.

Another reason is to rebuild the fiscal buffer or shock absorber. It was helpful, when the double whammy of the global financial crisis and Canterbury earthquakes hit, that the Government had inherited a strong balance sheet with net debt around 5 per cent of GDP.

Those years would have been even more unpleasant if we had also been bumping up against a debt constraint.

But the strongest argument for reining in debt is that the Government refuses to do anything to tackle the ever-growing cost of New Zealand Superannuation. It would be unfair to cut entitlements for those already retired. And people still working deserve decent notice if their super entitlements are to be significantly reduced.

But so long as the Government refuses to go near that issue, the least it can do is not burden future taxpayers with an ever-rising interest bill as well.

- NZ Herald

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Former Economics Editor of the NZ Herald

Brian Fallow is a former economics editor for the New Zealand Herald. A Southlander happily transplanted to Wellington, he has been a journalist since 1984 and has covered the economy and related areas of public policy for the Herald since 1995. Why the economy? Because it is where we all live and because the forces at work in it can really mess up people's lives if we are not careful.

Read more by Brian Fallow

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