Cullen - Melbourne Financial Services Symposium
9 March 2005
Hon Michael Cullen - Melbourne Financial Services Symposium Enhancing savings in Asia-Pacific
Sofitel Hotel, Melbourne
The subject of this symposium, “Enhancing savings in the Asia-Pacific region”, is of very great importance to the future social and economic well-being of our various peoples. At its heart, saving is the simplest of actions: foregoing consumption now, in order to consume later. However, when spread across whole populations and economies it becomes an important factor in social stability, the functioning of capital markets and the stability of fiscal and monetary policies.
As a finance minister, my concern is to find the right mix of policies that will enable social and economic progress within a context of long-term fiscal and monetary stability. From that perspective, ‘enhancing’ savings is more than a simple question of increasing the overall volume of savings. Who is saving; how much; over what timeframe; through what savings instruments; under what regime of regulation – all these become crucial questions.
What is more, because we live in a world of limited resources and competing interests, different policy settings involve trade-offs between objectives that are invariably difficult to make and, once entrenched, very hard to change.
So, this morning I would like to address from a perspective of government policy three important questions regarding savings:
Why individuals should save;
Why governments should save; and
Why governments should encourage individuals to save.
The answer to the first question is obvious, so obvious in fact that we can fall into the trap of making assumptions about the worthiness of a savings habit. Those of us who grew up in the 1950s and 1960s were encouraged to save simply because it was ‘good for us’. Conversely, spending acquired negative overtones of lack of self-control. All of this put saving on a par with all the other essential Presbyterian disciplines of life, such as brushing one’s teeth, taking one’s medicine, and doing one’s homework.
Putting aside a few coins every week was one of the things that prepared you for the adult world. Even if the short-term outcome was that we blew it all on a new bike, that practice of financial frugality taught us that those who could deny their immediate gratification were those who got what they wanted in the end.
There is still something of this feeling in much of the talk around personal savings. This is probably not a bad thing; but we need to ensure that we do not lose touch with how saving serves the needs of real families in the real economy. That is, how foregoing current consumption at one point in their life-cycle enables them to fund assets (property, financial assets and human capital) which can support their chosen lifestyle through the various phases of life.
We need to understand the dynamics of the life cycle, and to appreciate how they change over time. Changes to patterns of work and family, changes to the economy, to consumption patterns, and changes to where and how wealth is generated, are impacting on the role savings play.
To illustrate my point, someone who, like me, has just turned 60, probably grew up in a household with a single source of income (the father’s pay-cheque) where saving played a fairly simple role, contributing to the purchase of a family home, possibly to some of the costs of higher education, and latterly to the creation of a retirement nest-egg. Over the course of one generation, that scenario has become considerably more complex, with dual-earner households making a much greater investment in education, changing jobs and even careers over the course of a working life, with multiple sources of income, children who seem to linger around home into their twenties, and so on.
Saving is still something to be encouraged, but it is not what it used to be. It serves a broader range of purposes in the lives of today’s families, and both governments and the savings industry have to come to terms with that and design policies and products that serve a new configuration of financial goals and financial means.
My second question is: why should governments save? On the face of it, governments do not undergo the kind of earnings life cycle that households undergo. They do not grow old, and every year they manage to fund their expenditure from current tax revenue and, depending on a variety of cyclical factors, possibly some debt.
I would argue strongly, however, that governments need to commit to long-term fiscal goals, such as levels of public debt, and that saving needs therefore to be part of their financial armoury. This is particularly the case when there are long-term changes to the structure of the economy and the population which will impact upon the capacity of future governments to maintain essential public services alongside prudent fiscal policies.
Demographic changes are the most common candidates for this kind of response, since their impact can be predicted and assessed decades in advance. While there may be widely divergent views and legitimate debate about how our economies will be structured in 2025, most of the people who will comprise the population in 2025 are already here.
Population ageing is a matter of statistics, and not politics or economics. Like many countries in the developed world, New Zealand is undergoing a demographic shift which will see a much higher ratio of retired people in the next few decades. Simultaneously, governments have been putting in place a set of fiscal indicators and policies aimed at transparency and stability. These require that long term liabilities and commitments be identified and accounted for, and therefore beg the question of how they will be met.
New Zealand has a universal public pension from age 65, funded from taxation on a ‘pay as you go’ basis. This has the advantages of low administration costs per capita, since there are no individual accounts to be maintained and no variations on pension payouts based on earnings levels or years of work. The scheme delivers an equitable universal pension, albeit one that represents a basic standard of living which most New Zealanders aspire to supplement through their own savings.
The disadvantage of the scheme is that, because it has not had any element of pre-funding, it depends for its long term stability on a relatively stable and pyramid-shaped age-structure. Demographic changes over a certain degree of magnitude can cause severe inter-generational inequities, and that is exactly what we are now contemplating in the third and fourth decades of this century.
For this reason, the government has established a savings programme in the form of the New Zealand Superannuation Fund, in order to pre-fund a portion of the long-term liability for our public superannuation scheme. The benefits payable under the scheme – equal to roughly 65 per cent of the net average wage for a married couple – will not be affected. What the Fund will do is enable us to smooth out the fiscal impact of our commitment to older New Zealanders, so that future governments will not have to contemplate sharp increases in taxation in order to maintain the scheme.
At the end of the last complete fiscal year, 2003/04, the NZ Superannuation Fund had a balance of $3,956 million dollars. This is equivalent to 2.8 per cent of GDP. The 2004 December Economic & Fiscal Update (2004 DEFU), which is the latest official forecast by Treasury, forecasts that this will rise to $6,346 million dollars, or 4.2 per cent of GDP, by the end of the current (2004/05) fiscal year. By the end of fiscal year 2029/30 it is projected to grow to over $147 billion dollars, which is equivalent to 38 per cent of projected GDP.
Withdrawals from the Fund are projected to begin in fiscal year 2025/26. By 2029/30, the Fund is projected to contribute nearly 30 per cent to the net (after-tax) expenditure on NZ Superannuation. Of this just over one third will be sourced by withdrawals from the Fund, with the remainder coming from tax payments made on the Fund's earnings.
In later years, both the overall contribution to net NZ Superannuation expenditure and the share provided by withdrawals should increase. The overall contribution peaks at over 36 per cent around 2040, at which time the withdrawals and the tax payments should provide roughly equal shares. These projections are based on current forecasts of economic growth and demographics. Returns to the Fund will alter from year to year, as part of normal volatility, and this in turn will affect these projections too.
The Fund is managed at arms-length from the government by a statutory body known as the Guardians of the New Zealand Superannuation Fund. The Guardians must manage the Fund in a manner consistent with best practice portfolio management and with maximising the return to the Fund without undue risk.
In managing the Fund, the Guardians must also “avoid prejudice to New Zealand’s reputation as a responsible member of the world community”. They must establish investment policies, standards and procedures and review them annually. These are published in an annual statement, and each year the Guardians must publish a report that certifies whether or not the investment policies, standards and procedures have been complied with.
To round things out, at least every five years there has to be an independent review of how efficiently and effectively the Guardians are performing their functions. The Superannuation Fund will have three important macroeconomic effects. Firstly, it will require governments to be disciplined in their tax or spending plans, and to avoid spending commitments or tax cuts that are impossible to sustain, but painful to reverse. Secondly, it will increase the level of national savings. And finally, it is likely to provide a more stable setting in which New Zealand firms can seek long-term capital investment. However, it is not to be used as an instrument of government policy beyond its basic mandate. The Guardians have a clear legislative mandate to manage the fund in accordance with the principles set out in the Act. As responsible Minister, I may give directions to the Guardians regarding my expectations of risk and return for the Fund, and they must have regard to those directions, but I cannot give a direction that is inconsistent with the requirement that the Fund be run on a prudent and commercial basis. So, for example, I would not expect that the Guardians would view the New Zealand bond or equity markets any differently to another similarly sized fund seeking to maximise returns over the long term. To return to my question over whether governments should save, clearly they should do so when there are specific and measurable challenges to fiscal stability. This should be done preferably through a savings vehicle removed from the normal apparatus of government finances, so that a clear focus is maintained on the purpose of those savings and decisions as to their investment remain unclouded by short-term fiscal conditions.
This leaves me with my third question: why governments should encourage, and even incentivise, their people to save. New Zealand has a somewhat unique history in relation to this question which it is worth traversing briefly.
In the 1980s we had a savings incentive regime for long-term savings products based on tax deductibility of contributions. The main beneficiaries of this regime were workplace superannuation schemes run by individual companies and some larger funds. We had a relatively good rate of participation in workplace superannuation, in particular for public servants and older male workers in the private sector. Participation by women, non-professional or non-unionised workers, the rural population and the self-employed was at a much lower rate.
The 1980s were our decade of change, in terms of the composition of the workforce, the patterns of employment, and a raft of social changes. The sharemarket boom in the mid 1980s drew attention to a broader range of investment options, and while it ended badly in 1987, it did show up the rather lackadaisical management of some funds.
That decade also brought to light some cases of serious fraud or mismanagement within superannuation funds, as well as broader doubts about whether retirement savings vehicles were in fact being used for retirement purposes. Evidence of deadweight costs and distortionary effects cast serious doubt upon the efficacy of savings policy, which took on the appearance of a murky tub of bathwater.
Governments in the late 1980s proceeded to throw that bathwater out, specifically by changing the taxation of savings to a neutral regime in which contributions to long-term superannuation schemes were made out of after tax income, with the earnings taxed in the hands of the fund and payouts becoming exempt from tax.
This of course was in the context of a tax system which had no capital gains tax.
From today’s perspective, the decision to ditch the bathwater was certainly the right one. There was no evidence of a baby. It is clear that tax incentives for saving can be inefficient, and can incur high costs for quite low levels of net increase in savings. Tax incentives can also be quite inequitable. Those who have such low incomes that they cannot save do not have the potential to access the incentives, so the objective of bringing a larger proportion of the population into the ambit of retirement savings is not fulfilled.
Nevertheless, I am concerned about the rate of domestic savings in New Zealand, whether those savings are linked to retirement or not.
Stated simply, New Zealand has one of the lowest rates of domestic savings in the OECD. That is clearly not a reason to panic, since New Zealand has sustained one of the best growth rates in the OECD in the last five years, has one of its stronger currencies and, as of last month, has the lowest rate of unemployment.
The link between domestic savings and economic growth is not a simple one. The US economy has grown spectacularly over the past few decades without particularly high rates of domestic savings. This is because they have been willing to access the savings of others, whether the Japanese, the Chinese, the Arabs or the Europeans, and investors in those nations have been more than happy to oblige.
Many would point out that the US experience cannot be automatically replicated elsewhere. Growing economies other than the US, such as much of Western Europe, China and Japan, tend to have higher rates of domestic savings. Indeed the US is starting to realise that there is a limit to how long foreign investors will continue to fund their deficits. Hence the Bush administration’s suite of initiatives to support an ‘ownership society’.
I doubt that there will ever be unanimity amongst economists as to what type of economy is most likely to benefit from domestic savings; however, my belief is that the New Zealand economy is moving into a phase of development in which the rate of domestic savings will become increasingly important. I believe it will be particularly important in deepening our capital markets and attracting the type of investment needed to extract maximum value from the shift, which is well under way, from a commodity-based to a knowledge-based economy.
A concern that is commonly voiced regarding the current foreign investment in the New Zealand economy is that it is focused on companies involved in the domestic economy, rather than our export industries, and that it tends to involve the purchase of shares in existing companies, rather than greenfields investments. What this means for the venture capital market is that it draws its funds largely from domestic sources.
That leaves us with two options for increasing the flow of funds into the venture capital end of the market:
Encourage foreign investors to acquire a greater degree of familiarity with the growth sectors in the New Zealand economy, and in particular the opportunities in the export sector; and
Increase domestic savings, with their inbuilt ‘home bias’.
The agenda Peter Costello and I have been pushing for the last few years towards reducing the barriers to trans-Tasman investment flows, should go some way towards achieving the first objective. Harmonising taxation, business law and securities law, and bringing our key regulatory regimes closer together, will ultimately create a single Australasian ‘domestic’ investment market.
While we are moving towards that goal, my government will also be taking measures to increase the propensity of New Zealanders to save. We believe that, parallel to the changes in our economy, New Zealand society is moving into a phase in which families are juggling a more complex portfolio of income sources and investment decisions. Hence their long term well-being will depend to a greater extent upon their appreciation of how to create and manage wealth.
As one example, our rates of participation in tertiary education, especially amongst adult students, have been rising steadily since the early 1990s. Ironically, this has coincided with the introduction of a student loan scheme which reinforces the notion of tertiary study as an investment in skills which will secure a higher future earnings stream.
What we want to focus on are the positive side-effects of having a larger proportion of the population with significant financial and other assets. We acknowledge the important link between asset ownership and meaningful participation in society and the economy. Assets provide households with greater security, particularly in terms of their ability to cope with changes in employment or business failures or poor health. They also increase their ability to access opportunities, such as buying a house or financing an education, and encourage more of an orientation towards the future.
If this seems strange coming from a Labour politician, I should add that a broad distribution of ownership also appears to generate enhanced social cohesion, through spreading the benefits of economic growth and giving all citizens a sense of a stake in the future of out economy.
So how might we achieve an increase in domestic savings? Not easily, is my first response. The history of government is littered with failed attempts to do what might appear a simple thing.
There are several things a pro-savings regime has to do:
It must encourage genuine savings: not simply a temporary diversion of spending through vehicles that qualify for a tax break or some other advantage;
It must limit switching of past savings into an advantaged form;
It should increase net new savings into the future, and not simply divert what might be saved in the future down new avenues.
It must be equitable (although this is difficult to achieve given that a precondition for an equitable incentive regime is that lower income groups have the capacity to save).
Most importantly, it should change attitudes and habits and contribute towards a shift in the savings culture. Policies that rely purely on a “bribe” effect tend to limit the net longer term benefits that they produce.
It should be obvious that I am treading carefully, and seeking a path that does not rely too heavily on either the notion of compulsion or the manipulation of the tax system.
My concern with compulsory systems is that they can negate some of the economic benefits of saving (for example, if they end up involving regulations which stipulate a particular kind of investment policy) and also some of the social benefits (if there is not sufficient choice to promote education and wealth management skills).
Tax based systems can lead to dead weight losses and distortions between different savings options. By sequestering retirement savings in a special category, they can also make it difficult for households to take an integrated approach to all of their assets, including housing, education, and perhaps a business.
So what we are focusing on is a range of measures aimed at shifting our savings culture, creating a better basic infrastructure for saving and ensuring that we have a retail savings industry that delivers good results.
A number of initiatives have already been signalled, and this year’s budget in May will provide more detail.
We believe the workplace is the ideal context in which most New Zealanders can arrange long-term savings, and so we will have a set of measures aimed at rebuilding strong work-based superannuation schemes. This will include mechanisms through which the government will encourage participation amongst employees and minimise the transactions costs for employers.
We are moving to resolve some anomalies in the taxation of savings and investment.
We introduced a mortgage insurance pilot in September 2004 as a first step toward assisting people into homes. We are looking at further cost-effective ways of assisting home-ownership amongst New Zealanders who would otherwise struggle to get these important first runs on the savings board.
We have a Taskforce on the Regulation of Financial Intermediaries which is due to report mid year. This will address many of the concerns raised about the retail savings industry such as problems of conflicts of interest through commission-driven agents, transparency around fees and around the roll up of savings products with insurance products.
Clarifying the situation and taking action if necessary is an important priority, since a corollary of encouraging New Zealanders to save more is ensuring that we have a high quality retail savings industry. That means an industry that provides a range of products suited to local conditions, that operates transparently and applies a high level of expertise while charging competitive fees.
I do not see any of these measures as a magic bullet. Rather they are a set of converging forces, some of which may prove more significant than others, but all of which should encourage a greater awareness of saving in the context of a broad understanding of wealth creation and management, and a savings industry that is more in tune with both the priorities of savers and the opportunities in the economy.
These are objectives that are shared by governments and industry participants across the Asia-Pacific region, and I hope that New Zealand’s experience may provide useful fodder for the ongoing debate, both at this symposium and elsewhere.