Spending Our Way Out Of Trouble

The recent funding model proposed for the new Auckland rail developments, along with last week’s budget announcement shows the impacts of the Budget Responsibility Rules committed to by Labour before the election.  

These rules require net government debt as a percentage of GDP to be reduced from around 23% to 20% within 5 years. In order to achieve this target, the Government will need to continue to run surpluses, which will no doubt mean more belt tightening considering that our real GPD growth rate continues to slow.  

While we have all been singing from the Key/English, and more recently Robertson, ‘strong economy’ songbook, this fixation on debt reduction has left our infrastructure tinkering on the edge of crisis, the extent of which is summed up by Bernard Hickey here. It makes for grim reading.

Auckland's population shock on top of decades of infrastructure under-spending and a budgetary squeeze from Wellington has created a man-made crisis. There is now a shortage of at least 50,000 houses, four light rail lines, dozens of school rooms, hundreds of hospital beds, several mental health wards and at least one major prison. A significant increase in demand for mental health services from the existing population (a phenomenon seen globally) added to the pressure on public services over the last five years. At least $50 billion of infrastructure spending is needed in the next decade, including at least $14 billion in health.

Mr. Hickey suggests that we should forgo our budget rules and manage the situation like we did in the aftermath of the earthquakes that decimated Christchurch some years ago, using the government’s strong balance sheet to borrow and invest in the city’s infrastructure. After all, Christchurch is now the only city not facing crisis. House prices have remained flat over the last few years, and infrastructure spending has kept up with the needs of the population. Now compare that to Auckland and Wellington. 

Debt financing an infrastructure crisis quickly spiraling out of control is definitely worth considering. Unfortunately, the budget rules are not the only roadblock. In an ideal world we could operate with net debt to GDP at twice the current levels, however our penchant for allowing households to leverage to the hilt to speculate in the housing market (with much of that financed by the banks borrowing from abroad) has left the country with dangerously overextended debt ratios. While Mr. Hickey points out that the interest costs of mortgages as a percentage of household income represent just eight percent of disposable income now, which is well down on the 14 percent seen in 2008, this is off peak primarily because of the drop in global rates - which are now set to rise given the inflation pressures in the US. Household debt has surpassed the previous peak before the Global Financial Crisis and the only reason we can make the repayments now is because of this record low interest rate.  If rates were to rise as predicted, we would quickly struggle to service this debt, resulting in a credit downgrade. That prospect, which would have a significant impact on the ability for our economy to grow, is one which imposes a constraint on our government’s ability to raise debt without credit-rating consequences.

Adding to the constraint on the government is the considerable level of wasteful spending. Establishment Parties have written future cheques for baby boomers that we currently can’t cash. Health and superannuation will weigh heavily on our country in the years to come. Treasury is predicting that the bill for NZ Super will rise from around 5c in every dollar we earn to around 7c in 2040, and 8c by 2060. Meanwhile health spending is predicted to increase to around 10c by 2060 (it is currently around 6c). The Future of Tax working group background paper released recently predicted we would open up a year-on-year deficit of 4% of GDP by 2045. If this does not seem like a great deal, the much-vaunted government surplus from the 2016-17 fiscal year was equal to 1.5% of GDP.

Irresponsible government spending plus the refusal to close the loopholes that drive housing speculation and private sector foreign debt have hamstrung any ability we may have had to increase our government debt levels to fund our infrastructure woes. The rate in which both these issues are mounting really puts into perspective the long-term health of our economy, and raises the question of where we will find money to pay for these structural deficiencies. We simply can’t afford to skimp on capital expenditure any longer and the amount of capital stock invested in housing is a massive handbrake on productivity. The money must come from somewhere, and under current policy there does not seem to be an obvious answer, just more of the same, pushing the buck on to the next government.

It is beyond clear that something must give, but don’t expect it to come from the establishment. Radical policy changes are often dismissed because they are politically dangerous. Establishment parties, by their nature, choose instead to stick to the beaten path. Ironically, the beaten path has got us in this mess, and until we realize that, we will just continue up shit creek without a paddle.

Andrew Courtney - [email protected]