Report Pages 13-15

Section 2 - The economy matters; productivity matters[1]

The issues are familiar; so familiar that they scarcely need repeating. New Zealand’s population is ageing. This is not a bad or a good thing – it is something that will influence the way the economy develops. Those above the state pension age will about double in number, as will the annual cost of the pensions they expect to receive, if current settings persist. Those under the state pension age may also increase in number but will reduce as a proportion of the population. That demographic shift might see relative falls in real economic output, tax collections and growth prospects, all else being equal. Of course, all else will not be equal as that is not how we expect the economy to develop.

Healthcare costs are expected to follow a similar trajectory to pension costs and historically have been greater than pension costs.

It seems that a perfect financial and fiscal storm might unfold over the next two to three decades.

All this has encouraged what might be called ‘age catastrophism’. Now that the baby boomers are retiring, it seems like a downhill slide to national penury.

As baby boomers leave the workforce, some suggest that the economy could become caught between rising welfare and health costs with a flat or even a declining workforce and a flat or declining tax take on unchanged policy settings. Something will need to give.

Faced with ageing populations, policy settings that encourage growth are more constructive than settings that encourage or even require particular forms of economic behaviour. Underpinning calls for compulsory private provision (‘save-as-you-go’ or SAYG) is the feeling that with greater levels of private provision (‘savings’), there would be more investment and greater growth[2].

In fact, each of the links between savings, investment and growth is, at best, equivocal. More savings may (but may not) lead to greater investment while greater levels of investment may (but may not) lead to growth.

The direct link then between savings and growth is even more tenuous. The evidence from empirical studies is mixed at best and even the direction of causality is unclear; it may be that higher growth leads to more savings as incomes rise[3].

On the other hand, excess savings (low consumption) have even been known to lead to economic recession[4].

Growth is central to a country’s capacity to cope with growing numbers of pensioners. Whenever there are discussions about retirement income policies, at the bottom of every page that suggests a policy change should be the question: ‘How will this policy help the country grow more than alternative strategies?’

However, the ‘top-line’ growth statistics are only part of the story. There will be, proportionately, fewer people producing things relative to the total population while the total number of consumers (including the retired) will continue to rise. That places improving productivity as a ‘front and centre’ issue in the debate about the costs associated with an ageing population. Traditional measures of productivity growth have tended to show New Zealand in a poor light and our Productivity Commission has looked at aspects of our labour productivity:

“Productivity growth is about creating more value by making better use of a country’s resources. It is the most important source of income growth and has an important bearing on people’s wellbeing.”[5]

Economists have worried about New Zealand’s relatively poor productivity performance by comparison with our peers. The Productivity Commission acknowledges that more work is needed to understand what needs to be done. The Commission itself describes some of its work as “incomplete and speculative in some areas”. We need to fill those information gaps to the extent that is possible and to have a full national debate on the implications of improving productivity in the face of an ageing population.

Put simply, a stronger, more productive economy has a greater capacity to deal with all challenges, including more pensioners and higher health costs.

This is no better illustrated than from New Zealand’s fiscal experience of just the five years to 2015. As of 2010, the government’s ‘primary core Crown operating spending’, the starting point for the Treasury’s Long-term Fiscal Model (see section 5 below for more on this), was 32.2% of GDP[6]. In the space of just five years (2010 to 2015), that starting figure fell by 3.8 percentage points to 28.4%, or by about one-ninth[7]. That puts into context the expected 2.55 percentage point rise in the net cost of New Zealand Superannuation from 4.2% to 6.75% over the next 40+ years.

We understand the imperfections of GDP as a measure: that it includes/excludes things that should be excluded/included; that restoring earthquake damage, for example, is counted even if the community’s infrastructure is just put back to where it was, and so on. There seems, however, to be an unmissable connection across countries between GDP per capita and ‘social wellbeing’’ measures so that improving New Zealand’s resilience to coming age-related cost pressures can be measured by real GDP growth; until someone comes up with a better way of doing things[8].

Questions New Zealand needs to discuss about the economy:

  1. How robust are current projections of New Zealand’s economic future?

  2. What are New Zealand’s economic strengths and how might we develop those by reducing barriers and thereby encourage them to emerge?

  3. How can we better understand New Zealand’s limits to growth, including, specifically, the productivity conundrum?

  4. What are the key risks to New Zealand’s economic future and how might we mitigate those?

  5. What specifically is the government’s capacity to influence these issues positively and what do the answers to that mean for New Zealand’s regulatory environment?

  6. How can we make investments that lead to greater economic growth or reduced risk or lower growth?

There was no mention in the Terms of Reference for the Retirement Commissioner’s 2019 Review of the big-picture issues associated with New Zealand’s economic future. As we have said, growing the economy is the first priority in preparing for an ageing population. A bigger pie means there is more to share amongst everyone, including the old. Improving productivity is also important as the proportion of ‘workers’ shrinks.

[1]This section is based on a submission by Michael Littlewood for the Retirement Commissioner’s 2016 Review: Ageing populations, retirement incomes and public policy: the four ‘first principles’ of policy-making - A submission to the Commission for Financial Capability(accessible here).

[2]Does New Zealand have a household saving crisis?(2007) by Trinh Le (New Zealand Institute of Economic Research, accessible here) suggests that both the New Zealand Superannuation Fund (see section 6 below) and KiwiSaver (section 13 below) were unnecessary public policy interventions to, as claimed at the time, help fix an apparent savings ‘problem’. “Overall, the reasons that have been used to justify pro-saving policies lack economic underpinnings. If there is a policy that New Zealand needs, it must be one that promotes growth. Pro-saving policies are more likely to be regrettable than not” (page 16). The “regrettable” reference related to the Treasury’s ex postjustification of the large tax breaks delivered to KiwiSaver in the 2007 Budget in A Synopsis of Theory, Evidence and Recent Treasury Analysis on Saving (2007 – accessible here). The specific reference is that report’s conclusion: “However, in the light of the recent data, evidence and analysis mentioned above, on balance we think that further or stronger pro-saving action is now justified…..This judgement for further or stronger action rests on a least-regrets approach in the light of data uncertainties, persistent macroeconomic imbalances and the possibility that individuals are basing saving decisions on long-run expectations that could turn out to be mistaken” (from page 4 - our emphasis).

[3]For example, an analysis of US data from the U.S. Bureau of Economic Analysis between 1948 and 2015 used by Steve Roth here concludes, among other things, that personal saving and private investment are “very weakly correlated and what correlation there is is mostly negative.” Also “Personal saving has a significant and quite consistently negative correlation with business investment. Again: more saving, less investment.” These are actual data observed, not forward-looking models of what ‘should’ happen.

[4]Increasing the size of private claims on the economy, in the absence of growth, may actually worsen affordability issues associated with ageing populations.

[5]Achieving New Zealand’s Productivity Potential, The New Zealand Productivity Commission, November 2016 – accessible here

[6]Affording Our Future – Statement on New Zealand’s Long-term Fiscal Position, The Treasury, Wellington (available here)

[7]The Treasury’s 2016 Statement on the Long-term Fiscal Position (available here). This is the most recent version of the Model.

[8]In ‘Wellbeing’ Budget might need more, not less focus on GDP, Justin Stevenson (in Stuff, 1 May 2019 – accessible here) suggests that measuring GDP per capita changes against the international ‘Social Policy Index’ [see here for more] shows a “clear positive relationship between SPI and GDP, particularly when compared on a logarithmic scale. “Overall, New Zealand is ranked 10thon the SPI index, behind the usual Scandinavian suspects. However, in terms of bang per buck (SPI per logarithmic scale…) New Zealand is first. What New Zealand seems to need is more bucks.”