Roger Kerr: Cullen right to wield scalpel

Roger Kerr

The Government is reviewing its spending with the aim of finding savings to offset spending decisions arising out of election commitments and the coalition agreements.

This is a welcome initiative. Government spending has been rising rapidly and is projected to blow out by a further 2 percentage points of gross domestic product (GDP) by 2008. This is a massive increase, which can only be damaging to the economy.

Total government spending currently comprises central government current spending of 30-33 per cent of GDP, local government current spending of 2 to 3 per cent of GDP, gross capital formation (both sectors combined) of 2 to 3 per cent of GDP, and other capital spending of perhaps 0.5-1.0 per cent of GDP. At close to 40 per cent of GDP, this level of spending is inconsistent with sustained rapid economic growth.

Finance Minister Michael Cullen has demurred and pointed out that four OECD countries with such ratios of government spending achieved real per capita GDP growth of 4 per cent or more since 1985.

But these countries achieved that feat only for periods of around five years. At least a 10-year period is needed to avoid the bias introduced by cyclical factors and be consistent with the Government's goal of returning New Zealand to the top half of the OECD income rankings.

No comparable OECD country with a government spending share around New Zealand's level has achieved per capita GDP growth of 4 per cent or more for as long as a decade. Those that have grown this fast, such as Ireland and South Korea, have lower spending ratios.

The deadweight costs of taxation alone make it highly unlikely that rapid growth could be achieved with high levels of government spending, even if it were uniformly of high quality. There is ample evidence that much government spending is wasteful or poorly targeted.

The OECD has commented critically on New Zealand's budgetary processes: there was, and still is, no systematic framework for assessing value for money.

Although the budget process forces a detailed examination of new spending proposals, this represents only 5 per cent of total expenditure. There is no centrally driven, systematic or regular review of the remaining 95 per cent.

This is remarkable, especially given New Zealand's habit of regarding itself as a world leader in public sector financial management.

What can be done about these problems?

One proposal advocated by the Business Roundtable is to complement New Zealand's fiscal responsibility rules (now re-enacted in the Public Finance Act) by adding a tax and expenditure limit (TEL) provision, along the lines of the fiscal constitutions of many US states.

This would be a top-down constraint that would limit the rate of growth of government spending to population growth plus inflation, unless voters decided otherwise in a referendum. Surplus revenue would be returned to taxpayers. There would be provisions to deal with exceptional circumstances.

Dr Cullen has criticised this idea as undemocratic and ideological.

Another response would be for the Treasury to establish formal guidelines for Government spending. It is astonishing that none exist. This contrasts unfavourably with the effort the Ministry of Economic Development has made to improve the quality of regulatory policy through the requirement in the Cabinet Office Manual for a Regulatory Impact and Business Compliance Cost Statement to accompany regulatory proposals.

What might a good set of spending guidelines look like? One possibility would be to adopt a framework similar to that adopted in the guidelines for evaluating Government regulations. These require, inter alia, that:

(1) The problem requiring a possible intervention be defined and its causes established.

(2) A public policy objective be determined that is not so narrow as to prejustify the recommended policy.

(3) All practicable alternatives be identified, including market alternatives.

(4) The benefits from the recommended course of action should exceed the costs when compared to the best alternative course of action.

Such a set of guidelines for government spending would, if adhered to and applied professionally, make it harder for wasteful spending to persist.

A fundamental review of base spending is also required. The first step would be a screening aimed at determining which programmes serve a public purpose and represent an appropriate role for Government.

This filter should identify many activities as candidates for opening up to competition, or withdrawing government from entirely.

Leading candidates would be Government commercial enterprises. Exiting from these activities would contribute directly to economic growth and let governments focus on performing their core roles better.

The role of governments in providing other private goods should be critically assessed. Greater use of user-pays policies, reduced middle class churning and targeted assistance, in combination with private sector competition, would reveal if such services represented value for money in the eyes of users.

The remaining programmes would be concentrated in the core public good functions of government that are less amenable to the disciplines of competition and choice. This necessitates greater emphasis on clarifying objectives, allocating decision rights and monitoring and rewarding performance.

An important task would be to revitalise public sector management. The impetus to better performance, dating from the second half of the 1980s, seems to have waned.

An approach that has been adopted by many Governments would be to set up an independent spending review commission or taskforce. Such an exercise would allow the Government to tap expertise from outside the public service and get well-informed and independent advice.

Reducing the share of government spending in the economy by keeping spending growth below the growth rate of the economy and cutting wasteful spending is feasible, as the experience of many countries demonstrates.

In its recent budget, the Hong Kong Government projects a fall in public spending as a percentage of GDP from 20.2 per cent in 2005-06 to 16.0 per cent in 2009-10, and a cut in actual spending in that time.

Wasteful spending in government is a worldwide problem that worsened in the industrialised world with the growth in government from the 1960s. There is evidence that the expansion of government has harmed economic performance without improving social outcomes.

Effective responses to this problem require action across a broad front. Fundamental is the need for much greater public awareness of the need to focus government on its indispensable core activities.

* Roger Kerr is the executive director of the Business Roundtable