Alan McChesney: Tumbling Western economies likely to find safety net a little frayed

In announcing GDP growth of 7.9 per cent year-on-year for its second quarter, China made economic history, marking the first time since World War II that the US has not led the world out of a recession.

While question marks remain over the speed and strength of a global recovery, business and consumer confidence levels in most parts of the world have started to be a little more hopeful, and a semblance of normality is returning to the banking sector. We are not yet at a level where the global contraction has stabilised, but the economic data would suggest that we are getting nearer to that point.

There will, however, remain question marks over how robust economic growth will be, considering the significant changes that have occurred - none more so than the aversion to lending by banks and the need of Western Governments to address the massive budget deficits racked up as a result of the recession and the bailouts of the past year.

New Zealand's balance sheet is no different - even without sectoral bailouts - and this has major implications for New Zealand households.

We simply cannot continue to spend all, or more, than we earn.

This attitude has been the predominant driver of economic growth in the West for decades. This spending attitude has its origins in the assumption that Governments will be capable of providing a safety net.

For a long time Western Governments have offered some form of social welfare safety net be it free or subsidised education, healthcare, retirement pensions or unemployment benefits.

Having this underlying safety net has removed the need for taxpayers to save as much of their disposable income to meet these welfare costs.

Therefore this has allowed surplus income to be consumed - as we know only too well in New Zealand.

But maintaining this safety net assumes that Western Governments will continue to have the budget funding available to maintain them at current levels.

Billion-dollar bailouts and the lower tax take as a result of a recession mean budgets will be in deficit for many years to come. As Governments eventually attempt to reduce their deficits, the money has to come from somewhere. Higher taxation - either directly or indirectly - and a reduction of the level of social welfare spending may be the only answers.

Ultimately, it would unwind the basis on which many individuals in developed countries have managed their household balance sheets. They would have to significantly increase their savings to meet a portion of their own social welfare costs.

This is even before you see the potential of higher indirect or direct taxation.

Conversely, in the emerging world, Asia especially, there has been no social welfare safety net. Individuals have had to rely on their savings to meet health, education, unemployment and retirement needs. This is reflected in the very high level of savings we see in the emerging world and the much lower level of household consumption.

Yet most Asian Governments run large budget surpluses and we are now finally seeing the beginnings of a social welfare safety net being put in place. In China, for instance, the Government has allocated very large amounts of money to healthcare, education and some form of unemployment benefit.

These trends mean that we have the beginnings of a much bigger macro-economic shift. The consumption model now shifts to developing economies such as China, while a savings model takes centre stage in developed economies such as New Zealand's. One need only look at the current discussion about raising the retirement age to 67.

Paradoxically, while a savings culture is a good thing to have in New Zealand, it will have a marked impact on consumption behaviour - with ramifications for the local economy.

If you believe that New Zealand's economic cycles are largely consumer cycles, then we face some serious challenges ahead.

* Alan McChesney is principal of the investment firm New Zealand Assets Management.