New Zealand's budget faces its biggest test since the 1980s

Dr Oliver Hartwich
The Australian
6 May, 2024

Spare a thought for New Zealand’s Finance Minister, Nicola Willis as she prepares to deliver her first Budget later this month. The economic circumstances she has inherited from her predecessor, Grant Robertson, are the worst any Kiwi finance minister has faced since the tumultuous days of Roger Douglas and Ruth Richardson in the 1980s and early 1990s.

Where to start? The New Zealand economy is in a sorry state, with a gaping structural budget deficit and domestic inflation stubbornly high.

Productivity growth, the key long-term driver of living standards, is not just stagnating but going backwards. Kiwis are producing less per hour worked than they used to, a remarkable feat of economic mismanagement achieved by the previous Labour government.

Meanwhile, the nation’s economic output is shrinking, despite New Zealand having added the equivalent of a city of 140,000 people through immigration over the past year. More people producing less – that is quite a feat.

As if that were not enough, Willis has discovered that the cupboards are bare. The previous Labour government left more holes in the government’s accounts than a slice of Swiss cheese, with many ongoing spending commitments unfunded beyond the current fiscal year. The new government is now scrambling to find money just to maintain basic services like prescription medicines.

But perhaps the biggest fiscal time bomb is debt. Her free-spending predecessor took advantage of historically low interest rates to go on a borrowing binge, racking up tens of billions in new debt. Now the chickens are coming home to roost as these government bonds mature and debt servicing costs explode.

With the prospect of persistent deficits for the foreseeable future, the debt mountain will only grow. Net core Crown debt already stands at around 42 percent of GDP – a level not seen since the early 1990s. It is likely to get higher in the coming years.

This debt burden is not just a drag on the government’s books. It also represents a massive intergenerational transfer of wealth from younger and future taxpayers to today’s bondholders. It is a form of fiscal child abuse no responsible government should countenance.

To summarise: a stagnant economy, falling productivity, a structural deficit, and a looming debt crunch. If New Zealand were a listed company, markets would get nervous.

It is a daunting in-tray for any finance minister, especially one who has been in the job for less than half a year.

So, what is Willis to do? The glib answer is “everything, and all at once." But if there is a silver lining to this economic storm cloud, it is an opportunity for transformative change. Just as crisis triggered reform in the 1980s, so too could this Budget be the catalyst for a fundamental reset of New Zealand’s economic direction.

The first priority must be to stabilise the fiscal ship. Core government spending has ballooned from 28% of GDP in 2019 to a projected 33% in 2024, with much of the increase going to bureaucracy and transfers rather than productive investment. Willis must take a leaf out of Ruth Richardson’s book. Cutting spending substantially is unavoidable.

But fiscal austerity alone will not be enough. New Zealand also needs a productivity revolution. Output per hour worked declined by 0.9% last year, while multifactor productivity went down 2.2%. It now stands below countries like Lithuania, Turkey and Portugal. That is an appalling performance that explains the falling real wages and living standards Kiwis are experiencing.

Lifting productivity growth is crucial to sustainably raise incomes and service the nation’s mounting debts. In this context, a recent analysis of New Zealand’s productivity woes from the Treasury is instructive, if incomplete.

It identifies a range of culprits, from weak capital investment and declining educational achievement to stalling global innovation and diffusion. That is all correct. But Treasury neglects some glaring home-grown causes: high government spending, regulatory overreach and muted competitive pressures.

To unleash productivity, Willis must be bold in reducing the state’s economic footprint, liberalising markets, and embracing global integration, not least through bringing in more foreign direct investment. It requires systematically reviewing the regulatory burden on businesses and households, with the aim of lighter-touch rules. It means ensuring lower entry barriers throughout the economy to increase competitive pressures.

It also means addressing New Zealand’s infrastructure weakness, which acts as a bottleneck on growth. With net migration surging and the population projected to reach 6 million by the early 2030s, the country desperately needs investment in transport, housing, energy and water. Willis should use the Budget to announce a pipeline of productivity-enhancing infrastructure projects, using private capital and user-charging wherever possible.

On the tax front, Willis’ options are limited. New Zealand’s tax burden is high by international standards. Over many years, bracket creep has pushed more middle-income earners into high tax bands, sapping incentives to work, save and invest. Yet fiscal circumstances are so dire that there is limited room to address this for now.

In any case, only about 40% of New Zealand’s households are net taxpayers. The others receive more in government transfers than they pay in taxes. If the government targeted tax relief to low and middle-income households, that would reduce the share of net taxpayers further. It would hardly be productivity-enhancing if an ever-smaller proportion of taxpayers are asked to finance the bulk of the state’s activities. In fact, it might drive more high-income earners out of the country.

None of the things Willis must do will be easy, either politically or economically. Vested interests will fight tooth and nail to preserve the status quo – which somehow includes even subsidies for making films and videogames. The siren song of “tax the rich” will grow louder with every spending cut. There will be short-term pain as the economy adjusts to a leaner, more productive model. And we have not even mentioned the New Zealand media scene which is largely hostile to the new government and will hardly cheer on a reformist Minister of Finance.

But as the 1980s reformers showed, fortune favours the bold in times of crisis. New Zealand has been here before and emerged stronger for having made tough choices.

The alternative hardly bears contemplating. If New Zealand continued its current path, it risks becoming a new Argentina: a once-prosperous nation slowly suffocated by big government, vested interests, and the illusion that it can redistribute its way to prosperity.

The road to reform is lined with political pitfalls. But it is the only path to a more prosperous future for New Zealand.

To read the full article on The Australian ($) website, click here.

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