Fran O'Sullivan on business
Business analysis and comment from Herald columnist Fran O'Sullivan

Fran O'Sullivan: World Cup and rebuild not enough

John Key and Bill English will be expected to flesh out their agenda for economic growth. Photo / Getty Images
John Key and Bill English will be expected to flesh out their agenda for economic growth. Photo / Getty Images

Prime Minister John Key and Finance Minister Bill English need more than a pinch of luck as they try to convince informed New Zealanders that tomorrow's Budget will be based on sound Treasury forecasts.

It is extremely important that Budget 2011 does show the Government's economic policies will make a credible inroad into reducing New Zealand's galloping public debt.

Projections indicate that even before the impact of the February earthquake, net Government debt was forecast to be $42 billion by June 2011. This is still only 21 per cent of GDP which is low by international standards. (The gross debt figure is projected to be 33.3 per cent of GDP).

But it represents a massive quadrupling of the Government's exposure in just three years. Anybody doubting the speed with which a "modest" debt exposure can turn into a rampant monster that devours a nation's living standards should take a look at the United States which is now verging on Banana Republic status.

US Treasury Secretary Timothy Geithner issued bleak warnings this week as the US Government hit its US$14.292 trillion debt ceiling.

Geithner has already in effect raided two government employee pension funds by reducing contributions to free-up cash to help the US Government meet its obligations and stay within its borrowing authority.

But House Republicans are against raising the debt ceiling by another US$2 trillion - the hike that Obama has requested - unless it comes with big spending cuts. Something the Democrats don't want to do unless taxes are also hiked for wealthy families and the oil industry among others is sucker-punched by new taxes.

If the US does end up in "default" this will result in a major loss of confidence in global capital markets. One would hope the US Congress acts rationally to avert that prospect.

That's the external environment. Now for New Zealand.

Three years ago, Treasury forecast economic growth rates for the next three years of 1.5 per cent, 2.3 per cent and 3.2 per cent. In fact, the NZ economy flat-lined.

So what? English might say: "Those forecasts were made during my Labour predecessor Michael Cullen's last year in office. The Global Financial Crisis clearly changed the game. But even before the GFC New Zealand was in a domestic recession, I wasn't around to inject some fiscal stimulus."

As English did say at last year's Budget: "Despite the better growth outlook, by 2012 GDP per capita will still be about 5 per cent below Budget 2008 forecasts."

Trouble is the Finance Minister believed the National-led Government's growth-focused economic programme, which he unveiled last May, would contribute to a brighter outlook for the economy.

In last year's Budget the Treasury projected growth at 3.2 per cent for the March 2011 year compared with the 2.4 per cent it had forecast in December 2009 for the same period.

Since then the Treasury has had to revise the projected economic growth rate downwards. The two Canterbury earthquakes had a major impact on economic growth which could not have been forecast.

But the main contributor to the downwards revision is that Treasury over-estimated the impact of the May 2010 Budget's "tax switch" on domestic growth.

Instead of producing a "dynamic" consumption-led growth effect, New Zealanders put their chequebooks away with many using cash freed up by the tax cuts to pay off personal debt.

The upshot is that the subsequent pressure on Government borrowing has been immense.

When Key and English embarked upon the post-GFC fiscal stimulus programme it was to stop the economy going into a massive slump. That has been averted.

But National's prime duo is finding it is a very difficult feat indeed to wind back the massive borrowing programme which was necessary to prime the fiscal pump.

Tomorrow's Budget will show the Government's own cash deficit has basically doubled in a year.

A big contributor will be the fiscal impact of the two earthquakes and the South Canterbury Finance bailout.

But the failure of dynamic growth to emerge from the tax-switch is also a major factor.

We should look to the 2011 Budget to indicate that Key and English have got a strong grip on the nation's finances. The debt track has to be brought under control.

But the Budget also has to do more that produce blue-sky forecasts at the revenue end. It will be a sorry state indeed if the only credible factors that contribute to increased tax revenues are the Rugby World Cup and next year's projected injection of funds to rebuild Christchurch.

The New Zealand economy has to be built on much more that a one-off sporting event (however magnificent) and a disaster recovery package.

After last year's Budget I wrote that English had placed a billion-dollar bet that his tax-go-round would turbo-charge domestic growth and shift New Zealand out of the economic cul-de-sac so New Zealand could start closing the gap with Australia.

English's "once-in-a-generation package" was needed to fire-up growth by switching the tax system towards the productive sector and away from property investment.

Now is the time for the Government to flesh out its economic growth agenda - and remind us it has one.

- NZ Herald

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