Colin James: We love debt to bits but the party can't go on forever

Right, holidays are over, or nearly. Time to sober up. There are some things to be sober about.

I mean the economy. Specifically, I mean our spendthriftness and our belief that our personal finances are as safe as houses.

This belief has fuelled an impressive consumer boom. But who is really paying for the boom and what does that mean for the future?

Few will likely bother to ask or answer that question before the election. Michael Cullen, especially, will not want to disturb the feeling of wellbeing before election day. But it will bother the next government, whether Helen Clark or Don Brash is in the chair.

And not just that government. It is at the core of the economic challenge facing policymakers, which is to keep us getting richer at least as fast as the people of countries with which we habitually compare ourselves and to which we emigrate.

In the past 10 years or so, in fact we have kept up - even slightly improved our position.

In good part that is because the economy is more flexible and attuned to opportunity as a result of the 1980s and early 1990s reforms.

But it is also due to our love affair with debt.

Household debt has tripled to around 130 per cent of household income over the past decade and a-half. By that measure it is among the highest, if not the highest, in the developed world.

This is not quite as alarming as it looks because household assets, notably houses, have risen fast, too. But that is on paper: house prices are in a bubble. Over time house prices move roughly in synch with rents but over the past few years they have soared far ahead of rents. Because rents relate to real incomes, which cannot boom as house prices have, house prices will have to come back into line sometime - either by falling or by going sideways for a long time until incomes rise enough to allow rents to catch up.

Moreover, a lot of the new household debt has been spent on leisure and goods - that is, on a consumption binge. We have been pawning the family silver to pleasure ourselves. The upshot is the buoyant economy Cullen is basking in.

But the upshot is also a big red deficit in the balance of payments current account with the rest of the world.

Some of that is actually good for us because it is due to firms importing capital goods which, when put to use, increase productivity and make us richer.

Another soothing fact is that the current account deficit is matched by a surplus on the capital account. By definition, the overall accounts with the rest of the world must balance. Why worry?

Don't be too soothed.

First, the current account deficit is very high by historical standards and set to go higher - and this is at a time of sky-high world prices for commodities, on which our export economy still critically depends.

When those prices fall, the deficit will get much worse. That will at some point push the kiwi dollar down and the price of foreign travel and imported goods up. Result: we will be poorer.

Moreover, the capital coming in from abroad to balance the account mostly goes not into productive investment but to pay for consumer imports and to fund mortgages and other personal borrowing.

What does that point to? Dismal savings. In fact, households overall have been spending more than they are earning. They do invest in houses but not in financial assets.

Should we bother about that? Yes, yes and yes again, David Skilling, of the New Zealand Institute, will argue in a paper early next month.
Low savings constrain business investment and development because local savings are not available, the capital markets are thin and illiquid and foreigners charge a hefty and rising risk premium to lend to firms here.

Put another way, firms' cost of capital is high. That is in part why they need to keep a lid on wages - so they can substitute cheap labour for dear capital.

The result? Skilling cites an OECD report that business investment rates are in the bottom quarter of the OECD and a lot lower than in Australia, and an IMF estimate that three-quarters of the shortfall in labour productivity compared with Australia is due to a lower level of investment here. To that add: foreigners own a very large share of "our" economy. (And, increasingly, land.)

So Cullen has been getting more interested in savings. Improvements in workplace practice can lift productivity, on which sustainably higher wages depend, only so far. He also needs higher investment in equipment which enables workers to produce more.

And for that he needs us to save a lot more. Hence the relevance of Skilling's report. Expect more on the topic from Cullen in due course.
But he - and any future government - will face a conundrum. Higher saving will mean less spending and so a much less buoyant, maybe stagnant, economy until the investment pays off. A stagnant economy is deadly politics.

But don't worry for now. That is for after the election. Meantime, while you've got it, flaunt it, as Zero Mostel said in The Producers.