CTU Economic Bulletin No. 119 - Government Spending, Ideological Lemmings and the Cost of Living

November 2010

This is the last Economic Bulletin for the year. The next Bulletin will be at the end of January. We hope to have that in a new format. Thanks to those who have commented on and contributed to the Bulletin during the year, and best wishes to all for the new year.

Government spending, lemmings and ideology

The Treasury, Reserve Bank, ACT and two of the government's taskforces are all calling for reductions in government spending. The government has even considered the idea of a cap on government spending, but instead put a cap of $1.1 billion on "new" spending - its "operating allowance". A spending cap has all the attraction of an organised rush of lemmings over a cliff, and the government has already broken its operating allowance limit for 2010/11. Obviously we do want efficient and effective government services. But the evidence that smaller government as such is better for growth or innovation or quality of life is simply not there. There are plenty of examples of successful countries with much larger government expenditure in proportion to the size of their economies. It is not only total expenditure we should be looking at in any case. Around half of government expenditure is "transfer payments" - such as New Zealand Superannuation, unemployment and other benefits - which help to make society fairer but are largely money-in, money-out, reducing the size of the private sector economy very little. In the end it is quality of spending that matters.

A Treasury paper released just last week revealed that Treasury has explored a spending cap but the government rejected it largely because it was too complex. You can see why when you look at proposals from the 2025 Taskforce and ACT for a hard spending cap linked to percentage of GDP. Such a spending cap ignores the lessons of the current global crisis. The world is in the midst of the deepest financial crisis since the catastrophic depression of the 1930s. It has so far escaped the depth of that depression because governments heeded its lessons. They increased government spending to maintain activity in the economy. We are now seeing governments in Europe making draconian spending cuts. There is a high risk that will lead to a return to recession or worse.

Treasury acknowledged that a cap needed to cope with such crises. Some spending - such as unemployment benefits - would be left out of it. It would be hard to explain and administer. The government has limited its "operating allowance" - but is exceeding its own $1.1 billion target, budgeting for $1.21 billion in 2010/11. And about $4.6 billion of additional spending (such as for automatic adjustments to New Zealand Superannuation) are outside that allowance.

Notice that the proposals are all about expenditure caps. This betrays an ideological bias. The government's finances can be balanced either by reducing expenditure or increasing revenue. The proposals all assume less government is better government. Is that true?

What if we find that there are services more efficiently provided by government, or the private sector fails to provide for people's needs? An arbitrary cap would have stopped the previous government ensuring we had a functioning railway system, or the current government from acting quickly to create high speed internet infrastructure. The private sector has failed to provide these, putting other parts of the economy at risk.

A cap would also restrict a government from increasing spending on services like education and health. The level of funding is the stuff of democracy - not arbitrary technocratic limits. A cap would be a windfall for private health and education providers by forcing citizens to pay for services the state is no longer funded to provide.

That brings us to quality. There are many similar sized nations which spend a higher proportion of their national output in government services, and have considerably higher standards of living. It is quality of government spending, not quantity, that counts.

The chart shows government spending in 2007 (before the financial crisis pushed it up) as a proportion of GDP in "small" countries with GDP ranging from a third to three times our size. It is ordered from left to right by increasing income (GDP per person). It shows both total expenditure with transfer payments, and without them - "final consumption", which covers net spending on services such as health and education. New Zealand government spending rates are below the small country average, and below higher income countries such as Finland, Denmark, Sweden, Austria, and Norway. On the other hand, Ireland with lower levels of government spending is now suffering economic calamity. Average spending in these smaller countries is higher than the OECD average as a whole. Even so, New Zealand's expenditure has been below the OECD average for most of the decade (until about 2006).

One example of how quality counts: health. According to the OECD, the US with a largely private health system spent 16 percent of its GDP on health in 2007. New Zealand, spent just 9.2 percent, overwhelmingly through government funding. Yet the US has inferior health outcomes in many respects to New Zealand. It has lower life expectancy for example, and (in 2007) large parts of the population were without insurance coverage.

So comparing government spending in the US and New Zealand not only ignores the fact that the government in the US doesn't provide nearly as much health care as New Zealand. The economy and population get vastly inferior results from it. We are demonstrably better off with that higher government spending.

We do need to ensure debt levels do not become unsustainable. Debt is ok in the short run (such as during a crisis) but must be repaid. Revenue increases can address that as well as expenditure cuts.  Some say that increased government spending crowds out private sector investment. After years of saying "leave it to the market", Treasury is now rightly concerned that our tradables sector (production that competes with imports or is exported) is suffering due to low productivity and higher inflation in the non-tradables sector, some of which is government. But not all state activities are non-tradable (think of education, weather reports, coal) and the transfer payments don't count. Final consumption of government is only about 20 percent of GDP, not high by OECD standards. The latest analysis from Statistics New Zealand and Treasury suggests that the one of the biggest reasons for the slower growth in productivity in New Zealand compared to Australia may be Property and Business Services - largely private sector.

We should be concerned about build up of government debt and waste, but there is little evidence that this is a big problem for New Zealand compared to other countries. Beware of ideology dressed up as simple solutions.

Government policies and cost of living

I have been asked whether it is possible to compare increased costs due to government policies (such as increased GST, ACC levies, tobacco tax, and emissions trading) with the October tax changes. There haven't been reliable estimates of the effect of emissions trading on prices such as energy costs. However one indication is that the Reserve Bank estimates that in the year to March 2011, inflation would be 2.8 percentage points lower without the changes to GST, the tobacco tax and emissions trading. About 2.0 percent of that is due to GST, so another 0.8 percent is for those other charges. In addition there is the increase in ACC levies - I'd estimate another 0.4 percent, totalling 1.2 percent.

Treasury estimated that the bottom third of households, with income less than $40,000 per year, would have 0.7 percent more in the hand because of the October tax changes (including GST but not those other charges), the next third (up to $85,0000 household income) would have 0.4 percent more, and the top third 0.7 percent more. We are sceptical of those estimates (some low income people will in fact be worse off, and not all high income people will be affected by the changes to property taxation for example), and in the long run, high income people will get much greater benefits. But even on Treasury's figures, everyone will have less in the hand after the other costs are taken into account. Middle incomes feel it most with 0.8 percent less in their pockets (about $425 per year on the average wage), and the others will have 0.5 percent less. Of course some of those changes pay for services we want, or may have beneficial effects, but the costs do come out of our pockets.

Bill Rosenberg

NZIER Consensus Forecasts¹

These consensus forecasts were published on the 21 September 2010.

Economic Snapshot

• Gross Domestic Product (GDP) increased by 0.2 percent for the June 2010 quarter. In annual terms, this translates into 0.7 percent since June 2009.
• The Consumer Price Index (CPI) rose by 1.5 percent for the year to September 2010 and by 1.1 percent for the September quarter.
• Unemployment was at 6.4 percent in September 2010. M?ori unemployment was 16.2 percent, Pacific unemployment was 13.5 percent, Asian unemployment was 8.0 percent and European/Pakeha unemployment was 4.3 percent. Youth unemployment (15-19 year olds) was 23.3 percent. In October 2010, 64,798 people were on an unemployment benefit, a fall of 483 people or 0.7 percent on August.
• The total number of people in employment increased in the year to September 2010 by 1.8 percent to a total of 2,193,000.
• The minimum wage is $12.75 an hour and $10.20 an hour for new entrants aged 16 or 17 in their first 3 months or 200 hours, whichever ends first. The results of the annual review are expected shortly.
• Average ordinary time hourly wages, as measured by the Quarterly Employment Survey (QES) for the year to September 2010, were up 1.1 percent (0.7 percent in the private sector and 1.7 percent in the public sector). The average ordinary time hourly wage is now $25.71 ($23.72 in the private sector and $32.61 in the public sector). The average female wage is $23.93, which is 87.8 percent of the male wage of $27.26. The Labour Cost Index (LCI) shows that salary and ordinary time wage rates went up by 1.6 percent in the September 2010 year (1.3 percent in the private sector and 1.6 percent in the public sector). For those workers who received a pay rise in that year, the median increase was 2.9 percent and the average increase was 3.6 percent.
• On 28 October the Reserve Bank left the official cash rate unchanged at 3.00 percent. The next review will be on 9 December 2010.

Wages

According to the Quarterly Employment Survey average ordinary time hourly earnings were up 1.0 percent in the September quarter, but up 1.1 percent on September 2009. At the same time average overtime hourly earnings were up 2.6 and 5.5 percent on the last quarter and September 2009 respectively.

In the public sector, average ordinary time hourly earnings were only up 0.2 percent on the June quarter, but up 1.7 percent on September last year. In the private sector average ordinary time hourly earnings were up 1.0 percent in the September quarter and 0.7 percent on the year to September.

For female workers, ordinary time hours were down 0.2 percent for the quarter, but up 1.2 per cent for the year. Ordinary time average earnings were up 1.3 percent for the quarter and 1.4 percent for the year. In contrast their overtime hours were down an average of 4.8 percent for the quarter and 7.0 percent for the year, but their average earnings for those overtime hours were up 2.5 percent for the quarter and 4.1 percent for the year.

According to the Labour Cost Index, wages grew by 1.6 percent in the year to September 2010 (up on the 1.5 percent in the year to June). For the September quarter itself, ordinary time wages and salaries were up 0.5 percent (up from 0.4 percent in the June quarter). The median increase for wages that rose in the year to September was 2.9 percent and the mean increase was 3.6, both the lowest recorded rises since March 2001.

Household Income   

Average annual household income from all regular sources fell marginally between 2008/09 and 2009/10, from $78,019 in to $76,584, according to the Household Economic Survey. The Survey also collects information on average weekly household expenditure, but on a three-yearly basis. Between 2006/7 and 2009/10 household expenditure increased by 6.1 percent, from $952 to $1,010. The biggest drivers of that increase were average housing and household utilities expenditure, up $40 (18.8 percent) to $253, food, up $15 (9.1 percent) to $178 and communication, up $5 (16.3 percent) to $36.

Employment

Unemployment fell to 6.4 percent in September according to the Household Labour Force Survey. However this fall masked a significant divergence between men and women - female unemployment increased from 6.8 to 7.2 percent during the quarter, while male unemployment fell from 6.9 to 5.7 percent. The level of female unemployment is now the highest it has been during this recession.

The labour force participation rate rose 0.2 percent to 68.3 percent. The number of people employed was up 23,000 (1.0 percent) and the number of people unemployed was down 10,000 (6.1 percent). For the year to September the total number of actual hours worked per week rose 3.0 percent but this was more through overtime as the usual hours worked only rose by 1.0 percent.

According to the Statistics New Zealand Linked Employee Employer Dataset, the worker turnover rate declined in the September 2009 quarter. The turnover rate fell 0.6 percentage points to 14.9 percent. At the same time in 2008 the turnover rate was 16.8 per cent. In the year to September 2009 filled jobs fell significantly in a number of sectors including manufacturing (down 18,948 jobs, 8.5 percent), administrative and support services (down 11,794 jobs, 13.0 percent), construction (down 11,634 jobs, 9.6 percent)  and professional, scientific, and technical services (down 6,005 jobs, 4.1 percent). The only areas of growth in filled jobs were public administration and safety (up 4,548 jobs, 4.8 percent), education and training (up 2,898 jobs, 1.8 percent) and health care and social assistance (up 10,800 jobs, 5.8 percent).

Online Job Vacancies

According to the Department of Labour job vacancies advertised online increased 3.2 percent in the three months to October 2010, compared with an increase of only 3.0 percent in skilled vacancies. Regionally, skilled vacancies grew fastest in Christchurch (6.1 percent) and Auckland (4.0 percent), but fell 5.6 percent in the rest of the South Island. On an industry basis, skilled vacancies were up 8.8 percent in IT, but down 3.9 percent across the sales, retail, marketing and advertising sectors.

Migration

Permanent and long term (PLT) departures to Australia were on the rise again in October, contributing to a fall in net PLT migration to New Zealand. For the month of October 2010, PLT arrivals were down 332 to 7,116. For the year to October 2010 PLT arrivals were down 3,993 to 82,708. Departures for October were up 482 to 5,416 - including 234 more people than last month leaving for Australia. For the year to October PLT departures were 70,097, leaving net migration to New Zealand at 12,610, down 5,950 on the year to October 2009.

Food Prices

Food prices in October were up 2.2 percent on the month of September and 5.1 percent on October 2009. A primary factor in the jump was the rise in GST from 1 October. For the month the biggest increases were in fruit and vegetable prices (up 4.0 percent) and meat, poultry, and fish prices (up 2.9 percent), but all five subgroups were up.

Producer Prices

The Producer Price Index rose 1.2 percent for the September quarter and 4.0 percent for the year to September. The biggest contributors to the quarterly increase were livestock and cropping farming (up 6.0 percent) and dairy product manufacturing (up 3.9 percent). Forestry and logging prices were the biggest countering influence, down 5.7 percent for the quarter.

Public Sector Headcount

According to the State Services Commission 2010 Human Resource Capability Survey, the number of full time equivalent employees in the Public Service declined by 0.3 percent in the year to July 2010. FTEs fell by 118 to 44,554, the first yearly decrease since 1999.

DHB finances

DHB financial results for four months to 31 October 2010 show their deficits are $10.7 million less than planned at that date. Deficits totalled $19.3 million, but $30.0 million had been expected. However Waikato and Canterbury DHBs had $4.3 million and $3.9 million greater deficits than expected, respectively. Strongest financial results were from Auckland (with a $27,000 surplus in place of its planned $1.9 million deficit), Hawke's Bay (surplus $3.4 million compared to $1.9 million surplus planned), MidCentral (surplus $1.5 million compared to a $1.4 million planned deficit), Nelson Marlborough ($0.6 million surplus rather than $2.5 million planned deficit) and Southern ($0.9 million deficit instead of the planned $3.3 million).

Retail Trade

Total retail sales were up 0.8 percent ($133 million) in value in the September quarter, on the back of an 0.7 percent increase in volumes. A key factor may have been consumers seeking to beat the rise in GST with sales in September itself up 1.6 percent. Fifteen of the 24 retail sectors grew, led by supermarket and grocery retail stores (up 1.5 percent, $57 million). The biggest fall was in automotive fuel retailing (down 2.8 percent, $47 million).

Manufacturing Sector

For October 2010 the Performance of Manufacturing Index (PMI) recorded marginal contraction with an index value of 49.7³. While three of the five sub-indices were positive, including employment (51.5), production fell back 2 points to 46.0. Canterbury-Westland was the only region to record contraction (49.5). At the industry sub-group level there was a broad range of results from strong expansion in food, beverage and tobacco (64.2) to significant contraction in wood and paper manufacturing (40.6).

Service Sector

The Performance of Services Index (PSI) remained expansionary for October 2010 at 52.0³, but was down 2.9 points from September. Employment was the only sub index to record contraction (49.8). Regionally Canterbury/Westland (45.0) and Otago/Southland (45.5) continued to record decline, while wholesale trade (48.0) and retail trade (49.2) were the only subsectors to record contraction, after healthy expansion in September.

Property Values

Average property prices were up 1.1 percent in the year to October 2010, according to Quotable Value, but there have been falling prices since March 2010, with an average sale price of $399,055, down from $491,968 in September. Regionally the biggest increases have been in Queenstown (5.6 percent) and Auckland (3.0 percent), with the largest falls for the year in Whangarei (-4.0 percent) and Tauranga (-2.5 percent). Sales are still very low in Canterbury following the earthquake.

Building consents

In October, the number of new dwelling units, excluding apartments, fell 1.1 percent in seasonally adjusted terms. This continues a falling trend, being the fourth consecutive monthly decrease and a 20 percent fall on a trend basis since March. The number of new dwellings authorised was 1,099, and in addition 24 new apartment units were authorised. The value of residential building consents has fallen $65 million or 14 percent since October 2009 and non-residential building consents have fallen $57 million or 17 percent. Though earthquake-related building of new houses had not started in Canterbury, the number and value authorised in Canterbury was keeping up with previous levels.

Overseas Trade

Exports in October remained high due largely to continuing strong prices for dairy and forestry products - up $418 million or 62 percent over October 2009. Meat recorded the largest decrease, down $17 million (6.6 percent). Total exports were up $723 million (24 percent) over the year. Exports continue to be led by China which imported $208 million (79 percent) more than October 2009, with the rise mainly in unsweetened whole milk powder, and pinus radiata logs. Imports also rose steeply (16 percent or $541 million) although the trend is flat and below the September 2008 peak. They were led by intermediate goods, including crude oil, machinery, plant and industrial transport equipment, a healthy sign of investment in the economy. As with exports, China showed the largest increase in imports - up 20 percent or $115 million. As a result, there was a strong goods trade surplus for the year to October ($1.2 billion - 2.8 percent of exports). On average goods trade had been in deficit by 14 percent of exports for the five October years to 2009.

For further information contact Bill Rosenberg  or Andrew Chick

Notes

1 The consensus is made up of the average of forecasts from NZIER, Berl, ANZ-National Bank, ASB Bank, BNZ Bank, First New Zealand Capital, Deutsche Bank, UBS, Westpac, Reserve Bank of New Zealand and Treasury. Because the consensus forecasts are only done every 3 months, some of the more recent forecasts will be more accurate.
2 As measured by Statistics New Zealand's Quarterly Employment Survey.
3 A figure under 50 shows the sector is contracting; above 50 shows that it is growing. The index is an early indicator of business activity.