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Cullen Speech: to Bell Gully Perspectives Function

Michael Cullen Speech: The Role of Government: Address to Bell Gully Perspectives Function

Level 21, Vero Centre, 48 Shortland St, Auckland

I have been asked to talk to about the changing role of government, and I thought I would start this address by outlining three propositions.

Firstly, the role of government changes at the margin, and by evolution. Dramatic and revolutionary change is very rare, it tends to be associated with crisis, and it is not a feature that has been associated with New Zealand governments for at least a decade.

Second, much of the change in the role of government is driven by external events: governments are in large measure reactive bodies.

Finally, what governments do is shaped by how wealthy their countries are, and not, as the Business Roundtable plaintively tries to argue, the other way around.

Any discussion of the role of government needs to begin with the core functions of government which are timeless. Governments create the nation state and ensure the safety and security of the citizenry. They create internal order, and they create markets through which the citizens can specialise in economic production and exchange the rewards from their labour and the returns to their capital.

I make this rather obvious point because debate on the role of government sometimes sees the state as the enemy of the market. The reality is that the market is a product of the state. Without a government to define property rights, and establish and enforce the terms under which property rights transfer, there is anarchy, not markets. Contrary to what those on the right maintain, less government can mean less effective markets. Adam Smith’s ‘invisible hand’ cannot do its work unless it is connected to the visible arm of the state.

I will come back to this, because the fundamental role of the government in defining property rights is potentially one of the more contentious roles it has to carry out. We see this in the current high public profile arguments about foreign investment, access to land, and the seabed and foreshore issue. Indeed governments are constantly aligning property rights and market rules as different participants feel that existing laws disadvantage them. Competition laws and rules around the issuing of securities, on takeovers and the like all fall into this category.

How governments do these things evolves slowly and continuously. As an example, the notion of the safety and security of the population can be limited to safety of life and limb, or it can extend to cradle-to-grave welfare. History tells us that we move along a continuum over time, rather than redefine the role of the state through episodic but dramatic ideological repositioning.

I will move now from the more general to the specifics of this Labour Progressive Government. When we took office, we set as one of our key goals the restoration of trust and confidence in government. We saw that one of the main threats to a functioning democracy was if the people didn’t believe that political parties would do what they said they would do.

Of course the unexpected happens, and nobody expects governments to follow the letter of their manifestoes regardless of changes – for the better as well as for the worse – in the surrounding global, security, social and economic environment. But it is a different thing altogether if the electorate starts to feel that incoming governments had no intention of doing what they said they would do.

If we do start from the perspective that we will only promise what we expect to be able to deliver, parties that have a reasonable chance of forming a government have to be realistic about both the costs and time frame over which they can implement sustainable policy changes. There is a democratic asymmetry operating here: minor parties who will never form the government do not have to be realistic: they can promise the world in the safe and sure knowledge that they will be able to blame the major partner when the unachievable is not achieved.

As an aside, I recall observing that there was a stage during the last election campaign when the National Party implicitly gave up any pretence that it was likely to form the government. That signal was when its tax and spending promises stopped having any semblance of being capable of reconciliation with fiscal reality.

If I come back to my theme that a restoration of trust and confidence in government requires that realistic election promises be made, we are unlikely to see major swings in the role of government because there is not the political or financial headroom available to accommodate them. Our programme, on both the fiscal and legislative fronts, has revolved around a modest rebalancing of policy back towards what from an international perspective can be seen as the mainstream, especially for small, developed economies.

There are several aspects of this mainstream I want to touch upon. They are, in turn:

A fiscal strategy characterised by transparency and a commitment to long-term stability;

An active role in building and maintaining infrastructure;

A pragmatic role as shareholder in key industries; and

A role in redistributing resources within the community.

Firstly, our programme has not been built around a major increase in tax or spending levels, or on rising public debt. In the 1999 fiscal year spending in the core Crown sector (I am excluding SOEs and the like) was 33.8 per cent of GDP. In the current financial year it is expected to be 31.1 per cent. Gross debt was 36.1 per cent of GDP. This year it is forecast to fall to 25.7 per cent.

Despite what could be seen as a reasonably substantial rebuilding of the social wage: restoring the base rate of New Zealand Superannuation, income related state house rents, the revised student loan repayment regime and so on, the relative size of the state has actually contracted.

This is not a result of an ideological preference for smaller government. It is largely a result of a relatively long and strong economic expansion. The economic base has been growing relative to the government’s spending programme. What the falling ratio does reflect is a change in fiscal management.

We are open about allowing the fiscal stabilisers to work. The 1990s were the roller-coaster years. When surpluses rose on the back of an expanding economy, the government shovelled them out by way of what turned out to be unsustainable, not to mention inequitable, tax cuts. When the economy slowed, spending was cut in a vain attempt to maintain fiscal balance. The cuts, of course, compounded the slow-down.

We have been prepared to let the spending ratio drift down as the economy expanded, just as we will be prepared to let it drift upwards if the economy slows. We are looking to manage the size of the state at somewhere around 35 per cent of GDP, on average, over the business cycle, and taking a longer view. The longer view has to accept the reality that our population structure is ageing. The 35 per cent benchmark is over a roughly forty year time frame, so in these years of relatively kind demographics we put a bit under 2 percent of GDP into a special fund, and later on we can supplement the 35 per cent by drawing some money out of that fund.

I am pleased that our policy of allowing the fiscal stabilisers to work was put to the test on an economic upswing. Cynics would say that all governments want to let the stabilisers work in bad years, but want to spend the surpluses of the good years. By resisting the temptation to spend good year surpluses, we have shown that the discipline is there to manage fiscal settings over the full amplitude of the economic cycle.

I have been a bit vague in specifying our spending target because it is in fact a fuzzy not a point target in our fiscal framework. These days we tend to see spending – and by implication our operating balance – as a means to an end, not the primary aim of fiscal management.

The primary aim of fiscal management under this government is to keep Crown guaranteed debt at prudent levels. This is probably an under-acknowledged shift in the role of government that has emerged during the term of the Labour led government. We can run a surplus or tolerate a deficit for a year or two and nothing much changes. It is when debt gets out of control, and debt servicing costs eat up revenue, that governments get into crisis.

This leads me onto the question of the government’s role in infrastructure. We are now grappling with the consequences of infrastructure neglect in the 1990s. This neglect was brought about, at least in part, because it is relatively easy to balance the books in the short term by slashing capital spending.

If governments are going to create the conditions under which individuals can prosper through market activity, they need to do more than write the rules that govern commercial contracts. They need to create the environment within which market activity can flourish: to create, maintain and upgrade an infrastructure. Infrastructure costs money, and it impacts on the capital rather than the revenue side of the public accounts.

As I said, during the late 1990s the commitment of central government to the nation's infrastructure appeared to flag somewhat. Net purchase of physical assets by government during the period 1994 to 2000 amounted to around $5.8 billion, or an average of around $800 million per annum. That situation has been turned around, and the corresponding figure for 2001 to 2007 (actual and forecast) is a total of $8 billion, or around an average of $1.15 billion per annum.

I should stress that the role of government in infrastructure extends well beyond that of primary funder. This is an area in which there are multiple players, including local government and the private sector – as major users, builders and possibly financers. There are also important social and environmental interests which need to be protected. Hence, government’s role includes regulation and, perhaps most importantly, leadership in getting the various parties working together and avoiding unnecessary bottlenecks.

Our commitment to the long-term improvement of the nation’s infrastructure means that capital budgeting has become a lot more important under this government. We cannot simply turn large infrastructure projects on and off in response to what is happening to the government’s current year operating balance. What we say is that we need a modern infrastructure, but we must build and maintain it alongside prudent debt levels. We have defined prudence as having gross debt under 30 per cent of GDP on average, over the cycle. What that means is that any operating surplus has to be large enough to cover payments into the Superannuation Fund and finance a part of the capital expense so that the remaining borrowing requirement is consistent with staying inside the debt constraint.

I mentioned that debt is forecast to fall below 26 per cent of GDP, and this might indicate that there is some extra investment capacity. We need to be careful about going too hard on this. The debt ratio has fallen partly as a result of the growing economic base, but in a low interest rate environment cash flows have allowed a more rapid debt reduction that we initially anticipated. These factors can turn, especially as some of the planned capital spending comes on stream.

This leads naturally to the role of government as shareholder. The government has moved from a position of preparing state owned enterprises for sale to one of continuing to own. The financial benefits of privatisation were always a myth. The government got cash, but lost access to the dividend stream that flows out of ownership. The case for privatisation only ever rested on the economic benefits.

There is a tension here. Supporters of privatisation argue that it improves efficiency. The trouble is how we define efficiency. Lower costs in the short term can appear to improve efficiency, but the risk of under-investment ultimately comes back to the wider community – the users of services and the taxpayer – if the enterprise is providing an essential service like electricity or an integral service like air transport.

We did not have any ideological preference for state over private property rights, but felt that the remaining SOE portfolio was too central to the overall functioning of a modern and growing economy to risk the effects of downsizing if they were sold. It was after that decision was made that the Air New Zealand and Tranzrail difficulties emerged, but I think they underlined the basic logic of our more cautious approach on the ownership of strategic social and economic assets.

This raises another point that I have made; governments seldom go looking for trouble – trouble comes looking for them. Ministers don’t go into the office on Monday mornings and wonder what they can get up to this week. Inevitably they confront a range of options for dealing with circumstances that have arisen and that require a response, under conditions where it is only the government that has the financial resources, the capacity to take risk, the moral responsibility or the legislative authority to sort it out. I didn’t set out to be the majority owner of an airline: I just ended up as one.

I should perhaps comment on this in regards to the foreshore and seabed issue. A simplistic view of the role of government is that governments should set the rules and get out of the way. I once heard an economist comment that rugby was a game that was ideally suited to the New Zealand psyche. It requires enormously detailed and complex regulation if the game is to be played at all, even to the point now where the referee has to constantly explain the rules to the players while the game is in progress. The coaches and the teams then set about finding ways to get around the regulations. Every couple of years one team cracks the code, so the rules have to change again to keep the game flowing.

We should remember this when we talk about rights and roles. Rights are seldom linear or static. Rights are exercised at different levels. An example would be a right of access to, say, a piece of land versus a right to graze livestock on it. Rights can conflict. One person may claim a right to clean air as some sort of traditional right of citizenship. Another would claim a right to smoke because smoking is legal. Public perceptions of where the balance of rights should lie change over time. The courts can make rulings that change where the balance of rights lies, particularly in relation to common understandings of where the balance lay.

Every time that happens, some groups are advantaged and others are aggrieved. There is no stable state of rights. Managing change in a sensitive but practical way is one of the great challenges of governments, and I suspect that it has become a more important role as we have gone down a road of increased recourse to litigation.

This brings me to my last topic which is the role of government in redistributing resources. I am not just talking about welfare benefits but the whole gamut of financing schools and tertiary education, environmental protection work, providing health services and paying a universal public pension.

I see three big problems as having emerged with managing this role in the modern context. The first is technological change. Technology is exploding the range and cost of things that governments can fund to improve the lot of the citizens. This is stark with health interventions, but it cuts across all areas of public provision. You just have to look at a modern school and compare the facilities with the desk and pen, chalk and blackboard and possibly a gymnasium that completed the full complement needed to deliver the curriculum as recently as my own schooldays.

The second is demographics. When we had a young population, as in the sixties, a lot of the costs of supporting dependency were privatised: parents paid the rent, the clothes, the food and the phone bills. As the demographic structure shifts, more of the costs of supporting those not in the workforce shifts to the public sector. As a rough rule, Treasury estimates that the public cost of supporting a school age child is about a quarter of the pubic cost of supporting a retired New Zealander.

The third factor is exposure. We live in an age of high profile exposure of every conceivable personal support not delivered by the government, live on Holmes in our living rooms: and live on every other competing medium as well. This exposure has driven expectations and fuelled senses of grievance way beyond anything that politicians had to manage in a slower and less graphic communications era. A decade ago, hip or knee replacement surgery was relatively new, and the first recipients were happy to receive the new technology under any circumstances. Now the surgery is commonplace and any failure to provide it in a timely fashion is regarded in some quarters as an abrogation of human rights.

This means that there is a much sharper focus on what the citizens can reasonably expect from democratically elected governments in a developed capitalist economy. We should never apologise for having an active role for government in providing personal supports that it can afford. That is indeed a right – if I can use that word again – of progress. We do, though, have to try and create a consensus around what is affordable, and what the priorities for change are.

Right now, that pressure is acute in the health area. Year after year, for about a decade, governments of different hue and composition have increased the allocations to health well in excess of the rate of growth of government spending as a whole. The result is that health’s share of the public dollar has grown relentlessly and, might I say, spectacularly. And yet we still have pressures for more.

If we look at international experience, there is a very close correlation between the amount spent per head on health services and per capita GDP. The implication is that the main way to get more money into health is to take it from a growing economy, not to try and lift health spending above what is sustainable from the existing economic base. Getting that message across, maintaining the patience and keeping the discipline is, though, the number one challenge for political and fiscal management in every developed country in the world.

After health, the next most important redistributive role of government relates to the provision of income support to lower income families. That is one area that we have not really tackled during this term of office. We have done it through specific programmes like the rents, university fees and student loan initiatives. We have also tackled it indirectly as a result of falling unemployment and rising real family earnings. We must now look at the money side of the equation. It is complex, it is expensive, and it cannot be treated as a hermetically sealed set of issues.

There is a fundamental challenge in how governments manage their redistributive role. On the one hand, programmes such as health and welfare, and the less obvious examples such as conservation and education, all benefit from a high degree of certainty around future funding. On the other hand, they are invariably influenced by changes in the structure of the labour market or in patterns of family formation, to name just two influences; which would suggest that they need to be kept under review so as to ensure that they do not become wasteful or counterproductive.

For those on the right of the political spectrum, this ongoing tension is enough in itself to cast doubt on the whole redistributive enterprise. Government should step back and leave it to the market to run health or welfare or conservation, the argument runs. I believe this attitude merely sidesteps the real issue. As I said at the start, conferral of property rights which enables markets to function is as much a creation of government as is the redistribution of resources around the community. There are difficult choices to be made in how these systems interact.

However, one choice that governments cannot or at least should not make is the choice to walk away from the issues. Governments, unlike opposition parties, do not have this luxury.

Thank you.

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