A pre-Budget speech

Michael Reddell Fiscal policy

In a pre-Budget speech this morning the Minister of Finance announced that this year’s operating allowance – the net amount available for new initiatives – was being reduced from $2.4 billion to $1.3 billion (speech here, RNZ story here). Operating allowance numbers in isolation don’t mean a great deal (what happens to the rate of general inflation matters a lot) but a cut like that, at the very end of the Budget process, can probably be taken at face value. On its own, it is equivalent to about a quarter of a per cent of GDP.

Readers will recall my post last Thursday presenting the IMF’s Fiscal Monitor numbers, which show New Zealand being expected to have the largest general government primary structural deficit this year of any advanced economy. Cutting spending by $1.1 billion will, all else equal, probably shift the New Zealand government to having the second largest advanced country deficit.

If the headline sounded encouraging, reading the full text of the speech left me less encouraged.

First, it sounds as if more handouts are still part of the plan.

And second, although there is talk of a “significant savings drive” freeing up “billions of dollars”

there have been no announcements of things the government is going to stop spending money on, or of agencies/departments it is just going to close down. I guess it is still a few weeks until the Budget itself so perhaps something is coming, but there isn’t even a taster in this speech.

And third, it seems pretty clear from the speech that this operating allowance cut is mostly about avoiding yet another fiscal update in which the date for a return to operating surplus is pushed back yet again.

And note that the small surplus Treasury projected for 2028/29 was on the Minister’s slightly dodgy new ex-ACC measure of the operating balance (one that The Treasury did not endorse). On the more usual operating balance measure, HYEFU showed 28/29 as the 10th year in succession of deficits. From what the Minister said this morning, that is likely still to be the case in the BEFU numbers.

I’m not going to object to the cut to the 25/26 operating allowance – which is a policy lever chosen by the Minister, not something for Treasury to “forecast” – but without specifics we might reasonably be sceptical about the durability of the cuts.

Late in the term of the previous government, the then Minister of Finance was solving his problems with forecast fiscal outlooks by telling Treasury he’d stick to low operating allowances in future years. Willis seemed to be doing something a bit similar last year (Treasury noting the tension between inevitable cost pressures and those headline numbers they are required to use, as advised by the Minister). That really was vapourware. This year’s cut is likely to have more substance to it, since it will directly affect appropriations for the 25/26 financial year.

But without specifics on what the government is going to stop doing or paying for, there has to be a bit of a suspicion that what is effectively going on is across the board (real) cuts, with no real idea as to what the impact or opportunities for durable savings might be. This was the second item in the Minister’s three-point list.

But we already had one round of generalised savings last year. After the approach of the previous government it was always likely that most agencies would have some fat to cut (while still delivering things the government says it wants/needs). Whether that is still the case must be an open question. No doubt agency CEs – under tighter fiscal rules than, say, the Reserve Bank (see last week’s post) – will ensure that their departments stay within their budget, whatever it is set at. But at what point do inroads start being made in capability? It certainly isn’t as if economywide productivity growth is running at 2 per cent per annum.

It would all be a great deal more reassuring if there were specific announced things the government was no longer going to do. But, for example, all the subsidies in the system still seem to be continuing.

And finally, a reminder of the starting point. In my post last week I included this chart

As a reminder, this used the 2024 HYEFU and 2025 BPS as the base for the New Zealand fiscal data.

When I was writing that post last week I remembered writing some similar critical pieces in the run-up to the 2023 election, where the numbers were based on the then Labour government’s stated fiscal plans. The October 2023 IMF Fiscal Monitor came out just a few days prior to the election. This was the same chart – for structural primary balances – for 2024, as published in that edition.

In relative terms, we had the 5th worst structural deficit forecast then and have the worst now (maybe second worst with this morning’s announcement). In absolute terms, the IMF’s October 2023 estimate of the structural primary deficit for 2024 was 3.4 per cent of (potential) GDP. Last week’s new IMF estimate for the structural primary deficit for 2025 was 3.7 per cent of (potential) GDP.

To repeat a point from last week’s post, these are not operating balance measures but rather encompass all (non-interest) spending and revenue. The lines between opex and capex are often very blurry and malleable in government accounts, and not only does it often make sense to look at overall primary balances rather than operating ones even when looking at just your own country, it is only way in which meaningful cross-country comparisons can be done.

The fiscal bottom line still appears to be that things are no better, in structural cyclically-adjusted terms, than they were 18 months ago, and may even be worse. We should no doubt be thankful for small mercies – this morning’s announcement may be one – but the outstanding imbalances are large and do not yet seem to being addressed seriously. Those imbalances are bad, both absolutely and in international comparison terms. They are political choices. Unfortunate ones.

17 thoughts on “A pre-Budget speech”

  2. I had to ask ChatGPT to explain the term Primary structural deficit = local and national government underlying overspending, ignoring interest costs and temporary booms/slumps.

    As someone who uses the MMT lens the immediate question that jumps out to me is how is this possible? How can someone spend more than their total revenues from all sources – before receiving loans?

    It’s only possible because the government can create and spend money before revenues and loans are received. It is the process that creates new money and unlocks economic growth as productivity and or population increases.

    The money supply and the real economy are intrinsically linked, and government spending is a primary and foundational source of the new money that is needed to facilitate private sector surplus and savings.

    If you contract government spending (and it doesn’t matter how frivolous you think it is) you contract the money supply and depending on where you are in the economic cycle that will have different effects.

    Last year economic forecasts under-estimated the impact of cuts to government spending and the multiplier effect by at least 1% in most cases – the same thing will probably happen again this year.

    So – if we accept that the above is likely in NZ that means the economy will be smaller and tax revenue lower meaning the structural deficit is likely to increase in size.

    It is the great paradox of government spending – when you reduce it you typically reduce revenue as the ripple effect of a reduced money supply and the lowered economic potential fans out into the private sector.

    Every dollar of government spending is spent in the private sector – every public servant and contracted firm spends their money in the private sector. Every road, hospital and school are built by firms and contractors in the private sector etc.

    A government operating surplus means the public sector is removing more money than it creates from the private sector in a given time period. The private sector has to then draw down savings or take on debt to counter act a private sector deficit.

    Another austere budget in May will deliver much lower than forecast growth in NZ – unfolding as it did in 2024.

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    • That was a lot of words to say:

      public sector surplus = private sector deficit

      surplus = tax revenue (destroys money) > government spending which creates new money

      Consequently, there is a shrinking money supply in the private sector over time. Which means less savings and more private sector debt are needed or the economy contracts.

      An operating surplus is a necessity in a fiat currency system primarily because the government is not terminal like you or I (who may pay off our mortgage within our lifetime). The government cannot because it is spending for all generations not just the ones who’ve paid off their mortgage. I.e. the government is paying the mortgage for our children and grandchildren not just those of us paying taxes

      The government is forward paying into the future to provide the assets that it will need to own in the future for people who are currently in pre-school. Exactly the same as you or I do when we are younger and working to support a family and raise children. There is always a younger in the economy that the government is responsible for.
      Now that to me is a much better explanation of a government deficit.

      Is there an example of a successful modern economy that has run surplus for an extended period of time? I believe it was achieved in NZ in the 90’s but employment went above 10% for a long time.

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      • On your final question, a balanced budget is usually sufficient (at least in a growing economy) so one wouldn’t really expect large surpluses over long periods (altho an exception is Norway, with resource revenues). In NZ the period when unemployment was v high in the early 90s was actually when the budget was still in deficit (the unemployment was mostly a response to the restructuring of the economy and removal and protection and the monetary policy required to get inflation durably and substantially down).

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      • Thanks Michael. I don’t actually know a huge deal about the 90’s other than things were very different economically and huge changes were continuing to be made. Government surpluses are more complex than I suggest above because a trade surplus is another way of creating new money in your economy and I think there was an export boom for NZ in the 90’s so that would have helped.
        It will be interesting to watch how economies like Germany and Japan respond to their shrinking trade surplus over the coming years. Germany has already gone Keynesian with billions in ‘defense’ spending. ‘Defense spending’ is, also, how the US does Keynesianism – a trillion dollars a year. No wonder they’ve outpaced their peers since the GFC in terms of economic growth.

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    • Sorry, but at least from the Tech Sector’s perspective, this is not correct “Every dollar of government spending is spent in the private sector – every public servant and contracted firm spends their money in the private sector.”

      Govt and local body tech procurement in NZ is a disgrace when cf other advanced economies; esp the smaller ones (still larger than NZ).

      Years ago, they realised a thriving local tech sector would help the drive towards a hi wage economy.

      But here, they get convinced (perhaps by biased consultants, who gain from it) that they should spend more to “buy foreign” even when the software systems are less suited to local requirements (as well as being way more expensive). Auck CC and ChCh CC, along with many Govt agencies, are guilty of being conned into EPR systems = single-supplier agreements. When I explained this to Dr Deborah Russell (when she was in power) she reacted by suggesting it seems a buyer-created monopoly, that sb illegal!

      So, it’s probably well over $1Bn that does straight overseas due to public sector tenders that exclude Kiwi businesses.

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      • Thanks Noel. I agree with you on this – governments always have a choice on how they use fiscal policy and local spending is ideal. However, there might be scenarios were overseas skillsets or scale is needed. But long-term thinking would aim to build, over time, and retain the skillsets and scale we need. That’s hard to do – especially in a small country with a dispersed population like NZ.

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  3. “But, for example, all the subsidies in the system still seem to be continuing.”

    I’m with you – I so wish we could find a leader with a more bold vision of forward transformation. And I’m curious, Michael, as to what you think the subsidies that most need addressing are.

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