Cunliffe - Investment and Savings Conference
18 March 2005
Hon David Cunliffe - Fundsource Professional Investment and Savings Conference
A vision for the future of the investment and savings industry
Address to Fundsource Professional Investment and Savings ConferenceHyatt Regency, Waterloo Quadrant, Auckland
A Vision for the Future of the Investment and Savings Industry
My kids love Auckland Zoo. They love the long blue slide (as do I) and they love the elephants. Their favourite is an elephant called "Cashin".
Like the old school savings books, "Cashin" was one way a local bank sought to promote good savings habits among our kids. Sadly it clearly didn't work.
As a nation we do not save enough, by either international comparison or to meet broader economic and social objectives. The good news is that the government is proposing to take steps to address that and that will have positive spin-offs for the savings industry.
As announced by the Prime Minister in her opening of Parliament speech, the government is developing new savings initiatives. We want to help New Zealanders build up their assets and security and to reduce our national reliance on the savings of others. These sit alongside other initiatives on rationalising the taxation of savings and encouraging a stronger retail savings industry.
The guiding vision for these initiatives is the creation of a more broadly based ownership society in which more New Zealanders can enjoy the security of their own home, afford higher education for their children, and have a good standard of living in retirement.
Today I will discuss:
·Why New Zealand's current low rate of savings is
·the case for increasing New Zealand's savings rate further, and
·what the Government has done to enhance savings.
And without getting me in trouble with the Minister of Finance, judicious hints about wonderful things to come.
2.NEW ZEALAND HAS A LOW RATE OF DOMESTIC SAVING COMPARED WITH OTHER COUNTRIES
In recent months there has been considerable public debate over our level of domestic savings. David Skilling, who will follow me today, has been a major contributor to that debate. The nub of the debate is what role savings play in fostering economic growth and social stability. The world's economies provide a range of different models, which suggest that domestic savings rates vary in significance as a factor in economic growth according to the structure of an economy and the type of capital investment it needs.
So the questions we need to ask are:
·How does our domestic savings rate match up?
·Would increasing it fuel the long-term sustainable growth we need? and
·If we conclude that we do need New Zealanders to save more, how do we influence them to do so?
The answer to the first question is that we score a C minus on domestic savings. That is: "Could do a lot better".
We as a country save less than many countries with a lower standard of living than New Zealand. Over the last two decades, the aggregate saving rate in New Zealand (that is, the sum of household, business and government saving, divided by GDP) has fluctuated about a flat trend, declining sharply in the early 1990s before a more recent recovery. New Zealand's trend was lower than that of most other OECD-member economies over this period. What is more, looking more closely at the aggregate New Zealand rate we see a general decline in private saving, offset by rising government saving, over the last decade.
As a consequence, domestic saving has been insufficient to fund the capital investment that has been undertaken. It has been supplemented by overseas borrowing, which has resulted in persistent current account deficits - 5.8 per cent of GDP (as at the September quarter 2004) - and ultimately a build-up of overseas net debt.
A build-up of debt can be perfectly acceptable, if it is funding investment projects that are expected to generate high returns. However, New Zealand's net external liability position represents 83 per cent of GDP (as at the September quarter 2004). This is one of the highest ratios in the developed world.
While New Zealanders' net wealth position has increased in recent years, this has been largely influenced by an increase in the value of total housing assets. The level of New Zealanders' investment in financial assets as a proportion of income has declined. To date, New Zealanders' assets are concentrated in housing. I think it is wrong to say that we are over investing in housing. It's just that we are under investing in everything else.
While house values have been increasing, New Zealand's home ownership rate declined from 74 per cent in 1991 to 68 per cent in 2001. This drop predominantly occurs among the 20-39 year old cohort, yet stretches across all metropolitan and urban areas and income bands.
This observed decline has occurred for a number of reasons, including less affordable house prices in some areas in some periods, demographic changes, delayed family formation, and individual choices. Structural changes to the economy and financial sector may also have contributed to previous high home ownership rates, e.g. periods of negative real interest rates and constrained investment choices in the 1970s.
At the risk of gross generalisation, the picture that emerges is of the wealth of New Zealanders rising overall, but becoming more concentrated in older age groups and being held primarily in the form of residential property. Meanwhile, the funds for investment in our businesses are increasingly sourced offshore.
3.THE CASE FOR INCREASED SAVINGS
Is there a problem with this pattern of saving? Market purists would say no; but I believe that there are some weaknesses here that may hamper the next phase of growth in our economy (when a stronger venture capital market will become essential) as well as creating social divisions that could undercut the wellbeing of our communities.
·Social benefits of home ownership and savings
It was George Bernard Shaw, I believe, who said that to die poor was no disgrace; simply a matter of excellent timing. However, I do not think he would have denied that, during the course of our lives, asset ownership is important for enabling people to participate fully in society.
We have tended to think of savings primarily in the context of preparing for retirement, when people want to supplement the modest state pension to maintain a desired level of income. This remains very important, and we as a government have attempted to provide greater long-term certainty to New Zealanders by securing the financing of that universal pension through the period of the population ageing ahead.
However, assets play a much wider role, providing families with greater security, control, and independence. This is particularly so in terms of their ability to cope with changes in employment or business failures or poor health. Assets 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.
Asset-ownership is also central to the tenets of social democracy. The more evenly assets are spread in a community, the more social cohesion there is at a national level, the more all New Zealanders can benefit from economic growth. It is important that all New Zealanders have a sense of participation in society and in the economy that propels its wellbeing.
·Adequate Provision for Retirement
What applies to individuals also applies, in this instance, to public finances. We have on the horizon a significant fiscal challenge, and we need to prepare for that.
New Zealand has a universal public pension from age 65, funded from taxation on a 'pay as you go' basis. 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. What the Fund does 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.
The fact that the Fund now has the support of the National Party is a positive development from the Government's perspective as this helps to ensure the long-term viability of the Fund.
·Economic benefits of savings
The social benefits of saving arise, not just because it provides individuals with a claim on the future flow of goods and services in the economy, but because savings help to grow the economic pie overall. Savings, both domestic and international are the lifeblood of the economy, carrying nutrients from storage to where they are needed to make the limbs move.
The accumulation of capital -- machinery, computers and so on -- allows workers to be more productive. In turn, this higher labour productivity contributes to higher GDP per capita. However, it's not enough just to give workers more capital -- it's also important to have an economy that combines capital and labour in increasingly productive ways.
Given this, it's important for policy makers to be mindful of two things: first, having policies that are conducive to a business environment with strong multi-factor productivity growth, a broad measure of efficiency and second, making sure that there are no barriers to investors who want to provide capital for use by New Zealand workers.
·Foreign Direct Investment is not a substitute for savings
I look forward to what David Skilling has to say about this latter set of issues. He has argued in a recent discussion paper that the level of domestic saving is likely to be one of the constraints on the level of domestic investment. A combination of risk aversion, ignorance and prudence means that savers and their agents may be more likely to finance domestic rather than foreign investment - they may feel more comfortable investing in products, companies and a market that they understand.
Dr Skilling argues that, where savers and their agents do finance investment in foreign countries:
·their choice of country often depends on its
market size and proximity to other markets (as well as trade
linkages and language); and
·they are more likely to finance debt rather than equity, big rather than small, domestic rather than export focused, and established rather than start up.
To return to my analogy of savings with blood, while it is always feasible to depend upon transfusions of plasma from other people, it is highly desirable for a body to produce its own supply.
This suggests that, given New Zealand's size and geography and the importance for growth of small, export-focused start-ups, increased domestic saving is vitally important.
FDI can bridge the savings gap and bring important benefits. However it is not a perfect substitute for increased domestic savings. We see this first of all in its impact on interest rates. If we want to get foreign savers to finance the gap between New Zealand saving and investment, we have to use the lure of relatively high interest rates. In my view the whole of the economy pays the price in a higher cost of capital, an arguably lower GDP growth rate and, ceteres paribus, a higher exchange rate.
Studies have shown that New Zealand's real government bond borrowing rates tend to be modestly higher than in Australia and significantly higher than in the United States. Similar results are found in studies on other interest rates and on returns to equity.
One explanation for these results is that countries with a large stock of external liabilities are charged more by lenders to compensate for the higher default risk and (where liabilities are denominated in the local currency) exchange rate risk. (Other factors include the liquidity of the market for New Zealand currency.)
I want to talk about what the government is doing to promote savings. But first I want to take a step back and look at one of the great underlying themes of late Twentieth Century politics. That is: how to deal with increasing global interconnectedness.
As we all know New Zealand moved from a closed off "head in the sand" approach prior to the 1980s to an "open up and hope" approach in the 1990s. This government has recognised that neither approach will provide the standard of living New Zealanders aspire to.
Our levels of savings dictate how we interact with the rest of the world. If we are a country living on maxed out credit cards, huge mortgages and hire purchases we are always going to need foreign investment to fund our consumption. We are always going to be price takers.
If we are a country of savers and therefore investors we could have deeper capital markets and greater opportunities for New Zealand businesses to grow, expand off shore, bring money home, pay higher wages and boost our standard of living in a way that doesn't require the savings of other countries.
Of course the reality is that we are always going to be somewhere between those two extremes but local investment and deeper capital markets are good for New Zealand. The debate has moved on from "the market will provide and national borders don't matter" to how do we develop New Zealand Inc. to take on the rest of the world.
4.WHAT HAS THE GOVERNMENT DONE?
It is important to observe that the government's broad policy framework has always encouraged savings. For example, New Zealand enjoys lower income tax rates than many other developed countries, and does not have a capital gains tax. These general policy settings are clearly not enough.
The Government considers that specific savings policies are necessary given the spending and savings decisions people sometimes make. Sometimes we find it difficult to overcome inertia, particularly with regard to initiating actions that have high up-front costs and distant benefits. And sometimes we have difficulty in adhering to long-term plans. The behavioural economics literature suggests that differences in the institutional environment for saving - particularly with respect to the availability and strength of mechanisms that assist people to commence, and bind themselves to, long term saving plans - may have a bearing on aggregate saving outcomes.
So a lack of policies to assist and encourage saving by New Zealand households seems to have been a key reason why New Zealand's household saving outcomes have been relatively poor.
Conversely, poorly designed savings policies can backfire. Tax based systems can lead to dead weight losses and distortions between different savings options. For example, sequestering retirement savings in a special category may make it difficult for households to take an integrated approach to all of their assets, including housing, education, and perhaps a business.
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.
In addition, systems based on compulsion and paternalism 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).
So we are taking a cautious approach:
·We are ensuring that, as an employer, government is setting a good example in offering a flexible state sector retirement savings plan;
·We will be announcing in the Budget a set of measures aimed at encouraging workplace savings;
·We are regularising the tax treatment of savings; and
·We are considering options for regulation of financial intermediaries to ensure that New Zealanders have a high level of confidence in the professionals who advise them on savings objectives and instruments.
·State Sector Retirement Scheme
In November 2003, the Government confirmed its commitment to promote retirement savings amongst employees by announcing a new retirement savings scheme for the state sector. The Government as a major employer needed to set an example in promoting retirement savings.
Employees joining the scheme can choose their own level of contribution, and the Government will match that up to a maximum of 1.5 per cent of salary in the first year and 3 per cent from the second year. This scheme models the type of arrangements the Government would like other employers to develop.
The State Sector Retirement Savings Scheme has exceeded expectations with 46% of eligible employees signing on since the launch of the scheme in July 2004. There is no room for complacency and several initiatives are currently underway to build awareness amongst eligible employees and get more New Zealanders saving for their retirement to ensure better living standards in the years ahead.
·Budget measures aimed at encouraging workplace savings
Responding to the good work undertaken by the Savings Product Working Group, this year's Budget will include further initiatives to encourage individuals to participate in work based savings schemes. The Government intends to make progress on a workplace savings scheme designed to be a simple, low stress way to assist New Zealanders to begin preparing for their futures. As far as possible it will utilise existing processes and be aimed at minimising compliance costs for both employees and employers.
The package will primarily aim to promote a long-term savings habit with a view to raising the level of awareness and skill with respect to managing wealth.
Such a package is preferred over those that rely too heavily on compulsion or manipulation of the tax system where dead weight losses and distortions are hard to avoid. We want to encourage genuine savings not simply divert what might have been saved anyway down alternative avenues. Designing a package that achieves the aim of increasing private savings whilst remaining equitable is difficult but we believe it is a goal worth striving for.
The Budget may also include further measures to assist home ownership amongst those on lower incomes who currently face obstacles securing financing for a home. We recognise that home ownership is a crucial platform for a household's wellbeing, and we are concerned that rates of home ownership appear to be slipping in some sectors of the community.
·Stobo Report on tax treatment of savings and investment
As most of you will be fully aware, New Zealand's tax treatment of savings and investment has created anything but a level playing field. From superannuation funds, unit trusts, investment companies and property, to custodial or 'wrap' accounts and direct investments, the tax treatment of investment can have an important and uneven effect on the ultimate return. Certainly this can't contribute to generating an efficient market.
Further, it is disheartening to hear how often tax advice is the critical factor directing New Zealand's scarce investment resources.
This system has, for example, meant that equity investments made through collective investment vehicles such as unit trusts and superannuation funds will be taxed more harshly than direct equity investments. The capital gains from direct equity investment are typically not taxable, while even long term savings of individuals in many funds result in taxable capital gains.
The pooling of investment through collective investment vehicles is a critical part of the financial system, and to break that down is to hurt the financial security of New Zealanders and the Nation. Collective investment vehicles are typically used by those who have smaller balances or can't access the financial resources of the very wealthy, many of whom are able to avoid over-taxation at present.
A reform process is in place to remove this and other disparities in the taxation of investment. The Government's response to Craig Stobo's Review of Taxation of Investment Income will be announced in the Budget context. I would like to acknowledge the valuable role of Mr Stobo, and the industry more broadly, in this reform process.
·The Task Force on the Regulation of Financial Intermediaries
The last initiative I want to discuss today is the Task Force on the Regulation of Financial Intermediaries. An essential corollary of encouraging more New Zealanders to save more and to pursue a more integrated plan for growing and managing their wealth is a thriving, consumer-oriented, competitively priced retail savings industry. My view is that, by and large, our market is currently well served. However, there are some practices and concerns that have dented public confidence, and we need to raise the threshold overall in order to give ordinary New Zealanders a high level of assurance about the security and professionalism of financial advisors.
The Task Force has been asked to consider options for reform that will ensure that quality financial information and advice is provided to the public, and will assist New Zealanders to make the most of their savings. The Task Force is addressing concerns such as conflicts of interest through commission-driven agents, transparency around fees, and the roll-up of savings products with insurance products.
The Task Force is due to report back to government by the middle of 2005.
5.WHAT DOES THIS MEAN FOR YOU?
efforts to improve savings are good news for the financial
services industry. If our policies are successful, more
people will be looking for advice and for access to savings
vehicles tailored to their needs.
Improvements to the regulatory environment for financial services should also mean customers becoming more confident in the overall reputation of the industry, and more intelligent consumers of the services that the industry provides.
A recent study of New Zealand's capital markets found that improved capital market regulation and investor protection is likely to assist the development of New Zealand's capital markets. The study was commissioned by the Ministry of Economic Development, the Knowledge Wage Trust and Deloitte Touche Tomatsu and completed by Charles River Associates in 2003.
More broadly, an increase in the rate of domestic savings should, through the phenomenon of 'home-bias', create a boost to the New Zealand capital markets, and to the venture capital end of the market in particular. This in turn will assist the real economy by:
·providing a savings vehicle
for the surplus funds of households and facilitating the
transfer of these funds to their most productive
·facilitating risk diversification by investors and reducing liquidity risk of investments;
·allowing the separation of real and financial decisions within the firm;
·stimulating information production; and
·enhancing corporate governance.
This leads to the creation of a virtuous cycle, as firms provide returns that will attract investors, increasing market participation and liquidity.
As I said at the outset, this is a 'vision' for savings and investment in New Zealand. The vision brings together a number of strong convictions about the future prosperity that is within our grasp.
·First, a conviction that the New Zealand economy is worth investing in; that there are business opportunities involving the considered application of capital that will generate excellent returns;
·Second, that many of the best opportunities are for investors who take a long term position, and make themselves familiar within how our economy works, its drivers and particularly its potential in export markets. Inevitably, that scenario tends to favour domestic investors, rather than global fund managers who tend to be driven by headline indicators;
·And third, that there are considerable benefits from shifting the balance more towards domestic savings, and doing so by encouraging greater savings amongst ordinary New Zealanders as part of promoting a stronger culture of saving and of wealth management across the life cycle of families. In other words, we need a democratisation of savings, and one that is less focussed on the residential property market.
Making this a reality is a task for government, within the limits of its brief, and for the finance industry itself.
I trust that your deliberations during the rest of this conference will shift us some way along that path.