Hon Bill English

Minister of Finance

Speech to the Cullen Employment Law Firm breakfast function

Embargoed until 8am

Thursday November 18, 2010

Good morning and thank you Peter. It is a pleasure to be here.

Last week marked two years since the John Key-led Government was elected on a platform of building a more ambitious New Zealand.

As the Prime Minister said on election night 2008, the Government's driving goal is growing the economy to deliver greater prosperity, security and opportunity for all New Zealanders.

We promised to increase after-tax incomes, ensure government spending was focused on frontline services and lift investment in critical infrastructure.

And we said we'd tackle the enormous challenges thrown up by the global financial crisis.

Two years on we've met those commitments and in many areas have exceeded them. But our work has only started.

Looking forward, we've put in place a comprehensive plan to get our economy growing strongly and to lift New Zealanders living standards. I have every confidence this plan will lift our long-term growth rate.

However before I outline our economic plan in more detail, I'd like to talk to you a little bit about the decade we've just been through and what might be the new normal for the next decade.

The new normal

There haven't been normal times in New Zealand for a while. The past few years break into two distinct periods, neither of which was normal.

In the five years to March 2008 we had an unsustainable boom, with growth in all the wrong places. During these five years:

* Consumption growth averaged 4.3 per cent - almost twice its long-run sustainable level.

* House prices more than doubled.

* Credit grew by 83 per cent.

By the end of the boom our economy was dangerously lopsided.

Households were borrowing about $10 billion per year to finance consumption and our balance of payments deficit had widened to over 8 per cent of GDP for several years.

At the same time core Government expenditure grew by 43 per cent and floating mortgage interest rates rose to over 10 per cent.

This flowed through into our economic performance In the three years leading up to the global financial crisis - a time when many other countries grew strongly - our average annual growth was less than 1 per cent a year. And on the measurement of GDP per capita it was actually negative.

The tradeables sector – the internationally competitive part of our economy comprising exports and import competing industries – actually shrank in the five years from 2005 to 2010. By contrast the non-tradeables sector – the spending side of the economy - grew by 15 per cent.

All of this contributed to a marked deterioration in our net international investment position, which measures New Zealand’s total debt to the world, including households, business and the Government.

In 2000, our debt to the world was about $90 billion. It’s now over $160 billion and is forecast to head over $200 billion and keep rising.

The growing interest bill from that rising debt is a drain on our incomes and a drag on the economy. It is a major vulnerability.

By contrast, since 2008 we have seen a complete reversal of this trend:

* Households have become strongly averse to debt – they have lifted savings and are trying to restore their balance sheets.

* Both the housing market and credit demand have stalled.

* Banks have realised they are over-extended, with too much foreign borrowing.

* We have halted the growth of wasteful Government spending.

* The balance of payments, which represents net national savings, has dramatically improved.

It is fairly clear that both of these periods have been abnormal, and that neither is a good guide to what we can expect ahead.

While it seems quite obvious in hindsight that the trends through the bubble years were unsustainable, it is equally obvious that the current phase is likewise not the new normal. Rather, it is a correction to what has gone before.

In terms of what we can reasonably foresee, here are some suggestions:

* The economy's growth potential is currently estimated to be somewhere around 2.5 percent. This Government's overall economic goal is to lift that potential growth rate.

* Household behaviour will have changed for the better. We will see more saving, less debt-fuelled consumption and a continued shift away from leveraged property investment.

* Banks will be more cautious about lending as they rely more on deposits and on longer-term borrowing in volatile international markets.

* Government won't grow so fast again. Tomorrow's government will be more flexible and interactive with business, more contracted out, more tech-savvy, more value conscious and generally more responsive.

* The new jobs created will come from the areas that have not grown much in recent years; the export sector and its downstream industries, including service exports which have declined notably in recent times.

* Unemployment will continue to fall and skills will again be in demand.

* Our trade patterns will continue to move quite rapidly in favour of emerging markets. The succession of free trade agreements we are entering into or expanding, such as the Trans-Pacific Partnership, will accelerate that trend.

In this new world, growth will need to be based on savings and investment and it will need to be led by the earnings side of our economy – namely the export sector.

Increasing our national savings

One of our biggest challenges is increasing our national savings.

The Savings Working Group is looking at how to increase national savings – including both private and Government savings.

Increasing our national savings and investment levels is a critical issue for New Zealand, because our high debt raises our effective interest rates and makes it more expensive for businesses to get the capital they need to expand.

That affects every New Zealander, as it limits the number of jobs businesses can create and the wages they can pay.

The working group will consider specific areas including: * The impact of the tax system on savings and investment.

* Improving the operation and outcomes of KiwiSaver.

* And the role of fiscal policy in national savings.

The Government has an open mind about what might be required to lift our savings further and we don't want to prejudge the outcome.

However we will be looking closely at the group's work to see if there are practical ideas to materially lift New Zealand's long-term national savings.

The Government's economic plan

Looking back at our first two years, we have already taken steps to reduce projected government debt and put our books on a path back to surplus over the medium term.

In the short term we are running significant deficits to support the economy, including a $13.3 billion forecast cash deficit in the current year.

However that cannot continue indefinitely.

That's why we are focused on lifting growth in the productive parts of our economy – our exports and internationally competitive sectors.

Our economic plan is intentionally wide ranging. That is because there is no single silver bullet – action is needed on a wide front if we are to turn around our poor economic performance.

We are focused on six broad areas that we believe can contribute to a stronger economy.

The first is strengthening our tax system – you will have all seen the major changes we made in the Budget.

At a time when many other countries are being forced to consider income tax increases, we have delivered across-the-board personal tax cuts that leave the average household about $25 a week better off, even after the GST increase to 15 per cent. The average wage earner is about $15 a week better off.

The package, taken as a whole, tilts our economy towards saving, investment and exports and away from borrowing and consumption.

The changes also make us more internationally competitive.

From the 2011/12 income year, our company tax rate will fall to 28 per cent – lower than Australia. That helps provide businesses with the right incentives to invest and export.

Better, smarter public services – this has involved getting forecasts of never-ending Budget deficits and ever-increasing government debt under control.

We’ve reviewed the performance of major departments and agencies; we’ve capped the bureaucracy and moved nearly $4 billion of spending into frontline public services such as health, education and law and order.

All major departments will face significant change over the next four years, as we lift productivity growth in the public sector.

And we have sharpened policy advice by using a series of working groups with clear briefs, tight timetables and a mix of private and public sector people.

Lifting education and skills – we’ve introduced national standards in literacy and numeracy; we’re introducing the Youth Guarantee and trades in schools; and we’re focusing tertiary education on achievement by improving the quality and relevance of qualifications.

Better business innovation and an ambitious trade agenda – we recognise the benefits to growth and jobs this area makes.

Last year, we announced the $140 million-a-year Primary Growth Partnership with the private sector; and in Budget 2010 we confirmed a $321 million investment over four years in new science, research and technology initiatives.

Our ongoing drive for free trade agreements will deliver more benefits for New Zealand businesses – we’ve signed agreements with Malaysia, Hong Kong and ASEAN, and we’re in talks with India, the Gulf States, Trans- Pacific Partnership countries and Korea.

And at the weekend the Prime Minister announced that New Zealand is the first developed country to enter into free trade negotiations with Russia, Belarus and Kazakhstan.

Cutting red tape and regulation – we've put in place a package of employment law reforms that give businesses the confidence to invest and take on new staff.

We’ve simplified the Resource Management Act to reduce costs and promote growth, and further RMA reforms are underway in areas such as water, infrastructure and urban design.

And we’ve progressed major reform in aquaculture, construction, food and the finance sector – all aimed at better economic performance.

And last, but not least, we’re investing significantly in productive

infrastructure – we've increased investment and we've taken steps to get the best from limited resources through smarter planning, financing and execution of projects.

Our increased investment is well underway. Work has begun on a range of large roading projects that are part of an $11 billion investment over the next 10 years on State Highways.

Our $4 billion five year upgrade of the National Grid is progressing well and the first rollout of fibre to the home as part of our $1.5 billion ultra-fast broadband plan is expected to start before Christmas.

This is alongside significant work to upgrade our rail networks and schools.

Collectively these investments are supporting thousands of jobs around the country.

We've increased private sector engagement, including through publicprivate partnerships, and next year we'll produce the second National Infrastructure Plan which will help identify longer-term infrastructure gaps and improve central and local government co-ordination.

Signs of progress

In the past year, I've been encouraged by some clear signs of progress.

Firstly, New Zealand has pulled out of recession. We've now had five consecutive quarters of growth and in the past year GDP has expanded by 1.9 per cent.

That's a sharp improvement on the 2.5 per cent economic contraction the previous year and amounts to a 4.4 per cent turnaround.

Secondly, this growth is being reflected in a slow but steady improvement in the jobs market.

Unemployment has fallen to 6.4 per cent, with about 40,000 more people in jobs than a year ago.

We expect this steady rise in new jobs to continue over the coming year.

Thirdly, this growth is being driven primarily by exports.

In the past year, the value of New Zealand's exports increased by 15 per cent as we enjoyed near record commodity prices, according to Statistics NZ data.

Lastly, New Zealanders are choosing to pay down debt and increase their savings rather than borrow to speculate on houses or purchase flat screen TVs as they did for much of the last decade.

Reserve Bank and Statistics New Zealand data shows that at the peak of the housing boom in 2007 New Zealanders borrowed about $7 billion against the equity in their homes to spend on consumer goods.

By contrast, last year New Zealanders paid off about $5 billion of debt in their homes. This is of course a form of saving.

That's a $12 billion a year turnaround and is equivalent to about a 10 per cent reduction in incomes, in terms of household spending.

A recovery built on savings

This means the recovery will be quite different from others in our recent past. It will not be driven by domestic sectors like retail and housing.

That will mean slightly flatter growth in the short term, but it will create a foundation for stronger growth in the longer term.

That is encouraging and shows that if the signals and incentives are right New Zealanders know what to do.

This different trajectory means that in the short term there will be some mixed economic data – there will be fluctuations from quarter to quarter and differences from industry to industry.

However the economy is growing, unemployment is dropping and our exports are increasing.

Looking forward, we expect this improvement in our economy to continue.

But we can and will do better.

Rebalancing the economy to achieve a permanent lift in sustainable growth is not a short-term task. It will require a relentless long-term focus and commitment.

The fiscal and economic outlook

Since 2008 the progress we've made has had a positive impact on the Government's books.

However the weaker than expected global outlook and our faster than expected adjustment away from consumption is likely to flow into the next set of Treasury forecasts in the Half Year Economic and Fiscal Update on December 14.

We've already seen tax revenue below expectations in the first three months of the financial year as people choose to save more. Slightly lower than forecast growth plus the effect of the Canterbury earthquake has flowed into slightly higher debt.

That is being partly offset by export growth, but it is likely those factors will flow into a lower growth forecast for the year to March 2011, before a rebound in the year to March 2012.

Combined with the fiscal impacts of the Canterbury earthquake, it will mean higher forecast deficits in the short term, before improvements show through.

As I've said, the Government cannot run large deficits indefinitely. That is why we are taking steps to contain debt accumulation, keep finance costs down, and make sure we are ready for the next shock.

We are committed to getting back to surplus by 2016. We still have a significant medium term challenge to achieve that, so in many ways restraint in the public sector has only just started.

Investment statement

If the Government is to get the most out of every dollar, it’s important that spending discipline is applied equally to operating and capital spending.

At present, the New Zealand Government holds about $220 billion of assets – about half of them physical assets like roads, schools and prisons. This investment base is set to grow by about $30 billion over the next four years.

This means the Crown is the largest single investor in a capital constrained economy. It is therefore vital the Crown invests its capital efficiently.

A natural product of this privileged position is that the Crown is also the largest asset owner in the country.

Those assets were built up using taxes from hard working New Zealanders, so we have a huge responsibility to manage them well.

However, Government performance in this area has been poor.

We have set about to rectify this by introducing better planning, greater price competition and more engagement with the private sector.

At a time when our finances are constrained, even small improvements in this area could yield substantial gains to reinvest in vital public services and assets like schools, housing and hospitals.

We believe departments should be looking at their own balance sheets and identifying inefficient or surplus capital that can be freed up and reinvested in more productive areas.

Taking the lead from the first National Infrastructure Plan, which provides the strategic basis for our five-year $7.5 billion infrastructure investment in assets like schools, hospitals, broadband and prisons, the Government is now undertaking a wider stock-take of its entire balance sheet.

We will release a Government Investment Statement at the Half Year Update next month, which will clearly set out the Crown's assets and liabilities, identify emerging issues and state how the Government plans to manage its large and growing investment in taxpayers' assets.

We believe this level of transparent information – in a regular publication - will allow the public to demand a much greater level of accountability from the Government and lead to significantly better decision-making across the public sector.

Next steps

Over the next few months, leading into Budget 2011, the Government will continue implementing our plan to create a strong platform for faster growth.

That will include looking at more policies that can assist the economic rebalancing already occurring.

I've already mentioned the Savings Working Group and another group - the Welfare Working Group - will also report back early in the New Year.

It's critical we address long-term welfare dependency and create a system that is sustainable, fair and helps children out of poverty and into a better future.

Over 10 per cent of New Zealand's working age population - 337,000 - receive a main benefit and almost one in five children live in benefit dependent families.

In recent years, much of the growth has been in categories where people tend to stay for long periods such as the sickness and invalid's benefits, where the numbers have roughly doubled since 1995, rising from 74,000 to 143,000.

If current trends in the growth of these benefits continue 16 per cent of the working age population could be on a benefit by 2050. That is not socially or economically sustainable.

While there is a lot of focus on the more than $7 billion a year financial cost of welfare, the social cost of long-term benefit dependency is even greater.

Tackling this issue is critical to reducing the social and fiscal costs of longterm benefit dependency and we will seriously consider any practical options the Welfare Working Group puts forward.

Conclusion

In summary, our economy is recovering and is outperforming most other developed countries, but there is always more we can do.

The Government has a wide-ranging economic plan that I'm confident will help rebalance our economy and deliver faster growth. That is the only way we can create the jobs, higher incomes and the better living standards Kiwis deserve.

I'm encouraged by the early signs of progress we are seeing and we expect that improvement to continue.

Just as 2010 was better than 2009, I'm confident 2011 will be better than 2010.

I can assure you today the Government will continue to rise to that challenge.

Thank you.

ENDS

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