New Zealand is in a dangerous debt spiral
Published in Business Spectator (Melbourne), 10 March 2011
The earthquake that struck Christchurch two weeks ago was not only a national catastrophe for New Zealand. It is also becoming clear how devastating it is to the Kiwi economy. The New Zealand Treasury estimates an impact of 1.5 per cent of GDP, or $NZ15 billion, for this year. Prime Minister John Key went further and warned that the country’s economy could stand still in 2011 instead of growing 2.5 per cent, as initially forecast. The consequences for public finances will be substantial in any case.
Unfortunately, dealing with the tragedy of the earthquake is not New Zealand’s only problem. Natural disaster has hit a country that could ill afford it. Even before the darkest hour in New Zealand’s history, its economy did not look healthy. The similarities between the Kiwis and troubled European countries are too disturbing to overlook.
The financial crisis has made us remember some half-forgotten truths. One of them is that countries with negative net foreign assets and large government liabilities are in danger of being shut out of capital markets.
When markets started to worry about Portugal, Ireland, Spain and Greece, they all had foreign net debt roughly around 100 per cent of GDP. Whether that foreign debt was mainly due to the government as in Greece or the private sector as in Spain did not matter too much. Investors had concluded that in times of crisis and uncertainty both sectors could no longer be neatly separated. That’s why spreads on Spanish government debt rose quickly despite the Spanish government being less indebted than supposedly safer Germany.
Across the industrialised world, there is one country that shows a debt profile similar to the so-called PIGS countries, and that is New Zealand. Over the past decade, New Zealand’s total overseas debt has risen steeply. In December 2000, it stood at 109 per cent of GDP. Ten years later total debt had reached 132 per cent, while NZ net debt stood at 85 per cent of GDP.
The biggest difference between New Zealand and the PIGS is the relatively low extent of government debt. At 25 per cent of GDP, it is way below the debt levels seen in other countries. This does not mean, however, that Kiwis could relax about their financial vulnerability. Far from it.
The problem in New Zealand’s case is not so much the total extent of government debt but its likely increases in the coming years. Before the earthquake, a balanced budget was not expected until 2015, but by then every twelfth tax dollar would have to be spent on interest payments. After Christchurch, even this scenario now looks too optimistic and had to be corrected downwards.
The similarities between Europe’s southern periphery and New Zealand go further than macroeconomic indicators. The underlying problems of the Greek and Portuguese economy were a government sector that had become too large, steadily growing welfare states and poor productivity growth for decades. Admittedly on a different scale, these developments can also be observed in New Zealand.
In New Zealand, government now accounts for about 45 per cent of the economy – a full ten percentage points higher than in Australia and more in line with big European welfare states. It is telling that in the last four years, when the Kiwi economy virtually stood still, there was only one component of GDP that recorded a positive growth, and that was government consumption.
The New Zealand welfare state has dramatically increased. According to the Welfare Working Group, an independent inquiry into the Kiwi welfare state set up by the NZ government, in 1960 only one in fifty people of the working age population was on some kind of benefit. Today, this ratio stands at one in eight. And those New Zealanders, who are still working, work fewer hours than they used to. In the past two decades, the average Kiwi working week was cut by two hours from 36 to 34 hours.
With the growth of government spending, the increase of the welfare state and the end of the economic reform era under former Prime Minister Helen Clark, New Zealand’s poor productivity performance of the last decade was unavoidable. Multi-factor productivity has not improved since the turn of the century.
That the country keeps losing many of its brightest talents to its big Tasman neighbour does not help, either. Over the past three decades, net migration from New Zealand to Australia has varied between 10,000 and 40,000 per year. It has never been positive though, and on current trends the country could suffer a further loss equivalent to the size of its capital Wellington in the coming 15 years.
John Key, whose great personal popularity probably increased further through his handling of the crisis, has announced some economic reforms, partial privatisations and cuts to additional government spending. Whether this will help him win this year’s election remains to be seen. But in any case, given the magnitude of New Zealand’s problems the measures may well be too little too late.
The trajectory of a country that is slowly slipping into the danger zone of high foreign debt combined with a big, indebted government in a sluggish economy is dangerous. As Europe’s PIGS have demonstrated, once markets realise that a country is on an unsustainable path, the loss of confidence can happen almost overnight.
For the PIGS, at least, there was a safety net provided, thanks to European guarantees underwritten mainly by German taxpayers. Should New Zealand’s troubles get worse, who will Kiwis turn to?
Or asked differently: If you were an unemployed plumber or construction worker in Auckland, would you rather help rebuild Christchurch or move straight to Queensland?