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Dr Muriel Newman

Troubling Times

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National has released their long-awaited tax policy, political parties are launching their election campaigns, and in 27-days time we will be asked to vote in the 2008 General Election. But this is no ordinary election.

With financial markets in turmoil around the world and the credit crisis having far-reaching consequences for us all, the key focus for voters will undoubtedly be on which party can best manage the country during these troubling times.

The opening of the government’s books last week – as required by the Public Finance Act – provided an insight into Labour’s style of financial management. For nine years, with the economy growing strongly, Labour enjoyed year-on-year surpluses worth a total of $40 billion. Some argue that it was $40 billion of over-taxation that could have been returned to New Zealand taxpayers through a programme of tax cuts. Labour, however, viewed it as a dividend resulting from a growing economy to be used for the benefit of all New Zealanders through the paying back of debt, investing in the superfund, funding capital works and new spending commitments, as well as squirreling some away for a rainy day.

Treasury’s Pre-election Economic and Fiscal Update (PREFU) shows the worst outlook for the country in fifteen years. Since it was prepared before the full extent of the international financial crisis had unfolded, gloomy as the projections are, they may turn out to be overly optimistic.

The PREFU is forecasting weaker economic growth over the next five years with falling tax revenue and higher government expenditure. Combined with the increasing costs of some existing policies, the result will be bigger deficits and higher debt.[1]

The turnaround has been dramatic. Economic growth which was tracking at 2.9 percent in the year to March is forecast to fall to 0.1 percent by March of next year. The $2 billion worth of cash sitting in the government’s books at the end of June has turned into a projected deficit of $6 billion by June next year. Further, June’s operating surplus of $5.6 billion is expected to turn into a $64 million deficit by next June, growing to over $3 billion within four years.

The Treasury’s figures show just how fragile our economy really is. Driving the turnaround is an estimated $1 billion a year reduction in the tax take, a $500 million a year increase in welfare benefit expenses, and a $500 million a year rise in the additional cost of servicing the country’s debt – which is forecast to grow from 17 percent of GDP to 24 percent of GDP by 2012. In addition, Treasury has highlighted some $500 million a year in additional spending in areas that are far exceeding budget allocations including Treaty of Waitangi settlements, the 20 hours free early childhood education, and Kiwisaver which has seen a far greater take-up rate than expected. According to the National Business Review, part of the reason for this could be ‘imprudence’, due in part to “the ability of 37% of parents to put non-earning children into KiwiSaver for the $1,000 start-up deposit, but without contributions”![2]

Treasury’s outlook for households and businesses is gloomy: “Although prices for food and fuel are expected to ease slightly as a result of weaker world growth, their rapid rise represents a shock to household budgets which will be relieved only slowly, constraining growth in consumption for some time. As a result, growth in private consumption will be lower than previously forecast. Higher global commodity prices, especially for oil, are also adversely affecting firms’ costs. Price pressures for a range of inputs are expected to dissipate only slowly and may be offset by the expected fall in the exchange rate which will also make imported capital items more expensive. These factors will mean that firms’ margins remain under pressure and that profitability is low, constraining market investment.”

All of this should signal to the political parties vying for our vote that getting the economy back on track has to be the priority. That means cutting back on wasteful government spending and prioritising a programme for growth.

Over the last nine years it could be argued that rather than focussing on ensuring that the engine room of the economy – the business sector – is as resilient as possible to downturns, Labour has put great store in increasing the size and power of government. The public service has increased by an estimated 15,000 personnel from 29,000 in 1999 to over 45,000 today, growing the number of ‘paper pushers’ at three times the rate of front line workers.[3] This has resulted in the amount of office space leased for bureaucrats swelling by some about 77 percent to 445,915 square metres – an area about the size of 19 rugby fields.[4]

There have also been serious concerns about the quality of some of Labour’s spending: while the investment in health and education has soared, it has not returned markedly improved performance with longer surgery waiting lists, and falling educational standards.

Small business has had a particularly tough time under Labour. Far stricter controls over labour relations have put paid to the notion of a “flexible workforce”, which is critical to business success – especially when the economic environment is changing rapidly. And in spite of the rhetoric, government imposed compliance costs, remain a significant and growing dead weight cost on business.

With their pro-union, anti-business bias, Labour has been unable – or unwilling – to create the environment for business to prosper and grow, which is one of the main reasons for our decline in productivity over the last nine years. As a result, with the recession biting deeper, many businesses will struggle for their very survival.

In looking ahead, it is clear that the responsibility for pulling the country out of the recession lies with the business sector. That is why policies to promote business growth and boost productivity should be a priority. Given Labour’s underachievement in this area, the question is whether National has got what it takes?

National has announced a $6 billion increase in tax cuts over the next three years, with lower tax rates and increased thresholds – in addition to the changes already implemented by Labour. That means that someone on the average wage of $45,000 will eventually be $47 a week better off. With Labour’s increase in Working for Families payments for some 380,000 families already in train, National has also focussed on providing additional assistance to the 900,000 taxpayers who do not have children.

On top of their tax cut stimulus package, National has pledged to remove some of the serious constraints on economic growth, simplifying the Resource Management Act, amending the Emissions Trading Scheme, removing unnecessary business regulations, and investing in infrastructure development including roads and a faster broadband network. Whether this plan does enough remains to be seen.

With the international credit crunch and financial turmoil hanging like a cloud over New Zealand, I asked the Professor of Economics and Finance at Victoria University, Dr Roger Bowden – this week’s NZCPR Guest Commentator – for his view on the situation. In his article “Don’t Panic”, Professor Bowden explains:

“I think the financial system will recover all right and pretty soon, possibly through the medium of the very people who did all the short selling that aggravated the mess. Hedge funds will see that many of the troubled assets are in fact perfectly OK and badly underpriced at that. Governments that have bailed out their banks may even end up making a few bucks when they sell off all the preference shares they are acquiring as part of the deal. They can then afford to retire all the government debt they have had to issue. Right now there is an appetite for government debt because of the flight to quality. When the governments come to buy it all back, interest rates will be a bit higher, and it will cost them less to retire the debt.

“So it’s not all gloom and doom for the beleaguered governments. There will likely be longer term costs for society, notably in the huge prudential and risk management bureaucracy that governments will insist be put into place in the finance industry. But that’s another story.

“Where does it leave us here in NZ, and what sort of signals should it be sending to our policymakers? Our banks are in good shape; not too many worries there. I do not think that the government, of whatever ilk, should lose their nerve. If there is to be a slow down, then we need countercyclical action, not to make things worse by cutting back willy nilly.”

With new policies being announced by all of the parties on a daily basis – including Labour’s newly announced deposit insurance scheme for domestic savings in local banks – the key determinant for the election will undoubtedly be who can provide the safest pair of hands to manage the country through these challenging times.


1.Treasury, Pre-Election Fiscal and Economic Update 2008

2.Nevil Gibson, Editor’s Insight

3.Herald, Number of public servants up 5 percent

4.Dominion Post, Bureaucracy base expanding by the hectare