FRIDAY GRAPH: THE MYTH THAT NEW ZEALAND’S NET EXTERNAL INDEBTEDNESS IS A SAVINGS STORY

This week’s chart explores the contribution of the trade balance in the balance of payments to the evolution of New Zealand’s high external debt ratio.

The issue is significant because of the popular myth that the high net external debt ratio today results from a chronic inability of New Zealanders to save enough, for example, in the last two decades.  This, it is thought, is the cause of the chronic balance of payments current account deficits since 1974.  In reality, what was driving the deficits between around 1990 and 2004 was the cost of serving the net external debt built up by 1990.

This savings myth is bolstering the drive to force or subsidise today’s working age New Zealanders to save more.

Click to view larger

The red line on the chart shows New Zealand’s net external liabilities as a percentage of GDP.  It uses two time series published by the Reserve Bank of New Zealand in its May 2011 Financial Stability Report.  The first series, from 1972 to 1989 is an unofficial series.  The second series, from 1989 to 2011, is the official time series.  (Statistics New Zealand has since published revised statistics, but the RBNZ’s second series suffices for the purposes of this analysis.)

The first point to observe about the red line is that its level today is largely a legacy of the events that caused the 1984 foreign exchange crisis.  The ratio peaked at 74.5 percent in 1986 and is not vastly higher today.

The blue line in the chart plots how the net external debt to GDP ratio would have moved forward and backward through time from 1989 if the only factor operating had been the surplus or deficit in the trade balance of the balance of payments as a percentage of GDP in each successive year.

Focus first on the concurrent sharp rise in both the red and blue lines from the early 1970s to the late 1980s.  The unofficial estimate of the net external debt rose from 12.7 percent of GDP in 1974 to 63.9 percent in 1989, a rise of 51.2 percentage points of GDP.  That’s a massive contribution to today’s figure of around 80 percent.

The blue line shows the cumulative contribution to this rise of the large trade deficits (imports greater than exports) that occurred between 1975 and 1986. Summing the annual trade deficits as a percentage of GDP between 1975 and 1986 gives a cumulative deficit of 40.1 percent of GDP.  That’s a big number too.

It follows that the large trade deficits that followed New Zealand’s failure to adjust rapidly and flexibly to the 1973-74 oil shock may explain roughly half of the net external debt of 80 percent of GDP that is causing such widespread angst today. This was not a savings deficiency story (see below).  Instead the proximate reasons were the failure of the heavily controlled economy to respond adequately to the oil price shocks and the heavy overseas borrowing during this period to bolster the exchange rate and fund the large fiscal deficits.

Next, focus on the post-1989 period in the chart. The drop in the blue line occurs because, contrary to much popular belief, New Zealand ran surpluses overall in the balance of trade between 1990 and 2004.

It was only after 2004, when big government spending increases commenced, that the balance of trade returned to deficits, causing the blue line to lift slightly. The divergence between the blue and red lines after 1989 shows that the rise in net external liabilities from 63.9 percent of GDP in 1989 to 76.7 percent in 2004 was not a ‘spending beyond our means’ story.  To the contrary, domestic (consumption and investment) spending was lower than domestic production/income on average during this period.

Another reason for not unduly focusing on the savings aspect is that it is perfectly sensible to borrow overseas to fund some portion of domestic investment as long as the returns from that investment adequately cover the cost of borrowing, taking risk into account.

Savings rates are one thing, competitiveness is another. New Zealand’s exposed industries can lose competitiveness at any given savings ratio simply because of adverse international or domestic events, such as the big rise in government spending that occurred after 2004.

The loss of competitiveness after 2004 is a real concern from an economic management perspective, given the historically favourable export prices relative to import prices during this period.

Those who insist on portraying today’s high net external debt ratio as a savings deficiency story should be aware that New Zealand’s average gross national savings ratio was actually higher, at 19.6 percent of GDP, between 1972 and 1987 than it was between 1988 and 2004 when it averaged 17.2 percent of GDP.

Not shown in the chart is the second major factor affecting the ratio of net external liabilities to GDP.  This is the difference between the earnings rate payable on the net debt and the growth in GDP.  The former increases the numerator, the latter the denominator.  The rise in the red line in the chart after 1989, in conjunction with the fall in the blue line, suggests that the net earnings rate has exceeded the growth rate in GDP during this period.

Since New Zealand is too small to affect investors’ required return on capital, those who are concerned to see the ratio fall should be focusing on raising the rate of growth in GDP.  This needs to be done in conjunction with restoring competitiveness in the traded goods sector in order to stop the blue line from lifting unduly.

In summary, New Zealand’s high net external liabilities are largely a legacy of New Zealand’s pre-1984 ‘Polish shipyard’ economy (with apologies to post 1970s Poland).  They reflect past economic mismanagement and adverse oil price shocks, rather than any sudden change in national savings rates.  The reforms of the 1984-1991, including the move to a floating exchange rate, a disciplined monetary policy, and the progressive elimination of fiscal deficits, put an end to the chronic trade deficits of the earlier period.  Unhappily, the 2004-2008 loss of competitiveness and government spending discipline does not even have an adverse terms of trade excuse.

It could be worse than futile to try to penalise the current generation of workers for pre-1984 poor economic management by interfering with their consumption/savings decisions.  The focus instead should be on raising income growth, in part by raising external competitiveness.  After all, given the income gap with Australia and the number of New Zealanders voting with their feet, many would argue that raising the growth rate should be the focus even if the net external debt ratio were half what it is today.

A related point for those preoccupied with savings, as distinct from a higher savings ratio, is that higher growth means higher incomes and likely higher savings and consumption.

FRIDAY GRAPH: INDIRECT TAX REVENUES RELATIVE TO STANDARD RATES FOR VAT/GST

This week’s chart, prepared by Capital Economics Limited, suggests that New Zealand’s 15 percent broad-based GST could be giving it more revenue as a percentage of GDP than that typically being achieved by OECD member countries with standard rates for VAT/GST as high as 23 percent.   (Many countries have non-standard rates or exemptions that  reduce the revenue base.)  The statistics are not conclusive as they are based on all indirect tax revenues, not just revenues from VAT or GST.  The chart was motivated by this article in the OECD observer commending broad-based single-rate systems.

FRIDAY GRAPH: OUR FISCAL DEFICIT MAKES ITALY LOOK LIKE A MODEL OF FISCAL PRUDENCE

Last week’s chart showed what a strong net public debt position New Zealand is in, compared to Italy and most other OECD countries.  

This week’s chart shows that New Zealand is running one of the largest underlying fiscal deficits in the OECD, as a percentage of GDP.

Specifically, New Zealand’s cyclically-adjusted financial balance for 2011 is projected to be minus 5.2 percent of GDP, which is the 5th highest deficit in the OECD, far higher than Australia’s and makes Italy today look like a model of fiscal prudence compared to New Zealand!   For 2012 New Zealand’s projected underlying financial deficit of 5.4 percent of GDP would be the 3rd highest in the OECD.

Much the same rankings for New Zealand for 2011 and 2012 apply for the OECD’s other financial balance indicators – the cyclically-adjusted balance (fourth in both years) and the primary balance (second highest deficit in 2011, no doubt in part because of the Christchurch earthquake, and third highest in 2012).

New Zealand’s underlying fiscal deficit problem arises from the spending excesses post-2005, and the unwillingness of the current government to address the problem more decisively. The latter issue is of particular concern with the government lacking the political will to implement even such obviously necessary measures as eliminating interest-free student loans and raising the age of eligibility for New Zealand Superannuation.

FRIDAY GRAPH: CIAO DOLLAR?

A spate of Sovereign credit downgrades is occurring, with Italy featuring prominently this week following New Zealand’s downgrades the week before.

This week’s chart shows how fundamentally different the situation is in one vital respect between New Zealand and Italy.

In contrast to Italy, and the OECD as a whole, New Zealand does not have a public debt problem (yet, but watch this space given our underlying fiscal deficit).

Whereas 11 countries in the chart have net public debt at or above 50 percent of GDP, New Zealand’s ratio is only 4 percent of GDP according to OECD projections for 2011.

New Zealand has been downgraded for external debt reasons, but since the vast bulk of this debt is between private borrowers and lenders–who have every reason in 2011 to balance risk and return carefully and judiciously–this is a very different situation from that facing Italy and the ten other countries in the chart where government debt is clearly the problem.

FRIDAY GRAPH: BURGEONING PUBLIC SECTOR, WANING EXPOSED SECTOR

Click to enlarge

This Friday’s graph uses Statistics New Zealand’s just-released real GDP figures for the June Quarter to compare the rise in general government spending on goods and services (current consumption and gross fixed capital formation) as a proportion of GDP with the decline in the contribution of the production of traded goods in GDP.

According to one prominent line of economic reasoning, if government spending is predominantly focused on non-traded goods, a rise in such spending can be expected to reduce the competitiveness of the exposed sectors of the economy (ie firms that are exposed to international competition), thereby worsening export performance.  The chart is suggestive in this context.

FRIDAY GRAPH: WE WOULDN’T ACCEPT SUCH MEDIOCRE OUTCOMES FROM THE ALL BLACKS

Brace yourselves: this is a seriously scary chart.  According to the latest IMF World Economic Forum forecasts released this week, 148 countries will grow real GDP per capita faster than New Zealand in the decade to 2016. Gallingly, they include Australia – of course.

We wouldn’t accept such mediocre outcomes from the All Blacks, yet it says much about our priorities that we accept it for economic performance.

Our governments don’t hesitate to set grandiose targets for raising living standards.  The last Labour government said repeatedly that its top economic goal was to lift New Zealanders’ average standard of living back into the top half of the OECD by 2010.  The current National government has the stated goal of catching Australia by 2025.

Labour never had a credible strategy for achieving its goal, and National has yet to unveil one.  And even if it had a strategy, would it have the will and ability to achieve it under MMP?

The current government set up a 2025 Taskforce which produced two high-quality reports. These were regarded as politically unpalatable and accordingly side-lined.  Their orthodox OECD style recommendations would have given New Zealanders a much better chance for a more successful and prosperous future.

This is not a simple matter of blaming the politicians.  If the electorate rewards political parties for grandiose goals with nothing to back them up, the chart indicates what we can expect to get.

FRIDAY GRAPH: CONTRIBUTIONS VS BENEFITS

Today’s graph comes via Cam Slater, originally from the National Institute for Health Care Management Foundation.

New Zealand’s arrangements have never been based on an explicit contribution scheme along US lines.  Nevertheless it would be interesting to see the results of a similar exercise using New Zealand’s figures.  I’m laid up at the moment: any takers?