Just a few things caught my eye flicking through yesterday’s HYEFU summary tables – if you don’t count points like the fact that The Treasury projects we will have had five successive years of operating deficits (in a period of a high terms of trade and an overheated economy), and that net debt as a per cent of GDP (even excluding NZSF) is still increasing, notwithstanding the big inflation surprise the government has benefited (materially) from.
This chart captures one of the things that surprised me. It shows export volumes and real GDP, actual and Treasury projections. Exports dipped sharply over the Covid period (closed borders and all that), but even by the year to June 2027 Treasury does not expect export volumes to have returned either to the pre-Covid trend, or to the relationship with real GDP growth that had prevailed over the pre-Covid decade.
The Reserve Bank does not forecast as far ahead as the Treasury but has quarterly projections for these two variables out to the end of 2025. Here is a chart of their most recent projections
It is a quite dramatically different story.
The issue is here is not so much who is right – given the vagaries of medium-term macro forecasting there is a fair chance that none of those four lines will end up closely resembling reality – as that the government’s principal macroeconomic advisers (The Treasury) have such a gloomy view on the outward orientation of the New Zealand economy. One of the hallmarks of successful economies, and especially small ones, tends to be a growing number of firms footing it successfully in the world market. Earnings from abroad, after all, underpin over time our ability to consume what the rest of the world has to offer. Quite why The Treasury is that pessimistic isn’t clear from their documents – one could guess at various possibilities in aspects of government economic policy – but it does tend to stand rather at odds with the puffery and empty rhetoric the PM and Minister of Trade are given to.
Then there was this
On Treasury forecasts the CPI in 2025 will have been 13.3 per cent higher than if the Reserve Bank had simply done its core job and delivered inflation on average at 2 per cent per annum (the Reserve Bank’s own projections are very similar). It is a staggering policy failure – especially when you recall that the Governor used to insist that public inflation expectations were securely anchored at around 2 per cent. It is an entirely arbitrary redistribution of wealth that no one voted one, few seem to comment on, and no one seems to be held to account for, even though avoiding such arbitrary redistributions (benefiting the indebted at the expense of depositors and bondholders) was a core element of the Reserve Bank’s job. We don’t – and probably shouldn’t – run price level targets, but let’s not lose sight of what policy failures of this order actually mean to individuals.
And the third line that caught my eye was this
A good question for the National Party might be to ask how much of this 3.5 percentage point increase in tax/GDP they intend to reverse, and how, or would any new National government simply be content to leave little changed what Labour has bequeathed them?
As longer-term context (slightly different measure to get back to the 70s) the only similarly large increases in tax/GDP seem to have been under the 1972-75 and 1984-90 Labour governments.
A conversation about the similarities and differences between taxes and social security contributions – my son is studying economics – prompted me to head off to the OECD website and get the data on total taxes and social security contributions as a share of GDP.
Here is what I found for 2021 (the OECD didn’t have this level of data for its Latin American members, and I omitted Ireland and Luxembourg, as their GDP numbers aren’t a suitable basis for these purposes).
That is the snapshot for the most recent year, 2021, and here is how New Zealand has compared to Australia and to the OECD median (countries in the first chart) for the period back to 1995 when the data are comprehensive.
To be honest, I was a little surprised. I guess time passes and impressions need updating from time to time: the story I had been walking around with (probably formed a decade ago) was that New Zealand tax revenue as a share of GDP fluctuated around the OECD median. It used to but, whether under National or Labour-led governments, it hasn’t done so for some time now. It isn’t that taxes are trending down in New Zealand – as a share of GDP in 2021 they were about the same as in the first couple of years of the Clark government but (a) the contrast with huge surge in tax revenue in the 00s is striking, and b) the OECD median has been edging up.
Of course, Australia is an important comparator, given the number of New Zealanders who look at making – and often do make – the move to Australia, and there is not much consistent sign of a change in the relationship between the two countries’ tax/GDP shares. And the Anglo countries have tended to be lower taxers than continental Europeans, and of the five Anglo countries we were the median taxer in 2021. Whatever one thinks of the US, Australia is hardly some unliveable hellhole (certainly the New Zealanders who move there don’t think so), although neither is it some star productivity growth performer.
Opposition parties seem to be making a fair amount of noise about tax as we begin to head towards next year’s election. And in many respects I sympathise: I find it hard to think of a single one of the tax increases put in place in recent years that I thought there was a good economic case for, and the fiscal drag that results from not indexing income tax thresholds is just bad policy at any time. We tax business too heavily, whether under National or Labour.
But…..you have to identify the things you don’t want governments spending money on, and that is where our main Opposition party seems to struggle.
The picture is, if anything, a little more stark if we shift from taxes and social security contributions to total current revenue. Natural resources owned by the state are part of the picture here (see Norway in this chart vs the first one above)
On this measure, we are even more firmly to the left of the chart.
(Incidentally, there is a line – that I probably thought had merit – that we don’t need quite such high taxes because our public debt is low. But the OECD database had net interest data, and we turned out to have been the median country last year. (Low central government debt, but persistently high relative interest rates I guess)
All this data has been taken from the OECD. There is some IMF data, and for a wider range of advanced countries. I don’t put a great deal of trust in the IMF numbers (too often I find NZ numbers that look odd), but they do capture places like Singapore and Taiwan.
But here is the IMF’s total general government revenue data, for 2021
On this measure and this group of countries we are somewhat further from the left. And if (like me) you aren’t overly interested in underperforming Mexico, Chile, and Colombia, note nonetheless the really low revenue/GDP numbers for Taiwan and Singapore. One can have a highly productive economy (both countries now have materially higher GDP per capita than New Zealand) with a materially low overall share of government revenue and/or taxes.
I focused on taxes in this post because (a) that is where the political debate seems to be, and (b) because in 2021 government spending was much more thrown about by Covid one-offs than tax revenue was. In the longer-run, it is the level of spending that determines how high taxes eventually will need to be. Over the recent decades New Zealand governments have had a good record of returning to balance or surplus whenever shocks push the budget into deficit (which means we are one of a minority of OECD countries like that, and very unlike say the US and UK where deficits have been normalised). But note that – with an overheated economy, and thus cyclically high revenue – we are not projected to be at balance or in surplus this year.
(And to anticipate questions as to what I would cut were I granted a magic wand, here are the first five that come to mind: Kiwisaver subsidies, fees-free first year tertiary education, R&D subsidies, the accommodation supplement (having freed up peripheral land and collapsed house/land prices), and NZS (raise the eligibility age to 68 in the next five years not the next 25). But realistically I do not expect New Zealand wil operate with a lower tax or revenue to GDP share than it has now.)
When the National-led government took office in late 2008, the government’s books were in something of a mess. The Treasury’s projections were for operating deficits of 2 to 3 per cent of GDP each year over the forecast horizon. Since the mid 1990s, under governments led successively by National and by Labour, there had been 14 years in succession of OBEGAL surpluses (a very very small one in the June 1999 year). After all those surpluses there was, of course, not much debt (the Decenber 2008 HYEFU shows net Crown debt for the just-completed year at 0.0% of GDP). It certainly wasn’t, in any substantive economic sense, a fiscal “crisis”, but it was pretty substantially unsettling, both politically and at The Treasury (where I was working at the time).
There was a great deal of rhetoric about Michael Cullen, Minister of Finance in the outgoing government, having squandered the fruits of the boom years, and bequeathed a “decade of deficits” (some contemporary political stuff is here).
Over the years I have defended Cullen in a couple of posts (here and here), particularly centred on the 2008 Budget delivered on 21 May 2008. There is no doubt it was an(other) expansionary Budget. As a share of GDP, core Crown expenses were projected to increase from 31.8 per cent of GDP in 2007/08 to 33.4 per cent in 2008/09. The operating balance was projected to drop from a surplus of 2.9 per cent of GDP to one of 0.7 per cent of GDP (dropping away further to tiny surpluses later in the four-year forecast horizon). Against a backdrop of above-target core inflation, it is wasn’t exactly helpful in terms of macroeconomic balance, but in purely fiscal terms it was hard to argue against it very strongly. Recall that in the New Zealand system, ministers set fiscal policy (tax and spending choices), but the Secretary to the Treasury has independent personal responsibility for the fiscal and economic forecasts. The best professional advice the then-government had was that their fiscal policy was consistent with continuing to avoid deficits over the forecast horizon. And the initial level of public debt was untroublingly low.
It was, of course, election year. After 8.5 years in office, Labour was by then running well behind in the polls. One might expect taxpayers’ money to be thrown around with a bit more abandon than usual, but – in purely fiscal management terms – The Treasury assessment told them it was okay.
What were the projections like? By most reckonings it was an overheated economy. The latest unemployment rate available when the numbers were being finalised was 3.4 per cent (lowest of that cycle, lowest for a generation). Core inflation was running above target. Output gap estimates were typically positive. And the terms of trade – boosting nominal GDP and tax revenue – were at fresh record highs.
Treasury expected the economy to slow down. GDP growth over the 12 months to March 2009 was forecast to slow to about 1.5 per cent and over the following couple of years the unemployment rate was expected to rise back to about 4.5 per cent. With a Governor who wasn’t very focused on the midpoint of the inflation target, inflation was expected to remain right near the top of the target range, but ministers (and the public) were told there was likely to be room for the OCR to fall somewhat over the forecast horizon.
It was the sort of environment in which standard fiscal policy advice would be that it was appropriate to be running an operating surplus – not necessarily a large one, but a surplus. And Treasury advised that the government’s tax and spending plans were consistent with continuing to deliver surplus (headline and in cyclically-adjusted terms).
They were, of course, bad forecasts – bad economic forecasts translating into badly-wrong fiscal forecasts. The economic forecasts were completed using data up to 15 April 2008, but by then the financial system stresses abroad had been headline material for months, and oil prices were rocketing upwards towards their peak – higher even in nominal terms than anything we’ve seen this year – reached in July 2008. But if we don’t always expect ministers to agree with Treasury advice or even Treasury forecasts, the published fiscal projection numbers rely on exactly those forecasts (and there is no sign at the time that ministers had a wildly different view). It is fair to note that opinion shifted fast that year – the Reserve Bank’s June Monetary Policy Statement forecasts were finalised on 26 May 2008 (just a few days after the Budget was delivered): they saw the unemployment rate climbing back to 6 per cent over their forecast horizon, but even they – taking fiscal policy as given, but applying their own economic outlook – didn’t see looming fiscal problems.
My point re 2008 is that you can criticise that Budget if you want, but really – given the combination of economic forecasts from The Treasury, and the government’s polling plight – it still looks quite impressively restrained, in some ways a testimony to the 15-year record built up by then of a presumption towards a balanced operating budget (at least) or a surplus. Of course, the more left-wing among Labour’s supporters didn’t much like that presumption – they’d talk about missing out on opportunities etc – but (inaccurate as they were to be) looking through those June 2008 Reserve Bank forecasts, at the time they saw the policy and economic environment as consistent with 2 per cent annum productivity growth.
Against that benchmark of avoiding deficits – at least outside crises – Labour in 2008 might have done something close to “spending it all” (Muldoon’s claim of his 1972 pre-election Budget), but if Labour was going to lose that year, they thought they would still be bequeathing a small surplus. After 14 successive years of surpluses. Debt was projected to rise a bit – lots of capex planned – but, four years out, was forecast to be about 6 per cent of GDP. That 2008 Budget continued the track record, under both governments, of not projecting an operating deficit.
The contrast between Clark/Cullen that year and Ardern/Robertson this year is striking.
Now, in part, the climate has changed. We have become accustomed to deficits once again. Of the last 14 fiscal years, there have been operating deficits in eight of them. Some of that is to have been expected. In the 14 years from 1994 to the 2008 Budget, there had been only a single mild recession in New Zealand and no great natural disasters. By contrast, since 2008 we have had a serious (double-dip) recession in 2008/09/10, the big fiscal cost of the Canterbury earthquakes, and most recently the pandemic and associated severe disruptions to economic activity.
But what hadn’t changed – at least until now – was that governments projected to run balanced budgets or surpluses at times when The Treasury estimated that the economy was pretty full-employed, or even overheated. Now, you might push back that the sample is pretty small – on most metrics, there was excess capacity in the economy (negative output gap, lingering high unemployment, sluggish core inflation) for most of the decade after 2008.
But how about Robertson’s second Budget, in 2019? For the 2019/20 year, then just about to start, Treasury projected a small positive output gap (0.3 per cent of GDP), an unemployment rate (4.0 per cent) evidently a little below their view of the sustainable rate, and inflation was projected to be bang on the target midpoint. The government’s fiscal policy choices led Treasury then to project an operating surplus of 0.4 per cent of GDP. Tiny, but still positive. Focusing only on the macroeconomics, one couldn’t really complain. It all looked pretty prudent.
That was the, just three years ago. This is now – same Minister of Finance, same Prime Minister. The macroeconomic environment – at least per the Treasury’s estimates and projections, which the government showed no sign last week of questioning or disowning – has changed, but in ways that materially improve the government’s expected fiscal position. The output gap, for example, is estimated at 2.1 per cent of GDP in 2022/23. The unemployment rate is expected to average about the current 3.2 per cent (evidently well below The Treasury’s view of sustainable), we’ve had a huge upside surprise on inflation, and if the terms of trade are not making new record highs, in 2022/23 they were expected to hang around the very high level of recent years (see chart above).
Not a month ago the Minister of Finance announced his new fiscal rules. The first of them was this
Surpluses will be kept within a band of zero to two percent of GDP to ensure new day‑to‑day spending is not adding to debt.
It was, on paper, good stuff. Except that it doesn’t apply now, only in some future era beyond the next election. Because this Budget (for 22/23) projects an operating deficit of 1.7 per cent of GDP, despite all those (projected) overheating economy indicators. In cyclically-adjusted terms, it is probably a deficit of getting on for 3 per cent of GDP – just miles away from the Minister’s own good-stewardship benchmark. Brings to mind St Augustine: “Give me chastity and temperance—but not yet”.
It isn’t as if there is some Covid excuse for these big projected cyclically-adjusted deficits. No more lockdowns (and wage subsidies or equivalent) are planned, MIQ is all-but gone and…….if the sectoral pattern of activity is still different (not many foreign tourists yet, and Treasury projections in which foreign trade remains lower as a share of GDP) the economy is (more than) fully-employed. And on Treasury’s view, inflation remains above target for several years to come.
It is just cavalier – political management rather than responsible economic or fiscal management. And it isn’t even election year yet. When Muldoon in 1972 talked of “having spent it all”, and Cullen in 2008 acted in ways that one might reasonably suggest were much the same, they both probably thought the political odds were against them, that any problems would most likely fall to the opposite party soon to take office (and even if not, there would be three years to sort things out), this time it looks a lot like Robertson and Ardern have done it to themselves, and that fiscal chickens could come home to roost just a few months out from next year’s election. Unless, that is, they are really just giving up on the notion of a balanced operating budget – an idea which shouldn’t be that controversial (see the Minister’s own embrace of the principle).
Take a couple of other contrasts with 2008. By then, for example, the OCR was widely believed to have peaked already (at 8.25 per cent reached in June 2007) and attention was beginning to turn to when, and to what extent, the OCR might eventually be cut. And, to the extent the economy was overheated it was the culmination of a build-up of pressures over years – a fairly long and sustained economic expansion. Oh, and public debt had been steadily falling every year since 1992. Depending on your precise measure, it was basically zero (a little lower even than at the time of the 1972 Budget).
By contrast, Treasury now tells the government to expect lots more OCR increases (so looser fiscal policy is directly working against monetary policy), public debt – while still low by international standards- has risen a lot in the last couple of years, and the overheated economy at present, while real, was sudden, is ill-understood, and could have some distinctly evanescent aspects to it. You might not think it was time for savage structural fiscal tightenings – and I would probably agree – but it certainly isn’t time for choosing to move deeper into cyclically-adjusted deficits. And the precedent it sets for future governments is not exactly welcome – perhaps they too will commit to surpluses only beyond their own electoral horizons.
All the discussion of this year has been premised on The Treasury’s economic forecasts. They were what ministers had in front of them, and they were not disowned by Robertson in delivering his Budget last week. But they have a distinctly rosy tinge to them – I doubt if The Treasury was finalising them now they would be as upbeat – and it is very easy to envisage a much-worse outlook, not just for the medium-term but from now through to the election. Significant core inflation problems have very rarely if ever been resolved without a recession – and such recessions are rarely of the nature of two quarters of -0.1% growth. It isn’t “necessary” – soft landings are hypothetical possibilities, but achieving a fabled soft-landing assumes a state of knowledge (and ability to fine-tune tools) that is evidently rarely – and perhaps especially unlikely at present, since if governments and central banks had the level of knowledge required we should not have been in this overheated inflationary mess in the first place. That isn’t a criticism of any individual or agency, but an observation about the evidence of our eyes – here and abroad – over the last couple of years.
There was a famous line from the US 1988 vice-presidential debate. Senator Dan Quayle, the Republican nominee, had noted that he had as much congressional experience as Kennedy had had when he ran for President. But the memorable line of the night was Senator Lloyd Bentsen’s response
“Senator, I served with Jack Kennedy. I knew Jack Kennedy. Jack Kennedy was a friend of mine. Senator, you’re no Jack Kennedy.“
It came to mind when thinking about the contrast between Michael Cullen and Grant Robertson. One, miles behind in the polls, nonetheless projected surpluses (on best professional macro forecasts) in his last Budget. The other, on projections (valid or not) of an even more overheated economy, with more severe inflation problems, having already overseen (somewhat inevitable) increases in public debt) drops into significant projected deficits – complete with gimmicky handouts. And it isn’t even election year yet.
From a macroeconomic point of view, that title for this post really sums things up nicely.
Take policy first. The government has brought down a Budget that projects an operating deficit (excluding gains and losses) of 1.7 per cent of GDP for the 2022/23 year that starts a few weeks from now. Perhaps that deficit might not sound much to the typical voter but operating deficits always need to be considered against the backdrop of the economy.
Over the last couple of years we had huge economic disruptions on account of Covid, lockdowns etc, and fiscal deficits were a sensible part of handling those disruptions (eg paying people to stay at home and reduce the societal spread of the virus). Whatever the merits of some individual items of spending over that period, hardly anyone is going to quibble with the fact of deficits.
But where are we now (or, more specifically, where were we when Treasury did the economic forecasts that underpin yesterday’s numbers, and which Cabinet had when it made final Budget decisions)? Treasury has the terms of trade still near record highs, it has the unemployment rate falling a bit further below levels the Reserve Bank has already suggested are unsustainable, and over 22/23 it expects an economywide output gap (activity running ahead of “potential”) of about 2 per cent of GDP. In short, on the Treasury numbers the economy is overheated. And when economies are overheated revenue floods in. Surprise inflations – of the sort we’ve seen – do even more favours to the government accounts in the near-term: debt was issued when lenders thought inflation would be low, and although the revenue floods in (GST and income and company tax), it takes a while for (notably) public sector wages to catch up. On this macro outlook, the government should have been making fiscal policy choices that led to projected surpluses in 22/23 (perhaps 1-2 per cent of GDP), consistent with the idea – not really an right vs left issue – that operating balances, cyclically-adjusted – should not be in deficit. Big government or small govt, on average across the cycle operating spending should be paid for tax (and other) revenue.
Instead in an economy that is grossly overheated (on the Treasury projections) the government chooses to run material operating deficits. It is the first time in many decades a New Zealand government (National or Labour) has done such a thing, and should not be encouraged. It risks representing slippage from 30 years of prudent fiscal management by both parties, and once one party breaches those disciplines the incentives aren’t great for the other once it takes office.
And this indiscipline isn’t even occurring in election year (and already I’m getting an election bribe). It is fine to talk up projections of smaller deficits next year, but slotting a number in a spreadsheet is a rather different than making the harder spending or revenue decisions to fit within those constraints. Perhaps they’ll do it. Who knows. The political incentives may be even more intense by then. And the economic environment could be (probably will be) quite different.. What any government should be directly accountable for is their plans for the immediately-upon-us fiscal year.
You will hear people suggest that fiscal policy isn’t anything to worry about. Some like to quote The Treasury’s fiscal impulse measure/chart. But it just isn’t a particularly useful or meaningful measure at present (at least unless you line up against it a Covid “impulse” chart). But even if you want to believe that the overall direction of fiscal policy wasn’t too bad – and my comments on the HYEFU/BPS were not inconsistent with such an interpretation – the real impulse we should be focused on is how near-term fiscal policy has changed since December.
In December, the operating deficit for 2022/23 was projected at 0.2 per cent of GDP (allow for some margins of uncertainty and you could call it balanced). Now the projected deficit is 1.7 per cent of GDP, in an economy projected to be even more overheated that was projected in December.
What about spending? Well, here are the projections for core Crown spending. Back in December the government planned that spending in 22/23 would be a lot lower than in 21/22 (which made sense since no more expensive lockdowns were being planned for). Yesterday’s projections for 22/23 are $6.8bn higher than what was projected only six months ago – and only about a billion less than last year’s heavy Covid-driven spending.
Some of it is inflation, but whereas in December Treasury projected that spending would be 30.5 per cent of GDP, now it is projected to be 31.6 per cent of GDP. It is a lot more spending and, all else equal, a lot more pressure on the economy and inflation. In case you are wondering, in both sets of projections tax revenue is projected to be 28.9 per cent of GDP.
Perhaps there is a really robust case for all this extra spending, making it so much more valuable and important than the private spending that will have to be squeezed out. But the evidence for any such claim is slight to non-existent, and the general presumption should be that if you want to spend a lot more you do the honest thing and make the case for higher tax rates. Instead, the Cabinet has chosen operating deficits amid a seriously overheated economy. It is cavalier and irresponsible.
That is policy, things ministers are directly accountable for. But there is also a full set of economic projections, amid which there are some quite disconcerting numbers. Now, before proceeding, it is worth stressing that these economic projections were finalised a long time ago, on 24 March in fact. If anything, that only makes things more concerning.
Here are The Treasury’s inflation forecasts
You will recall that the government has given the Reserve Bank an inflation target range of 1-3 per cent per annum but with an explicit instruction to focus on the midpoint of that range, 2 per cent annual CPI inflation. You should be aware that monetary policy doesn’t work instantly, with the full effects on inflation of monetary policy choices today not being seen for perhaps 18 months or even a bit longer. You should also be aware that The Treasury (and other forecasters) generally don’t include future supply etc shocks in their forecasts, because they are basically unknowable (and could go either way). So (a) any annual inflation forecasts more a few quarters ahead will be wholly a reflection of fundamentals (expectations, capacity pressures, and perhaps some small exchange rate effects), and (b) any forecast annual inflation rate 18 months or more ahead is almost wholly a policy choice. Actions could be taken now to get/keep inflation around the midpoint of the target range.
But Treasury forecasts inflation for calendar 2023 at 4.1 per cent – as it happens reasonably similar to many estimates of core inflation right now – and 3.1 per cent for calendar 2024 (December 2024 was the best part of 3 years ahead when Treasury finished the forecasts). Only at the very end of the forecasts – four years away – is inflation back to 2.2 per cent, close enough to the target midpoint that we might reasonably be content. It is a choice to forecast that the Reserve Bank’s MPC will simply not be serious in showing any urgency in getting inflation down, and seems barely to engage with the risk of entrenching expectations of higher future inflation. If one takes the annual numbers on the summary table, it is still a couple of years before they even expect the Reserve Bank to be delivering an OCR that is positive in inflation-adjusted (real) terms.
Now, The Treasury does not set the OCR, the Reserve Bank does that. But the Secretary to the Treasury is a non-voting member of the MPC, The Treasury is the government’s chief adviser on macroeconomic policy including monetary policy targets and performance. And they finished these projections two months ago, and will have shared them with the Minister of Finance and with the Reserve Bank. At very least, there should have been a “please explain” from the Minister to the Governor/MPC. Treasury might have been quite wrong, but if so the Bank should have had a compelling response. But it doesn’t seem likely that anything of the sort happened, and you may recall that when the Bank last reviewed the OCR they explicitly said they weren’t seeing any more inflation than they’d projected in February.
The Treasury numbers are doubly disconcerting because – finished in March – they are persistently higher than the expectations (late April) of the Reserve Bank’s semi-expert panel in the quarterly survey. For the year to March 2024, the survey of expectations reported expected inflation of 3.3 per cent, but The Treasury projects 3.8 per cent inflation.
Now, maybe this will all be overtaken by events. The forecasts were completed in late March, and since then the economic mood – here and abroad – has deteriorated quite markedly, with a growing focus on the likelihood of a recession (almost everywhere significant reductions in core inflation have involved recessions). Quite possibly, if the projections were being done today they would be weaker than those published yesterday (and the RB’s will be finalised about now) But I hope journalists and MPs are getting ready to compare and contrast the RB and Treasury forecasts and to ask hard questions about the differences.
Soft-landings rarely ever happen once core inflation has risen quite a bit (as it clearly has this time). That doesn’t stop forecasters forecasting them, but if forecasters knew the true model well enough we probably wouldn’t have had the inflation breakout in the first place. I was, however, particularly struck by The Treasury’s quarterly GDP growth forecasts, which ever so narrowly avoid a negative quarter in Q3 next year (as the election campaign is likely to be getting into full swing). I’m not suggesting Treasury overtly politicised the forecasts, but had they assumed a monetary policy reaction more consistent with returning inflation to target quickly (say, under 3 per cent for 2023, which seems a reasonable interim goal at this point), the headlines might have been rather different.
I’m going to end with two charts that have little or nothing to do with short-run macroeconomic policy management.
This one shows The Treasury’s projections for (nominal) exports and imports as a share of GDP.
Of course, with closed borders for the last couple of years we saw a sharp dip in both exports and imports as a share of GDP. But the end point for these projections is four years ahead. For both imports and exports, the shares settle materially below pre-Covid levels, in series that have been going backwards for decades. No doubt the Greens would prefer we all stopped flying, but successful economies have tended to feature – as one aspect of their success – rising import and export shares of GDP.
The Budget talked of a focus on creating a “high wage economy”. Sadly, all I could see in the documents that might warrant that claim was the expectation of continued high inflation – which will raise nominal wages a lot, but do nothing for actual material living standards.
One of the striking features of the last decade was how relatively weak business investment as a share of GDP had been. Firms invest in response to opportunities, and the absence of much investment is usually a reflection on the wider economic and policy environment (much as bureaucrats like to think they know better, few firms just leave profitable opportunities sitting unexploited). For what is worth – and all the corporate welfare notwithstanding – The Treasury doesn’t see the outlook for business investment any better this decade than last.
And so in time will pass yet another New Zealand government that has done nothing to reverse decades of productivity growth underperformance. If that is depressing enough, this government seems to be in the process of unravelling the foundations of what had been a fairly enviable reputation for fiscal discipline and overall macroeconomic management. The situation can be recovered, but there is no sign in this Budget that the government much cares. And it isn’t even election year yet.
No posts last week between some mix of the war news (including related economics and financial markets news) being more interesting, and Covid – in our house that is. Not being too sick, but not being entirely well either I wasn’t concentrating very hard for very long. Fortunately, the isolation is now half over and no one’s health is particularly concerning. So back to some domestic economics and policy.
The leader of the National Party yesterday gave what he billed as a “State of the Nation” speech. You can read it all here. It was, however, largely a tax speech. And – and I say this as someone who would really really like to be able to vote for National – it was pretty disappointing.
It wasn’t that I disagreed with any of the tax ideas – none of them very radical anyway. So when he committed to repealing “each of these new taxes implemented by Labour”
I was quite pleased. On Radio NZ this morning he also committed to getting rid of the “ute tax” as well, and I was pleased to hear that as well. One might debate the merits of some of these measures at the margin (eg I’d be happy to limit interest deductibility – for all businesses – to real interest, not nominal), but none of them really represented good tax policy, and they make the economy work less efficiently.
I was also quite keen on the idea of adjusting income tax thresholds to take account of inflation since 2017 (although would be rather keener if that included a commitment to legislate indexation of the thresholds as a permanent feature of the income tax system). That is simply fairly good tax policy.
So far, so positive, although do note that all these proposals involve turning back the policy clock to 2017. National was the government then, so no doubt they look back fondly on that time. But our structural economic performance (productivity growth, business investment etc) wasn’t much chop then – as Labour then used to point out, before becoming indifferent to such trifles when in office, and implementing policies – and running into circumstances – that are likely to have made things worse.
My concern is the fiscal and macroeconomic aspects of what National is saying – in Luxon’s speech yesterday, and (on the other hand) in every second parliamentary question for weeks.
Of all those tax promises listed above, only the one-off indexation of the income tax thresholds is costed, presumably because they are actively calling for the government to adopt this proposal in this year’s Budget.
National has been trying to make a thing of the size of the operating allowance ever since it was announced in December. But doing so isn’t entirely straight. Here a couple of paragraphs from my post at the time
To illustrate the practical implications, here is a chart from that post.
The simplest explanation is simply that when there is a lot more inflation, things cost a lot more – the same bundle of goods and services (or real transfer) cost more – and the way the government’s systems are set up, most of that “cost more” has to be met through the operating allowance. I thought it was a daft system when I worked at The Treasury, and I still think it is a daft system – presentationally – but it is the system and both National and Labour-led governments have used it. When inflation is very low (eg undershooting the target), operating allowances can be low without any great austerity, and when inflation is very high (eg overshooting the target, operating allowances can look (and be) very high without any great fiscal extravagance. As the graph shows, if the government keeps to the plans announced in December, government spending will be falling (modestly) as a share of GDP over the next few years.
And what has happened (and is forecast to happen to) the price level?
When the current government Budget, and appropriations, were decided, Treasury thought that the price level (CPI) by June 2023 would be 6 per cent higher than it was in June 2020. By HYEFU time – when they decided on the operating allowance – they thought the increase would be 11.9 per cent. We don’t have new Treasury forecasts, but the Reserve Bank’s MPC published forecasts recently (and recall that the Secretary to the Treasury sits on the MPC) and they expected a 12.7 per cent increase. It isn’t impossible that events of the last 10 days – including last week the biggest weekly rise in commodity prices in 50 years – will have pushed those numbers higher again.
Things will cost more. That is true of things you and I buy (a point Luxon has, fairly, been keen to stress) but it is also true of things the governments buys or spends money on.
A very large proportion of that $6 billion operating allowance will be required simply to keep real spending at the levels the government had in mind in last year’s Budget. It is a really big price level shock, at a time when – almost every year – nominal GDP is at record highs, so it is hardly surprising that the operating allowance is itself a record high. It tells one nothing about fiscal profligacy. I suspect Labour is already finding putting together this year’s Budget quite a bit harder than they planned in December – harder that is if they are going to stick to the $6 billion.
I’m not suggesting that when the $6 billion was announced in December there was no room for new government discretionary initiatives. I’m quite sure there was (as pretty much every government ever has done). And it is quite likely that adjusting the income tax thresholds – for that big price level shock – is at least as good a use as whatever Labour has been cooking up. But……as the graph shows, Labour’s spending plans for the next few years were hardly looking reckless.
Here it is also worth repeating that National has not offered costs, or funding ideas, for their other tax promises. For some it doesn’t matter – the “Light Rail Tax” is vapourware at present anyway – but we know that the 39 per cent rate is pulling in a lot more people than initially envisaged, and probably a fair amount of money. Unless National proposes to run larger deficits/smaller surpluses in the out-years than Labour is planning/forecasting, the money needs to come from somewhere – presumably lower (than otherwise) government spending.
National has for months been running the line that high government spending is to blame for much of the surge in domestic inflation. I’ve been quite sceptical (and critical) of that view, including in a couple of recent posts, here and here).
If were a serious line of attack – as distinct from something that looks a lot like rank opportunism – one might have supposed Luxon and his party would be identifying significant areas where they would cut government spending. But this all they had to say
I’m not a fan of any of those policies, although it is hard to conclude that either the water system or the health system are just fine as they are, and (at least as far as I’m aware) daft as the “underground tram” might be, little is yet being spent on it, so it isn’t an explanation for the inflation we are now seeing. There was reference to welfare dependency – and again I agree it is a real issue – but no concrete ideas for materially cutting those outlays.
So we seem to be left with:
claims that high inflation – even high domestic inflation – are substantially the responsibility of high government spending, but (a) no serious analysis in support of the proposition, and (b) no substantial or material proposals for cutting government spending now, and
for the future, tax cuts promises that, while individually sensible and perhaps even laudable, aren’t supported either by burgeoning projected surpluses or by even a hint as to what expenditure will be cut (bearing in mind that demographic pressures on spending are likely to rise, not fall).
At best, even in the shorter-term we are left with an Opposition that wants to run no smaller deficits than Labour (operating to the same operating allowance for the coming year), and – on the things actually announced yesterday – smaller surpluses or larger deficits than Labour in the years to come. And all this while standard macroeconomic forecasters will put MUCH more weight on deficit/surpluses (and changes in them) as an influence on aggregate demand – something the Reserve Bank needs to respond to in setting monetary policy – than on the level of government spending in isolation.
Ideally, National would now use this as an opposition to pivot and move on, abandoning the “government spending explains inflation story”, shifting their inflation focus back onto the Reserve Bank’s failings (and the government responsible for holding them to account), and if they are serious about future tax cuts, start telling us how they plan to pay for those cuts. A serious move on the NZS age – a fairly prompt lift to 68 and life-expectancy indexation from there – would be a good place to start (as distinct from National’s policy hitherto of doing nothing at all for another 15 years or so).
Finally, as I noted earlier the speech seemed to involve turning back the policy clock to 2017. But productivity growth – the foundation of longer-term improvements in material living standards – was nothing to write home about back then either. One hopes – probably against hope – that before long Messrs Luxon and Bridges might let us on on their thinking on how we might do rather better over the medium-term than simply turning back the clock to five years ago, how we might at last begin to close those yawning economywide productivity gaps between us and the rest of the advanced world.
I don’t have too much to say about yesterday’s HYEFU, but two things caught my eye.
The first was a bit of attention on the $6 billion “operating allowance” the government has given itself to increase spending (or, I suppose, cut taxes) at next year’s Budget. It is a big number, but it doesn’t mean a great deal. In principle, the operating allowance covers things where the government has some discretion (whereas, by legislation, tax revenue tends to rise each year as nominal GDP does, and welfare benefits rise each year as inflation/wages do, and without new legislation the government of the day has no choice in the matter).
But governments tend to care about purchasing/delivering real goods and services, and they need actual people to work for them. And when there is inflation, the dollar cost of purchasing goods, services, and labour tends to rise. Governments don’t have to – and tend not to – compensate agencies/votes for inflation each and every year but when inflation is higher, over time more dollars need to be allocated for increased spending just to keep the real volume as the government intended. And since inflation – in principle – just blows up prices and incomes, making us as a whole neither richer nor poorer, they can do so with no particularly ill effects.
To illustrate, suppose the government spends $100 billion a year in an economy with nominal GDP of $330 billion (so roughly 30 per cent of GDP). Now assume that prices generally suddenly rise by 5 per cent, with nothing else changing. The things the government wants to purchase cost more, but its tax revenue also rises by more. In fact, it will now cost $5 billion more than otherwise to purchase the same volume of goods, services, labour (or real transfers). In practice, as noted above, quite a bit of government spending is indexed by legislation (roughly a third of core Crown spending is on welfare) and so not covered by the operating allowance. But in this scenario a 5 per cent lift in prices might require a $3.3 billion operating allowance, just to keep real government purchases unchanged.
I don’t have the time today or the patience to try to reconcile all the numbers, but to illustrate that inflation is a big part of the picture note that in this year’s Budget Treasury forecast that inflation for the year to June 2021 would be 2.4 per cent, for the year to June 2022 1.7 per cent, and for the year to June 2023 1.8 per cent. In the HYEFU, those numbers (2021 now known) are 3.3 per cent, 5.1 per cent, and 3.1 per cent. The total increase in the price level over those three years was expected to be 6.0 per cent, and is now expected to be 11.9 per cent. So of course the government needs to put more money (quite a lot more) in the operating allowance just to maintain real spending at the levels they intended only a few months ago. A lot of it is simply an inflation illusion. In the same way that a very small operating allowance would reveal nothing about the fiscal stance if inflation was to be unexpectedly low (as it was, say, a decade ago).
Don’t take it from me. Here are The Treasury’s forecasts of core Crown operating expenses as a per cent of GDP, including the government’s fiscal plans (those “big” operating allowances) as communicated to them and published yesterday.
On these plans, core Crown spending as a share of GDP will be around the same share of the economy as it was going into John Key’s final term.
There is plenty to criticise about individual spending items under this government – take $51 million wasted on the aborted, always ludicrous, Auckland walking bridge, let alone $5 billion in Reserve Bank losses – but the bottom line at this stage is one in which total spending ends up much where it was as a share of GDP. One might, of course, worry more about timing. With an overheated economy (on Treasury and Reserve Bank numbers), with high and rising inflation, and with a high terms of trade, the government really should be running a surplus next year (headline surplus consistent with cyclically-adjusted balance. But, in fairness, the forecast deficit for 2022/23 is small.
As noted, there has been – and is expected to be – quite a bit more inflation. Like the Reserve Bank, Treasury now seems to think that even core inflation will move outside the top of the target band the government set for inflation. They expect 3.1 per cent inflation in the year to June 2023 – ages away, and fully within the control of monetary policy now – and won’t be forecasting the sorts of one-off price shocks that often distort near-term headline inflation forecasts.
But, on the Treasury’s numbers it doesn’t seem like anything to worry about because by the end of the forecast period (June 2025) inflation is back to 2.2 per cent, basically the midpoint of the target range.
But how is this being achieved? Sure, they expect the Reserve Bank to raise the OCR, to a peak of 3.2 per cent by June 2023. But raising the OCR above neutral – as the Governor told us they expect to – usually dampens (core) inflation mostly by generating some temporary excess capacity in the economy.
But here is The Treasury’s view on the output gap.
They reckon it was deeply negative a decade ago, when core inflation was low and falling (reaching a trough around the end of 2014), but now they reckon it will be positive – quite materially so for the next couple of years – throughout the forecast horizon. All else equal, that should normally be consistent with core inflation rising further.
What about the labour market? The Treasury doesn’t publish an “unemployment gap” number, but comparing their unemployment rate forecasts, and the medium-term trend assumptions they use in their Fiscal Strategy Model makes very clear that they expect the unemployment rate to be below sustainable levels over the next few years.
So how is it that they expect (core) inflation to come down?
I can think of two possibilities, neither very convincing. The first is that they are still treating all the current (and forecast over the next 18 months) surge in the inflation rate – including on the core measures – as really just transitory and having nothing to do with excess demand. If so, as (eg) supply chain disruptions dissipate, what now looks like core inflation vanishes like the morning mist. But that certainly doesn’t seem to be the Reserve Bank’s view, just doesn’t square with (eg) forecast positive output gaps, and isn’t really consistent with expecting fairly rapid increases in the OCR.
The second possible story might involve inflation expectations. Perhaps they too stay firmly rooted at 2 per cent and inflation just vanishes, despite the headline pressures, despite the (on Treasury’s own estimates) overheated economy. But it doesn’t make a lot of sense, and isn’t consistent with any of the other swings or slumps we’ve seen in core inflation over the decades.
I don’t know what Treasury thinks the story is. In the end, perhaps it doesn’t matter that much. The Reserve Bank will – we presume – eventually do what needs doing and adjust the OCR to get core inflation credibly heading for the midpoint. But if there is enough inflationary pressure built up that the OCR really needs to be raised more than 200 basis points more from here, it is a little hard to believe that would be consistent with an economy still generating a positive output gap and such low unemployment rates. Medium-term forecasting is a mug’s game – no one is any good at it – so my interest is more in the logic of their model than in what the economic outturns a couple of years hence might be. But if the OCR has to be raised a lot more over the next 18 months, you might normally expect the biggest adverse economic effects (normally needed to get core inflation back down) might well be showing themselves in the second half of 2023. Which might be awkward timing for the government.
But who knows how many shocks – positive, negative, Covid and other – will be along before then.
The OECD’s latest Economic Outlook came out a few days ago. As always with the OECD, the value is rarely in the analysis or policy prescriptions, but mostly in the vast collection of more-or-less comparable tables, collating data for a wide range of advanced economies (and a few diversity hires).
Take public debt as an example. Next week our Treasury will be out with their HYEFU and more-detailed New Zealand numbers for central government. But there is no easy way of comparing Treasury’s New Zealand numbers with those for other countries. And so I tend to focus most often on the OECD series of “net general government financial liabilities”, which includes all layers of government, and doesn’t exclude things that particular national governments find it convenient to exclude (in New Zealand’s case, all the assets in the Crown’s hedge fund, the NZSF).
The OECD’s forecasts only a couple of years ahead, but that is probably about the most that is useful anyway, Here are their recent forecasts for net general government liabilities as a per cent of GDP (for the 30 countries they do these numbers for).
For New Zealand, the 2023 number is 14.82 per cent of GDP and on these forecasts we’d be 7th lowest of (these) OECD countries. There isn’t a forecast for Norway for 2023, but they have net financial assets of about 350 per cent of GDP, so call it 8th.
Going into the pandemic, our net general government liabilities as a per cent of GDP in 2019 was 0.8 per cent. (Including Norway) we were 8th lowest of these OECD countries.
That is a not-insignificant increase in net debt as a per cent of GDP. Between 2007 and 2012 – serious recession and the earthquakes – net general government financial liabilities were increased by about 12 percentage points of GDP. But, and on the other hand, in five good-times years (from 2002 to 2007) net general government liabilities as a share of GDP dropped by 23 percentage points of GDP.
Here is the cross-country comparison over time
I’m not suggesting we should be totally comfortable about that picture, but our net public debt is forecast to remain (a) low, and (b) much lower than the typical advanced country.
What if we break out the countries. Some argue (I’m not really convinced) that big countries, at least those with a history of reasonable government etc, can comfortably ran higher ratios of public debt than smaller countries. And, on the other hand, perhaps the countries most like New Zealand are the fairly-small places with their own central bank and floating exchange rate. Here are the relevant comparisions over time (medians in both cases).
The big countries – Germany excepted – really have been on a rising debt path. I’m not one who believes crisis and/or default is looming (generally – Italy remains a wild card) but were I a voter in one of those countries I’d be seriously uneasy. Were I involved in an opposition political party, I hope the high and rising debt would be made a salient political issue.
But – and generally – the small advanced countries have done pretty well (true on this sample of countries, or if one uses all the small countries – including those in the euro – in the database), and there has been (and is) nothing startling or particularly impressive about the New Zealand performance. If anything, one might note the widening gap at the end of the period.
Of course, none of this includes the fiscal challenges imposed by the rising NZS fiscal burden from maintaining the age of eligibility at 65 (although it is now a decade since baby boomers started turning 65) and the expected trend increase in public health expenditure….but I really can’t see public debt itself being a particularly salient issue in 2023.
But what about deficits? No one argues the government should have been running a balanced budget last year, and perhaps not even this year (given the renewed lockdowns and big output losses the government left itself open to), but why not 2023? These are the OECD’s projections – the primary balance excludes financing costs, and a common rule of thumb is that even a small primary surplus is consistent with keeping debt in check. “Underlying” captures cyclical-adjustment.
In 2023, with the economy projected to be fully-employed (a reasonably significantly positive output gap), with a strong terms of trade, and (as ever) with some of the highest real interest rates anywhere in the advanced world, the OECD estimates that the government’s fiscal policy will see us in 2023 with a large primary deficit, a bit worse than the median OECD country. (Norway’s primary deficit is much larger, but remember that they have big net earnings (finance receipts) on the government’s huge net asset position.
Were one confident that spending initiatives were being ruthlessly scrutinised to keep waste to an absolute minimum, perhaps one might be a little less worried – although small structural surpluses, where spending is funded by taxes remains a good rule of thumb – but does anyone suppose that describes current New Zealand approaches to public spending.
I don’t suppose Ardern and Robertson are likely to let things get really out of hand. They seem oriented enough towards broad macro stability – in the traditions of all New Zealand governments of recent decades – even as they too watch our real economic performance decline, but at present the structural deficit picture (as the OECD interprets our data and policies) isn’t looking that good.
There should be considerable scrutiny on the government’s plans in the forthcoming Budget Policy Statement, and the Treasury’s HYEFU projections.
Over the last few days I’ve noticed a few political partisans on Twitter squabbling about health spending under various governments. I’m not exactly sure what triggered it, although perhaps it had something to do with John Key’s op-ed at the weekend.
Not being a political partisan myself – let alone a recent supporter of either National or Labour – I decided to have a quick look at the data myself. The Treasury publishes a quite useful long-term set of annual fiscal data, including a breakdown of spending. It is all in nominal dollars, but they also show those numbers as a percentage of nominal GDP. Here is how health spending has changed, as a per cent of GDP, since 1972 (bearing in mind that the years shifted from March to June years about 30 years ago). The data for the year to June 2021 should be out shortly (one would hope).
The trend over time is upwards. That shouldn’t surprise anyone. There is a lot more medical technology can now do for us, expectations are higher, and a larger proportion of the population is now relatively old. Oh, and as far as we can tell productivity growth in the government health sector has been pretty unimpressive.
And if the trend is upwards, there are quite material fluctuations around the trend. But note that they won’t always tell you much about health policy. After all, the ratio has a numerator (health spending) and a denominator (GDP), and nominal GDP growth can be quite variable, even in the low inflation era of the last 30 years.
The state of the economy influences what can be spent on health (and other things) but you wouldn’t expect this year’s health spend to be affected much (if at all) if the terms of trade happened to fall sharply this year, perhaps after the Budget was set.
And thus, to revert to the first chart, you may already have noticed the two big increases in health spending as a share of GDP – neither of which were sustained – happened in the 1970s (when our economy badly underperformed after 1973 for several years), and over the first few years of the last National government, when we went through a severe recession (not caused by that government) that took quite a few years to recover from. Note that part (but not all) of the reason health spending rose as a percentage of GDP in the year to June 2020 is that GDP plummeted in the first half of 2020.
Now, of course, recessions should be expected to slow the growth of health spending – even if not necessarily the volume of health services delivered. After all, a big chunk of the health budget, directly and indirectly, is salaries, and real wage inflation tends to slow (often quite sharply) in significant economic slowdowns. But it isn’t a mechanical or immediate connection, especially as much of the health workforce is unionised and sometimes on multi-year collective contracts. Equally, of course, in relatively good times, the government may be willing to settle more generously with the health workforce, boosting spending (if not necessarily the volume of health services delivered).
Comparisons across governments aren’t just affected by denominator issues. There is also the facts that (a) government fiscal years don’t line up with the dates of changes of governments, and (b) even if they were, it is hard to change spending immediately (at least if purchasing more/less health services is the aim). But, for what it is worth, here is my best effort – using annual data only – at average health spending as a percentage of GDP for each government since 1972
To be clear, it is not some gotcha effort at the current government. You can see from the first chart that health spending as a share of GDP has been rising under this government from the levels they inherited, although are still below – for good or ill, for whatever reason – the percentages run during the previous recession and immediate aftermath.
That chart involved multi-year averages and (at least for the three nine-year governments the numbers aren’t so sensitive to the choice of first or last years). The same can’t be said for crude changes from the beginning to the end of the government. But for what they are worth:
Labour 72-75: Fiscal years were March, governments changed in December. In the March 1973 year, health spending was 4.2 per cent of GDP, and in the March 1976 year it was 5.3 per cent.
National 75-84: March years. National took office in Dec, and left office in July (hot having delivered a Budget). In the March 1976 year, health spending was 5.3 per cent, and in the March 1984 year it was 4.8 per cent.
Labour 84-90: Data change to June years in 1990. Labour left office in November 1990. Health spending was 4.8 per cent of GDP in the March 1984 year, and 5.0% in the June 1990 year and 5.2% on the June 1991 year.
from here on June fiscal years, and government changes in the Dec quarter. I assume outgoing government is responsible for health spending in the June year it leaves office (Budget having been passed etc)
National 90-99: 5.2% in June 1991 year and 5.4% in the June 2000 year.
Labour 99-08: 5.4% June 2000 year, 6.5% for June 2009 year
National 08 to 17: 6.5% for June 2009 year, 5.9 per cent for June 2018 year
Labour 17 to present: 5.9 per cent for June 2018 year, 6.5 per cent for June 202 year
Here is one more chart, this time showing health spending by the government as a percentage of total primary (ie non-interest) spending.
The two big trends seem to be about welfare spending. Up to the early 1990s not only were numbers unemployed rising (latterly sharply) but NZS eligibility at age 60 was becoming a heavier fiscal burden. Both trends were reversed from the early 1990s. The sharp drop in the 2020 year is, of course, mostly a reflection of the huge wage subsidy spending in the first half of last year. For those wanting to play gotcha about the previous government, health spending increased as a share of total (primary) government spending over the entire course of that government.
What do I take from all this? Not a great deal. Economic fluctuations happen, and there are limits to what governments can do about them quickly. Productivity slowdowns occur, and if there is more governments can do about them, they make it harder to manage health demands. And raw spending on its own doesn’t necessarily mean a great deal anyway, at least in terms of the health outcomes the wider public probably care about – and that is especially so if the changes in spending substantially reflect (say) a few years of being stingy or generous with the public sector health workforce.
Still on health, this post might be a good opportunity to introduce a couple of cross-country charts I showed on Twitter a couple of weeks ago. The OECD gathers data on total health spending (public and private) as a percentage of GDP, mostly for OECD countries.
This was the OECD’s chart, useful because it shows the splits across countries between government (or compulsory private) and voluntary private spending on health. I was interested in it partly because there seems to be much more difference across countries in the public/compulsory spend (per cent of GDP) than there does in the voluntary spend, and there is no sign (for example) that countries with a high government/compulsory spend (per cent of GDP) spend less voluntarily.
You’ll notice it is labelled “2020 or latest available”. Usually that might be fine, but of course 2020 not only saw big increases in health spending in many countries, but also saw significant drops in GDP in many, so comparisons that involve 2020 for some of the countries and 2019 for others aren’t going to be reliable.
Here is total health spending for 2019 for the OECD countries from the earlier chart.
The US is, of course, something of an outlier. But, focusing on New Zealand, mostly the countries that spend more on health (public and private) as a percentage of GDP are richer and more productive than we are (Chile is the exception), and countries that spend less of health (percentage of GDP) are similar productivity/income to us, or poorer (Luxembourg is the exception, but much of Luxembourg’s GDP is generated by people who work there but live in neighbouring countries). We look to spend about as much of health – public and private – as you might expect if you knew our productivity/income performance.
FInally in that group of charts, I lined up total (public and private) spending on health with total primary government spending (both as a percentage of GDP) for the OECD countries (most) that have data for both series. I’ve marked New Zealand in red. You can see that government spending as a share of GDP is well towards the lower end of the range for these OECD countries (as people on the left often bemoan) but also that there is no cross-country relationship between the two series. Countries – all in Europe – in which the government spends a great deal more of GDP (15-20 percentage points more than New Zealand) don’t spend greatly more (public and private) on health as a percentage of GDP. To the extent they do, it appears to be mostly because they are richer and more productive than New Zealand, and richer and more productive countries choose (public and private) to devote a larger share of that higher income to health.
I’m much more interested in productivity (under)performance than health spending per se. As far as I can see, we devote about what one might expect to health in a country of our productivity/income. A much better productivity performance – something that seems to seriously interest neither side of politics – would open up lots more opportunities (public and private), including the likelihood that we would choose to devote a larger share of our higher incomes to health.
Economic underperformance – over many decades now – has real consequences.
The Public Finance Act requires that every four years The Treasury publishes a “statement on the long-term fiscal position” looking “at least” 40 years ahead. Parliament allowed them to defer the report due last year, but yesterday they published a draft – for consultation – of the report they will formally publish later this year. Quite why they have chosen to go through this additional step, of consulting formally on the draft of a report that is likely to have next to no impact even when finalised, is a little beyond me.
These long-term fiscal reports are fashionable around the world. As I’ve noted previously I was once quite keen on the idea, but have become much more sceptical. They take a lot of work/resource – which should be scarce, and thus comes at a cost of other analysis/advice The Treasury might work on – and really do little more than state the obvious. As I noted when the last long-term fiscal report was published.
I was once a fan, but I’ve become progressively more sceptical about their value. There is a requirement to focus at least 40 years ahead, which sounds very prudent and responsible. But, in fact, it doesn’t take much analysis to realise that (a) permanently increasing the share of government expenditure without increasing commensurately government revenue will, over time, run government finances into trouble, and (b) that offering a flat universal pension payment to an ever-increasing share of the population is a good example of a policy that increases the share of government expenditure in GDP. We all know that. Even politicians know that. And although Treasury often produces an interesting range of background analysis, there really isn’t much more to it than that. Changes in productivity growth rate assumptions don’t matter much (long-term fiscally) and nor do changes in immigration assumptions. What matters is permanent (well, long-term) spending and revenue choices.
And I’m old enough to remember people lamenting the potential fiscal implications of an ageing population – at least conditional on government choices – well before long-term fiscal reports were a thing.
What’s more, lots of countries have these sorts of reports, and of them some have very high and rising levels of government debt, and others don’t. It isn’t obvious that access to these sorts of long-term reports really makes any difference at all (see, for example, the US, with a rich array of private and public sector analysis – although do note that the US is well ahead of us in raising the eligibility age for Social Security retirement benefits).
New Zealand, to the credit of politicians in both main parties, has been one of the (not so small) other group of countries where government debt as a share of GDP has been kept fairly low and fairly stable. We’ve had recessions and earthquakes, and governments with big spending ambitions but if you reckon – as I do – that low and fairly stable government debt is generally a “good thing”, New Zealand has been a success story. We even ramped up the NZS eligibility age from 60 to 65 (back to the 1898 eligibility age) in fairly short order. For good or ill – and no doubt there is an argument to be had – government health spending as a share of GDP was not much higher last year than it was 40 years ago (recall, 40 years is the statutory timeframe for long-term fiscal statements).
At the start of last year I’d probably have put myself in the camp of those saying “we’ve done okay on fiscal management and there is no obvious reason to suppose we won’t adjust as required in future”. Among other things, there is a certain absurdity in paying out a universal state welfare benefit to everyone at 65 as an ever-increasing share of those 65+ are still in the workforce, so change was likely to happen – it had in other countries, it had here previously and actually Labour in 2014 and National in 2017 and 2020 had campaigned on beginning to raise the age of eligibility (to which you might respond that none of those parties then got elected, but National still won 44.4 per cent of the vote in 2017).
I’m no longer so sure.
One chart that didn’t feature in the draft long-term fiscal report was this one from the Budget.
On their own numbers and estimates, the cyclically-adjusted primary deficit for the current (2021/22) financial year is projected to be really large (in excess of 5 per cent of GDP), at a time when – again on their own numbers – the economy is more or less back to full employment, with an output gap estimate close to zero. Note (again) that this is not a dispute about appropriate policy in the June quarter of last year when most of us were ordered to stay home and many were unable to work. It is about now.
In their text, Treasury is at pains to play down the current fiscal situation. They don’t mention these cyclically-adjusted estimates, but they claim that the situation is temporary, the spending is temporary, and will go away quite quickly. Of course, they have lines on a graph that show such an outcome, but that isn’t the same thing as hard fiscal choices over a succession of years. No doubt there are still some temporary programmes – the subsidies for Air New Zealand and exporters, MIQ costs, and vaccine costs – but a cyclically-adjusted primary deficit in excess of 5 per cent of GDP is getting on for a gap of $20 billion per annum. And every instinct of this government appears to be to spend more.
Here is the chart from the draft report
The primary deficit for 2060 on this scenario actually isn’t much larger than the primary deficit The Treasury smiles benignly on this year (assuming it will all go away quite easily). There are long-term issues that need addressing, but perhaps a less complacent approach to the current situation – and the poor quality of a lot of the new spending decisions – might be a better place to start.
Ah, but of course we heard from The Treasury a couple of weeks ago – the Secretary no less – that they are now keener on more government debt and a more active use of fiscal policy. Which probably isn’t the best backdrop against which to make the case for adjustment.
More generally, one of the things that has shifted over the last couple of years – and certainly since the 2016 LTFS – is some sense, especially on the left, that lots more public debt is something to embraced or welcomed, coming at little or no cost (so it is claimed). The focus is always on interest rates (low) and never on opportunity cost (when the coercive power of the state is at work in the spending choices). It makes it a bit harder to mount fiscal arguments about NZS if – as is probably the case – New Zealand could have government debt of 177 per cent of GDP without being cut out of funding markets (although note that, in the nature of such scenarios, the debt ratios mechanically explode beyond that 40 year horizon). And that is another reason why I’m sceptical of the benefits of reports like this: The Treasury really can’t offer any useful insights on the appropriate level of public debt, even if they can offer useful technical advice on the implications of various specific measures that might raise or lower the debt. The real debates to be had are political – both about the debt and the numerous progammes and even (to some extent) around the tax choices.
On NZS here were my thoughts from a post a couple of years ago (emphasis added)
As for NZS itself, personally I’m not overly interested in arguing the case for reform on fiscal grounds but on a rather more moral ground. Even if we could afford it, even if there were no productive costs from the deadweight costs of the associated taxes, there just seems something wrong to me in providing a universal liveable income to every person aged 65 or over (subject only to undemanding residence requirements). 45 per cent of those 65-69 are now in the labour force – suggesting they are physically able to work – which is substantially greater than the 30 per cent of those aged 60-64 who were in the labour force 30 years ago when NZS eligibility was at age 60.
I don’t consider myself a welfare hardliner. I think society should treat quite generously those genuinely unable to work, especially those who find themselves in that position unforeseeably. Old age isn’t one of those (unforeseeable) conditions, but personally, I have no particular problem with something like the current flat rate of NZS, or even of indexing it to wage movements (which would be likely to happen over time anytime, whether it was the formal mechanism from year to year), from some age where we can generally agree a large proportion of the population might not be able to hold down much of a job. I don’t have a problem with not being overly demanding in tests for those finding work increasingly physically difficult beyond, say, 60. But what is right or fair about a universal flat rate paid – by the rest of the population – to a group where almost half are working anyway? It is why I would favour raising the NZS age to, say, 68 now (in pretty short order) and then indexing the age in line with further improvements in life expectancy, and I’d favour that approach even if long-term fiscal forecasts showed large surpluses for decades to come. At the margin, I’d reinforce that policy change with a provision that you have to have lived in New Zealand for 30 years after age 20 to be eligible for full NZS (a pro-rated payment for people with, say, between 10 and 30 years of actual residence). Why? Because in general you should only be expected to be supported by the people of New Zealand, unconditionally, in your old age, if most of your adult life was spent as part of this society.
Reasonable people can, of course, debate these suggestions. But they are where I think the debate should be – about what sort of society we should be, what sort of mix between self-reliance and public provision there should be, even about what mix of family support and public support there should be, or what (if any) stigma should attach to be funded by the taxpayer in old age – not, mostly, about long-term fiscal forecasts.
And Treasury can’t help with very much of that. It is what we have politicians, think tanks, and citizens for.
I don’t think enough weight is given to the role that rules of thumb play in disciplining choices. If, in modern floating exchange rate open-capital account economy, many governments can take on almost any amount of debt as they want, and even the interest rate consequences of higher public debt are really quite small, what constrains government choices? No doubt there are a few zealots who think no constraints are necessary, but most people – left, right, or centre – don’t operate that way.
I favour running fiscal policy to two rules of thumb (not legal restrictions, but political covenants/commitments). First, aim to keep the (cyclically-adjusted) operating balance near zero, and second, aim to keep net public debt (all inclusive measures) near zero.
Note that (a) neither rule of thumb would be binding year by year (the state needs to cope with pandemics, earthquakes, or the like), they would be constant aiming points, the standard reference points towards which policy is oriented over several years, and (b) neither rule of thumb says anything about the appropriate size of government (if we conclude we want governments to do more (less) longer-term than adjust tax rates to pay for that. Adjusting tax rates – especially upwards – is a much higher hurdle (and appropriately so) than the Cabinet (commanding a majority in Parliament) simply deciding one morning to substantially alter spending.
There is probably less dispute about the operating balance rule of thumb than about the debt one. Smart people will mount arguments about (a) infrastructure, or (b) the potential capacity of the Crown to capture various high returns. A typical householder or company will, after all, have some debt. But (a) the disciplines on individuals and firms are much stronger, and more internalised, than they are for governments, and (b) much of government activity acts to reduce private savings. I’m not going to pretend there is any great difference between the narrow economics of a 20% debt target vs a -20% one, but zero has a resonance that no other number is ever likely to have. (And if you think this benchmark is demanding, on my preferred analytical measure – the OECD series on net general government financial liabilities – New Zealand has been between 10 per cent and -5 per cent of GDP continuously since about 2004.)
If you want the state to do more, make the case, have the debate for higher taxes – which takes the resources from specific identifiable types of people (tax incidence arguments aside), rather than by monetary policy squeezing out other private sector activity to make way for the government (in a fully-employed economy they are the only two options, there are no free lunches).
This has gotten rather rambly and I’m going to stop here, except to point you to this interesting table at the back of the Treasury report.
the sharp drop in the long-term assumed birth rate (largely reflecting recent developments presumably)
the reduction in the assumed improvement in life expectancy
the significant reduction in assumed long-term productivity growth, and – unlike the others, substantially a policy matter,
the substantial increase in the assumed long-term annual rate of net inward migration
When the Reserve Bank and Treasury advertised a full-day workshop with the title “Fiscal and Monetary Policy in the wake of COVID”, I immediately signed up to attend. It sounded like a good idea for an event. After all, lots of tools were deployed, some new, some old, some deployed less than usual, some much more. And we’ve had a Budget, and projections from both agencies suggesting that the economy is now getting pretty close to operating at full capacity (albeit a capacity a little diminished by Covid restrictions).
It was just a shame about the execution. Notably, even though monetary policy has been the principal tool for macroeconomic cyclical stabilisation for decades – and not just since 1989 – here and abroad, there was not a single paper looking at the role of monetary policy, past, present or future. The Governor didn’t attend – which is fine – but nothing of substance was heard from any senior Bank figure. Orr’s deputy for macro policy, Christian (“The Future is Maori”) Hawkesby contented himself with opening remarks that had just some bonhomie and his recitation of a Treasury prayer (which, to add to the strangeness, seemed to appreciate “skilled workers” but not the rest of the public), but not a word of substance. There were a couple of technical papers from Reserve Bank researchers in the afternoon session, but one was little more than an early-stage in a research agenda on the distributional aspects of monetary policy (the paper itself couldn’t shed much light when the only asset in the model was bonds), and the other – on dual mandates – didn’t seem to offer any fresh insight.
So the stage was largely left to The Treasury, and particularly a series of three papers (complemented by a presentation from a US academic) that seemed dead-set on making the case for a bigger and more expansive role for fiscal policy and government debt in the new post-Covid world. Bureaucrats making the case for a bigger and more powerful bureau.
First up – and clearly most important – was the Secretary to the Treasury. She spoke for 40 minutes, but then took no questions (and, in an amateur-hour effort, the text of her speech was then not available until more than a day later). The Secretary is still quite new to the country, to the job, and to national economic policy matters. Probably most non-government attendees (of whom there were many, in a well-attended event) had seen and heard little or nothing of her before. So it didn’t speak well of her that she wasn’t willing to engage, despite having made a barely-disguised (“I would stress that we are not making policy recommendations”) bid for quite an upending of the way macro management is done her, in ways that would just happen to favour her agency.
But what of the substance? It was a workmanlike effort (NB with a minor mistake in footnote 2) but hardly persuasive to anyone not already champing at the bit for fiscal policy to do well. For example, there was no serious discussion about the effectiveness of monetary policy. The Governor has previously told us he thinks monetary policy has been as effective as ever. The Secretary seems to disagree, but we can’t be sure – perhaps she just thinks fiscal policy is even better, but she doesn’t make that case either. Much in her case seems to rest on the effective lower bound on nominal interest rates but (a) as the next Treasury speaker acknowledged that is not some immoveable barrier, and (b) she offers no thoughts on the effectiveness or otherwise of things like the LSAP programme. Surely one starting point for thinking about the future might involve some careful diagnostic work reaching a thoughtful view on what roles the various elements of fiscal and monetary policy played in economic outcomes over the last 15 months. But neither she, nor anyone else on the day, attempted anything of that sort. Remarkably no one – from the Bank or Treasury – looked at the options and merits for removing – or greatly easing – the ELB so that at least ministers have effective choices in future severe downturns,
Quite a bit of Treasury’s thinking – or at least their marketing – seems to have been shaped by the success of the wage subsidy scheme. And it was a success – getting money out the door quickly, at a time when the government had just done the unprecedented and (a) shut the borders, and (b) simply compelled most people not to go to work, or do anything much else. It provided immediate income support, and probably had some beneficial effects beyond that (some smart person might attempt to model what difference it has made to outcomes not just last March/April but now). But it isn’t exactly a conventional event of the sort we can expect to see every cycle. And the primary consideration wasn’t really macroeconomic stabilisation at all – the whole point of the lockdowns was to aggressively (but temporarily) reduce activity, including economic activity – but income relief/support (as unemployment benefits have an incidental automatic stabiliser benefit, but aren’t primarily about macroeconomics). There are always going to be one-off events when the the government’s spending capabilities need to come into play – one can think of earthquakes (where fiscal measures and monetary policy will often tend to work in opposite directions, since earthquakes cause real disruptions and significant wealth losses, and but also generate a lot of fresh (reconstruction demand), plagues, wars, and so on. But it is seems like a category error to use such episodes as the basis for some sort of generalised play for more routine use of discretionary fiscal policy with cyclical stabilisation in view, when most recessions are quite different in character.
And even just thinking about the last 15 months or so, neither the Secretary nor her colleagues seemed to make any effort to unpick the effects of the wage subsidy scheme from the rest of the fiscal policy initiatives of the last year. One could easily imagine an alternative world in which the wage subsidy was used much as it was, but otherwise fiscal policy was kept much on the path it had been on at the start of last year, and at the same time the OCR was used more aggressively. How different would the outcomes for the economy have been, in aggregate and sectorally? The fiscal option involves the coercive use of state power, and politicians making discretionary choices playing favourites, while monetary policy adjusts relative prices and then let individuals make choices about how they (personally and individually) are placed to respond. And one thing that was striking about both the Secretary’s speech and the more technical discussion that followed from her colleague Oscar Parkyn is that in all their new enthusiasm for using fiscal policy more aggressively in downturns (and monetary policy less so) is that neither mentioned, even once, the exchange rate – typically a significant element in the adjustment mechanism in New Zealand recessions. New Zealand recessions often see sharp falls in international commodity prices (fortunately not this time) and the lower exchange rate acts as a buffer. But a much heavier routine reliance on fiscal policy will tend, all else equal, to hold up the exchange rate relatively more in downturns. It isn’t obvious – without a lot more analysis – that that would be a good thing.
The Secretary included this chart in her speech
It was apparently designed to show that fiscal policy in New Zealand has generally done sensible things. That might be generally true (although if so why change?), even setting aside the huge pressure loosening fiscal policy put on monetary conditions over 2005-2008, but it conveniently ignores where we are right now. This chart, which I’ve shown before, is from the recent Budget documents.
So with the output gap almost closed, the cyclically-adjusted primary balance (deficit) in 2021/22 year is expected to be almost as large as it was in 2019/20 (when the – sensible – big wage subsidy spending was concentrated. Extraordinarily, in a speech bidding for a more active role for fiscal policy in cyclical stabilisation she never mentioned this situation once – let alone engaged with why, from a macro policy perspective, such big deficits make sense now. As sceptic might suggest that this is the real world outcome when the Secretary’s textbook ideas get given some rope.
One could go on. The Treasury is clearly tantalised by the lower interest rates – although not now lower than pre-Covid – and the “appeal” of taking on more debt. But never once did we hear any serious examination of the typical real-world quality of the marginal additional public spending they had in mind (it wasn’t until the panel discussion late in the day that I heard a Treasury official – a temporary one, so perhaps not well-socialised – refer to the Auckland cycleway bridge). There was a paper reporting some model results suggesting, sensibly enough, that fiscal consolidation is most costly to GDP if done via taxes on capital income, but (symmetrically) there wasn’t a sense in the rest of the day that (say) Treasury was champing at the bit to lower company taxes. Rather they seem keen on public infrastructure – which often sounds good on paper, until we get to the concrete ideas. As it was, a discussant cast considerable doubt on one Treasury paper suggesting high payoffs to more government infrastructure spending.
We also never really heard any serious political economy discussion, or even a discussion of how we should think of the government balance sheet – is it a plaything for politicians or should it be best thought of as operating on behalf of citizens, each of whom have to make their own spending and borrowing choices. There wasn’t much about using coercion and compulsion rather than the indirect instruments of monetary policy. And, on the other hand, it was a little surprising that there wasn’t even a mention of MMT – so that in a floating exchange rate, the level of government debt isn’t really likely to be materially constrained by the market, which doesn’t mean that just any level of government debt is a socially good thing.
It was all a bit unsatisfactory really. Perhaps one could say it was just exploratory, and they are wanting to open the issues but (a) the speech was from the Secretary herself and (b) was making a case more than deeply and thoughtfully exploring the issues. We will have to see what more is in the papers they plan to release next week (a draft long-term fiscal statement and a draft insights briefing) but if the energy is with The Treasury at present, it isn’t really clear that they yet have the depth of analysis and engagement to support their enthusiasm.
And just finally, they arranged for an American professor, Eric Leeper, to speak, via Zoom, on monetary and fiscal issues. Leeper is pretty highly-regarded and has visited New Zealand previously. He is also very keen on a much greater use of fiscal policy and, it would appear, more debt (for various reasons including, he said. “the rise of the right” which didn’t seem quite relevant to New Zealand, let alone a good basis for official advice). Anyway, after the geeky bits of the presentation, he tried to make his case by reference to the Great Depression. He is clearly a big fan of Franklin Roosevelt, and was talking up the fiscal aspects of Roosevelt’s approach (while barely really mentioning the substantial monetary bits). But it was odd. Here he was talking to a New Zealand audience, championing the use of fiscal policy in the US Great Depression, but seemed quite oblivious to the fact that the US was one of the very last countries to get back to pre-Depression levels of output and unemployment. Here is the experience of the Anglo countries.
Those aren’t small differences. And as anyone who knows New Zealand economic history – or have read my past posts on it – New Zealand’s recovery from the Depression (back to pre-Depression levels by the time Labour took office) was barely at all about fiscal policy. The excellent quote from Keynes that our Minister of Finance of the time recorded in his diary, along the lines of: “if I were you I would no doubt seek to borrow, but if were your bankers I should be very reluctant to lend to you”.
When a half-baked loaf is finished cooking it can be a fine thing, but this loaf seems to need a lot more work before New Zealanders should be rushing to embrace a much more active role for fiscal policy or a lot more public debt. That includes a lot more work on what we reasonably can, and can’t, do with monetary policy.
UPDATE: A former RB colleague, now a lecturer at Sydney University, sent me a link to a paper he and a Reserve Bank researcher have written attempting to evaluate the impact of the New Zealand wage subsidy scheme. I haven’t yet read it, but it looks very interesting. Here is the end of their abstract
We then study the impact of a large-scale wage subsidy scheme implemented during the lockdown. The policy prevents job losses equivalent to 6.8% of steady state employment. Moreover, we find significant heterogeneity in its impact. The subsidy saves 17% of jobs for workers under the age of 30, but just 3% of jobs for those over 50. Nevertheless, our welfare analysis of fiscal alternatives shows that the young prefer increases in unemployment transfers as this enables greater consumption smoothing across employment states