What Business can expect from the Budget
Wednesday 26 May 2004
Hon Dr Michael Cullen Speech to Wellington Chamber of Commerce : What Business can expect from the Budget
Deloitte Lounge, Westpac Trust Stadium
There is a somewhat awkward truth about modern budgets that many New Zealanders find hard to accept. In the last two decades we have subtly turned on its head the very notion of what a budget is. We have created a regime of public financial reporting that is remarkable for its openness and transparency, and consequently for its strong incentives for governments to focus on long-term fiscal goals and present credible short term fiscal objectives that will get us there.
As a result of this, there is no particular reason for governments to save up all of their promising initiatives for budget time and produce them like Santa Claus from a large sack. The business of government goes on every day. And while budget day is the day on which the detail of the government’s three-year rolling expenditure plan is set out, it is in many regards just another day at the office.
So my answer to today’s question – what can business expect from the budget? – is that you should not be looking for some kind of economic circuit breaker. I am not about to unveil any measures that change the underlying structure of the economy or create any brave new world for business.
Despite that, I believe the budget will be good for business and later on I want to go through some of the ways in which that will happen. What I want to stress is that the government is already doing many things that are good for business, and these are happening outside of the budget process and need to be appreciated and followed for their own merits.
There are three in particular I would like to mention.
First, we are reviewing the Resource Management Act. Over the past year-and-a-half we have been talking with business, local government, environmental organisations and the broader community about how the RMA is working. Some key problem areas emerged, and our focus is on finding practical solutions to them.
We are not going to revisit the ideas that underpin the RMA, because they are fundamentally sound and any country that aspires to democratic government would end up with something broadly comparable to what we have.
What we are seeking is greater certainty and efficiency in the way the RMA operates, while not sacrificing public involvement and protection for our environment. The review will focus on some areas where we believe there is room for improvement.
One example is the need to achieve the right balance of national and local interests. This is particularly important for transport and energy infrastructure, which have been weighing on my mind in recent months.
The problem is that local authorities are increasingly being asked to consider projects that raise issues of national significance using an Act that provides little or no guidance on how competing national benefits and local costs should be weighed. There is no need for the Act to be silent on such matters, and I am confident we can find a way of expressing some straightforward principles in this regard.
The review will also look at improving the consent decision making process, to ensure more consistency between councils; reduce delays and costs; provide greater clarity and certainty for applicants; and largely eliminate opportunities for abuse of the process for personal gain, trade competition, or other vexatious reasons.
We will also be considering measures for building capacity and promoting best practice among the 86 councils who decide approximately 50,000 resource consents each year. While local authority practice has steadily improved, the performance of some councils could still be better.
We will be looking to introduce proposed RMA amendments to the House in September 2004 and those amendments should be passed in this term of Parliament.
The second set of initiatives that will not be included in the budget are those relating to oil and gas exploration. It is crucial that we get this right, in light of the approaching depletion of the Maui gasfield and the importance of gas in sustaining our baseload electricity supply.
Oil and gas exploration has its own unique microeconomy involving immense upfront costs, large scale capital investment and uncertain returns. What this means is that it needs essentially purpose-built regulatory and taxation regimes. We need to make sure we are sending the right signals to attract the kind of middle level players who are likely to be best suited to the task of exploring and tapping our resource.
Work is progressing on this front, and announcements will be made later in the year.
The third extra-budget issue I want to mention is the trans-Tasman relationship. As you will recall, the recent Australia New Zealand Leadership Forum brought together business and political leaders from both sides of the Tasman to discuss ways of building on the platform of CER.
There were both positives and negatives at the meeting, as is usually the case. On the negative side, much of the media attention was directed towards two proposals that, in the view of some, would symbolise trans-Tasman unity. I am referring to the notions of a common currency (inevitably the Australian dollar) and a common border.
The problem with both of these is that, when you examine them closely, they turn out to offer quite limited benefits at quite considerable cost. Thinking about the currency question, if we were to accept the line of argument that says that smaller nations are better off adopting the currencies of larger ones, we would have to ask ourselves why we would not go the whole hog and adopt the US dollar, the world’s most liquid currency, rather than the relatively miniscule Australian dollar. We would also need to see benefits to compensate for the loss of control over monetary policy.
As for a common border, again this might symbolise closer economic relations but it would require alternative mechanisms for addressing a raft of bio-security and law and order issues. Any economic benefits may end up buried under additional economic costs.
The strategy my government is taking is to focus on what is doable. I have for the past few years been working with the Australian Treasurer Peter Costello to develop a single economic market by co-ordinating business regulations between Australia and New Zealand. This will provide greater opportunities to sell into the larger Australian market and a freer flow of investment within the trans-Tasman economy as compliance costs and other regulatory barriers are reduced.
We are focusing on a number of key areas:
We are undertaking work on options for mutual recognition and harmonisation in prudential regulation of our banking systems with a view to enhancing the efficiency and soundness of the banking systems in each country.
We have established an Advisory Group on Accounting Standards whose task is to propose a single set of accounting standards to operate across the Tasman to streamline business for companies which are doing business on both sides of the Tasman. The ultimate aim is to permit such companies to keep only one set accounts which serve in both jurisdictions.
We have just released a discussion document on mutual recognition of securities offerings. This proposes a model under which an issuer, having complied with the substantive requirements of one jurisdiction’s fundraising laws, will be able to extend an offer of securities to the other jurisdiction with only minimal further requirements.
We are also working on coordinating trans-Tasman competition policy. Whether or not this leads ultimately to a single trans-Tasman agency, there are some significant gains to be had in a strong alignment between our legislation and practices.
Our goal is to arrive at the point where a properly constituted New Zealand company can function as a company in Australia as of right, and vice versa. It is, if you like, a sort of de facto common citizenship for companies.
These are areas outside the budget process in which we are working to improve the environment for New Zealand business. So what can you expect in tomorrow’s budget?
First, you can expect a positive economic and fiscal outlook.
The New Zealand economy is essentially strong, and is confounding most forecasters by absorbing some pretty negative conditions without slowing down. 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. While some major elements of that growth (specifically the earnings in some important export industries) have stalled in the last year, the domestic impact of that fall off has been delayed by hedging contracts.
Those contracts have started to come to end, and the weak external situation has started to depress incomes in the second half of last year and will continue to do so for several quarters.
Nevertheless the domestic economy continues to show an impressive head of steam, and we are starting to see 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. We are starting to see some strengthening of the US dollar, although it 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, and we are also seeing a strong resurgence in global commodity prices. 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 it is not an easy time to be a forecaster. Most 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. The economy has consistently surprised on the up side for the past year or so, and there is probably good reason to suspect that it will continue to do so.
Meanwhile the budget will also demonstrate a sound fiscal situation. Unfortunately it is not quite as sound as many would wish.
As usual, much of the focus of the media headlines will be on the operating balance. The December Economic and Fiscal Update forecast an operating balance 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. As any company director will know (and as any financial journalist or former Reserve Bank Governor ought to know) 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. 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. Most tax revenue is received within the first three quarters, while government expenditure is more evenly distributed. It will be reversed to a large extent during the fourth quarter.
Suffice it to say that when I unveil the latest set of accounts tomorrow 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.
From the start of my tenure my priority has been to build long-term fiscal strength for the country through prudent management of spending and revenue. 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. And 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.
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.
The budget will include the largest single set of changes to the benefit system and assistance for families since the benefit cuts of 1991. It is a phased package which takes several years to come into full effect; but eventually around 300,000 households will receive direct assistance from it.
It has a mixture of social and economic 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 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.
It is quite likely that one of the effects of the package will be to aid our ongoing shortage of semi-skilled labour. The Department of Labour’s study of job vacancy listings confirms what many employers – and particular manufacturers – are saying: that it is hard to fill positions which require moderate level skills. Some part of the problem appears to be that people with children currently face very marginal gains in income from increasing their labour market participation, say by taking on a part-time job, or increasing their work hours. This family assistance package will go some way towards shifting the balance for those families towards increasing labour market participation.
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 again, 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.
The other major area for new spending is in assistance to business, and in particular assistance for our export industries. Much of the budget package has already been announced.
The new measures 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.
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 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.
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. Gross sovereign-issued debt is forecast to fall to 25 percent of GDP 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 the tune of some $7 billion to finance the Crown’s activities. That is an option I do not intend to take up, as will become apparent tomorrow.
Tomorrow’s budget will prove 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.
We have held the line fiscally, and will continue to do so. But we are also delivering for ordinary New Zealand families and businesses.