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May 20, 2013 | by  | in Features |
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Demystifying the Budget

“Rebalancing the economy”

The economy isn’t a gymnast, so it’s a bit weird that everyone talks about ‘balancing’ it. The idea is that there are some things you only want a bit of in the economy – you need some for people to be happy, but too much is unsustainable.

One of those things is debt. It’s okay for the Government to take on more debt during a recession, because they can pay it off when the economy picks up. During recessions, Governments have unusually high expenses: people are out of work, so they have to pay more unemployment benefits. Further, in a recession people are earning less and spending less, so there’s less tax revenue. Recessions are normally caused by people not spending enough, and reducing Government spending can make that worse. However, you don’t want the Government to be borrowing too much. Debt has to be paid back sooner or later, and the Government’s debt is already costing us $3.6 billion in interest every year.

Debt isn’t just a problem for Government. On an individual level, there’s a feeling that New Zealanders spend too much and save too little. This is, of course, bad for those individuals – nobody wants to live their lives drowning under mortgage payments. It’s also bad for the New Zealand economy as a whole, as it means we have less capital to invest in local businesses. That means less growth for the economy as a whole.

Our saving problems are compounded in the international field. In part, that too is a problem of imbalances: balancing the ‘tradables’ and ‘non-tradables’. The tradable sector is the part of the economy which produces things that can be traded internationally, like condoms and porn. The non-tradable sector is the part which produces services, like prostitution, which can’t be traded internationally. If our tradable sector shrinks, we’ll have to import more and export less.

We’re already spending more than we earn. In order to bridge the gap, we have to borrow the difference from overseas. This is the ‘current-account deficit’. Most Western countries run current-account deficits, but ours is much bigger than average (five per cent, versus an average of one per cent). The current-account deficit is, in many ways, an aggregate of the private and public borrowing problems in the economy. To the extent that New Zealanders’ saving problems aren’t being met by other New Zealanders, we have to go offshore.

When Bill English first became Minister of Finance, he talked a lot about rebalancing the economy. That’s one reason he increased GST to 15 per cent – he wanted to discourage people from spending, so that they would save more. He didn’t have much luck. It’s pretty hard to shift people’s behaviour: saving is fine until the family has to cut its annual trip to Rarotonga. The structure of our economy is a difficult thing to meddle with – new industries don’t pop up as easily as we’d like. A report released earlier this week suggested that, if anything, our economy is becoming less balanced. Despite the rhetoric, our ‘economic imbalances’ are here to stay.

“Housing bubble”

You’d freak out if the floor of your house started bubbling molten-lava-style. Similarly, economists freak out about ‘housing bubbles’. House prices are often the result of speculation – when people think that houses will become more expensive in the future, they buy quickly. This increase in demand makes houses even more expensive, fueling a self-fulfilling cycle. Eventually, like all bubbles, housing bubbles pop. This can devastate the broader economy, as we saw with the ‘sub-prime mortgage crisis’ in the United States, which was one of the main causes of the current recession. In New Zealand, with our cultural craving to ‘get onto the property ladder’, this is worth worrying about.

The risk of a bubble is one of the reasons why all political parties want to lower house prices. There is also a strong cultural push for lower house prices – we want the classic quarter-acre section to be realistic for most families. This Budget has tried to control house prices in two ways. One is by controlling ‘loan-to-value ratios’ – the size of the deposit required before a bank will give you a mortgage. By requiring a larger deposit, you discourage people from buying houses, reducing demand and thus reducing prices. The trade-off is that people who might struggle to raise a deposit will have a harder time getting their first house. The second way the Budget aims to reduce house prices is by giving the Government the ability to override councils’ planning processes. National has tended to blame high house prices on an under-supply of land, caused by city councils forbidding building in certain areas. By allowing more land to be built on, the cost of land will go down, reducing the cost of housing. Again, this comes with a trade-off: more land released means more ‘urban sprawl’ – less-compact cities which are spread over a bigger area.

“BEFU”

The BEFU—pronounced “beef-you”, for those of us geeky enough to use the word in day-to-day conversation—stands for the ‘Budget Economic and Fiscal Update’. It’s a Government report on the economy which is released at the same time as the Budget. The Government has a team of economists at the Treasury who focus on economic forecasts: what will happen to GDP, unemployment and wages over the coming years.

This BEFU contained a lot of good news. The Christchurch rebuild will be sucking up much of the economy’s spare capacity, and the Reserve Bank, which sets monetary policy, is keeping interest rates low to encourage businesses to invest. The means that the real economy should grow by about two per cent over each of the next few years, in turn reducing unemployment to about six per cent. That’s pretty neat.

Unfortunately, it’s not all good news on the horizon. The BEFU outlined last summer’s drought as potentially devastating, and the international dimension is risky. While many of the economies which buy our stuff are growing (which means they’re likely to buy more of our stuff), our high interest rate will reduce the value of those exports. Further, there’s a risk that the Eurozone crisis will blow up, with global ramifications.

“The Government is increasing the health budget by $400 million”

This means that the Government is increasing the health budget by $180 million. Or decreasing it by $150 million. Or, really, all of the above.

Every year, New Zealand dollars are worth less than they were the previous year. Most things get more expensive over time, which is why you can’t buy $1 lolly mixtures anymore. This is inflation, and it’s a bit shit, but it’s not worth worrying about too much. Even though everything becomes more expensive, people’s wages increase at the same time, leaving people no worse off. For the Government, inflation makes everything more expensive (so they have to spend more money) while also increasing their tax revenues (so they have more money to spend). Inflation shouldn’t make a big change either way to the Government’s books.

Not all prices rise in exactly the same way at exactly the same time. For example, peak oil has increased the price of petrol at a rate much higher than most other things. Similarly, healthcare costs tend to increase much more quickly than average inflation. It’s debatable whether governments should increase funding to cover that sort of increase in costs. If something is getting more expensive, it might be less value for money, and so unworthy of further spending. Of course, that argument loses popular appeal when it means less support for cancer victims and heart-disease patients.

Every year, New Zealand’s population grows because of immigration and new babies. All else the same, an increase in population will increase both the Government’s tax revenue and costs. Unfortunately population growth is a bit more complicated, because not all new
population is the same – kids require more education spending but won’t give us new tax revenues for a couple of decades (child labour tends to be frowned upon). Conversely, adult migrants increase tax revenue without increasing the Government’s costs very much. While New Zealand’s overall population grew by 0.7 per cent, the overall aging of our population means that different parts of the Budget need to react in different ways.

When trying to account for both population growth and inflation, the end result is incredibly subjective. The Budget’s dollar increase to the health spend was about $400 million, but controlling for inflation and population growth makes the increase more like $180 million. The accelerating effects of healthcare inflation and the changing population structure mean that the Budget is $150 million less in real terms. The number you use is more a function of your politics than of the evidence.

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