Apply the golden fiscal rule and invest prudently.
A lender is greatly disadvantaged compared to a borrower. The borrower gets the cash immediately. In exchange, the lender gets a promise that the borrower will repay the loan (plus interest) at some time in the future. No matter how honourable the borrower is, the lender knows the loan may not be repaid and so has no certainty that the full deal will be completed.
Ironically, this disadvantage means the lender is a stronger position in any transaction. Borrowers usually end up with less funds than they want; that they think they can repay. Lenders constrain their advances to what they think the borrower can be reasonably certain to repay – which is much less.
However, lenders want to lend. They look for good quality borrowers, with propositions which reduce the uncertainty that they will not repay. So the bank manager looks at the requester’s past record including the extent to which they have been able to live within budget, as well as their prospects.
The same is true for an international lender to a sovereign nation. Sovereignty does not guarantee that a country will repay its debts. Many countries have failed. Argentina’s debt rescheduling has tried both the international financial community and the Argentinian people; it is but the most extreme case.
One of the tests that the international lender has, is the extent to which a country lives within its budget, including how much the private sector is borrowing for consumption and how much the public sector is borrowing for consumption.
What is an international lender to think of a country whose central government spent more on their current consumption than its current revenue in the period from 1979 to 1993, from 2009 to 2013, and is currently projecting to do so from 2020 to 2029 (perhaps longer if they current projections turn to custard)? Sure, there is much attractive about New Zealand, including low corruption and transparent government accounts, but if you were a bank manager would you look so kindly on a client with such a savings record; would you not downgrade their credit rating?
To be clear, this is about current consumption. Lenders will be more sympathetic to a government which wants to borrow for investment, especially if it involves a means of repayment. But that is not what New Zealand has been doing. Certainly the government has been borrowing for investment, but it is also currently borrowing for consumption in probably the second-longest binge its history. The Muldoon-Douglas-Richardson binge being the longest. Previously the government borrowed for only investment – the lenders made sure of that. (To complete the record, English borrowed to soften the GFC shock but painfully swung the government accounts back into surplus; he was forgiven by lenders.)
The principle that the government accounts should usually run a small surplus of current revenue over current spending is known as the ‘golden (fiscal) rule’. Whether the government resolves its deficit by raising taxes or cutting government spending (or a bit of both) is a political decision. I have my choice and each reader theirs. Lenders probably don’t care a lot – their demand is to ‘just do it’.
Once New Zealand is pursuing the golden rule, they will upgrade our credit rating (which lowers the interest rates they charge us) and look benignly on lending to us for investment purposes. They may be willing to lend generally to an investing government, but they may be even more willing where they see the investment generates a revenue stream or cost reductions. Here are three examples.
Three Waters
When the government was in the height of its centralisation of three waters I argued for a single agency which would borrow offshore and then lend to the regional water agencies. Lenders would be more attracted to this than lending to each region, because it would expect the centralised New Zealand agency to monitor its lending to ensure the investment was handled prudently.
Lenders would also prefer the regional agencies were to increase their dependency on water charges to service the debt because local body rates are politically harder to raise. (I acknowledge there are equity issues with water charges, most of which can be resolved. There are also welcome efficiency gains.)
Healthcare
As wrote in the previous column, even the Treasury thinks that the public health sector’s buildings desperately need upgrading. Additionally, the public health sector outsources treatment to the private sector because of its capital constraints; in effect the private healthcare sector is borrowing for buildings and equipment on the security of the revenue flows from public sector outsourcing.
Suppose we cut out the middlemen and Health New Zealand did the borrowing either directly or the central government borrowed on its behalf. For New Zealanders it would be cheaper and treatment decisions would not be distorted by capital markets peculiarities. (Do you want a banker in your operating theatre?) Lenders would probably not find the deal quite as attractive as the three waters centralisation, but they are realistic enough to recognise that this is a cost-saving for the government, which is unlikely to renege on its commitment to public healthcare.
Transport Infrastructure
Once upon a time there was the principle that the public costs of the development of transport infrastructure were covered by the revenue from taxation on fuel and motorist licences. In those days the sector did not borrow, a consequence of which was that the transport network did not evolve as fast as usage. Let’s return to the general principle that transport users pay but now allow the sector to borrow, with the requirement that the resulting debt services be payed out of the user payments. Again lenders would be more willing to divvy up the cash.
Such changes may seem to be revolutionary. In fact, they were broadly the way that the government operated after Vogel. The traditional Keynesian prescription was to regulate demand by changing the level of public investment. As far as I know the golden rule was not abandoned before the (second) Muldoon era.
That past system served us a lot better than we acknowledge – better than the current system with its threat of lenders increasingly losing confidence in New Zealand followed by a downgrading of our credit rating and rising costs of borrowing. A return to the golden fiscal rule as a key fiscal objective and borrowing only for investment would offer better prospects for our future.
This column is based on research which extends the pioneering work of the late Dennis Rose. It is not yet fully written up but has been discussed with colleagues. Depending on the exact measure, the dates when the golden rule has been broken shift around a little, but only by a year or so. There is no doubt that it was breached over the three identified periods.