I asked him [Keynes] if he would borrow if he were in New Zealand in order to get through the crisis. Keynes replied, ‘Yes, certainly if I were you I would borrow if I could, but if you asked me as a lender I doubt whether I would lend to you.’
(Diary of the Minister of Finance Downie Stewart, 1932)
The history of the New Zealand economy is riddled with borrowing crises in which offshore over-borrowing was followed by the tap being turned off; New Zealand then experiencing cold turkey with its ugly domestic consequences. It is not something which is at the forefront of the public’s thinking, but it is an ongoing concern to Treasury and the Reserve Bank officials. They are regularly reminded of it by the reviews of credit-rating agencies, who are going through the same process publicly as our big lenders do privately.
As a result, there is an ongoing quest for measures that reduce New Zealand’s exposure to foreign debt. For example, in the 1980s it was announced that the government would not (usually) borrow overseas, but only domestically. But private New Zealand was allowed to borrow overseas virtually without restriction.
This strategy was assumed to insulate the government from foreign borrowing. A standard neo-liberal analysis was that private transactions were nothing to do with the government but were the responsibility of the foreign lender and the private New Zealand borrower.
Faced by the Global Financial Crisis, the theory collapsed. The New Zealand government found itself exposed to bailing out the financial sector (which was the main channel of the foreign borrowing) both as finance companies failed and as trading banks faced an international liquidity crisis. Fortunately, measures had been already taken to prepare for the management of such crises, and world liquidity did not really jam up. But this memory has been added to a number of earlier borrowing crises.
The high private international debt that New Zealand carries is why the credit rating agencies are cautious about the level of public debt which, as we shall see, is low by international standards. I understand that when they draw attention to it on a visit, our officials who understand the problem as well as the agencies are always a little uncomfortable.
One measure is to keep the New Zealand government’s debt to a low level (even though it is domestically denominated). The 2017 budget promises to reduce it even further.
Definitions of outstanding public debt are complicated. The OECD provides ‘General Government Gross Financial Liabilities as a Percentage of GDP’. ‘Gross’ may mean there are some offsetting assets such as foreign exchange reserves; ‘general’ includes levels of government below central government. For 2015, the latest year available, the New Zealand ratio is 38.1 percent compared to the OECD average of 111.2 percent. Only Australia and Estonia are lower.
The Budget uses a different definition. It estimates Net Crown Debt (i.e. excluding local authorities and offsetting foreign exchange reserves) as 24.4 percent of GDP for the year ended June 2016, forecasting that it will fall to 19.3 percent in 2021. Moreover, so it could tell the credit rating agencies, the Net Worth attributable to the Crown is 35.3 percent of GDP in 2016 and expected to rise to 40.9 percent five years out so the Crown balance sheet looks healthy. The agencies would respond that in the net worth there are many assets which could not be flogged off in a debt crisis – an extreme example is the treaty document signed on 6 February, 1840, but it is not clear how one might sell off New Zealand’s roads either.
Even so, we might argue that it is unnecessary to lower the debt ratio any further. Suppose we kept to the current ratio. Then each year there would be about $2-3 billion which could be spent on worthy public causes or used to cut taxes. Should we? (Multiply this figure by four to compare with budget expenditure statements which refer to spending over four years.)
The government is reticent about its debt strategy. Usually all it does is post a number in its Fiscal Strategy Report with a platitude such as ‘[o]ur intention is to reduce net debt to around 20 per cent of GDP in 2020 and to between 10 per cent and 15 per cent of GDP by 2025.’ It is perfectly reasonable to ask, why? Is it just a fetish, a chest beating to show how macho we are?
The issue is complicated. For instance, the government has a few assets it could sell if it was pressed (such as its shares in SOEs). On the other hand we probably need to reduce net debt a bit below the financially prudent level because of the risk of earthquakes and other catastrophes. (A complication is that the assets set aside for this purpose need to be held offshore.)
The debt position is fundamentally the sum of the fiscal deficits over the years; a lowering of the debt ratio usually means running a fiscal surplus. Moreover, the private sector is running a savings deficit – borrowing for consumption disguised as a housing boom. Borrowing to speculate on housing does not add to the capacity of the economy to service the debt, while much of the borrowing leaks into the transaction costs associated with the house purchase: realtor, lawyer, surveyor, banker, carrier, advertising fees and spending on builders, new durables and decoration.
Perhaps rather than being obsessed with the public debt track, but without ignoring the need to be fiscally prudent, we need to pay more attention to the private debt track especially that which involves foreign borrowing. This is not to say we should build fewer houses – although medium-sized rather than large ones would be a blessing for those who do not own a home. The aim should be to restrain the speculative boom.
The government, prodded by the Reserve Bank, has made a number of small changes, but it has been reluctant to take serious action because it upsets all those interests listed a couple of paragraphs back. They will beat up public concern about how price stabilisation makes them worse off. (It does? Would the vast majority of homeowners be any worse off if the price of their house fell; they would still live in it with much the same outgoings; if they want to sell their house the one that they would move into would be cheaper too.)
Among the things that might be done are to make the capital gains tax on second homes more comprehensive, eliminate the tax incentive of negative gearing, improve savings opportunities, ease back immigration to areas of severe housing shortages and build more medium-size houses. (This could be financed at the expense of a slightly higher public debt track; explain to the credit rating agencies that they generate revenue for debt servicing and many will be sold off.) Instead the 2017 budget hardly did anything on the housing front; such measures there were applying sticking plaster.
For the government may be taking a stern position on the public debt track but it is shying away from dealing with the private debt track. By doing so, it is once more exposing New Zealand to another foreign debt crisis. Who knows when the next one is due? But it would be better to start dealing with it now rather than sitting on our hands with certainty of it happening later.
Brian Easton is an adjunct Professor of the Auckland University of Technology and is currently writing a history of New Zealand from an economic perspective.