Brian Fallow: Policy of neglect wilts savings

For too long savings policy has suffered from a kind of malign neglect, founded on two dodgy dogmas.

One is that people must be saving enough because if it wasn't enough they would be saving more.

That is, they are rational economic agents who know best how much of their income to save at any given time to optimally smooth consumption over their lifetimes, and they will stick to that with a will of iron.

Sound plausible? I didn't think so.

The other dogma is that it does not matter if collectively we don't save enough to fund the investment the economy needs because we can import other people's savings to make up the shortfall.

"A small open economy is not dependent on the savings of its own citizens for investment capital," said Business Roundtable executive director Roger Kerr in a speech yesterday. "It can tap into deep world capital markets."

But there are serious limitations and costs to endless reliance on foreign capital, and these are explored by the New Zealand Institute in the latest of a series of papers making the case for policy changes to encourage savings and build an "ownership society".

The think tank's chief executive, David Skilling, says our household savings rate is low and declining and the rate of business investment has generally been in the lowest quartile among developed countries. Those two facts are connected.

"The international evidence shows clearly that the financing of much investment remains local, despite the globalisation of capital markets, and that the level of domestic savings continues to have a significant impact on the level of domestic investment.

"In short, domestic savings are more likely to finance productive investment in New Zealand than are foreign savings."

New Zealand has been able to attract more than $200 billion of foreign capital. But this is less likely to be directed into productive, growth-enhancing investment than in larger developed countries.

And the level of overseas debt pushes up interest rates and the cost of capital.

"New Zealand's household savings performance over the past decade is particularly troubling given the many factors that were conducive to households savings over this period," Skilling says.

"Economic growth has, at least by New Zealand standards, been strong over the past decade or so and higher incomes should act to lift savings."

The demographic situation was also favourable, with baby boomers entering their prime earning years.

"And New Zealand experienced low and stable inflation, high real interest rates, reducing generosity of the public provision of retirement income, health and education, and some tax cuts in the mid to late 1990s - all of which should have impacted positively on households savings."

But although incomes have been growing, household spending has been growing even faster as people borrow to finance additional consumption.

At a national level, the current account balance can be seen as the difference between domestic investment and domestic savings.

New Zealand has been running current account deficits for decades, requiring a continual inflow of foreign money to meet the shortfall. In the year to September it was $8.25 billion.

The cumulative legacy of such deficits is that foreign claims on the economy exceed New Zealanders' investments abroad by $118 billion, equivalent to 82 per cent of the value of all the goods and services the economy produces, or $29,000 for every man woman and child.

So far New Zealand has had little trouble accessing the foreign capital needed to fund its deficits.

But Skilling argues that the nature of that inbound investment makes it an imperfect substitute for domestic savings. Much of it flows into uses that are not particularly economically nourishing, such as bank lending to home buyers.

Much of the inflow of foreign direct investment in the 1990s arose from the privatisation of state-owned assets. Little was greenfields investment and little went into export-oriented industries. In any case, those flows have dwindled.

Foreign investment in New Zealand is now largely debt (71 per cent). Foreign investors own about 60 per cent of Government debt, but that represents only 12 per cent of total overseas debt.

Private sector debt is dominated by bank borrowing (57 per cent) rather than corporate borrowing (31 per cent).

"Although debt capital is useful to New Zealand firms, small high-growth firms need equity capital as well, and this is the type of investment that is less likely to be forthcoming from foreign savers."

Equity invaders have a "home bias" or preference to invest in their own country, or large nearby ones.

"The bulk of capital inflows are now intermediated through banks for household borrowing," Skilling says.

"Foreign savings flow disproportionately into financing consumption and residential mortgage borrowing rather than investment. In sum, foreign savings do not look likely to finance significant productive investment in the New Zealand economy going forward."

A string of commentators and policymakers, including Reserve Bank Governor Alan Bollard last Friday and Prime Minister Helen Clark on Tuesday, have stressed the importance of lifting labour productivity.

That is the only way to lift living standards and to maintain or improve economic growth rates as the supply of additional labour dwindles.

It will require higher rates of business investment. There are signs in the national accounts and in imports of plant and machinery that it is picking up, but from a relatively low base.

If foreigners are not going to fund that investment, New Zealanders will have to.

In her state of the nation speech, Clark said: "The Government is developing savings initiatives to help New Zealanders build up their assets and security and to reduce our national reliance on the savings of others."

The recommendations of the workplace savings group headed by Peter Harris offered a "viable way ahead" for retirement savings.

The Harris proposals are designed to minimise compliance costs for employers and the psychological impediments for workers to save through workplace superannuation schemes.

The Government was also considering proposals to encourage savings for tertiary education and the deposit on a first home.

Such a change is overdue.

Skilling says: "It is unlikely to be a coincidence that New Zealand has the most hands-off approach to asset accumulation in the Anglo world and also among the worst outcomes in terms of savings and household wealth."