Auckland's City Rail Link. Big, costly projects can't be turned on and off as economic circumstances dictate. Photo / NZME
OPINION:
So the Treasury has recommended, and the Finance Minister has adopted, a couple of ways of quantifying what constitutes prudent management of the public finances.
At its heart is what is sometimes called the Golden Rule of government finances: that over the economic cycle the government should borrow only to invest and not to fund current spending.
In other words it should save (run surpluses) during the upswing of the cycle, to allow running deficits during downswings.
Underpinning that is a concept of intergenerational equity. Current taxpayers should pay for current public services and transfers, while borrowing should be for (rigorously vetted) investments whose benefits will be enjoyed for years to come.
Accordingly, Grant Robertson announced in a pre-Budget speech on Tuesday "a commitment that, once we reach our Obegal surplus as planned in 2024/25, we will maintain that within a low range of 0 to 2 per cent of GDP over time".
That range is based on advice from the Treasury, he said, and is the same as the forecast ahead of the 2017 election under the previous Government's spending plans for the coming years.
The return to surplus is still a year later than expected in last December's half-year economic and fiscal update, since when we have had the further global shock of the war in Ukraine. It would mean five years of deficits — one fewer, Robertson pointed out, than during the previous Government's response to the global financial crisis and Canterbury earthquakes.
But what does "over time" mean? Ten years, the same timeframe for which the Public Finance Act requires a government to set its long-term objectives.
The aim is to avoid the penny-wise, pound-foolish myopia of a fiscal rule with a much closer time horizon. That sort of approach could require a government to curtail spending on areas like health, if it was faced with a transitory shock emanating from, let's say, global equity markets or trading partners' GDP.
In a similar vein, the soon-to-be-reformed public health system will move from annual budgets to a rolling three-year budget, "so that they can plan for what services New Zealanders will need and then put their heads down and get on with the job of delivering services instead of delivering deficits", Robertson said. Rolling three-year budgets are also planned for justice and natural resources.
The Government has already moved to a rolling four-year allowance for new capital spending. It currently stands at $9.8 billion over the next four years — a sum Robertson said would not be increased in the coming Budget.
Why not? "Current inflation pressures and capacity constraints." He acknowledged, however, New Zealand's "gaping" infrastructure deficit. "Every one of us knows what that looks like and feels like in real life. It's the hours of productivity lost stuck in Auckland's traffic. It's the burst water pipes here in the capital. It's the run-down hospitals in the provinces." Which brings us to the other fiscal rule he announced: a debt ceiling. It is intended to be a backstop against a bias towards running deficits.
The challenge in setting such a ceiling is that it needs to be high enough to:
• Accommodate shocks, whether from Mother Nature or from the other 99.8 per cent of the world, with its repeated tendency to sideswipe us
• Fund the necessary investment, including catch-up spending, in infrastructure,
• But not leave future taxpayers with an interest bill that would make it increasingly difficult to meet the primary fiscal rule about running surpluses on average over time. In any case, that will become more challenging given the rising costs associated with an ageing population.
The Treasury has revised upward its view of where a prudent debt limit is from what it reckoned back in 2019.
Back then, Treasury thought it would be around 30 per cent of GDP, when debt is calculated in New Zealand's traditional, but internationally eccentric, way.
Since then the pandemic and the associated fiscal response have driven government debt higher. As of the half-year economic and fiscal update last December, net core Crown debt was expected to peak at 40 per cent of GDP over the next couple of years before falling back to 30 per cent by the 2025/26 year.
Those forecasts predate Omicron and the Ukraine war, with its mounting toll on global growth and inflation, and will be revised in the coming Budget.
But it is not just the Covid shock. The Treasury has also revised up its assessment of how much public investment will be needed in the medium to long term. "Therefore a 30 per cent net debt target — as recommended in 2019 — would now be likely to overly constrain capital investment in a way that could reduce well-being." They now recommend a debt ceiling of 50 per cent of GDP, based on the current net debt indicator
By the standards of what we have become used to, 50 per cent might look improvidently high, especially to people who have better things to do than wade into the fiscal weeds.
So we get to the least significant of Tuesday's announcements, the plan to use the International Monetary Fund's measure of general government net debt as the headline measure in future, though the traditional one will still be published.
The main difference is that the traditional measure does not include, among the financial assets netted off, the assets of the NZ Superannuation Fund, currently about 18 per cent of GDP. Nor does it include other assets like student loans or the billions of dollars of cheap money lent to the banks under the Reserve Bank's Funding for Lending programme.
On the liabilities side, the traditional measure does not include debt on the balance sheets of Crown entities like Kāinga Ora (the former Housing NZ Corp) or Waka Kotahi (the Land Transport Agency).
The IMF forecasts that on its standard measure, New Zealand's net government debt will peak at 21 per cent of GDP in the coming fiscal year, when it will compare with 41 per cent in Australia, 71 per cent in the United Kingdom and 95 per cent in the United States.
On the new headline measure, the revised and more accommodating debt ceiling would be 30 per cent of GDP. Robertson stressed it was a limit, not a target.
ANZ economist Miles Workman sees the announcements as overall a slightly looser set of fiscal rules than those prevailing before the pandemic, particularly on the capital expenditure front.
From a cyclical point of view, with the economy looking extremely stretched, if the Government wanted to subtract from inflation pressures and rising interest rates it should be focusing on fiscal consolidation and non-spending ways to free up economic capacity — via immigration, for example, or cutting red tape, he said.
"However, the reason capacity constraints are biting so hard is partly due to decades of under-spending on the infrastructure front as the population expanded," Workman said.
"That has weighed on productivity, which is the holy grail of sustainable growth in real incomes."
Infrastructure spending takes time to plan and any Government that chooses a strategy of turning it on and off as economic conditions warrant risks losing capacity in the industry.
He concludes that tweaking fiscal rules so that debt is less of a constraint on infrastructure spending may well pay for itself over a long enough time horizon.
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