Brian Fallow: Wrong time to focus on long-term woes

New Zealand's horse isn't moving, so there's no point yanking the reins. Photo / Glenn Taylor

Why yank the reins on a poor old horse that isn't moving?

The contractionary fiscal policy the Government is evidently planning for next month's Budget is risky. To see how risky we need look no further than this week's quarterly survey of business opinion from the Institute of Economic Research.

We already knew that the economy had flatlined through all but the first quarter of last year. The survey indicates that will continue for the first half of this year as well - no growth, or as near as to make no difference.

So the question facing the Government's no-new-spending Budget, or advocates of an earthquake tax for that matter, is this: When the economy is starved of demand, why suck demand out of it?

Over the past three years the economy has suffered two shocks: first the global financial crisis and then the Canterbury earthquakes.

The policymakers' response should be the same in both cases: to ease.

We have not recovered from the first shock yet. Only half of the drop in the level of output that occurred during the 2008-09 recession has been clawed back so far.

Households have got the message about the perils of excessive debt-fuelled consumption and have pulled in their horns with a resolution few expected.

And in an environment where household incomes and credit are barely growing, inflation in the necessities, food and fuel is crowding out spending on other things.

Export commodity prices are at record highs but during the boom farmland prices rose even more steeply than house prices, so farmers remain focused on reducing debt. For how long, who can say?

It is not an environment that encourages businesses to hire and invest. Caution remains the watchword.

The survey found firms' investment intentions running at levels in line with their long-term average.

That is not good enough. At this stage of the cycle, after a severe downturn, investment should be as strong as it was after the recession of the early 1990s, because there is a lot of catching up to do.

The recovery, never strong, had fizzled out a year ago.

In the Government's current fiscal year to June, there may be no growth in the economy at all. The forecasts are within the margin of error above zero.

And that is with the Government borrowing and spending $300 million a week and the official cash rate at an all-time low.

What would it have been like without that support?

It is not a good starting point for fiscal policy to switch from a tailwind to a headwind.

The Government's half-year economic and fiscal update in December last year showed that the "fiscal impulse" was about to flip from positive to negative, to the the tune of about 0.7 per cent of gross domestic product in the year to June 2012 and 1.1 per cent the following year.

At that stage the Government still had an allowance for new spending of $1.1 billion a year. That has now been scrapped. Any initiatives will have to be funded by cuts elsewhere.

It is only fair to acknowledge that Government spending will increase anyway.

It is on track to shell out $70.6 billion of operational spending this year, which would be $6.6 billion or 10 per cent higher than two years ago.

Yet in both the 2009 and 2010 Budgets, the cap on new spending was $1.1 billion.

The rest of the increase is largely automatic including payments which are indexed to inflation, or the average wage in the case of superannuation, or are driven by uptake or the number of people eligible, like the unemployment benefit or much of the educational budget.

The earthquakes have been an additional expense but not as big as one might think.

In the current year, which still has another three months to run, the Government has so far spent $1.1 billion in response to the two earthquakes but the lion's share of that, $800 million, is funded from the Earthquake Commission's reserves. It is not a charge on the taxpayer per se.

The Treasury reckons that over the four years to March 2015 nominal gross domestic product - a proxy for the tax base - will be a cumulative $15 billion less than it had thought in December, implying somewhere between $3 billion and $5 billion less tax revenue.

But two-thirds of that is because of the weaker growth outlook already apparent before the February earthquake.

Which is the point, really. Is it smart to want to halve the deficit next year when the economy is as fragile as it currently is?

The response is likely to go like this: The country's debt to the rest of the world is perilously high; it is now Government borrowing rather than the private sector's which is adding to that debt; and the credit-rating agencies, as proxies for offshore lenders, are drumming their fingers at us impatiently and looking expectantly for a credible plan to bring it under control.

But the country's foreign debt problem is getting better.

New Zealand's net international liabilities, measured against the size of the economy, have been declining for the past two years, from 90 per cent of GDP in March 2009 to 82 per cent by the end of last year, its lowest level since mid-2006.

As far as the Government's debt goes, Standard & Poor's has noted that before the February quake net debt was on track to peak at a level only half the median for Aa-rated sovereigns.

The peak will now be higher and later but still at levels downright virtuous by international standards.

There is a world of difference between an increase in public debt that arises from a natural disaster and one which reflects a chronic lack of political will to live within a government's means.

This is not to deny that the Government needs to get its spending under control.

The Treasury believes most of the deficit is structural and will not disappear automatically when the economy turns up.

Then there is the looming demographic challenge of providing healthcare and superannuation to an ageing population.

But the Government needs to deal with the short-term problem before the problems of the medium to long term.

Opportunism is in the air. Those who think it is always the right time to cut government spending are happy to point to the earthquake, as are those who think the Government has gone too far in cutting taxes and want to reverse that, even if only for a few years.

Timing is everything. A doctor has to treat the acute problem before worrying about the chronic one.

If you go to an emergency room with a broken leg, you don't expect to hear: "You're overweight. You need to start jogging."