Which is the economy's biggest problem right now: too much debt or not enough work to go around?

That is the basic question the Government faced as it prepared this week's Budget. Other countries have the same dilemma.

The fact that it has foreshadowed a second consecutive zero Budget, with no allowance for additional spending, indicates it has plumped for too much debt.

But the unemployment rate is 6.7 per cent and would be higher still if fewer people chose to go to Australia to live.


It has wobbled around the 6.5 per cent mark for three years now, indicating that the economy is only creating enough jobs to keep pace with the growing number of people looking for one and not enough to bring unemployment down.

The statisticians have just revised down last year's economic growth to a sluggish 1.1 per cent from 1.4 per cent previously.

Together with a stubbornly high unemployment rate, that suggests the economy could handle more demand. The Budget will not provide it.

Indicators such as business and consumer confidence are pointing to a modest pick-up in growth to a bit over 2 per cent this year.

The huge task of rebuilding Christchurch will be positive for growth.

But offsetting that is that prices for export commodities have been falling for a year now, turning off one of the main sources of momentum the economy has had since it technically emerged from recession three years ago.

Mortgage rates are at 47-year lows; they are not going to stay that low indefinitely.

And financial markets are displaying a heightened level of concern about Europe.

Why, then, is Finance Minister Bill English so determined to rein in the deficit and return to surplus by 2014-15 that he will deliver a Budget on Thursday that will subtract from economic growth?

After all, the Government's debt is respectable by international standards. The International Monetary Fund's projections put New Zealand's gross government debt this year, relative to the size of the economy, at a third of the average for advanced economies, and net debt at just 15 per cent of the average.

And the interest the Government has to pay on the debt it raises is at historically low rates.

So what's the problem?

Well there are two, and they are big.

One is the level of foreign debt the country - as distinct from the Government - has run up over decades of living beyond our means and borrowing the difference from the rest of the world.

It stands at $147 billion, net of New Zealand assets abroad, or the equivalent of 72 per cent of gross domestic product.

That is an improvement on three years ago when it was 85 per cent of GDP, which put us in the same league as Portugal, Ireland, Spain and Greece.

But it is forecast to deteriorate again.

Most of the debt has been run up by the private sector, households especially, but since the recession the Government has been driving the increase.

Credit rating agencies, proxies for our international creditors, are very clear this is not a sustainable position.

New Zealand has to fund more of the investment that occurs here from its own savings and rely less on importing the savings of foreigners.

The economy has to "rebalance" towards growth driven by export sectors and away from growth that depends on debt-fuelled consumption - whether the debt is accumulated directly by households or vicariously via the Government.

The other big argument for getting the Government's bottom line back in the black as soon as possible is demographic. The oldest of the babyboomers have begun to retire and as the population ages the cost to taxpayers of funding health care and superannuation will relentlessly increase.

This is a challenge all developed countries face, but we have an outsize case of it because of the particular design of New Zealand Superannuation and our heavy reliance on it for retirement income.

The OECD has estimated its member states' fiscal gaps, which is how much budgetary belt-tightening they need to do to ensure their government debt is below 50 per cent of GDP by mid-century.

It reckons we have the second-biggest long-term fiscal challenge, exceeded only by Japan which starts with government debt six times larger than New Zealand's, allowing for the relative size of the two economies.

That argues for returning to surplus and resuming contributions to the Cullen Fund as soon as possible - while at least some babyboomers have working life left.