In the middle of May, the Government announced its Budget for the next financial year. New Zealand has never seen anything remotely like it. It made clear the Government’s intention to spend vast sums of money in an attempt to protect New Zealanders from the economic shock caused by the coronavirus and the Government’s draconian measures to deal with it.
Last month, I suggested that the Government had over-reacted to the virus, stampeded by a projection of thousands of deaths unless drastic action was taken. It now seems clear that that projection was wildly inaccurate, and that a much milder policy reaction to the virus would have produced similar health effects with much less damage to the economy and the lives of those who work in it. The severe Level 4 lockdown was premised on a belief that, without such drastic action, the public health system, and particularly the availability of intensive care beds, would have been overwhelmed. In the event of course, at no point over the last few months have more than a tiny fraction of the intensive care beds which are available been used for Covid-19 patients. And of course, the total death toll from the virus, currently standing at just 21 – all of them with other serious health issues – is tiny compared with the projected death toll, and similar as a share of the total population to the death toll in Australia, despite Australia’s much “gentler” lockdown policy.
But the economic shock is what it is, and there is no point in wishing it were something else – though voters should remember the high economic and human cost which the Government has forced us all to bear when they cheer the Government’s performance.
The Budget was ostensibly designed to respond to that economic shock. And in terms of the scale of the response, it is hard to disagree with what has been announced. With unemployment projected by the Treasury to approach double figures (and personally I think that projection is optimistic), major stimulus was needed.
In most cyclical downturns, the primary policy response is from monetary policy, for which the Reserve Bank is responsible. Monetary policy can be changed in a matter of minutes, either easing or tightening policy as circumstances demand. By contrast, fiscal policy – government spending and taxing – takes weeks, months or even years to change.
When New Zealand was hit by the Global Financial Crisis in 2008, the Reserve Bank reduced the Official Cash Rate by some 5%. That reduced the cost of borrowing across the economy and produced some depreciation in the exchange rate. The stimulus was quite immediate, although even then it took years for the economy to get back to full employment.
On this occasion, faced with an economic shock which is almost certainly several times as severe as the GFC, monetary policy has done very little to cushion the shock: the Official Cash Rate has been reduced by a very modest 0.75%, and the Reserve Bank has promised not to cut the rate further before March next year. Of course, to have cut the Official Cash Rate more materially would have required it to have become negative, and the Reserve Bank has said that some banks are not yet able to handle negative interest rates. This is more than somewhat scandalous: when a significant fraction of developed country central banks have negative official interest rates – including the Eurozone, Japan, and Switzerland – and with our own Official Cash Rate at just 1% even before the cut in response to the pandemic, all banks should have been prepared to handle negative interest rates. The Reserve Bank has now made it clear to all banks that they need to be prepared for negative interest rates.
In any event, in this situation fiscal policy has been forced to do the heavy lifting, and we’ve seen an enormous increase in government spending proposed in the Budget with the result that government debt is projected to rise from its current level of around 20% of GDP to some 54% in four years’ time.
If I thought that that enormous increase in government spending was well-targeted, I would not be too concerned at that increase in debt. After all, there are plenty of other developed countries which have a ratio of government debt to GDP which is higher than 54% even before this global recession. With fiscal restraint in the future, we could as a country work our way back to a prudent debt level, hopefully before we are hit by the next economic or seismic shock.
But alas, the proposed spending involves spraying money around with little sense of any consistent strategy. As Norman Gemmell, Professor of Public Finance at Victoria University, has noted recently, the Budget envisages extra spending of $62.1 billion over the next couple of years as a direct result of Covid-19. The Treasury estimates that that extra spending will save 140,000 jobs – at a cost of nearly $450,000 per job saved for two years. They sound like extremely expensive jobs.
Too much money is being spent on poorly targeted schemes, in some cases having the effect of holding people in jobs for which there is no future at all in the short- or medium-term future. The Budget envisages pouring more money into rail, even though successive cash injections to rail have failed to make rail a viable proposition. Hundreds of millions are poured into special programmes for Maori health. Billions are being put into the New Zealand Superannuation Fund, though why anybody would borrow billions in order to invest in the New York share market at a time of crisis is beyond me. And having proved unable to build more than a tiny number of houses under the unlamented KiwiBuild programme, the Government nevertheless promises to build 8,000 houses over the next five years.
Most worrying of all, there is no sign at all that this Government has any more idea than the last Government did of how to raise our rate of productivity growth, or our ratio of exports to GDP.
For several decades, our productivity growth has been one of the slowest in the developed world, despite successive Governments committing to “getting New Zealand into the top half of the OECD” (Helen Clark) or “catching Australia by 2025” (John Key).
For several decades, successive governments have committed to raising exports as a share of GDP. John Key took office when the ratio of exports to GDP was around 30%, and he said his Government would aim to reach a ratio of 40%. At the end of nine years, the ratio was 27%, despite strong export prices and buoyant export markets.
The Budget released a few weeks ago will very probably see that ratio fall further because it envisages a big increase in spending on sectors focused on the local market – more infrastructure and more housing for example.
Very large countries can afford to have relatively small export sectors because they don’t need to import too much: they can get efficient production within their own economies. We cannot. We already have a smaller export sector, relative to the rest of our economy, than almost all other small countries. And calls to make more stuff locally, importing less and exporting less, are just crazy, a sure way back to expensive clothing, shoes, cars and appliances.
Sadly, the Budget provides no clear strategy driving us towards something better.