Politicians claim they focus on economic imperatives but are often enslaved by politics of the day.

Joe Hockey's second Australian Budget last week was a bit of a lolly scramble and yet he couldn't please everyone. Unfortunately, there's always someone who misses the handout or, worse, has to pay for it.

Hockey's inaugural Budget last year was more austere, reflecting the nation's dire economic situation. That situation hasn't improved, so why the changed approach? The answer is that politics often overrules economics.

Politicians will claim they focus on the economic imperatives but are often enslaved by the politics of the day, particularly when economies are in trouble and opposition parties can point to unpopular belt-tightening measures.

Bill English releases his Budget today. How will this respond to the economic and political forces in the nation?


Of course, the answer is never 100 per cent either way. To be fair, the Key and English Government has earned a reputation for fiscal prudence and NZ's recent economic performance has rewarded that approach.

The topical but distracting issue for this Budget is the promised surplus. The fiscal position will be a near break-even with a deficit of less than 1 per cent of GDP. What is the economics of this matter? The gap from a break-even is trivial. The size of the deficit distracts from a more meaningful question: what should government spending and taxes be as a fraction of the national income?

At around 30.5 per cent, both are too high. For example, Australia's Federal 2015 Budget puts tax to GDP for 2014/15 at 22.1 per cent and Federal spending to GDP at 25.4 per cent. All of government tax to GDP was 27 per cent in 2013/14.

NZ's nominal GDP has increased significantly in the past decade from about $148 billion to $240 billion but the percentage of government expenditure rose from 28 per cent to more than 30 per cent. The Government is spending 34 per cent of the additional $91 billion expansion, about $31 billion. Surely there can be scale economies in government spending?

So how is the Opposition politicising the deficit? It's pointing to a broken promise and questioning the Government's reputation for prudent fiscal management.

And yet political motives may have also encouraged the Government to deliberately time its delivery of a surplus further out from its recent landslide electoral victory and closer to the next election. This would also make any level of new spending seem more generous.

Another topical issue is the Auckland housing problem.

This is a contextual issue rather than one calling for a specific Budget measure. How do the economics and politics play out for this matter?


Whenever there is an increase in market demand, supply must respond if prices are not to change.

The Government understands this. We've seen some measures, mainly from the Reserve Bank, designed to depress demand, which effectively prejudices certain categories of consumer. Prejudicial immigration policies depress demand by immigrants. Prejudicial Reserve Bank LVR measures depress demand by borrower homeowners, as do keeping up interest rates.

Demand-depressing measures are questionable in markets where the underlying activity is legitimate. The Reserve Bank's prudential concerns in the banking sector go to the balance sheet construct of the banks rather than regulating their asset and debt transactions.

Tax is an instrument that can affect both sides of the market. For example, the Government's weekend announcement of taxing houses sold within two years of purchase will partially depress supply and demand for those affected, however, that is likely to be a small fraction of market participants, particularly given that most such participants will already be taxable under existing rules.

The Government should maintain its emphasis on supply factors, such as land availability, regulatory approvals and costs, the availability of builders, materials and their costs.

Fear of a housing bubble is legitimate. Bubbles are a by-product of a shrinking relative supply with an increasing price trajectory over time. If buyers and sellers think tomorrow's price will be systematically higher than today's price, sellers will defer selling, buyers will accelerate buying, and a component of asset prices will reflect those inflationary expectations.

And what about the politics of the housing issue? That's mainly about the Government needing to be seen to be doing something.

The international community will be a relevant scene-setter for the Budget. China will be identified as a risk, as it should be. China is targeting a growth rate of 7 per cent this year - down from 7.4 per cent in the previous year. It has roared along at an average growth rate of 10 per cent for the past 30 years and will feel the pain of a slow-down.

China is practically on par with Australia as the top two NZ export markets, although NZ is still a net importer from China, which hedges the currency relationship.

NZ is suffering a decline in dairy prices, although much of this has its roots in Russia's dairy import reductions. China is struggling to expand consumer spending and is facing an ageing population, a declining workforce, a possible housing price bubble (from the loose monetary policy it ran in response to the global financial crisis), and high national debt levels.

Australia faces more difficulties than NZ, with its strong dollar, unemployment pressure, weak business and household confidence, fiscal deficits, and low commodity prices. The Australian dollar price of iron ore has more than halved recently. Australia is also more dependent on China than NZ.

Rob McLeod is the chairman of EY New Zealand.