Securing New Zealand Super into the Future
Hon Michael Cullen
8 November 2000
Securing New Zealand Super into the Future
Speech by Finance Minister Michael Cullen to the Society of Actuaries
Thank you for the opportunity to talk to an influential audience on an issue close to my heart. I am referring, of course, to the Government's plan to partially prefund New Zealand Superannuation.
Initial reaction to the proposal - among the public, in the media, in the savings industry and politically - has been heartening. It is important to me personally, and to the scheme's robustness, that we build a strong constituency of popular support for it. I am confident that can be done. We know the public wants clarity and certainty around this issue but we cannot just expect it.
We have to ensure a broad
measure of understanding in the electorate about what is
involved, and we have to satisfy people that what we are
offering is sustainable at every level - politically,
economically and fiscally.
The facts of the policy challenge posed by the ageing population will be familiar to you but let me just run quickly through some of the actuarial issues surrounding sustainability.
Since 1992, we have been moving the age of eligibility for NZ Super from 60 to 65. That process will be completed on 1 January next year. Over the transition, the costs of NZ Super have fallen. However, from next year they will begin rising again.
They will increase most sharply after 2011 when the baby boomers start to retire. The cost escalation will not just reflect the relative size of the baby boomer generation. It will also reflect improvements in life expectancy arising from new medical technologies and improved diet.
Not only will the number of retirees increase, so will the time the average person spends in retirement. We could call this the demand side of the equation. Its effects will be amplified on the supply side by lower birth rates and a higher educational threshold for workforce entry.
What it all adds up to is a sharp increase in the superannuitant dependency ratio. If you begin, as the Government does, with a commitment to maintain a universal pension which guarantees an adequate if basic standard of living, some form of cost smoothing or partial prefunding seems to me the only fair and viable solution to the demographic circumstance facing us.
Some have argued that immigration could be used to offset the increase in the number of superannuitants but Treasury modelling of different migration levels shows its impact to be marginal even assuming a much younger age profile for migrants than applying in the existing New Zealand population.
The details of the proposed scheme will be familiar to you as specialists in superannuation so I will not bore you with repetition. Instead, I want to comment on two issues that are starting to emerge in the public debate: is it sustainable in a fiscal sense, and what economic impacts will it have?
Before I do that, I want to reiterate some points about the basic structure of the policy to counter some misunderstandings that are emerging.
Firstly, the scheme is not about the government saving on behalf of individuals. The government is saving on behalf of itself. This is a first tier scheme designed to secure the state pension. If people aspire to more comfort in retirement than NZS offers, they will need to save to provide for it.
I am not indifferent to the poor incentive regime that currently surrounds private superannuation savings and will open up policy development and debate on what we should do about it once we have put this particular part of the package – securing confidence in the future of the first tier – behind us.
The Government has also come under some criticism for taking a leadership role rather than setting up blank sheet multi-party talks to try to establish a cross-party agreement.
I have been Labour’s superannuation spokesperson for thirteen years now. In that time the need for consensus has never been far from the formal political agenda and the content of consensus never close to it. We simply cannot afford political skirmishing for another thirteen years.
My view is that the enduring consensuses internationally – like around the US or Australian schemes – have followed rather than led scheme design. The government’s proposal has a facility for political parties to sign up to the new scheme as they wish.
Let me get back now to the question of whether the scheme is sustainable.
The discussion has to begin with what it is designed to secure. The planks are:
An age of entitlement of 65
A married couple rate no less than 65 percent of the after tax average wage.
Single living-alone and single sharing rates of 65 and 60 percent of the married rate, respectively.
No means-testing or asset-testing.
The public has accepted many cuts to superannuation over the last 25 years. Since the so-called Muldoon scheme, the gross relationship to the average wage has been converted to net, the age of entitlement has been raised, and the percentage floor has fallen from 80 to 65. These are all big reductions.
They reflect a degree of realism and tolerance by the electorate. But that tolerance appears to have drawn the line on two additional changes: means testing the entitlement and reducing it below 65 percent of the average wage.
We have made the preservation of current entitlements our promise and our starting point.
Now take two scenarios. One is that we put a dollar in a fund, earning net interest at 6 percent a year, and the other that we do nothing. What happens in 25 years time? In 25 years time, the dollar invested today is worth $4.30. If it is not saved now, the money will have to come from radically higher taxes in the near future.
Some people have questioned whether we will be able to produce the surpluses necessary to finance the Fund. Their scepticism derives from our recent history when the country ran persistent deficits.
But by and large, New Zealand governments have run surpluses except in exceptional circumstances like the 1930s depression.
The aberration was the response to the 1970s oil shocks. The increases of producer subsidies and the Think Big underwriting created a large hole in the public finances, and it took the period from the end of the Muldoon era to the end of the 1980s to fill it.
Since then, there has been a natural tendency for surpluses to emerge. We have only failed to capture the benefits of fiscal reconstruction that took place in the late 1980s because the previous government adopted a policy of dissipating surpluses by introducing rounds of tax cuts.
Money illusion is the other danger. Opponents of the scheme run large numbers across our personal radar screens to lull us into the inertia that desperation brings.
But over time, two things happen. The nominal value of money rises even with low, but persistent inflation. It is important to focus on the real value of money. Secondly, the economy grows, and with it the tax base. It is the value of real money in relation to the size of our economy that determines our capacity to make payments into the fund.
When the issue of fiscal affordability is assessed, we should be looking at today's equivalent money in relation to the level of real GDP in the future.
On this basis, the numbers are not so scary.
The highest annual contribution to the fund is $2.4 billion in today's money. That peak contribution is scheduled for 2010. By then, though, GDP will have grown, so the contribution is around 1.7 percent of GDP.
Indeed, as a proportion of GDP the contribution peaks in 2005 at a little less than 1.8 percent of GDP.
By 2016, the annual contribution is less than $2 billion in today's dollars. By 2019 it is less than the equivalent of one percent of GDP. By 2026 new injections cease.
Overall, then, there is a tight period from 2005 to 2010 during which something like 1.7 to 1.8 percent of GDP has to be put into the fund. That tightness reduces gradually over the following 15 years. It is a discipline, but not the fiscal straitjacket it is being portrayed as.
It is easy to get carried away with fashions, but equally most fashions exist because they resonate with the public. One of the current fashions is goal setting. We are encouraged to set goals, individually and collectively, and to monitor progress towards meeting them. As long as the goals are realistic, they help discipline expectations and behaviour.
Goals on inflation targets, on fiscal balance and on government debt have been useful contributors to improving performance in each of those areas. I have no reason to doubt that the same will not hold true for our superannuation fund.
This raises the question about whether the savings will squeeze out all other spending – both current spending on government programmes and the financing of its future capital programme.
A lot of work was done on this in collaboration with our Alliance coalition partner, because as you can imagine it was a major concern of theirs.
I will start with operating discretion. The government has established a long term goal of keeping its operating expenses at around 35 percent of GDP. It is hard to know what the longer term expense elements will be. In the Fiscal Strategy Report this year, we established what we called a “fiscal allowance”.
The fiscal allowance was not a specific policy commitment. Rather, it was an amount that reflected the fiscal flexibility that the government had. It could be absorbed responding to weaker than expected economic and fiscal results, by spending initiatives, by revenue initiatives or by accelerating contributions to the super fund. That amount was set at an extra $1,200 million per year for each year after 2003/04.
With that allowance, and the prefunding, the government still operates within its 35 percent spending target, with a degree of comfort and over the ten year fiscal projection that is used in defining progress outlooks. That, remember, is the decade under which contributions impose the greatest discipline on the government.
There is that level of fiscal flexibility even with prefunding. It is not extravagant, but nor is it excessively tight. It is as much tolerance as finance markets and the monetary authorities would probably be comfortable with. In other words, even if we wanted to spend more than the headroom we have, after prefunding, the constraints of modern global finance markets would probably stop us doing so.
The contributions to the fund would be a capital appropriation. The key here is that after the contribution, gross and net debt – ignoring the balances building up in the fund – would need to remain within the long-term objective limit of gross debt not more than 30 percent of GDP and net debt no more than 20 percent of GDP.
This raises the completely spurious question of whether the government will borrow to put money into the fund. There are two extremes to this. One would say as long as there was a dollar in the fund, the government could not add a single cent to its debt or it would be borrowing to pay into the fund. The other extreme is that the government would say that it will never borrow for super, only for health, education, prisons, defence equipment and the rest.
Practical considerations suggest the real answer falls somewhere inside these two extremes. The government has a capital expenditure programme. It has to finance it. It therefore needs to manage its debt. At times nominal debt will increase, and at times it will fall.
The point is not whether at any point in time nominal debt is increasing or not. The point is whether the capital expenditure represents quality investments, and the associated debt burden is manageable.
Again, the projections show gross and net debt well below the target ceiling over the next decade, even alongside small increases in nominal debt in some years.
The Alliance has argued that we need a much more systematic approach to medium term prioritisation of capital spending, and this will develop alongside the prefunding to ensure that we manage capital needs and superannuation funding in a harmonious way. It is a big plus for the policy development process, and was necessary anyway.
On all fronts then, the proposal is fiscally sustainable, and consistent with prudent and sensible fiscal management.
What will it do to the economy?
The bald advice from Treasury is that the prefunding proposal itself is not expected to have significant macroeconomic effects. They argue that retirement income policies in general could have economic effects, but they could be adopted regardless of whether or not the fund existed.
In lay terms, if the fund did not exist, governments could do many other things. They could change tax rates, change policies towards investments in SOEs or in granting student loans, or borrow. They could cut the level of NZS entitlements, change other spending programmes, alter policies towards the private savings for retirement or run surpluses to accelerate the reduction of debt.
Because the future is so uncertain, it is not possible to isolate the effects that prefunding itself may have from the effects that other policies may have. I think Treasury was bound by constitutional conventions and professional ethics to avoid speculation about what other governments might do instead of prefunding.
That is their job. My job is to do the opposite. I have to speculate on what governments might do if prefunding does not go ahead, because I have to put realistic choices in front of the public. If not this, then what?
As I have said, I don’t expect a substantial increase in spending compared with what might have been if prefunding does go ahead, although over time there could be some weakening of discipline on both the quantity and quality of public spending. The spending discretion is constrained by the realities of financial market disciplines.
Instead, my core expectation is that in the short term, the temptation will be to create an impression of a more rapid run down of government debt than if the prefund had taken place, but reality will be that debt reduction will be by a lesser amount than would have been building up in the fund. In short, the savings rate will be lower. There will be tax cuts in one form or another, and the emerging demographic pressures will simply build.
On the scenario of lower national savings, primarily through lower government savings, and higher private spending, we can anticipate various less than desirable economic results, in both the medium term – say ten years – and longer terms – say twenty five.
I would expect that a lower trajectory of
national savings would tend to postpone and reduce an
improvement in the balance of payments deficit.
I am reasonably confident that any fund would increase the liquidity of domestic capital markets. In the absence of a fund, we will continue to rely more on foreign market sentiment. In a pure market model, the fund would be too small, as a part of global markets, to make a difference. The market, though, is not pure.
There are scale economies associated with analysis of opportunities, and there are country specific exchange risks that fund managers have to take into account. I cannot accept that even with purely commercial motivations, a fund manager in New York will have the same information about New Zealand investment opportunities and the same exchange risk tolerances as a fund manager in Wellington.
I do see a better flow of funds through both bond and equity markets, and that will tend to improve prospects for investment, production and employment. The fund will be managed on an arms length, commercially prudent basis. The government will not be directing investments into ventures that do not stack up commercially. This is no soft loans facility. But I do think that a robust New Zealand based investment fund can only be good for us.
The worst thing you can say about the fund, from an economic point of view, is that it will make no difference.
That is in the medium term. In the longer term, if there is no fund, we will face a fiscal crunch as a future government tries to find the money. We cannot predict how that will spill out, but it will not be a pretty economic, let alone social or political sight.
The scheme has been launched. I am proud of the design, and would like to congratulate everyone – from inside the government and from the savings industry – who has made a constructive contribution to that design. I do not rule out fine tuning some details about how it might operate, but basically I think the framework is sound.
This is the best chance we have had to move to a politically robust solution. I am determined to seize it on behalf of present and future New Zealanders.