There's a Fiscal Hole All Right

After the Honeymoon . . . 

New Zealand is running the risk of a serious economic earthquake.  After years of a successful National regime, the tide appears to be turning.  It is a fast running ebb.  The present government risked it all, as it were, and have spent recklessly. 

The left wing Labour-Green-NZ First coalition has forgotten what it is like to live in any condition other than fiscal prudence.  Devoid of any serious or substantial policy, they managed to squeak into government by promising heaps and heaps and heaps of new Government spending that we could afford.  The present Prime Minister, Jacinda Ardern smiled her way into popularity with a Goofy-esque grin.  In recent days, as the mess of her administration begins to bubble to the surface of the swamp, the grin has been replaced with a dark frown.  The mutter, "It wasn't meant to be this way," is now being heard in the corridors of power.

First up, the doyens amongst the economists have started to sound some alarm bells.  Previously relaxed about the (ostensibly) benign economic prospects of the country, now the collective brow is furrowed.

Here is economist Cameron Bagrie:

But the Labour-led Government's fiscal hole is looking deeper by the day - and bigger than the $11.7 billion of additional borrowing that Joyce identified.  Growth is weaker, the Government is already borrowing creatively to the tune of $6.4 billion via Crown entities (keeping it out of core government net debt metrics) and spending demands are headed one way.  That combination will pressure its fiscal position. . . .

I'd favour more attention to detail when it comes to this country's economic plan. The 2018 Budget stretched the definition of an "economic development initiative". Those initiatives, or the lack of them, was a glaring hole.  Conversely, the combination of a weaker economy and rigid adherence to the 20 per cent debt target and budget rules will require a revising of the Government's social spending agenda. [NZ Herald]. 

There is a slight problem with the Government "revising" its social spending agenda.  It squeaked into government promising a grand spending splurge for those "left behind"--that is, it would spend money on every social nip and tuck.  No longer would everyone need to "suck it up".  Now, the favoured initiatives would have wasted tax payers' money poured out upon them.  But voter fury has few bounds when promised entitlements get thwarted.

Before the election there was broad agreement from economists, myself included, that there was no fiscal hole in the Labour's fiscal plan.  The lack of money left in the kitty post the 2018-Budget raised issues of credibility, but the fiscal parameters were technically achievable.  It wasn't going to be easy, but it was possible, so the Government was given the benefit of the doubt.  But the picture is changing and the Government's ambitions are looking more and more like pipe dreams.

So, what has changed?  Budget spending and investment demands needed funding, whilst at the same time sticking to the narrative of hitting debt objectives and being fiscally responsible.  The result was crown entities borrowing an additional $6.4 billion between 2017 and 2022.  That is an accounting fudge to get it out of the core Government debt figures.

Public sector pay and spending demands are only heading one way.  Few bemoan the need to pay teachers and nurses more but that money needs to come from somewhere.  The realities of a coalition Government meant more needed to be spent. Spending allocations in the 2019 and subsequent Budgets were increased by $525 million to $2.4b per year.

That looked fine against a backdrop of solid projections for growth. But it was a risky strategy with the economy late cycle as opposed to early cycle.  The economy is not tracking as expected. The Treasury is projecting 3 per cent plus growth. Something closer to half of that is on offer.  We won't get that growth back. Each 1 per cent change in growth is worth around $800m in revenue.  And with it goes more than $1b per year in tax.  Over four years you lose more than $4b. A second year of the same sort of growth would really hurt.

The Treasury and Government are under-estimating the transitional cost of changing New Zealand's economic model. As some sectors contribute less to growth than we've seen in the past, other sectors will need to step up. That will take time.  We've been too reliant on debt fuelled growth for too long.  [Ibid.]

We fear that we are going to see more of the pinched frown and less of Goofy's grin.