He’s Spent It All

The just published PREFU, Treasury’s assessment of the economy, raises more important questions about our fiscal stance than what the election is talking about. Have we the right borrowing strategy?


It was amusing how the Minister of Finance, Stephen Joyce, had to present the PREFU (Pre-election Economic and Fiscal Update) as both an optimistic account of how well the economy was doing, and yet caution that it was not doing so well that the opposition parties could spend or cut taxes big.

The PREFU arises from the statutory requirement that the Treasury report on the state of the government accounts shortly before the election so that all contestants have a common account of the state of the economy. It is the Treasury’s assessment independent of the minister. More bluntly, he is stuck with whatever the Treasury decides.

The Treasury sees volume GDP at an annual rate of 3.0 percent for the four years to June 2021. That may seem not too bad, as the population is growing at 1.6 percent p.a., so per capital incomes are increasing at 1.4 percent p.a., about the same as the long run grow rate for the economy.

A caution. Some 57 percent of the population growth can be attributed to net immigration. Since they are more of working age than the New Zealand population as a whole, they will get a greater share of the production increase, so the incomes of those who already live here will, on average, rise more slowly. Not that the Minister mentioned this, but to be fair, there are many countries in the rich world which would be very happy to have the PREFU figures.

If the future economy is looking good, why is there not room for a party either by government spending it up or by tax cuts for private consumption or both? Joyce said that there could be more government spending, either by increasing taxes or by borrowing more on which I focus here.

Each year the government has to borrow around $7 billion a year, but this is mainly to rollover maturing debt. This year and next, however, there is expected to some borrowing in addition to debt rollover, while for the following two years the budget forecasts a cash surplus and debt will be retired. The net effect is that the level of government debt is expected to be roughly the same in June 2021 as it was in June 2017.

But, you say, was not the government projecting a falling level of its debt? Not exactly. What it is projecting is a fall in the government debt to GDP ratio. If the net level of debt remains constant and (nominal) GDP rises the ratio falls.

What the Minister is saying is that if we are set on the falling debt-to-GDP track and there is no rise in taxes, then there is no room for more public spending. Joyce could have echoed of Rob Muldoon’s ‘I’ve spent it all’ in the 1972 election campaign . (He backed down a little, saying there might room for a family support package in 2020. So he has only spent it all in the next two years.)

Are we locked onto this debt track? The Minister pointed out that New Zealand had to keep its debt down to maintain room to manoeuver for a shock, citing the Global Financial Crisis and the Canterbury earthquakes as examples of the unexpected. So how low should one go? Are we in a sort of game of limbo in which the bar keeps being lowered?

The issue is not how much we want to borrow. It is how much the international lenders are willing to advance. Aside from our being a small economy, a bit vulnerable to erratic export price shocks (and earthquakes), we must look a good proposition to those lenders. We have prudent and robust fiscal controls and proven political leadership (not only Joyce but his predecessors such as Bill English and Michael Cullen). Even so, they are unlikely to lend to us if we say that we have decided to borrow to fund a party.

We could present the argument in a more attractive way. We run a substantial operating surplus (current revenue less spending) but most of it is invested in public capital projects. That is why at the end of the day, after deducting investment outlays from the operating surplus, we have only a small cash surplus (or deficit). We might ask our potential lenders whether we should finance all of our capital spending out of current revenue.

We need a thoughtful public discussion on such a tricky question. I think there is a strong case for funding a lot of the government’s capital outlays from current revenue. But there is one area where this may not apply.

When a migrant arrives in the country, he or she gets automatic access to the benefits of New Zealand including its public capital. (Also education and health spending and the like, but they pay their fair share of taxes – I hope.) Their share of the net central government capital comes to about $25,000 a migrant. It is, in effect, a free gift with the rest of us sacrificing public and private consumption (spending by government and paying higher taxes) for them. I am not sure that we should be quite so generous

Is there a case for our borrowing offshore the capital demands immigrants generate? What would our potential overseas lenders say if we argued that we were borrowing to match the migrant inflow? That would amount to about an extra $1 billion or so a year at current rates. Our debt-to-GDP ratio track would still be downward but not as fast as the PREFU projections.

We could use the extra fiscal room the $1 billion a year on poverty reduction, more health and education or so on, tax cuts (and more private spending), more government infrastructure or whatever. The balance between them is a political one, to be settled by an election – if our lenders are willing

That is the point of the PREFU: it provides a framework for a serious discussion about the direction of the country; the election cacophony may drown it out.