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Hon Dr Cullen Speech to Canterbury Manufacturers

Thursday 13 May 2004

Speech to Canterbury Manufacturers’ Association

Chateau on the Park, 189 Deans Avenue, Christchurch

Later this month I will be presenting my fifth budget. From the start of my tenure I set out to pursue a number of goals which have remained more or less constant features of my budgets ever since. The first priority was to build long-term fiscal strength for the country through prudent and conservative management of spending and revenue (conservative with a small ‘c’, that is). This strength is, if you like, the platform upon which other goals can later rest, goals such as investing in economic development, strengthening public services, securing the incomes of the elderly and upgrading our key infrastructures.

We have taken a cautious approach in the last four years. We have not wanted to fall into the trap that governments in the past have fallen into of responding to the slightest whiff of optimism by committing themselves to spending promises or tax cuts which quickly proved unsustainable. We have been careful to restrain extra spending to a level that allows us to establish a fair degree of fiscal headroom.

Partly as a result of that, budgets have become less and less interesting in themselves. A clear and consistent fiscal stance, combined with a ‘no surprises’ fiscal reporting schedule providing frequent updates on the state of the public accounts and the key parameters for government expenditure, does not provide much scope for histrionics.

Gone (thankfully) are the days when the whole country gathered around the radio or the television to listen to the Minister of Finance unveil the government’s plans for spending and revenue gathering, and then madly rushed out in the ensuing hours and days to buy petrol or alcohol or foreign currency.

If anything I now have the opposite problem; for there are significant issues and signals contained in Budget 2004 which need to be widely understood by all New Zealanders, and not just those with an interest in public affairs. Budget 2004 represents an important watershed, since – as I indicated in last December’s Budget Policy Statement – we have now achieved a degree of financial stability and strength that is remarkable for New Zealand governments in the last few decades, and can start to make some significant, although still cautious, moves towards increasing future spending in areas which impact broadly upon the living standards of many New Zealand families.

So my objective this afternoon is to set out the context for Budget 2004 and to discuss some of the key features you are likely to see. By and large these have been signalled in last December’s Budget Policy Statement and other information releases. However, it is good to bring the various strands together to form a picture.

The first thing to observe is that Budget 2004 comes in the context of a New Zealand economy that is essentially strong, although somewhat delicately balanced. We have seen a period of relatively strong growth since 1999; relative both to our performance during the previous decade and to the performance of our major trading partners. But some major elements of that growth (specifically the earnings in some important export industries) have stalled in the last year, and although the domestic impact of that fall off has been delayed by hedging contracts and by the impressive head of steam in the domestic economy, it started to depress incomes in the second half of last year and will continue to do so for several quarters.

Nevertheless, there are some countervailing factors which may mitigate the effect of the fall off in export revenues. The US economy appears to be recovering strongly, with many of the indicators heading into healthy territory. The one that has lagged has been employment growth, and that in turn has affected interest rates in the US, since it is an important focus for the Federal Reserve.

However, the latest employment figures are showing something of a turnaround, and this augurs well for consumer confidence. What is less certain is whether some progress can be made on the US dollar, which is still being held back by the combined effect of a large current account deficit and a large federal government deficit. (The latter is of course testimony to the danger of premature tax cutting.)

Meanwhile there is a positive picture on the Asian economies, particularly Japan, which is coming out of a long slump, and China, which barely seems to have missed a beat.

We are also seeing a strong resurgence in global commodity prices in some key industries. The monthly ANZ World Commodity Price Index, which measures New Zealand’s main export commodities in world prices, has seen ten consecutive increases and is now 18 percent higher than in April 2003.

This, in combination with the retrenchment in the value of the dollar from its high in February, should contribute to an improvement in export revenues.

So most forecasters have been predicting the growth rate to slow to around 2.5 to 3 percent over the next year or so, but then to return to an average of 3 to 3.5 percent per annum over the medium term.

Given this context, what can we expect for Budget 2004?

To begin with the message that nobody seems to want to believe: there is no pot of gold.

Like previous years, I am bracing myself for the usual Budget cartoons portraying me, in various poses, like Scrooge McDuck atop a mountain of cash, vehemently fighting to retain every last note and coin against the encircling hordes with their more or less worthy spending plans. This kind of image has become standard iconography around budget time, ever since it became apparent that my government was serious about its commitment to prudent fiscal management, part of which is the running of fiscal surpluses.

I have to say the joke is getting stale. What is more, it is based upon a misunderstanding of the accounting principles that underlie the budget.

It is perhaps forgivable when the error is made by general journalists with no training in GAP accounting rules. But when such ignorance is purveyed by the Leader of the Opposition – a former Governor of the Reserve Bank – it becomes merely contemptible. He, of all people, should understand the realities and support a prudent fiscal stance.

But then if you can believe you can have a nuclear free policy without being nuclear free then there is no reason why you can’t have fiscal prudence without being fiscally prudent.

Much of the attention is given to the operating balance published in the government’s accounts. The central measure is the OBERAC – the operating balance excluding revaluation and accounting policy changes. The OBERAC for the 2003 fiscal year was $5.58 billion, which was 4.3 percent of GDP. The forecast for the current year (from the December Economic and Fiscal Update) is for an OBERAC of just over $5.2 billion, or 3.8 percent of GDP.

Many people see this figure and assume that it is immediately available for either increasing spending or cutting taxes. Indeed, those with worthy projects for extra spending usually note that the hundred million or so they are seeking is only a small portion of the total pot, and would barely be noticed.

The situation is somewhat akin to the AGM of a publicly listed company at which the directors need to explain to small shareholders why the entire operating surplus of the company cannot or should not be distributed as dividends. Two further steps have to be taken.

First, a number of non-cash items – such as depreciation and the retained profits of SOEs – need to be taken out of the equation to arrive at an accurate figure for the sum available for new core Crown expenditure. In the December Economic and Fiscal Update this meant that the $5.2 billion forecast operating balance for the 2004 financial year was reduced to just under $4.8 billion of net cash flow from core Crown operations.

The second modification needed is to take out commitments to capital spending. While it is true that our revenue streams cover our costs, we are also investing in the future of the business, as it were, through capital spending and through strengthening our financial position to meet future expenditure pressures.

Once we take those factors into account (and I want to expand on both later on) the result is that the $4.8 billion surplus is reduced further. Indeed, the December Economic and Fiscal Update listed for the 2004 year:

net purchase of physical assets of $1.4 billion (including major investments in roading);

net increases in advances (chiefly student loans) of $1.7 billion;

net purchase of investments (including hospitals and housing) of $780 million;

purchase of marketable securities and deposits by the New Zealand Superannuation Fund of $1.9 billion; and

forecast new capital spending of $144 million.

That capital programme amounted to some $5.9 billion, and as at December, left us short of around $1.1 billion which would need to be financed from new borrowing or from the leftover balance from the 2003 year, which conveniently stood at $1.2 billion.

Those figures have changed somewhat, although we should not be misled by the recent Crown Financial Statements for the March quarter, which showed a very large operating balance of some $7 billion. This is a common seasonal effect which will be reversed to a large extent during the fourth quarter.

At budget time I will be presenting a new picture of the balance between net cash flows to the core Crown and capital spending. Suffice it to say that there will be no large pot of gold left over. Those who would covet some portion of the operating surplus need to explain why their purpose should take precedence over such things as roads, hospitals and student loans.

There are some businesses that are in a position to pay out a large proportion of their net earnings in dividends. Those are businesses that have no need to expand, have low growth prospects and operate in a low risk environment: ‘cash cows’, in common parlance.

The government is not in that position. There is a need to invest in the factors that underlie growth in the economy, such as infrastructure and skills. There is a need to improve capacity in some public services. And we are facing risks that need to be managed. To suggest that the government is awash with cash is in fact a gross misrepresentation of the situation we are in.

Our new priorities, as we see additional resources becoming available over the next few years, are centred around two objectives:

Recasting the income support system for low to middle income working families; and

Supporting the export sector.

I announced in December that this year’s budget would include a significant family assistance package. This is a phased package which will take several years to come into full effect. Nevertheless, it is the largest single set of changes to the benefit system and assistance for families since the benefit cuts of 1991. Eventually around 300,000 households will receive direct assistance from it.

It has three broad aims:

First, it will make work pay, by supporting working families with dependent children, thereby increasing the wedge between benefits and paid work. This is a hoary old chestnut of welfare policy, ensuring that there are very clear returns to be made for sticking to the workforce and acquiring the mid-level skills that our economy needs. Our opponents on the right have always contended that the answer is to push beneficiaries into poverty, pour encourager les autres, as it were. That was the logic behind the 1991 benefit cuts.

Our philosophy, unashamedly, is to design a system that targets assistance to those at the low end of the labour market (and in particular those with dependent children) to ensure that they are significantly better off in work than out. (As an aside, in the process it may take some of the pressure off wages, although that is not its primary intent.)

That leads me to the second aim of the package: ensuring income adequacy for low to middle income families with dependent children. This has always been at the heart of Labour’s policy. But while it is a social policy goal, it is also good long-term economic policy.

The fact is that the majority of the workforce of the future is currently being formed in families who will receive assistance from this package. And we know that better, more stable, incomes – along with other factors such as good housing, education and primary health care – create the conditions in which cohorts of skilled and motivated citizens are created.

The third aim of the package is to support people into work and keep them there. The transition to work has always been a difficult area of policy: how to design an interface between welfare and work that does not pull the welfare rug out from under people the moment they make their first tentative steps into the full time workforce. Fixing that problem requires careful policy design, so as to get the incentives right; but the payback is that we bring people though to the point where they are firmly attached to the labour market, gaining skills and independence, rather than occupying the fringes where they are always vulnerable.

I want to stress that the family assistance package is a phased programme which will take a number of years to come into effect. It sits alongside and complements a number of ongoing initiatives to foster a more skilled and more productive workforce.

Investing in industry training continues to be a key strategy. Some time ago we adopted a target of getting 150,000 New Zealanders learning on the job by the end of 2005. We are well on the way to meeting that target, with the number of workers participating in industry training jumping by nearly 20,000 last year to a new record high, and the number of employers involved in the programme also increasing substantially, with around 29,000 firms now on board (up from around 25,000 in 2002).

Our tertiary education reforms are continuing, and we are beginning to see amongst our tertiary institutions a stronger culture of responsiveness to industry in terms both of teaching programmes and research. We value education for its own sake, of course; but courses that are informed by partnerships with industry or with local business communities are in fact better learning opportunities.

You will see a progressively stronger emphasis on the quality of education. The more flighty or purely recreational courses that have crept in under the tertiary funding umbrella will fall by the wayside. And quality will not be an abstract concept; but one which includes relevance to the needs of New Zealand businesses and communities.

The other major area for new spending is in assistance to business, and in particular assistance for our export industries. Our future is as a trading nation, and the quality of our international linkages is therefore essential to our future prosperity.

Much of the Budget package has already been announced. There will be a total of $195 million for the combined budget of NZ Trade and Enterprise, building over time. This will include:

$26 million over four years to enable New Zealand Trade and Enterprise to boost its offshore efforts;

$35 million over four years to market specialised business sectors offshore;

$42.6 million to deepen Investment New Zealand’s offshore representation and funding, increasing their capacity to find offshore companies to partner growing New Zealand companies;

$40 million over four years for the education sector to develop stronger offshore relationships to protect and promote export education; and

Funding for New Zealand participation in the Aichi Trade Expo in Japan.

These spending initiatives, alongside the family assistance package and a number of smaller initiatives to increase capability in important parts of the public sector, are ambitious within the constraint of overall fiscal prudence. They will have the effect of tightening the forward fiscal position, with the result that other parts of the public sector will be operating strictly within baselines for the foreseeable future.

They may also, as the Governor of the Reserve Bank noted, have the fortuitous effect of being mildly stimulatory at a time when the domestic economy may benefit from a more secure underpinning floor.

I want to stress nevertheless that long term financial stability remains the watchword of the Budget. This will be seen in further contributions to the New Zealand Superannuation Fund. At the end of the 2003 financial year the Fund had assets of around $1.9 billion, and that is forecast to rise to $3.9 billion in the current financial year, due to further contributions and some retained earnings. On current forecasts, by 2008 the Fund will have assets of over $15 billion, or around 9 percent of GDP.

The important point to grasp about the Fund is that it is not an attempt to fully fund the future cost of New Zealand Superannuation. It is primarily an exercise in long term management of fiscal pressures. The performance of the Fund will have no direct impact upon the level of payment to retired New Zealanders in the future. What it will impact upon is the capacity of future governments to fund a basic universal retirement income without experiencing destabilising fiscal pressures. The Fund will smooth the fiscal cost of a basic public superannuation scheme, to avoid a situation where future governments face impossible choices either to increase taxes, increase debt or tamper with the elderly’s entitlements and conditions.

By 2040, for example, the Fund will be in a position to offset the current cost of superannuation by about a third. If that cost were to be borne by taxpayers of the day it would be a very significant impost, severely constraining the options available to the government of the day.

The Fund is a logical extension of the move away from short-term-ism in public finances (epitomised by the frequent mini-Budgets of the Muldoon era) towards more prudent long term fiscal planning which started with the Public Finance Act in 1989, and continued with the Fiscal Responsibility Act 1994, and the Public Finance (State Sector Management) Bill which is currently before Parliament.

For too long in this country we engaged in spending commitments or tax cuts in which the implicit assumption was that future generations would pay. What the Superannuation Fund does is to start to rein in this tendency by making explicit both the nature of the commitment and the distribution of its costs. Those who oppose the Fund and advocate that it be wound up and its assets used for current consumption now have to be equally explicit about what they would put in its place, what level of tax increase they are happy to impose upon future taxpayers, or what degree of cuts to superannuation entitlements they are willing to contemplate.

As the Fund grows more substantial, I believe the political barriers to this kind of short term-ism around superannuation policy will grow higher.

Finally, as further confirmation of the fiscal prudence that underlies this year’s budget, I want to say a few words about the debt target. This was alluded to in last December’s Budget Policy Statement.

The current debt target is to manage total debt at prudent levels, with, in the longer term, gross sovereign-issued debt below 30 percent of GDP on average over the economic cycle. This has in fact been the debt target since the current government came into office in 1999.

The previous government had established a 30 percent of GDP target when the Fiscal Responsibility Act was passed in 1994, and had reduced it to 25 percent in 1999. When we came into office that year we made the judgement that the Crown finances and the state of the economy could not sustain that lower target, so we restored it to 30 percent of GDP.

This year, gross sovereign-issued debt is forecast to be 28 percent of GDP, and to fall to 25 percent at the end of 2004. This makes a 30 percent target somewhat meaningless, except that it implies that the Finance Minister has an option of using additional debt to finance the Crown’s activities. That is an option I do not intend to take up, as will become apparent on Budget day.

To sum up, Budget 2004 will be proof positive that there is no fundamental clash between prudent financial management, proactive social policy and an active role for government in supporting business and investing in economic capacity. Whereas governments in the past have espoused this view, their tendency has been to sacrifice one or other of these objectives due to impatience or political expediency.

It has not been an easy road to Budget 2004. But it has been worth it.

Thank you.

ENDS

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