Brian Fallow 's Opinion

The Economics Editor of the NZ Herald

Brian Fallow: The sceptics' case on Labour's plan

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Economists say well-paid employees made to contribute more to KiwiSaver would merely switch how they save.

Labour's finance spokesman  David Parker. Photo / Sarah Ivey
Labour's finance spokesman David Parker. Photo / Sarah Ivey

The contrary view to Labour's plan for monetary policy and savings goes broadly like this: It is a cute idea but it won't work.

Underlying the policy Labour's finance spokesman David Parker released last week is the idea that there is a nexus between national savings and the current account deficit on the one hand and the high trend level of interest rates and the exchange rate on the other.

The key therefore to a sustained reduction in the gap between our interest rates and those of comparable countries, he argues, is a set of policies to increase national savings: Budget surpluses, compulsory KiwiSaver at a higher contribution rate than now and tax changes designed to rid us of the idea that the best way to provide for your old age is not to save money but to borrow money and engage in highly leveraged plays in the housing market.

This is not a million miles from what we have been hearing from the Reserve Bank for some years now, indeed repeated by governor Graeme Wheeler yesterday, that New Zealand's persistent gap between savings and investment, and the resulting reliance on importing foreigners' savings, puts upward pressure on interest rates and the exchange rate.

There are two parts to Labour's proposed changes to KiwiSaver.

One is the move to compulsion (most likely with some exemption for low-income earners where the effect would otherwise be too regressive) at a gradually raised contribution rate, with the aim of increasing national savings.

The other is the "big new tool" of a variable savings rate (VSR), which empowers the Reserve Bank to recommend an increase in the contribution rate as an alternative to interest rate rises as a means of slowing demand growth when inflation threatens.

The question is how effective that would be, compared with the interest rate lever.

Wages and salaries paid to employees are running at around $100 billion a year. That is the sort of amount compulsory KiwiSaver contributions would be levied on.

Meanwhile the banks have around $340 billion outstanding in loans.

They pay interest, of course, as well as charging interest, so what is good for the mortgage belt is not so good in the retirement villages. But a rise in interest rate does not simply represent a transfer from New Zealand borrowers to New Zealand savers (and the Inland Revenue); nearly a third of the banks' lending is funded by foreign savings.

A survey the Government commissioned in 2010 found that on average, respondents who were KiwiSaver members said they would have used 64 per cent of the money they were now putting into KiwiSaver for other forms of saving or for debt reduction. That implied only 36 per cent of the members' contributions to KiwiSaver constituted additional saving.

This seems to be the origin, by way of the savings working group's report in 2011, of Economic Development Minister Stephen Joyce's claim that a 1 percentage point increase in the KiwiSaver contribution rate would yield just $400 million of net new savings.

He contrasts that with the $2.5 billion or so in extra savings he says it would take to keep the official cash rate 1 per cent lower.

When the Herald asked about the provenance of that number, Joyce cited work the Treasury has been doing about the trade-off between government spending and pressure on interest rates.

Back in 2011, when the Treasury was modelling the effects of changes to KiwiSaver on national savings, it warned that such estimates necessarily depended on assumptions about how individuals and businsses would respond to changes in incentives and regulatory requirements.

"Hard evidence on these behavioural responses is limited," it said.

The caveat remains valid today when considering economists' immediate scepticism about how effective the variable savings rate would be.

They argue that for well-paid employees, having to contribute more to a KiwiSaver scheme would not reduce their consumption but merely result in some switching in how they save.

For the low-paid, to be compelled to consume even less would be unjust and inefficient so some mechanism, most likely exemption, would be required to preserve their spending power - so again no reduction there in overall consumption.

And many of those in-between would have mortgages.

The risk there is that they would seek to dial back their mortgage payments to offset a lower take-home pay as a result of the increased KiwiSaver contributions and that banks would happily accommodate that. The banks, after all, are major KiwiSaver providers and would also profit from people taking longer to pay off their home loans, even though paying off the mortgage is a pretty efficient form of saving.

All of that is educated guesswork, however, in the absence of any evidence of how a variable savings rate has worked elsewhere.

Should that preclude innovation in public policy?

After all, how much interest rate changes bite varies too, among different groups of borrowers and over time.

Interest rate hikes affect the marginal borrower more than the average borrower, who may be protected - at least for a while - by fixed-term loans or by loans which allow them to keep repayments steady but adjust the spilt between interest and repayment of principal.

The central bank was frustrated by such things during the last cycle and talked about "spongy brakes".

In the end, if the bank shares the scepticism about how effective the VSR would be, it presumably would not recommend using it, given that its responsibility for price stability remains.

If it did decide it was worth a go it would have to make the case, given the circumstances at the time and in light of the alternatives.

The Government would get independent advice from the Treasury and if it was dubious about the plan that would provide political cover for a "Sorry, no, do it the old-fashioned way", response from the Government.

That assumes that Parliament is unlikely on constitutional grounds to delegate to the Reserve Bank the right to employ at will an instrument which would feel very much like a tax, even if the proceeds go to the individual's own savings rather than the Crown.

- NZ Herald

Brian Fallow

The Economics Editor of the NZ Herald

Brian Fallow is the New Zealand Herald's economics editor. 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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