NZBR: How to Future-Proof New Zealand

17 May 2007.

A goal of finance minister Michael Cullen has been to 'future-proof' New Zealand: to protect it against the economic consequences of the bulge of aging baby boomers and to protect the welfare state against budgetary stress.

These intentions are admirable, although there is scope for debate around the nature and extent of the state's involvement in the provision of welfare benefits, superannuation, health and education.

In pursuit of his goals, Dr Cullen has run large budget surpluses, reduced public debt, established the Cullen Fund (the New Zealand Superannuation Fund), changed tax rules on saving and encouraged private saving through KiwiSaver.

He has also amended the Public Finance Act to require the Treasury to produce long-term fiscal forecasts every four years in order to increase public awareness of the future costs of current policies and the economy's capacity to sustain them.

Reducing public debt from the unsustainable levels reached under Muldoonist 'borrow and hope' policies has been a task that governments since 1984 have successfully confronted. Public debt is now at low levels by OECD standards, allowing more scope to reduce surpluses and taxes while maintaining prudent debt ratios.

Instead of doing so, however, Dr Cullen's approach has been to lock money away in public or private 'piggy banks' to guard against a future rainy day.

This is a flawed strategy. The Cullen Fund has much higher administrative costs than reducing Crown debt and does not provide a better return when adjustment is made for risk. It does nothing to reduce the total cost of tomorrow's superannuation, invites political meddling, and reduces economic growth relative to a lower-tax strategy.

KiwiSaver also reflects a 'piggy bank' mentality. It is based on another 'government-knows-best' premise: that New Zealanders should be saving more in the form of financial assets than by repaying mortgages, building up a business or investing in work-related skills.

The fundamental problem with Dr Cullen's thinking is that putting coins in piggy banks won't future-proof New Zealand.

The living standards of future retirees and the quality of health and education services depend on the productivity of the economy now and in the future, not on money put away today.

This may not be intuitively obvious. Take superannuation. Surely if governments have promised future benefits, and even partially pre-funded them, and people have a nest egg of their own, their future security is assured?

Alas, no. What matters for retirees is what goods and services are available to them, that is, the level of future output. As an IMF paper puts it, "pensioners are not interested in money (ie colored bits of paper with portraits of national heroes on them), but in consumption - food, clothing, heating, medical services, seats at football matches, and so on. Money is irrelevant unless the production is there for pensioners to buy."

What's more, the purchasing power of superannuation benefits, even if they are pre-funded, can never be guaranteed. Governments can 'raid' piggy banks and erode benefits through inflation, tax changes and in many other ways. Those of working age will vote out any government that puts an intolerable tax burden on them to support retirees, or migrate. That is why future productivity and output matter, not the size of the Cullen Fund.

Politicians like Michael Cullen have also been concerned not just to redistribute income to those in need but also to middle and higher income voters in order to shore up voter support for the welfare state. Working for Families is a classic case in point.

But this policy also promises to make future generations poorer by reducing the returns from working and making more people dependent on the state. The costs of large-scale redistribution are high and the productivity performance of state-run monopolies such as health is poor. Paradoxically, the strategy being followed is likely to make the welfare state as we know it less sustainable.

The upshot is that future-proofing New Zealand requires a quite different strategy, one focused on economic growth through lower tax rates, more competitive provision of social services, and more modest redistribution.

In turn, economic growth on a long-term basis depends mainly on raising labour productivity. Here Dr Cullen's record is underwhelming. Under his stewardship labour productivity in the business sector of the economy grew by 7% in total in the six years to March 2006, whereas the increase in the previous six years was 18%. The outlook is for further mediocre growth on current policies.

In pursuing the worthy goals of underwriting the living standards of New Zealanders in the future and the provision of government-provided social services, it seems likely that Dr Cullen is in fact putting both at risk. Only a departure from a piggy bank mentality and a focus on productivity and economic growth will reverse that outlook.

Roger Kerr is the executive director of the New Zealand Business Roundtable

ENDS

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