Editorial: OECD review bitter medicine before Budget

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Every economy can do with an inspection from outside, ours particularly.

The latest report on New Zealand from the OECD's review committee largely confirms familiar concerns about high external deficits and debt, an overvalued exchange rate, low savings, poor productivity and a stalled recovery.

But some of the medicine it prescribes will be unwelcome to the Government in the preparation of the Budget.

The OECD finds that after a promising start in 2009, the recovery has stalled as business and households reduce debt and a high dollar discourages investment in exports.

The economy is in limbo, lacking the usual bounce-back in domestic demand but not yet getting a boost from exports.

The first Canterbury earthquake was a setback to the recovery and the second, in February, "makes the outlook highly uncertain".

The Rugby World Cup will provide a temporary boost this year but the now-delayed reconstruction of Christchurch will start next year, when its stimulus for domestic activity will be offset by a necessary fiscal tightening.

Public spending is at levels that could not be sustained once the housing bubble burst and the recession struck in 2008.

The previous Government's introduction or expansion of maternity leave, childcare services and subsidies, interest-free student loans, KiwiSaver subsidies and the like has left a Budget deficit that will not disappear with an export-led recovery and will be a drag on it unless the present Government finds more courage to cut spending.

The OECD is unimpressed with its present ceilings and projected return to surpluses in five years.

It thinks it should raise the pension age, index benefits partially to price increases rather than wages alone, remove KiwiSaver subsidies for the well-paid and make enrolment automatic for all employees, not just the newly hired.

Some of these measures are recommended for their influence on private savings as much as reductions in public expense.

The OECD believes the country's poor savings performance would also be helped by further tax reforms, possibly by aligning the company, capital and top personal income rates at a lower level, and by introducing a capital gains tax on property or giving productive investments a tax advantage over real estate.

The increase in New Zealand house prices in the boom exceeded that of most other OECD countries and despite the "modest adjustment since 2007", says the review committee, "prices remain historically very high relative to incomes and rents".

This country's unusual aversion to capital gains tax leaves too little savings available for other capital investments, increasing the country's demand for foreign capital, which in turn keeps the dollar high, reducing export returns.

Thus the lack of a capital gains tax deals a double blow to the exports the country needs to reduce its external deficits and tackle net foreign liabilities exceeded only by Ireland, Portugal and Hungary on a graph in the OECD report. It also shows our Government debt to be lower than all members except Australia and Luxembourg.

Government surpluses have been our saving grace but deficits are contributing to our total debt now. The report warns that "net foreign liabilities have accumulated to levels that make the economy particularly vulnerable to sharp changes in investor sentiment".

Considering the strength of the Chinese and Australian economies - New Zealand's largest markets - the OECD team finds the country's recovery surprisingly weak. The Government needs to curb its borrowing, reduce spending and broaden its tax base.

The goal is to reduce our reliance on foreign credit and boost our confidence to invest in ourselves.