New Zealand Economic and Fiscal Outlook
Thank you for inviting me today.
It’s a pleasure to speak to the Trans-Tasman Business Circle again.
Yesterday I announced that the Government had achieved one of its key fiscal targets, posting a surplus of $414 million in 2014/15.
That was the culmination of years of focus on a target that has brought discipline to spending.
But it is far from the end of the road for our programme of responsible fiscal management.
Today I want to talk to you about how we are going to continue to manage the books in the future – by understanding and addressing the drivers of demand for public services, and through better management of the Government’s assets.
But first, I’d like to briefly discuss the economy.
Businesses such as yours are the engine rooms of the New Zealand economy.
Growth in the economy is driven by businesses investing another dollar, or hiring another person.
The Government’s role is to support an economy where businesses can be flexible and resilient enough to respond to changing international and domestic conditions.
The current state of the global economy underlines the continued importance of this approach.
I returned from IMF and World Bank meetings in Peru on Monday. These reaffirmed that slowing growth in China and other emerging economies like Brazil is a concern for the world economic outlook.
However, the composition of China’s growth is important.
Its investment driven growth cycle is waning, but this is being replaced by consumption and services driven growth from a rapidly expanding middle-class.
This is a big opportunity for New Zealand, given our major exports are in softer commodities like dairy, beef and lamb – and also for our services companies, whether they be in tourism, technology or business services.
Another key topic for discussion was inflation – and in particular the lack of it.
This is a global phenomenon, not just something affecting New Zealand.
As Reserve Bank Governor said yesterday, in the vast majority of the 30 or so economies where central banks pursue inflation targeting, headline and underlying inflation have averaged below specified goals over the past few years.
Low global inflation is expected to persist for some years to come. For governments, this means revenue won’t grow as fast as previously thought.
And one driver of low global inflation, lower commodity prices, is directly relevant to New Zealand – with dairy prices being the most notable example.
From a high in February 2014 to a low in early August of this year, dairy prices fell 65 per cent – but have come back some way since then. This is clearly a major change, and is having an impact not just on the dairy industry, but on other sectors of the economy.
The fall in dairy prices has contributed to a significant depreciation in the New Zealand Dollar, which is down more than 25 per cent against the US Dollar since mid-2014.
A lower Kiwi dollar helps all export industries, not just dairy - as well as local businesses that compete with imports.
Unfortunately it appears the global economy has hit another weak patch. IMF’s outlook for the global economy is now slightly weaker than it was six months ago and growth this year could be the lowest since 2009 - although the United States is a relative bright spot.
For New Zealand, both lower export prices and global growth translate into an economy that is expected to grow a bit slower than the around 3 per cent that was being forecast last year.
The IMF’s latest forecasts – released last week – have the New Zealand economy growing at 2 to 2.5 per cent.
For calendar year 2015 it could drop a little below 2 per cent, given the slow growth figures for the first half of the year.
While that is a bit slower than we previously expected, this is the sort of moderate but sustained growth that should continue to deliver more jobs and higher wages.
The average wage is now just over $57,000 per year. That’s an increase of more than $10,000 since National came into office.
Wages increased by 3.2 per cent on average in the last year – which is significantly higher than 0.4 per cent inflation.
Unemployment is higher than we would like at 5.9 per cent.
Part of the reason is that the proportion of the population participating in the labour force is near record high levels, and among the highest in the developed world.
In fact our labour market is working well overall, as indicated by our employment rate at 65.2 per cent.
That is the 6th highest employment rate in the OECD, and compares to 61 per cent in Australia, 59 per cent in both the UK and the US, and is well above the OECD average of 55 per cent.
So the Government continues to focus on supporting businesses by improving our economic policy fundamentals through the Business Growth Agenda.
This weaker world growth highlights the importance of continuing to expand our international connections through trade agreements like the TPP. The more markets exporters have access to, the more resilient they will be if any one country faces economic headwinds.
As the world changes, we need to make sure economic settings remain fit for purpose.
Part of this is steady and sensible management of the Government’s books.
Drawing on the lessons of previous economic cycles, when we inherited a recession in 2008 we decided to support the most vulnerable, maintain benefits and focus on better public services, rather than cut spending.
We did that knowing that we would subsequently have to rein in spending and get on top of debt.
So four years ago the Government set its target to return the books to surplus in 2014/15.
This was always going to be a tough ask – we were committing to turn an $18.4 billion deficit into a surplus in just four years.
And we struck a few challenges along the way. Core Crown revenue for 2014/15 was $72 billion, just over $4 billion lower than the $76 billion initially forecast in Budget 2011.
To a large extent fluctuations in revenue are out of the Government’s hands. So we’ve had to focus on what we can control – our spending.
Back in Budget 2011 the Treasury was forecasting core Crown expenses would reach $77 billion by 2014/15. Instead, they were actually just $72 billion.
But the Government hasn’t got on top of spending by saying no to everything.
It has been by undertaking careful, robust and evidence-based analysis of the investments we say yes to – just like you do in business.
Over the last seven Budgets, the annual cost of new initiatives averaged around $600 million.
By comparison, the average cost of the last seven Budgets of the previous Government was almost $3 billion
There isn’t much difference between a $400 million surplus and a $400 million deficit in an economy our size.
What matters is the overall path of the finances, not the exact number.
I’m very proud of the steps the public service has taken to deliver on that target – but we now need to keep on this path.
With 2014/15 now behind us it’s timely to take stock of whether our suite of fiscal targets continues to be appropriate.
The surplus target has been highly effective when the books needed a sharp improvement from an $18.4 billion deficit.
It has certainly motivated me as Finance Minister, as well as the wider Cabinet – it was the driver of two net-zero budgets.
But now the books are back in balance, we need to consider whether a point target in a particular year is still the best option.
A lot of things that impact on the accounts fluctuate out of the Government’s control – so you don’t necessarily want to be forced to respond to them in any particular year. That can create pro-cyclical fiscal policy.
The Treasury is investigating whether a refreshed set of targets would better support ongoing responsible fiscal management.
But while the Government is open to refreshing its fiscal targets, we are not looking at changing direction.
We have worked hard to establish a track record of fiscal responsibility against a challenging backdrop following the Global Financial Crisis and Canterbury earthquakes. Now we have to maintain that reputation.
New Zealand families work hard to pay their taxes.
And I know that if those families kept that money they could do a lot with it. It would make a big difference, so we need to treat it carefully.
Ongoing careful spending is also required because we now need to get on top of debt.
As a result of the GFC and Canterbury earthquakes, net debt has increased from 5.5 per cent of GDP in 2008 to 25.2 per cent now.
This is much better than what the Treasury was projecting when we first came into office, when it had debt ballooning to more than 60 per cent of GDP.
However it is still something we need to get on top of.
So any new fiscal targets will be consistent with ensuring net debt is reduced over time
I expect to say more about any potential changes to the Government’s fiscal targets as part of the Budget Policy Statement in December, and in Budget 2016.
Previously Governments have been able to passively get on top of debt from tax revenue windfalls helped by strong inflation.
That option isn’t open to us.
Economic conditions mean that Crown revenue for the next few years is likely to be lower than Treasury were previously forecasting. We will have to wait until the Half-Year Update – which I can today announce will be on 15 December - to see its latest forecasts.
The lower international dairy prices I described earlier will flow through to incomes and spending. And inflation is unlikely to drive increases in income tax and GST.
So the Government will focus on what we can control and maintain prudent expenditure management – just as we’ve done to return the books to surplus.
Over the last few years we’ve managed spending tightly while improving public services.
The Prime Minister set the Public Service ten challenging targets around three and a half years ago. Since then:
· there are more than 40,000 fewer children living in a benefit dependent household,
· the proportion of 18-year olds who achieve a NCEA Level 2 qualification has increased from 74 per cent to 81 per cent, and
· total crime has dropped by 17 per cent, with youth crime down by almost 40 per cent.
The Government has managed to drive substantial improvements to public services in large part because of, rather than in spite of, the financial constraint we’ve put ourselves under.
Because we haven’t been able to spend indiscriminately we’ve been making every dollar we do spend count by increasingly applying rigorous and evidence-based investment practices.
That means using data and new analytical techniques to better understand the people who need public services, understanding what works to meet their needs, and adjusting services accordingly.
Much of the focus is on investing early to assist more vulnerable people to change their lives and become more independent.
For example, take children who at five are known to Children, Youth and Family Services, have at least one person in their household on a benefit and either of their parents has had contact with Corrections.
In 1995 there were 600 of these children – about 1 per cent – and we now know that:
· three quarters did not achieve NCEA level 2 or equivalent,
· four in ten had been on a benefit for more than 2 years before they are 21, and
· a quarter will have been in prison by the time they are 35.
That is a huge loss of human potential and means long-term harm to families and communities.
And there are big costs for taxpayers.
Each of these children will cost the Government an average of $320,000 by the time they are 35, and some will cost more than a million dollars.
We are willing to invest now to help these most at-risk people lead better lives – and save taxpayers money in the long run.
We call that social investment.
This approach is long-term – taking into account benefits that will accrue over next 25 years or more. But it is working.
By focusing on social investment, last year the expected cost of supporting current beneficiaries over their lifetimes was reduced by $7.5 billion - with $2.2 billion of this due to steps we have taken as a government.
Another driver of long-term costs for the government is our balance sheet, and in particular the assets we own.
As in many other businesses, the Government’s operating spending can be significantly driven by poor management of capital.
A lot of day to day operating expenditure is driven by poor capital investment decisions that have been made anytime over the last 50 years – and because of the poor management of those assets.
Many governments around the world don’t really understand what they own. Seven years ago we didn’t understand basic things like the condition of the property that the Government owned. Nor was there tough testing of the $6 billion of annual capital spend.
The latest example is social housing. Politics has locked us into the demographics of the 1960s. It is a $21 billion asset, a third of which is the wrong size or in the wrong location and it needs substantial upgrading.
So we’ve embarked on a large scale reform programme.
Owning houses, it turns out, is not actually that specialised an activity.
95 per cent of houses are owned by quite normal people who seem to manage their assets rather well – in fact, often better than the state.
Government has a clear responsibility to our most vulnerable – but we don’t need to own the houses in order to give effect to that responsibility.
We want to have the best managed public balance sheet in the world.
We’ve increased the hurdles and rigour for new capital investment, and are increasingly shifting our focus to the management of existing assets.
The Government Share Offer programme brought private sector discipline to public assets while providing funding for valuable public investment. For our 51 per cent share last year we received $139 million more in dividends from the three energy companies than in the final year of full Crown ownership.
We are working to get much better information about our existing assets and their performance, sharpening our monitoring of significant projects and requiring investment-intensive agencies to develop long term investment plans of at least 10 years.
We are also getting a better understanding of the Government’s exposures to things like earthquakes, interest rates, foreign exchange rates and even wage rates, because the value of some of our assets like Student Loans are heavily dependent on how much people earn.
Just like social investment, improved performance across a $280 billion asset base can deliver significant savings for taxpayers.
So let me conclude.
Reaching surplus was a significant milestone, and one the public service can be proud of.
But the job is far from done.
Fluctuations in revenue remain largely outside the Government’s control, so we are going to continue with our focus on responsible and prudent management of expenditure.
As we’ve demonstrated in our path back to surplus, this isn’t about slashing spending or services.
It is about understanding and addressing the underlying drivers of demand for social services – so that we can support people to lead better lives, and save taxpayers money in the long run.
It is also about better managing our balance sheet – good asset management now means less debt later.
So while yesterday was an appropriate time to take stock of how we’ve moved from an $18 billion dollar deficit to a surplus in four years, its now time to get back to work on making continued improvements into the future.