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.

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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: 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?

FRIDAY GRAPH: INDIVIDUAL AUTONOMY AND WELL-BEING

Respected Australian researcher Winton Bates has posted an interesting graphical investigation into the relationship between international measures of freedom and well-being.

His paper concludes that the evidence supports the view that the overall relationship between freedom and well-being is positive.  He further finds that increased feelings of individual agency do not seem to be associated with more selfish behaviour.  “If anything, the opposite seems to be the case.”

The chart below from his paper illustrates one of the associated relationships – the percentage who have low levels of life satisfaction is much higher among those who feel that they have little ‘freedom and control’ and the percentage with high levels of satisfaction is much higher among those who feel that they have a great deal of ‘freedom and control’.

The chart is based on data for about 80,000 respondents in 57 countries from the 2005 World Values Survey.

FRIDAY GRAPH: FREE MARKET ATTITUDES

Here is an interesting chart based on a survey by GlobeScan, a polling firm, and published in The Economist (online) on 6 April 2011.

The survey tested attitudes on the question of whether the free market was the best system for the world’s future.

As one would expect, the United States ranked fairly high, with 59% agreeing ‘strongly’ or ‘somewhat’ with the proposition.  But this was down from 80% when the question was first asked in 2002, perhaps influenced by the interventionist Bush and Obama administrations and the GFC (global financial crisis).

More interestingly, there was more support for the free market in China than in the United States.  Both China and Brazil have seen strong growth in their rankings in recent years.

A German economist suggested to me that Germany’s top ranking may have reflected a different ‘social market’ interpretation of the question.

Australia has a relatively low ranking and New Zealand was not covered.

FRIDAY GRAPH: US vs EU (and NZ)

Today’s Friday Graph is courtesy of prolific chart-maker Mark Perry:

In a New York Times editorial last year titled ‘Learning from Europe’ Paul Krugman wrote:

The story you hear all the time about Europe– of a stagnant economy in which high taxes and generous social benefits have undermined incentives, stalling growth and innovation – bears little resemblance to the surprisingly positive facts. The real lesson from Europe is actually the opposite of what conservatives claim: Europe is an economic success, and that success shows that social democracy works. The European economy works; it grows; it’s as dynamic, all in all, as our own.

The BEA recently released data for the amount of GDP produced by US states in 2010, which allows for an updated comparison with European countries (and Japan and Canada).  See the table below (international countries are adjusted for PPP).  Key findings:

1. The European Union as a group ($32,700 GDP per capita in 2010) ranks below America’s poorest state, Mississippi ($32,764).

2. Even relatively wealthy (by European standards) Switzerland would rank #32 as a US state, behind Georgia.  The countries of Belgium and Germany would rank even lower at #46 and #47, and the United Kingdom, Finland, and France would be close to the bottom of American states, below #48 South Carolina.

3.Spain, Italy, Greece and Portugal all rank below America’s poorest state (Mississippi) for GDP per capita.

On a similar PPP basis, New Zealand comes in at US$27,700, between Greece and Portugal.

FRIDAY GRAPH: NEW ZEALAND’S SPEND-UP

Here is a graph from the latest OECD Economic Outlook.  It’s an illustration of how much more OECD governments are projected to be spending in the year ahead compared with average levels of spending in the period 1993-2012.  The government spending data are on the OECD basis which is standardised across OECD countries, and includes for New Zealand central and local government.

The chart shows that for the current year, government spending in New Zealand is at an all-time high.  It currently stands at 46.2% of GDP, over 2 percentage points of GDP higher than the 1993-2012 average.  Spending has gone up by more than the OECD average, and only by slightly less than Greeceand Portugal, which is food for thought. Sweden has done best to rein in government spending, albeit from a high long-term average.

No OECD country has achieved sustained rapid GDP growth (4% per capita or more) with government spending at New Zealand’s current level of over 40% of GDP.

FRIDAY GRAPH: THE GREAT SPEND-UP

The following chart uses Treasury–Statistics New Zealand long-term time series to show that the increase in real tax revenues per capita during the Clark-Cullen period rivalled the increased taxation to fund World War II and the first Labour Government’s big spending programmes. Quite a remarkable ‘achievement’, in peacetime.  (The dollars are June quarter 2006 dollars).  A grand opportunity for tax cuts during a period of strong economic growth was sadly missed.