Subsidies could help us save more – and boost economic growth. 

Listener: 19 May, 2007. 

Keywords: Macroeconomics & Money; 

New Zealanders are not saving enough. The consequence is that a high proportion of our most productive capital is becoming overseas-owned, as we use foreign savings to finance our new investment and sell existing assets to cover the national savings shortage. 

Even more seriously, the foreign savers funding our over-consumption require high returns that push up interest rates and the exchange rate. That squeezes the profitability of the export sector, whose resulting poor performance ruins the economy’s growth prospects. 

Much of the recent criticism directed at the Reserve Bank is unwarranted. The fundamental problem is the eccentric US fiscal stance, with its large deficit driving down the US dollar, thereby increasing our (and just about everyone else’s) exchange rate against it. Monetary policy is virtually irrelevant. 

A sensible response would be to increase the nation’s savings, pay off debt and invest in productive assets. We are doing the opposite. The dis-savers must be relying on the government to bail them out in due course, but that requires the rest of us to be prudent, and willing to carry the necessary burden. 

To be fair, the business sector has a good savings record, but that is not as much help as it might be, given that the sector is increasingly overseas-owned. The government has a good savings record too, as I shall explain. The real failure to save is by private households, many of which are spending more than they earn, running up debt on credit cards and mortgages on overpriced houses. It is their failure that has to be addressed. 

The government is – broadly – saving enough to fund its investment and it is also putting aside some for future New Zealand Superannuation obligations (the Cullen Fund). This savings-before-investment figure is an accounting notion, frequently referred to as “The Budget Surplus”, even though almost all of it has been spent. 

Treating the amount as available for tax cuts (or for more government spending) confuses an accounting aggregate with an economic reality. It was a monetarist confusion that seemed to lead the National Party during the 2005 election to propose using this “surplus” for income tax cuts. Had the policy been implemented, the cuts would have fed into household consumption, reduced national saving, and so pushed the exchange rate up further, screwing even more exporters and ruining the economy even further. 

Fortunately, wiser – or at least more economically informed – heads seem to have since prevailed in National. 

But even with a more responsible approach, the large apparent Budget “surplus” (before investment and such spending) is politically unstable: there will always be those who, from economic ignorance or political opportunism, argue that this money – which we haven’t got – should be given away in tax cuts. The danger is that enough of the public may believe the ill-informed to drive an irresponsible economic policy – as almost happened in 2005. 

It is said that this year’s Budget might introduce a savings subsidy. Perhaps worker contributions to KiwiSaver will not be subject to income tax. The government’s apparent surplus will thus be lower, but the nation’s total savings will not be compromised and the exchange rate will not rise as a result, despite the apparent income tax cuts. 

Because the government “surplus” will look smaller, while the macroeconomic stance is not undermined, budgets will look more politically sustainable, with less opportunity for the politically illiterate to propose destructive policies. 

Better still, if designed right, savings subsidies could encourage households to save more, since the more you save the less tax you pay. If so, the tax-cut-for-savings package could reduce the pressure on the balance of payments and lead to a reduction in the exchange rate – to the benefit of exporters and economic growth. 

Done well, a savings subsidy could be an important contribution to a better-balanced, sustainable and growing economy, while preparing us for the day when the US fiscal position turns the world economy to custard. We will have to wait for the Budget to find out whether the government has the skills to finesse such a gain.