Will KiwiSaver Boost Economic Growth?

Will KiwiSaver Boost Economic Growth?

There is much controversy about whether KiwiSaver is a ‘solution’ to a non-existent problem of poor savings in New Zealand, and about whether it makes sense as a retirement income policy.

Leaving those debates aside, another issue is whether it will boost New Zealand’s economic growth.

Writing in the New Zealand Herald after the budget, columnist John Armstrong had no doubts on this score.

“KiwiSaver should reinforce Labour’s economic management credentials”, he said. “The boost in household savings and the surge in investment capital should drive the kind of growth needed to substantially lift personal incomes – and, in the process, lift New Zealand up those dismal OECD rankings with which National currently flays Labour.”

Really?

How should we think about the impact of KiwiSaver on GDP?

Mr Armstrong is clearly thinking of a link between domestic savings, investment and growth. But this is tenuous.

First, New Zealand has access to a vast international pool of capital for investment at a price that is set in world markets. KiwiSaver cannot stimulate investment by reducing the world cost of capital. If it increased domestic savings, firms would simply use less foreign savings.

Moreover, much of any additional saving would not be invested in New Zealand. In the interests of prudent diversification, fund managers are likely to place more than 50 percent of the inflows offshore, as the New Zealand Superannuation Fund does. Domestically, they will have to put most of their equity funds into listed companies. The diversion of savings from other vehicles into KiwiSaver might reduce local funding for sectors like small business and farming. These are amongst the most innovative and productive in the economy.

Even if the funds going into KiwiSaver translated fully into additional investment and were manna from heaven, the impact on GDP would be small.

The capital:output ratio of the economy is about 3:1. The budget puts the build-up of KiwiSaver funds by 2011 at $1,093 billion a year. Assuming the productivity of new investment is the same as that of capital already in place, the effect of $1 billion of KiwiSaver funds channelled into new investment would be an increase in GDP of about $333 million. On this basis KiwiSaver would boost GDP in that year by about 0.2 percent – hardly a big step towards the 4 percent plus growth rate that Dr Cullen is targeting.

But the KiwiSaver funds will not represent net additional saving and will not be manna from heaven.

On the first point, many people will simply switch savings from existing schemes or mortgage repayments into KiwiSaver to take advantage of the tax subsidies. Low income people will not be in a position to save more, despite the inducements.

On the second, the budget estimates the fiscal costs of increasing household savings by $1,093 million in 2011 will be $1,214 million. Taxes will be that much higher in 2011 than they would otherwise be, and will impose a drag (deadweight cost) on the economy. For the purposes of public sector cost benefit analysis, Treasury uses a conservative deadweight cost estimate of 20 percent. On this basis the cost of the additional taxation will slice some $240 million off GDP by 2011.

The contribution of KiwiSaver to GDP is thus looking very small at best, and could easily be negative, having regard to deadweight losses and distortionary effects on savings and investment decisions. Its contribution is clearly negative compared with equivalent tax reductions.

These calculations are illustrative; many refinements could be made. However, they seem consistent with the Treasury’s own estimates. In the budget it puts the boost to GDP of KiwiSaver in 2011 at just $68 million, or 0.04 of GDP. Indeed Treasury gets its result largely through an assumption that the tax subsidies will allow some people to accumulate the same level of funds by saving less, so allowing them to consume more!

As an experienced journalist, Mr Armstrong no doubt read the budget and noted this figure. It would be interesting to know how he reached wildly different conclusions.

This is all the more puzzling since it has been well established in the retirement income debate that tax incentives and compulsion have at most a small overall effect on savings – so that the very first premise of his argument breaks down.

I have yet to find any research which suggests Australia’s compulsory savings scheme and tax incentives have been a major factor in its economic performance compared with trade liberalisation, deregulation, privatisation, labour market reforms, and sound monetary and fiscal management. It is implausible to suggest that KiwiSaver would have a major impact here.

And because growth in the economy – the output of real goods and services – is what matters most for people in retirement, it is hard to see what KiwiSaver does for retirement income security either.

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

ENDS

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