Borrowing to spend makes no economic sense

If 2010 was a year of inert economic activity, with a majority of entrepreneurs and wealth creators remaining shy of investment and reinvestment, the New Year promises to be one of brisk economic and political activity.

The former will be triggered (hopefully) by the Rugby World Cup and the latter by the General Election due to be held before we celebrate another Christmas.

But the seriousness of the economic situation seems to escape most of us. With sovereign debt, perpetrated by incessant Government borrowing (a whopping $350 million a week) reaching 35% of our GDP, there is cause for concern.

Many are beginning to wonder if they were better off paying higher rates of corporate and income tax, rather than worry about repaying the accumulating public debt. Questions are also asked if the tax incentives have had any impact on real income, with the higher rate of GST (15%) triggering price spiral of all consumer goods and services.

We will continue to watch and analyse the emerging economic situation.

But for a start, the fact that 2011 will be a year of challenges for the Government was indicated by Finance Minister Bill English in his Budget Policy Statement issued on December 14, 2010.

Key issues

Despite the bearish outlook, he was hopeful that economic growth will lift during the New Year, reflecting higher labour income growth and terms of trade.

But he warned that households and businesses would remain cautious in their spending and investment decisions as they look to pay off debt and strengthen their financial position.

Someone asked us, “Should such an approach be that of the Crown?”

Mr English said the Government was keen to witness higher rate of economic growth, with such growth sustainable and its gains widely distributed.

“This Government is doing its part in managing the vulnerabilities the economy faces by allowing room for stronger private sector-led growth and by focusing on our plan for growth and jobs,” he said.

Budget 2011 is a few months away but the Finance Minister’s attention is being drawn in six key areas, including the tax system, public sector performance, education and skills, science innovation and trade, the regulatory environment and productive infrastructure.

Saving and investment are also important, he said.

According to Mr English, the first two budgets of the National Government had focused on lifting the economy out of recession, building a solid base for future growth and getting the medium-term fiscal position under control.

“Budget 2011 will be delivered against a backdrop of a New Zealand economy that is well down the path of recovery, having recorded five successive quarters of growth,” he said.

Although his political adversaries would disagree, Mr English maintained that the rate of unemployment is falling, after peaking in 2009. His other observations were that Core inflation and short-term interest rates remain low.

Fiscal surplus

“The Government remains committed to rebuilding our fiscal buffer against future shocks. Our objective is to ensure that net debt remains under 40% of Gross Domestic Product (GDP) and brought back to a level no higher than 20% of GDP by the early 2020s,” he said.

The Government hopes to manage the balance sheet of the Crown with prudence and achieve a surplus by 2016.

“Budget 2011 will support this plan by delivering on our commitment to restrain new discretionary initiatives within an operating allowance of $1.12 billion per annum and a capital allowance of $1.39 billion. To support that restraint and help manage underlying pressures, Budget 2011 will see further reprioritisation of spending towards higher value priorities,” he said.

But a Maxim Institute take on Budget 2011 had a number of warnings. Following is an extract:

A hard truth that New Zealand has to face is that we do not have as flush an economy as we would like. We are continually spending money we do not have.

According to the half-year economic and fiscal update from Treasury, our Budget is looking less than ideal. More money has been spent in 2010 than was planned, and the expected tax revenue from GST and corporate tax did not materialise because all of us are more cautious as the economy recovers.

Some expenses were unavoidable, including earthquake relief for Canterbury.

But other areas of government spending could be trimmed so that we can begin clawing back the hefty red mark across our country’s accounts.

The New Zealand Government will be borrowing $350 million a week into next year. It is true that the government has to spend on projects and programmes, irrespective of the economic situation.

Prudent expenditure

It is necessary to support the short-term unemployed through the worst of the recession, and spending on infrastructure can be productive for the economy.

But there are areas of government spending that are unproductive, and given our financial position, are difficult to justify.

As identified in a Maxim Institute Report (‘Lifting the Bucket’) last year, government operating expenditure was 29% of GDP in 2004. It is now about 34%. There is scope to reduce the size of government spending by reducing unnecessary spending.

Making it more difficult for higher-income earning households to receive Working for Families payments is one example of how spending could be reduced.

The half-year fiscal update should be a wake-up call. As the Government begins to plan for the 2011 Budget, it must tighten its belt.

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