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Cullen NZIM Breakfast Briefing

Michael Cullen Speech to NZ Institute of Management Breakfast Briefing

Wellington Club, 88 The Terrace, Wellington

Yesterday’s budget set out a robust and forward thinking fiscal strategy for New Zealand. The reaction was as expected. Health groups, education groups and those who advocate for the poor and for workers were generally strongly supportive of the budget’s policy thrust.

The financial market commentators accepted that the fiscal stance in the budget would be modestly stimulatory but was consistent with the government’s fiscal objectives and would not put any real pressure on monetary policy.

The business lobby groups, so far at least, have failed to take up the challenge I issued in my budget speech and either identify what payroll, capital gains and other taxes they would be prepared to accept as a trade-off for a lower headline tax rate or start to promote overseas the very real advantages New Zealand’s overall tax structure offers.

The National Party failed to take the opportunity a budget offers the opposition and outline their alternative policy programme. Instead they resorted to their usual dreary divide and rule tactic, grizzling that only some households would benefit from the Working for Families package.

I make no apology for that. The package is designed to deliver to low and middle income families with children. The budget invests substantially in our children, not only through Working for Families but also through the large increase given to Vote: Education. That makes the budget a far-sighted document which invests in the workforce of the future. Given the aging of our population, we need to take this longer term perspective.

To review the economic outlook against which the budget was framed: the economy is forecast to grow by 2.8 percent in the year to March 2005, and 2.5 percent in the year ended March 2006. While this represents a slow down from the 3.5 percent growth we posted for 2003, it remains in OECD terms a very creditable performance. Moreover, as the recent trend has been for the economy to consistently outperform the forecasts, one might expect any risk around these forecasts to be on the up side.

After 2006 growth is forecast to pick up to 3.4 percent in the following year and return to Treasury’s current assumption of medium term growth of 3 percent.

Significantly the next year is expected to bring with it a rebalancing of our economy, tempering some of the key factors that have brought about a two-speed economy. On the external side, strong growth in the United States and China and recovering growth in Japan and Australia should underpin continuing growth in our export volumes. Meanwhile a return of the currency to something near its true value and ongoing strength in commodity prices should lead to an improvement in export earnings.

On the domestic side we are forecasting a slow down as the reduced export incomes of the last year work their way through into reduced consumer demand, and as the construction industry reaches the limits of its capacity.

Meanwhile the government’s fiscal situation remains strong as a result of prudent management. Total core Crown operating expenditure, at $42.2 billion, is around 30 percent of GDP – down from 35.2 percent when we took office in 1999 – and even with the new spending announced in the budget this will increase only to 31.6 percent in 2007/08.

One of our key fiscal objectives has been to keep gross sovereign-issued debt below 30 percent of GDP on average over the economic cycle. Since taking office we have reduced that indicator from 33.7 percent of GDP to 24.7 percent, based on the current June forecast.

This is a measure of our resolve to manage the government’s finances for the benefit of future generations. We have kept a tight lid on spending, and – as one would expect of a Labour-led government – we have left unheeded the calls for tax cuts for the wealthy.

We are convinced that the current generation of New Zealanders can and should pay its own way by banking surpluses for the future, rather than pushing out a bow-wave of fiscal costs and risks for future generations to wear. Getting debt down to more prudent levels is a key part of that goal, so we have amended the debt target to further reduce gross sovereign-issued debt over the longer term, aiming for 20 percent of GDP by 2015.

Alongside reduction of debt, we are continuing to strengthen the long-term fiscal position through making contributions from our operating surplus into the New Zealand Superannuation Fund. Transfers into the Fund will be $2.1 billion in 2004/05, and at June next year the Fund is forecast to total $6.3 billion. Meanwhile the Fund Guardians are moving from a cash portfolio to a fully invested portfolio by the end of this financial year, and, during the first period of investment, have exceeded their target rate of return.

The Fund mitigates the fiscal risk of the demographic shift which will begin to take effect in around 2015 and intensify in the decades that follow. At its peak, the Fund will pay for around a third of the cost of New Zealand Superannuation, enough to make the scheme affordable as a basic universal pension, and enough also to question the credibility of those of my opponents whose intention would be to scrap the Fund and plunder its assets for current consumption. Without the Fund the choices become stark: poverty for a good portion of the elderly or severe tax increases for the working population, or both.

A further, and positive, effect of the Fund is that it will contribute to the reduction of net debt, which including the Fund’s assets is forecast to be down to 8.7 percent of GDP by 30 June this year. What is more by the end of the forecast period this will fall to zero, as financial assets equal gross debt. This will be the first time in decades that the government has been in the black in net terms.

So we have carved out some fiscal headroom while committing significant resources to ongoing infrastructure investment and maintaining expenditure on core public services such as health care and education. That careful stewardship has created room for new operating spending of around $2.4 billion in 2004/05, rising to $3.8 billion in 2007/08.

The new spending includes increases to business assistance and increasing capacity in some core areas of the public service. However, the centrepiece of the new spending is the Working for Families package.

The package involves a set of linked changes to the tax and benefit system aimed at achieving three objectives:

To support people with dependent children to move into work and to remain connected to the labour market;

To make work pay by creating a much more significant wedge over benefit entitlements for people in paid employment; and

To ensure income adequacy for families with dependent children, and address issues of child poverty in particular.

There are several features of the package that I want to stress. First, it is a phased package, costing $221 million in 2004/05 and rising eventually to $1.1 billion in 2007/08 and outyears. Once it is fully implemented over 60 percent of families with dependent children will be financially better off, with an average gain of $66 per week overall, and a gain in the $25,000 to $45,000 a year bracket of around $100 a week.

Second, it is places workforce participation at the heart of a strategy for the long-term well-being of families. Indeed the majority of the expenditure will be on families who are in work. The package is about altering the factors that make it hard for low-income New Zealand families to remain attached to the world of work.

That is why, for example, improved access to good quality childcare is an important part of the package. Childcare Assistance thresholds will be increased by about 50 percent in October this year, immediately making a large additional tranch of families eligible. The Childcare Assistance rates will also increase, by 10 percent this year, and a further 10 percent next year.

In addition an extra $365 million over four years will be spent on early childhood education, including, from July 2007 an entitlement to 20 hours free education per week for all three and four year-olds. This commitment represents an increase of 79 percent over government spending in 1999.

The third aspect of the package I want to stress is that it is likely to have a positive effect on the supply 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 limited gains in income from increasing their labour market participation, say by taking on a part-time job, or increasing their work hours. This Working For Families package will go some way towards shifting the balance for those families towards increasing labour market participation.

It is worth pondering for a moment how the benefits of the package compare to what would be delivered by the kind of tax cuts that those on the right are proposing. A family with four young children and a single income of $55,000 a year will be better off under the Working For Families package by nearly $150 a week once it is fully implemented in 2007. By contrast, that family would gain just $39 a week from a reduction in income tax to a 20 percent flat rate. Moreover the fiscal cost of a flat tax at that rate would be some $5.5 billion.

The simple fact which the advocates of tax cuts fail to acknowledge is that tax cuts are an incredibly blunt instrument when one is trying to assist low to middle income families with children. The costs are tremendously high – because the vast bulk of tax cut is captured by those on high incomes without dependent children – and the gains are meagre, both in terms of increased disposable income for low to middle income families and therefore in terms of increased incentives to be in the labour market. There are much smarter ways of managing the benefit-tax interface, and of improving the rewards that ordinary New Zealanders receive from acquiring and applying their skills.

Alongside spending on New Zealand families, the budget announced $500 million of additional spending over four years for economic development initiatives. 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.

In addition, there is extra money to promote collaboration between industry and research institutions and improve the interface between our scientists and our entrepreneurs.

Research, Science and Technology receives $212 million extra over four years, with $50 million allocated in 2004/05. Of that $50 million, $17.3 million is earmarked for the Research for Industry fund, rising to $19.2 million in each of the following three years. This will take that particular fund to around $205 million per year.

Funding increases are also earmarked for the research consortia programme, the international investment opportunities fund, the new economy research fund and funding for environmental and health research.

What is contained in the budget is of course only a small part of what government is doing to encourage economic growth. The business community should not evaluate the budget merely on the basis of whether it delivers a shot of economic caffeine. What is more important is to see new initiatives in the light of the ongoing programme of government.

Hence, aspects of the Working For Families package sit alongside our ongoing investment in education and industry training and our immigration policies as instruments for building a higher skilled workforce. We are working to make tertiary education more affordable and to encourage better quality and focus in the system to ensure that the qualifications that students gain bear a close relationship to the competencies that employers are looking for.

Similarly our science and technology spending sits alongside a recurring theme of all budgets in the last five years, which is the uptake of new technologies and creating better international linkages through investment and trade.

The additional spending on the operations of the Ministry of Foreign Affairs and Trade - $19 million initially, rising to $28 million in out years – will assist that organisation with the very significant work load they will carry in securing trade access with some of our key trading partners. There is a very full agenda in reducing the remaining barriers to trans-Tasman trade and investment. As most of you will know, 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 considering a proposal for mutual recognition and harmonisation in prudential regulation of our banking systems; 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; and we are also working on coordinating trans-Tasman competition policy.

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. There are significant gains to be made if we can achieve this, and I think you will find that more symbolic gestures such as the notion of a common currency will fall by the wayside.

Beyond the relationship with Australia we have very real prospects of a free trade agreement with China in the medium term. Next month the beginning of negotiations on an FTA will be formalised with the signing of a Trade and Economic Cooperation Framework.

New Zealand’s small size, and the fact that we have relatively few areas where tariffs currently operate, offers China an opportunity to take its first steps on an FTA with an OECD economy that would involve a less complex negotiation than it would face with larger developed economy trading partners. The Chinese also recall that New Zealand was the first developed country to sign off on terms for China’s accession to the WTO.

If the current WTO round fails to deliver, an FTA with China would provide us with some insurance against the possible creation of free trade blocks in the Americas, Europe and Asia. It would mean we are not locked out, if this eventuates.

Alongside CER and China, we are also actively pursuing and FTA with the ASEAN nations after their economic ministers recommended initiating discussions with Australia and New Zealand on free trade. ASEAN is a region of some half a billion people with increasingly sophisticated economies and very fast growing middle classes.

Improving trade access is only part of our work agenda on behalf of New Zealand businesses. We are continuing to work on our infrastructure problems, none of which is amenable to simple solutions. Later this year we will be announcing a package of measures to create an environment that is conducive to oil and gas exploration. This is one element in a raft of issues around securing our energy supply.

We are also reviewing the Resource Management Act, not to revisit the ideas that underpin the RMA, because they are fundamentally sound, but to get greater certainty and efficiency in the way the RMA operates. 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 where 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.

So to sum up, Budget 2004 combines significant milestones in long-term fiscal management with significant new spending that will directly benefit a large number of New Zealand families and support New Zealand businesses. It proves the contention that has always been at the heart of Labour’s politics, 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.

Thank you.

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