Do we treat the government finances with the common sense that household’s manage theirs?
It is a commonly held view that we should treat the government as if it is a prudent household. We don’t when it comes to its debt. Currently the government says it wants to constrain its net debt to between 20 and 40 percent of annual GDP; that is, between about 67 and 133 percent of its annual revenue. But households borrow up to 450 percent of their annual before-tax income.
Households borrow at that rate to purchase houses. They look at the whole of their balance sheet including their assets as well as their liabilities. When did you see mention of government assets in a discussion on our debt policy? For the record, they sum to about 400 percent of government annual revenue although not all generate income or save spending. Net worth (which deducts all the liabilities) is about 133 percent of annual revenue.
Focussing solely on debt without looking at the balance sheet as a whole distorts public investment. Some examples:
Suppose a significant private business collapsed (as did Air New Zealand and Kiwi Rail) and the best rescue involved the government taking over the enterprise. Even if there was no equity to be purchased, the government may have to take over the failed business’s debt. ‘Sorry, minister, you can’t rescue the business because that would exceed the debt ceiling.’
Suppose we wanted to tackle the problems of our fresh-, storm- and waste-water which will require borrowing up to $20b in the next 30-odd years. The most cost-effective structure would be to leave the responsibilities for water with (large enough) regional authorities which borrowed their funds from a central government agency which borrowed the $20b (or whatever) offshore. ‘Sorry, Minister, you can’t do that because the central agency would appear on the government balance sheet which would then exceed its debt ceiling. So we will have to design a more inefficient and costly solution.’
‘Sorry, Minister, you can’t get around the debt ceiling constraint by using a public-private-partnership in which the private sector does the borrowing but the government services the debt.’ Other countries use this ghost public debt so they can, in effect, borrow more than their debt ceiling allows. But it is still a government liability and, because we use more rigorous accounting standards, it appears as such as in the Government's Financial Statements and is included in overall debt. (Currently it amounts to $3.7b. It is backed by two state highways, three corrections facilities, and some education assets.)
On the other hand ‘Sorry, Minister, your focus on a debt target ignores any assets which may match it means that we are failing to provide sufficient infrastructure and maintenance to offset the depreciation of assets. Not just central government. Local government too. That is one reason our fresh-, storm- and waste-water systems are increasingly failing us.’
It’s Gilling’s law isn’t it? By prioritising the debt target we shape the game to ignore assets.
There are complications. A household’s borrowing is not simply constrained by its belief in its ability to service the debt. It is also constrained by the willingness of lenders to advance the funds. They are particularly concerned that they can recover their advances if things go belly up. (That is why they won’t advance you unlimited amounts to speculate on crypto-currencies, even if you think it is a sure thing.)
International lenders have got tangled up in countries which cannot meet their debt obligations. So they are cautious. Even so, New Zealand’s relative public debt level is well below the debt levels of many countries which are considered prudent borrowers.
There is a case we should be a little below that level. All prudent households (which are not facing too much hardship) hold a reserve they can use for an unexpected shock. It may be cash or an investment which can be readily liquidated; it may be an additional capacity to borrow. New Zealand has some of the former (the Reserve Bank has foreign exchange reserves) but low public debt makes it easier to borrow offshore in an emergency. New Zealand is probably more vulnerable than average to some shocks – earthquakes, volcanoes and tsunamis and the volatility of its terms of trade (but not militarily shocks so much) – so we need to maintain a lower debt level than what is normally accepted. (Another factor is the private banking debt, which may be pushed back onto the Reserve Bank in a financial crisis, but we have greatly reduced that exposure since 2008.) A margin for additional prudence does not explain all the difference in our lower debt target.
Observe too, that the above analysis has been in terms of debt levels offset by assets. It did not argue we can borrow for consumption. (It accepts a government may borrow or raid the reserves for short-term emergencies; any net asset reduction should be reversed reasonably quickly.)
Let me passionately state a moral perspective. Public borrowing is a cost to future generations. I do not think one generation should borrow unless it can justify its debt servicing to those yet-to-be-born, even if deciding what they will value when they are adults may be difficult. The decision is easy for investments which make a return; it is much harder where the borrowing funds activities which do not.
There are items which do not give a financial return but can be justified; conservation and heritage projects for instance. Future generations are likely to bless us if Aotearoa New Zealand is predator-free in 2050 (although the amount of borrowing the program generates is trivial).
Conversely, education is an investment but (largely) an investment in the individual who may migrate taking their education with them. I am committed to providing every New Zealander with a decent education (and healthcare) but it should be funded from current revenue.
The logic of this analysis is critical of the current government fiscal strategy, which amounts to borrowing for current consumption via income tax reductions. We are not in an emergency (and the government is not proposing to reverse the tax cuts when it gets through the current phase). We should support borrowing for projects which future generations would value, such as in conservation and infrastructure.
Once we ran the government as if it were a prudent household. Initially Keynesian management ran a surplus on current public spending which was invested in businesses and infrastructure; further funding was supplemented by borrowing. Today we are not as prudent. Borrowing to fund consumption is likely to be unfair, inefficient and detrimental to future generations.
If we are to have a target, perhaps something like the following: over a medium term, public current spending including transfers should not exceed public revenue. In the medium term, public borrowing should only be for public investment.