Brian Fallow

The Economics Editor of the NZ Herald

The view from the Treasury

Reduce inequality? Improve education? Yes, this is the Treasury speaking. Economics editor Brian Fallow reports

New Zealand underplays the role of education in lifting growth and lowering inequality, argues Treasury Secretary Gabriel Makhlouf. Photo / Mark Mitchell
New Zealand underplays the role of education in lifting growth and lowering inequality, argues Treasury Secretary Gabriel Makhlouf. Photo / Mark Mitchell

Treasury officials, it seems, think a lot about inequality these days.

This may come as a surprise to people who think of them as the temple priests of the cult of the market.

But sit down with Secretary to the Treasury Gabriel Makhlouf to discuss the economic challenges the country faces, and by the time you stand up again you will be clear that if that view was ever fair, it isn't any longer.

Concern about income inequality is one of the big long-term global trends the Treasury is mindful of, alongside the rise of Asia.

"It is something economists are paying much more attention to than they may have done 20 or 30 years ago," he says.

Though New Zealand is in the middle of the pack among developed countries for measures of income inequality - and those measures have stayed at similar levels since the mid-1990s - they are a lot higher than they were.

"That is down to a combination of globalisation, technology and changes to family structure," Makhlouf says.

To his list one might add policies advocated by the Treasury of 30 years ago.

In any case, the question is what can be done now to increase equity, which is one of the criteria the Treasury has to consider when formulating policy advice.

"For adults it is work. For children it is education. And you need a good safety net for people who need it," he says.

The Treasury backs welfare reforms intended to address barriers between people and work, and to increase incentives for them to surmount those barriers.

For children it sees education as the main way of breaking the transmission of low incomes from one generation to the next. "Education is for us a central plank for addressing those equity issues for children, and also a platform for economic growth, that we underplay, actually, to my surprise, as a country most of the time."

Makhlouf incurred the wrath of the teaching profession early last year, by comments which were taken to imply that fewer but better teachers would be an acceptable trade-off.

But he is unapologetic about focusing on the quality of education, given the significant proportion of kids who are, in his words, being failed by the system.

The OECD has characterised New Zealand's school system as high performing but low equity because, though overall performance is good - as measured by standard tests of 15-year-olds - it does not appear to counteract family background as much as other systems do.

As education is the main way of improving intergenerational social mobility, that clearly puts a big cross in the equity box.

"Ultimately, though, raising our living standards through economic growth, becoming a more prosperous nation, is the way to raise that particular group in a sustainable way," he says.

If greater inequality is one legacy issue, another is the size of the Kiwi diaspora and the persistence of the income gap between New Zealand and most other developed countries which underpins it.

Some of that gap, Makhlouf suggests, may be a result of globalisation. He has some sympathy for the view that there is a worldwide trend towards widening income disparities between major urban hubs, where highly paid activities tend to be clustered, and their hinterlands. And New Zealand is all hinterland.

But at the heart of sub-par incomes is sub-par productivity.

"Have we done enough to address that? I don't think we have, but that is partly because it is very hard," he says.

"Human capital, R&D, innovation, entrepreneurship, access to export markets - all of those things matter. Human capital is incredibly important."

Right now the Treasury does not have a set of answers to why New Zealand is a productivity laggard, Makhlouf says.

"We want to go out and talk to businesspeople, talk to academics, talk to the biggest stakeholder community we can to try and arrive at potential answers. We are doing a lot of work in this space and I will be talking publicly towards the end of the year about where our thinking is getting to."

Achieving economies of scale is one of the biggest challenges.

But Makhlouf is more upbeat about the other limb of the size-and-distance constraint. He points to the potential for broadband to at least mitigate the tyranny of distance, especially when value chains can span the globe and cross several borders.

"There are unique things about New Zealand as a place. Imagine a world in which we are doing a lot more in service industry exporting than we are now. Who's to say that a lot of the diaspora wouldn't want to come back and live here? Not because they are going to earn the money they can working in central London, but because of the combination of the job and living in New Zealand."

In a recent speech Makhlouf declared himself hugely optimistic for New Zealand.

"For the first time in our history we find ourselves in the region which leads the world in economic activity, and broadband is bringing us closer to the rest of the world than we have been before."

But the rest of the world also has the capacity to wallop the economy with shocks such as the global financial crisis.

Making the economy more shock-resistant - or reducing "macro-economic vulnerabilities", in Treasury-speak - is another preoccupation for its policymakers.

The large build-up of debt at the household and foreign levels is a source of vulnerability. "Excessive growth in debt, whether by governments or households, is one sure sign of trouble ahead."

In the past, negative household savings rates were offset in part by the Government running fiscal surpluses and paying down its debt.

"One of the very good things about where the Crown's books were when the GFC started was that we were in a fairly healthy position debt-wise, which meant that international capital markets could look at New Zealand and see we weren't like the Europeans," he says.

"But if you group private and public debt together it is a pretty uncomfortable position. So the Government absolutely has to do its job and ensure that its debt is kept as low as possible.

"And over time - because we are not going to fix this quickly - we do need to help households have different and better opportunities to [save]," he says.

One of the important reasons for the programme of selling down state-owned power companies and Air New Zealand is to provide more places for people to put their money, he says.

"We do think that people are not saving enough.

"What we mean by that is not that they are acting illogically. In view of the fact that housing is tax-privileged and we have a very good pension etcetera, they make rational choices about how much they save." The International Monetary Fund has linked NZ's high levels of household and foreign debt, and how high house prices are relative to incomes, to housing being the only tax-preferred form of saving.

In that context people tend to reach for a capital gains tax (CGT), but Makhlouf sees no silver bullet there.

In his experience of the British CGT, it became more and more encrusted with exemptions over time, he says. "And the UK still had a mega housing boom. Australia has one too."

Some modelling the Treasury has done indicates that a capital gains tax excluding the family home would take 10 years to ramp up to $2 billion a year, and then only if there was no adjustment for inflation.

"There are things we can look at in the tax treatment of housing and property that might reduce demand. The big problem is housing supply, though."

A challenge for any Government trying to rein in its deficit is the ability businesses have to move their operations - and more especially where they recognise their profits - to the best tax advantage.

The current name for this problem is "base erosion and profit shifting" and the OECD, at the behest of the G20 group of countries, is working on it.

Ten years ago Makhlouf was doing the same thing. "We used to call it harmful tax competition."

Governments are having to respond to changes in the global economy, such as the emergence of digital trade.

But another factor which makes it an intractable problem, he says, is that the right to tax is something individual states hold incredibly dear. "As a result, deciding what you are going to do globally requires every country to line up behind a single policy. The OECD represents 35 of the world's industrialised countries. It doesn't represent a bunch of other economies, some very big. So these things take time. It is just hard," he says.

"But the international community has agreed rules around transfer pricing, around double taxation and around thin capitalisation, and they are going to arrive at a set of rules around this base erosion stuff."

- NZ Herald

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