Paying our way in the world

Bernard Hickey has finished his blog on Stuff with a final blast on economic issues that is actually a really interesting look at where New Zealand is at. It's well worth a read. I don't necessarily agree with his prescriptions but I appreciate an informed perspective when I see it, given the generally dismal state of the economic debate in the popular media.

His blog, along with the Easton stuff I mentioned earlier in the week, and recent NZ Institute reports on the credit crunch, draw all of our attention to one of the key economic problems of any periphery economy in a capitalist world - or any colonial economy in an imperial system - or of New Zealand in February 2009. 

That problem is a lack of saving. Ever since colonisation, New Zealand has depended on foreign capital to finance its economic development. The gain? Faster development than local savings would have allowed. The pain? The need to pay for it - so less of our production stays local, and more goes to pay the foreign lenders.

Traditional theories of economic development would argue that over time, the dependence on foreign capital will lessen. The capital is invested in productive assets; incomes and profits grow; people start to save as their incomes grow; they will invest locally and internationally and so on. The biggest economies and those which are most developed have neutral to positive net international investment positions, and their current accounts are broadly in balance.

It is clear that in New Zealand, this has not happened. In New Zealand, we continue to draw massively on the savings of others, and we have failed the basic test of investing those funds in productive assets. Instead we have invested in residential housing, which has no productive value at all once it is built. So we continue to draw on the savings of others, but instead of building assets that will generate income to pay for the debt, we literally throw the money away. We consume it instead.

The consequences of this long run trend are that New Zealand now owes around 85% of GFP more than it owns. Our current account deficit is sitting in massively high territory of over 8% of GDP. We are running regular deficits on the trade account, which would need to be in $10bn surplus to pull the overall current account into a reasonable position.

This is not good enough. It is not sustainable. It is not the path to economic independence and development on our own terms. It is not compatible with the development of a social democratic society. It is not going to carry on because the credit markets which sustained it have run out of room.

It was recognition of this problem that led to Labour's heavy focus on public savings (by government, in response to households' and firms' almost lemming-like and foolish insistence on dis-saving and/or frivolous investment), and massive encouragement to start private savings through the KiwiSaver scheme.

Over time those policies would have built a stock of assets, invested in productive assets in NZ or in financial instruments and equities that drew new income to the NZ Economy from outside our borders. That stock of assets would end up righting the balance, over time, between what we now own and what we now owe. It was hoped, I guess, that no roadblocks would emerge that would disrupt a gentle adjustment and shift from our profligate behaviour to a more considered savings culture.

Three stumbling blocks have emerged. 

The first is the new Government's almost suicidal desire to shaft both savings policies: first by eroding KiwiSaver, and second by considering cancellation of the Cullen Fund. In a context where Kiwis are insistent on behaving badly, strong incentives to start saving again were needed. They were there, and now they are being undone. Further, National's additional tax cuts (which are now clearly unaffordable) contribute a big chunk of the $40bn of new borrowing the government will have to undertake in the next five years. We cannot afford the tax cuts: they should be cancelled.

The second is that the economic crisis and the recession mean that instead of contraction (higher savings) - either by households or by government - we now need expansion. Ironically tough times do mean people will save more or pay off debt faster, to build flexibility, but that just puts even more pressure on government to "do something". This is not possible to square. In the short run we need stimulus. In the medium and long run, we need higher savings.

The third stumbling block is the world financial crisis. We could slowly have reduced our overdraft if our creditors were prepared to keep us on the ride. The strident and scary noises coming out of the Reserve Bank these days, and the banks too, indicate that this might be drawing to an end. With $60bn or so of credit rolling over this year, we are in for a very scary and nasty end to the endless national credit card if our creditors wish this to happen. 

So. What do we do?

We need to do a number of things. First is we need to accept that for a considerable period of years, we have to save more and spend less. The Government sector needs to spend more now but in the medium term has to rebuild a more stable fiscal position, either through lower spending or higher tax income (which may mean tax rates but may not - tax revenue grows through economic growth too). It also needs to save, buying financial assets overseas that draw new income into New Zealand (e.g. through the NZ Super Fund).

Households need to save more too. A restored KiwiSaver needs to be at the core of that, and I think it's time to have a serious debate about the tax subsidy that housing receives here. We tax all capital gains except those on redidential housing. It's mad, but changing it is seen as political suicide. That has to change: the playing field should if tilted be tilted towards productive investment, not massively sloped to unproductive investment in housing. 

Harder is the cultural change. We had higher taxes twenty years ago but higher savings rates. Cutting taxes does not lead to higher savings. People need to save: they need to be told point blank that their profligate ways with their mortgates, credit cards, etc, are damaging New Zealand's economy.

Firms need to invest more out of this growing pool of savings. They need to be incented to improve productivity and given the tools to do so: through proper research tax credits, consideration of tax structures that help this, improve management ability to drive productivity, invest more in training, etc etc. 

it is only by doing these things that New Zealand can start to live within its means again. The free lunch provided by the massive bubbles that have been flowing through the world economy for the past couple of decades have come to an end.

The adjustment costs should be shared, too: low income Kiwis are least able to bear the real costs of this adjustment. It is a case of all hands having to pull, but as a social democrat would say, those with the most should pay the most. That is why National's unfair tax changes, which increase taxes on low income earners and cut them on high income earners, should be abolished. 

If we want to have any show of running our own economy, and having some say in our own destiny, we need to leave behind our colonial dependence on other people's savings. We need to change our behaviour, consume less, and save more. If we don't do it on our own, other people are going to do it to us, and that won't be at all pretty.

Comments

[sagenz]

A reasonable post let down completely by a fundamental failure to accept reality. "The Government sector needs to spend more now".

Why???

The Government needs to lead the way in saving and investing in long term infrastructure. Not current consumption spending.

Justify your comments regarding how reducing private sector consumption by saving differs in any way from government also needing to constrain spending.

Cullen achieved surpluses by excess taxation, not constraining spending. This government should not compound the error.

[George Darroch]

Labour destroyed NZ's manufacturing industry by cutting protection, National followed with glee, and then Labour signed away free trade agreements which further ballooned the deficit.

It's not like no-one said these things. But Labour was not interested in listening, as the current account deficit ballooned and ballooned on the back of housing speculation, oil imports and plasma bloody TVs. Cause these were needed to balance the electoral calculus. These structural problems weren't going to solved by Kiwisaver (laudable though it is), and certainly not by borrowing billions to put into foreign companies.

Is Labour serious about moving away from mad neo-liberalism?

[Jordan Carter]

George: there are two ways of thinking about the current account. One is to consider the trade side. The other is to consider the investment side. If we saved enough and owned enough assets overseas, we could afford to buy all the tat.

I also don't see why a fortress NZ approach on the trade side would help. All the evidence is that those countries that rely on import substitution do less well than those who rely on export promotion, which requires competitive export industries that aren't consistent with closed import markets.

Labour did gut the manufacturing industry by deregulating badly. But a long run trend to freeing up the fortress economy started in the 1960s.

My concern is not what we do here, per se: though I have a support for manufacturing, that's not the topic of this thread. It is the lack of savings that is the bigger issue and overconsumption compared with our incomes. We could have as much manufacturing industry as we wanted but it would not help us if we don't save more: it would all just be owned offshore.

I'll talk about economic structure in another post later.

Sage: It's total economic orthodoxy both to let automatic stabilisers work or to enhance them in a recession (thru increasing the govt's fiscal impulse). If everyone in the economy starts saving at once, then aggregate demand falls through the floor. We would end up with unemployment at four or five points higher, and a much sharper downward correction in GDP, than otherwise.

That's why we need short term stimulus, and the government's accounts per se can sustain this. The problem is that the private sector for dozens of years has been borrowing and borrowing and borrowing, creating an external constraint on what the government can do.

Everyone's doing it, and in this case, everyone's right. Our special problem is our longer term savings problem, which is extreme, and needs to change.