BNZ Weekly Overview: Budget Edition

2007 Budget released

This afternoon the finance minister Dr Cullen released his eighth budget. You can read details in all the media and there seems little point in repeating everything here especially as my whole afternoon was taken up sitting in a TV studio for three hours commenting on various aspects of the afternoon’s events.

So here are a few of the our conclusions regarding the budget.

First, it is stimulatory. Treasury calculate that the fiscal impulse being applied to the economy will amount to approximately 1.9% in the year to June 2008. This is up from their previous estimate of a 1% stimulus.

This will be of some concern to the Reserve Bank. In addition we feel that Treasury are still making heroic assumptions about the rate of productivity growth in the New Zealand economy going forward. Over the past three years labour productivity growth in New Zealand has averaged 0.4% per annum and over the past 10 years has averaged 1.2% per annum. Treasury assume growth going forward will average 1.7% per annum. We think this is very unlikely even though business investment activity is quite strong.

In addition we think the labour market will prove stronger than they assume with ourselves expecting the unemployment rate to remain below 4% over the next two to three years while they see a rise back over 4%. This implies greater wages growth than they are assuming.

We can discuss some other factors here but what it adds up to is a continuing high chance that the Reserve Bank may need to raise interest rates again this cycle and that scope for any easing in interest rates still remains an extremely long way off.

With regard to some of the specific things in the budget there is a business tax package involving a cut in the company tax rate from 33% to 30%, tax credits for research and development, some market development assistance money and funding for extra industry training, and a tax exemption for active income earned by New Zealand-based companies with overseas operations. This is aimed at discouraging New Zealand companies from shifting their entire operations offshore.

BNZ WEEKLY OVERVIEW

The business tax package is a welcome development but one has to ask why it did not happen many years earlier. One can't help thinking that the Finance Minister has only begrudgingly delivered things which have been sought for a long time. At the margin the measures will take some pressure off companies to raise their prices and increase capital expenditure. But the package is not earth shattering and certainly does not signal to the rest of the world that the government is business-friendly as such and they should consider moving to New Zealand.

The second big part of today's budget was an enhancement to the Kiwisaver scheme. The government will match employee contributions into their accounts up to a maximum of $20 a week. The government will also give employees the ability to force their employers to contribute up to 4% of their income. In other words part of the Kiwisaver scheme has become compulsory but not for employees only for employers. The employer contributions will be tax deductible The government will compensate employers for these increased contributions but only up to a maximum of $20 a week and they estimate after two years the compulsory part will start costing businesses cash flow. This looks very much like a payroll tax and just as the Kiwisaver scheme has always been a skeleton upon which flesh will be placed in future years one suspects that under a future Labour government we could see extra employer compulsion introduced.

The Finance Minister has taken the bold step of suggesting that the compulsory employer contributions will encourage employees to exercise restraint in their wage negotiations. But it is very unlikely to happen because it is entirely at the employee discretion whether they force their employer to put the money in or not and if they say it should be done then employers have no choice but to do it.

The other big part of the budget was government funding of over $0.5b for electrification of the railway network in Auckland and extra work on the Wellington railway network. The government is going to allow regional authorities to levy a petrol tax up to 10 cents a litre to fund transport related infrastructure developments.

So there are definitely some positives out of the budget and it would be churlish to say otherwise. But there are also at least two tax increases being the compulsory superannuation contribution from employers and they new petrol levies local authorities may impose. But in addition the Finance Minister has scrapped previously planned small inflation adjustments to income-tax thresholds. This counts as a third tax increase!

The challenge now will be for the government to come up with something next year that delivers tax cuts.

The problem there however is that the Finance Minister has already said in recent days he will in next year’s budget only discuss the conditions under which tax cuts might be possible. That is like the labels on bottles of pills which say they may relieve some of the symptoms associated with some illnesses. If next year’s budget contains actual big tax cuts then the chances are it will be a new Finance Minister reading it, and the Reserve Bank could tighten interest rates going into the late-2008 election.

You can get lots of extra information on the budget from the following website. www.treasury.govt.nz/forecasts

Higher Wages Growth Vital For Economic Improvement

During the week a top level unionist dragged out the old straw man that says us economists consider a tight labour market and high wages growth to be a bad thing. This is completely wrong – at least from our point of view. When the labour market is tight – as we saw in the Household Labour Force Survey last week – there are obvious implications. One is that businesses will find it hard to grow so they must undertake higher capital expenditure. This has been our strong message to the business community for eight years.

Another implication is that wages and salaries growth will likely be higher than when the labour market was loose and this will add to inflation and tend to generate higher interest rates and a higher exchange rate. This is basic stuff which comes without some subjective interpretation of whether such outcomes are good or bad. They are simply outcomes we try to explain to people.

BNZ WEEKLY OVERVIEW

But lets look at the issue of wages growth specifically. There is something we have written here on a number of occasions over the past two or three years which few people have picked up on. It is this. One of the best things that could happen in the New Zealand economy is if the average rate of growth in wages rises quite strongly. The reasoning goes like this.

Our economy is now short of resources (like Australia’s and some others). What we want is for these resources to go to the industries generating highest profitability, productivity, wages etc. But how do we get such a shift? In particular, how do we pry people out of their existing workplaces which they have been in for 20 years and have built a comfortable, steady life around? They may be earning something like $25 an hour but there are companies with great products to produce who would gladly play $30 an hour once the employee’s skills are up to good company-specific levels. Yet they can’t seem to get these existing employees to shift.

If wages growth accelerates in an environment of high unemployment then this is bad for the economy as unemployment will rise. But if wages growth accelerates when the labour market is tight businesses with low productivity and profitability will close down as they would in a high unemployment environment, but their exemployees will be snapped up by firms hungry for new staff. This is where we are at in New Zealand now and have been for perhaps five years.

The faster the rate of growth in wages these days given the tight labour market the faster the closure of inefficient businesses, and the faster the reallocation of low wage employees to higher wage and productivity positions. Along the way there will be pain and understandable moaning from the businesses closing down.

But just as many of us would ascribe to tough love theories when it comes to youth problems so do is tough love needed to get our economy onto a higher profitability, productivity and standard of living footing.

Our comments will upset many businesspeople. But even when we state simple conclusions in black and white about what a tight labour means we still upset some people looking for media headlines. So what the heck. The more the merrier.

For more, see… BNZ Weekly Overview (pdf)

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