GDP in calendar-year 2024 was 0.5% down on 2023. Our productivity – how much we produce per hour worked – continues to decline. This poor performance suggests something fundamental is still holding New Zealand back.
There is another dimension to our growth challenge that could complement the Government’s existing reform agenda: reducing the overall footprint of government in our economy.
The Government in New Zealand has grown considerably in recent years. When we combine central and local government spending, it now accounts for approximately 38% of everything our economy produces.
Government alone – what Treasury calls “Core Crown expenses” – stands at 33.9% of GDP. Our government debt has climbed to 45.1% of GDP according to Treasury’s latest figures, compared with just 15% in 2019. At the same time, we face an operating deficit of around $17 billion.
While emergency spending during the pandemic was necessary, government has not returned to its pre-pandemic size either absolutely or relative to GDP. Rather, it expanded significantly during the Dame Jacinda Ardern years and has remained around that level since.
Economic research consistently shows that an oversized Government hampers economic growth. When government spending exceeds a certain threshold, it begins to reduce prosperity rather than enhance it.
Think of it this way: the Government provides essential services that support economic activity – maintaining law and order, providing basic infrastructure and education. In the early stages of development, more government spending typically enhances growth by providing these foundational elements.
However, as government expands beyond its core functions, it increasingly diverts resources from higher-valued private uses. High taxes and excessive borrowing to fund government activities create distortions that discourage work, saving and investment. Administrative burdens grow. Decision-making becomes less responsive to market signals.
Many economists call this the “Armey Curve” or “Rahn Curve”, named after the researchers who identified this relationship.
Their work suggests an optimal government size of around 25-30% of GDP for developed economies, though the precise threshold continues to be debated. Beyond this point, the negative effects of larger government typically outweigh the benefits.
At approximately 38% of GDP, New Zealand’s total government spending has likely crossed the threshold at which additional government size begins to hamper growth.
The evidence is not merely theoretical. Treasury research specific to New Zealand shows distinct differences between types of government spending. Government consumption expenditure – day-to-day operations and transfers – has small or even negative economic multipliers. In contrast, productive government investment in infrastructure has significantly larger positive effects.
Unfortunately, much of our recent government expansion has been in consumption rather than investment. The public service workforce grew by about 34% between 2017 and 2023, with much of this growth in policy and administrative roles rather than frontline services. While numbers have recently declined slightly to 62,968 fulltime-equivalents (FTEs), they remain well above pre-2017 levels.
International examples reinforce this point. Countries like Canada, Sweden and Ireland all experienced stronger growth after reducing oversized government sectors in the 1990s. These nations focused on cutting low-value spending while maintaining essential services and productive investments.
What would this mean for New Zealand?
While the Government has signalled intentions to gradually reduce central government spending toward 30% of GDP, both the pace and target deserve reconsideration. After all, 30% is still higher than government spending was when Ardern presented her first “Wellbeing Budget”.
A more ambitious approach to fiscal consolidation could deliver growth benefits sooner while maintaining quality public services. This is not about implementing harsh austerity but about more urgently identifying and eliminating spending that delivers poor value.
Candidates for review include programmes with documented low returns such as the fees-free tertiary education policy. Treasury analysis suggested this would not significantly increase participation rates and enrolment trends since the policy was implemented have vindicated that analysis.
Corporate subsidies such as film industry incentives cost taxpayers tens of millions per major production. Despite industry claims of economic benefits, these subsidies essentially transfer money from taxpayers to international studios with little evidence they deliver genuine long-term value.
The original Provincial Growth Fund, which directed $3b towards regional projects, was sharply criticised by the Auditor-General for poor oversight, inadequate reporting and failure to demonstrate value for money. Many funded projects struggled to meet their objectives or deliver sustainable economic benefits. It is doubtful that the reset fund will do any better.
To be clear, the goal is not minimalist government.
Rather, it is a focused, efficient state that maximises its positive contribution to economic growth. Indeed, there may even be areas, such as productive infrastructure, where increased government investment would yield significant returns – but that too requires careful assessment, as the Infrastructure Commission has warned.
After years of expansion, the size of government may now be constraining rather than enabling prosperity. The Government’s current reform agenda establishes a strong policy foundation for growth. Reducing the size of government could enhance these efforts.
Addressing this balance thoughtfully would strengthen the Prime Minister’s growth agenda and deliver economic rewards that benefit all New Zealanders.
