As background to today’s budget, this is an interesting analysis of the New Zealand economy by London-based investment advisory firm Independent Strategy.

The author was probably David Roche who has followed New Zealand closely and is attached to the country, as he states:

We all love to love New Zealand — a fine and beautiful place — but is the object of our affections one-eyed; lacking a chunk of the vision thing?

His answer is:

The lack of a vision or a radical plan to deal with the fiscal debt and deficit problem and, by connection, with the excessive level of foreign liabilities, leaves us unenthusiastic about NZ’s sovereign debt.

Like the 2025 Taskforce, he notes:

NZ’s official aim is to close its 35% income (GDP per capita) gap with Australia. Policies do not seem to match this ambition.

The paper makes an important point about New Zealand’s sovereign debt which is often overlooked:

A number of Kiwis have likened NZ’s fiscal and external liabilities to that of Greece. This seemed glib. So on a recent visit, we checked and were gobsmacked to find that NZ’s net external liabilities are as high as a percentage of GDP as Greece’s (Figure 2)!

 However, they don’t mean the same thing. Statistically, the overall net figure for NZ and Greece looks much the same. But much of NZ’s gross external liabilities are composed of equity (40%), namely the foreign ownership of NZ companies. And much of the debt represents the external funding of Australian-owned banks in NZ (34%). The former never causes credit crises and the latter is unlikely to do so — unless the Aussie banks are in deep trouble themselves.

Nevertheless, the debt issue is serious:

According to our estimates, based on unchanged policies, NZ will reach a 50% gross sovereign debt to GDP ratio by end 2015. That may seem way better than Japan or the US, but it is nevertheless the beginning of a long day’s journey into night and not somewhere NZ wants to go, particularly as economies with small financial markets reach the critical tipping point for a sovereign debt crisis much earlier than countries like the US or even the UK.

The underlying problem is correctly seen as excessive government spending:

NZ’s sovereign debt to GDP ratio is rising inexorably and is being driven by a rising trend of government spending as a share in the economy, not by the impact of recession. The NZ government is a big spender when placed beside Australia, even if it has not been so by OECD standards until recently (Figure 9).

But comparing government spending in NZ to the OECD is probably the wrong benchmark for a country that wants to make a growth sprint to catch up with Australia. Europe, the US and Japan are not paragons to be imitated if this is the objective. It is like comparing the fitness of an ambitious sprinter to that of a dowager lady walking her lap dog.

When it comes to remedies the report endorses the government’s broad direction but is concerned about the slow pace of reforms:

But the government and civil servants are aware that the state of NZ’s public finances cannot go on deteriorating. So there is considerable focus on getting more out of public resources; prioritising spending better as well as maximising its efficiency; and of shifting the tax system at the margin to encourage higher savings, better labour participation and more productivity.

But the government’s approach is an incremental one economically and gradualist politically. The problems it seeks to address are not. They will be in your face but a historical jiffy away. They are deep and structural. By the time they are incremental, they will be exponential.

There is still ample opportunity for radical reform — even in a country with a great civil service and clean government and where much has already been achieved. In a recent paper, the NZ Treasury demonstrated that economies with small government have higher (annual) GDP growth and that the growth cycle lasts longer. Of course, the policy mix of how taxes are raised and how money is spent matter too. New Zealand has the scope for improving all items. But the focus has to be on the size and scope of government.

The paper goes on to endorse the recommendations of the 2025 Taskforce and mentions ‘tax churn’ which “promotes inefficiency by taxing the middle classes and returning the taxes to them as subsidies and transfers”.  It also points to the problems of the Resource Management Act, local authority control of land for housing, and restrictions on foreign direct investment.

On privatisation it states:

The government owns assets worth NZ$223bn, or 118% of GDP. This figure has almost doubled in the last decade. These publicly-owned assets include a wide range of state enterprises in power generation, banking, coal mining, TVNZ and a controlling interest in Air NZ. Many of these would be better in the private sector and could add substantially to productivity and growth.

It goes on to advocate changes to the eligibility age for New Zealand Superannuation, student loan policies and the minimum wage, which it notes is the second-highest in the OECD (on a relative basis).

On present policy settings the report concludes:

… it probably means that NZ living standards will continue to slip relative to Australia and non-Japan Asia. It’s cold comfort that, given the worse policy denial and fiscal dilemmas of Japan and the US, NZ’s slippage relative to the OECD may be less.

And it grades New Zealand’s present policy settings about five out of ten.

All this is consistent with views the Business Roundtable, other business organisations, the OECD and the 2025 Taskforce have expressed.

Will today’s budget surprise on the upside?  We will soon know.