Brian Fallow: NZ should heed recession warning

Like the duke with a fancy for biscuits, New Zealanders need to lower their sights on spending. Photo / Glenn Jeffrey

An English duke, the story goes, was given the hard word about the need to economise.

He sat down with his accountant for a line-by-line review of his expenses.

"I can see that your grace needs a chef, but do you also need a pastry chef?" the accountant asked.

"Can't a fellow have a biscuit?" was the querulous reply.

Reining in the growth of Government spending is liable to prove harder than finding a cheaper way of satisfying the ducal sweet tooth.

The hard word delivered to the rest of the public sector, in a pointedly public way, by Treasury secretary John Whitehead this week should come as no surprise.

You only have to look at the spending track, past and forecast, in the Budget to see that some serious belt-tightening is expected.

Over the past four fiscal years annual spending grew by $17.5 billion, or about 9 per cent a year.

Over the next four years spending is forecast to grow $11 billion, less than 4 per cent a year or 1 per cent at most in real per capita terms.

But that would still, on the Treasury's forecasts of economic growth and revenue, see a cumulative $35 billion in operating deficits, driving gross debt from 25 per cent of GDP now to 39 per cent in 2013.

The government is a large part of the non-tradeables sector, which over the past five years has grown by 15 per cent. The tradeables sector, said Whitehead, where the country earns its living as a trading nation, contracted by 10 per cent.

"To help New Zealand compete internationally and lower costs to exporters we have to raise the quality of public spending and ensure the lion's share of increased national resources goes not to the public but to the private sectors," he said.

"In other words the public sector has to raise its productivity - provide more for every dollar spent - and grow more slowly than the private and export sectors, to rebalance the economy."

That is an observation that is likely to be echoed in the work of the taskforce led by Don Brash which has been asked to recommend policies to achieve the goal of closing the income gap with Australia by 2025.

But some points need to be noted:

We need to be realistic about how compressible Government spending is in a democracy.

The message about living within straitened means applies as much to the household sector as to the Government.

And the message about raising productivity applies as much to the business sector as to the public sector.

Almost a third of Government spending, around $20 billion, is classified as income support, transfer payments to superannuitants, the unemployed and so on.

At some point the entitlement side of the superannuation scheme will have to be tackled but in the meantime both major parties are treating it as a "third rail" issue: touch it and you die.

So how much fat is in the remaining two-thirds?

"I don't know if any departments or agency chief executive would argue that they couldn't think hard about better utilising 5 or even 10 per cent of their baseline," Whitehead said.

Easier said than done, one suspects, but they will need to all the same. The budget allowance for new spending has been slashed and as debt mounts a growing share of revenue will be pre-empted by higher interest costs.

The bottom-line arithmetic is that, even with serious fiscal restraint, chronic deficits and mounting debt will be part of the legacy of this recession. All else being equal, this represents upside risk to interest rates.

It will also make it much harder to accomplish the kind of tax reform that the economy needs.

Significant structural changes to the tax system are a lot easier to accomplish in the context of fiscal surpluses, to lessen the extent to which it is an exercise in robbing Peter to pay Paul.

As it is, the tax working group which has been set up to deliberate on such matters, made up of private-sector practitioners, academics and officials, has been told to think in terms of changes that would be broadly revenue neutral.

But it is not only the public sector that needs to go easy on the spending for the foreseeable future.

Our productivity levels place us in the bottom third of the OECD, in the same neighbourhood as Greece and Korea.

But we like to live as if we were still in the top third like the Australians and have borrowed heavily to fund the difference - so heavily that the country's net external liabilities are approaching 100 per cent of GDP.

To assume that the rest of the world will continue to be willing to fund relatively cheaply this collective improvidence is folly. Warnings about our credit rating, first from Standard & Poor's and more recently Fitch, attest to that.

The rebalancing that needs to occur - less spending and more saving by households, more investment and a stronger export focus by the business sector, and a tight rein on Government spending - will not happen automatically or easily, however.

Reserve Bank Governor Alan Bollard warned last week that the trend rate of economic growth over the next few years was likely to be closer to 2 per cent than the 3 per cent we have enjoyed over the past 10 years.

Strong income growth is therefore unlikely to take care of the big increase in debt run up by households, and some dairy farmers, during the boom.

A premature rebound in the exchange rate isn't helping either.

Households collectively spent more than they earned for 14 of the past 15 years. A return to that borrow-and-spend behaviour before household debt has been reduced to more prudent levels is a clear risk, Bollard warns, and a threat to a sustained recovery.

There is a danger that people treat this recession as viral, something that we suffer through then can shake off and carry on as before.

It is much more like a first heart attack, a serious wake-up call to change our ways on a sustained basis, or the next shock will be much worse.