This article appeared in the Dominion Post today, 17 May 2007.
 
 
 By Roger Kerr
 
How to Future-Proof New Zealand

A goal of finance minister Michael Cullen has been to protect New Zealanders against the economic consequences of an aging population.  Another, perhaps less explicit, goal has been to protect the welfare state against such economic pressures.

Both goals are admirable, although there is scope for fair debate around the nature and extent of the state’s involvement in the provision of welfare benefits, superannuation, health and education.

In pursuit of these goals, Dr Cullen has run large budget surpluses, paid 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 4 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 successive governments have successfully confronted.  Public debt is now at low levels by OECD standards, giving governments more scope to reduce surpluses and taxes while maintaining prudent debt ratios.

Dr Cullen has wanted to go further, however, and put money away in ‘cookie jars’ (public or private) to guard against a future rainy day.

This is a more dubious strategy.  The Cullen Fund has no advantages over a policy of allowing debt to fall and the rise somewhat in the future as the population ‘bulge’ moves through, and it is highly likely to be vulnerable to political meddling over time.

KiwiSaver is based on the false premise that New Zealanders are poor savers, and for many of them repaying mortgages would be a better savings strategy.

But the main criticism of Dr Cullen’s thinking is more fundamental.  It is that putting money in cookie jars 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 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 erode benefits through inflation, tax changes and in many other ways.  They will do so if the superannuation burden on the productive generation becomes politically unsustainable.  There would be a potential ‘war between the generations’ and mass out-migration.

Politicians like Michael Cullen (David Lange was another) 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 class case in point.

But this too is unlikely to be a sustainable long-term strategy.  The costs of redistribution on this scale – in terms of blunted incentives and lower national output – are huge, and the quality of quasi monopoly state services continues to disappoint.

The upshot is that future-proofing New Zealand requires a quite different strategy, one focused on economic growth and more modest redistribution.

In turn, economic growth on a long-term basis depends mainly on raising labour productivity.  Here Dr Cullens’ record is underwhelming: labour productivity in the business sector of the economy grew by X% in total in the six years to March 2006, whereas the increase in the previous six years was Y%.  The outlook is for further mediocre growth on current policies.

For a politician with the worthy goal of underwriting the living standards of New Zealanders in the future and government–provided social services, it seems likely that Dr Cullen’s legacy will put both at risk.  Only a departure from a cookie jar mentality and a focus on productivity and economic growth will reverse that outlook.

ends

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