Hon Dr Michael Cullen
Deputy Prime Minister, Attorney-General, Minister of Finance, Minister for Tertiary Education, Leader of the House

4 May 2006 Speech Notes

Pre-Budget Address to the Canterbury Manufacturers’ Association

George Hotel, 50 Park Tce, Christchurch

It is now two weeks until Budget 2006. This will be the first Budget in a new three-year electoral cycle. Although I would not rank it as the most difficult Budget I have had to put together, it does present a number of challenges.

At the best of times, Budgets are a juggling act. But this year it seems it is not just a matter of keeping balls in the air, but also managing a few flaming torches and tomahawks, and doing all of this while perched on a unicycle.

Budget 2006 needs to address three main issues:

- It needs to respond to the fresh, but altered, mandate provided to the government in last year’s election; in particular, by delivering on a range of election promises made by Labour and by the parties which now support Labour in government;

- It needs to maintain a steady hand on the macroeconomic tiller as the economy travels through some difficult waters ahead; and

- It needs to maintain firm indications of the long term direction of fiscal and economic policy in order to support confidence within the business community here and the international investment community.

I would like to give you a rundown of the key elements in each of these, by way of providing a broad overview of what you can expect to see in Budget 2006.

First of all, the election promises. Governments in New Zealand learned over the last decade that when parties are elected on specific programmes they must implement those within their term of office. Broken promises in politics reflect either of two things:

- Either an immature political culture in which the electorate cannot see through unrealistic policy proposals;

- Or a poor system of public accounting that provides no accurate picture of the public finances, such that parties can ‘discover’ once in office that their manifesto promises are unaffordable.

New Zealand has suffered from both of these; but in the last two decades we have developed perhaps the most transparent system of public accounts in the world, and the Labour-led government has certainly sought to promote a mature relationship with the electorate in terms of making and keeping realistic policy promises.

So, we went into the last election with some undertakings which we knew were important to many New Zealanders, and the resulting mandate binds us morally to deliver on those. That obligation aside, there is a compelling logic behind each of them.

The Working for Families package is a major reshaping of the family support and income tax system as it impacts upon families. A key result of the package is that it will increase the effective gap between benefits and earned income, hence maintaining and strengthening incentives for workforce participation.

At the same time, it represents a long term investment in the families in which the next generation of New Zealanders are being formed. It is, if you like, an early intervention strategy, providing a more secure financial base for families bringing up children. It is that kind of secure underpinning that we know has wide ranging benefits in areas such as educational achievement, social cohesion, reduced crime and improved health status.

Another major plank of our election campaign was the removal of interest from student loans for graduates resident in New Zealand. You will remember that we had already removed interest on student loans while students were still studying. It became increasingly apparent that the level of debt amongst those graduating from tertiary institutions was a matter of great concern to many New Zealand families.

The loans scheme has certainly contributed to an increase in participation in tertiary education; but there was widespread concern that debt levels were starting to skew important decisions for young New Zealanders; like the decision on whether to seek work overseas, how long to stay away, and when to start a family.

There was a groundswell of opinion that the scheme was creating some incentives that run counter to the national interest. We needed to respond to that. We needed in particular to return to the underlying objective, which was investment in building a skilled workforce. The best way to do that, and to retain that workforce in New Zealand, is to reduce the financial strain upon students and their families.

Other election promises that need to be accommodated in the Budget were those that were high on the priority list for the other parties which, in the event, provided Labour with support to form a government.

One example was the commitment to increase police numbers. This reflects the clear message that New Zealanders value the sense of personal security and the security of their property. They want to feel safe in their streets, and want to feel that their police force is not so stretched for manpower that it cannot take seriously crimes such as burglary, shoplifting and vandalism, which have a demoralising effect on the community.

To these commitments one needs to add expectations around investment in infrastructure, in particular roading and transport, and also the impact of the natural growth in core areas of government spending such as health, New Zealand Superannuation and education. We have a growing population, and an ageing population.

Although there is always a need to seek efficiencies in how such services are delivered, what international experience repeatedly shows is that cost pressures and rising expectations are very hard to contain. Anyone who has needed urgent medical treatment can vouch for that.

Just as there are no atheists to be found in a foxhole, so there are no fiscal conservatives to be found in an emergency ward.

The first issue to be addressed in Budget 2006 then is how to accommodate the expectations New Zealanders have for their public services, and what one might call the particular social contract formed between the government and the electorate in the 2005 election.

The second issue, as I have said, is the need to maintain a steady hand in economic management. The current economic situation is a delicate one, and it could be made worse by unwise fiscal policy.

Since 1999 we've benefited from strong economic growth and thus revenue growth. The government has focused on ensuring this is used wisely. Our careful planning and husbandry has paid off, such that I'm delighted to announce that in March the government moved into a positive net financial asset position as will be shown in the March accounts released tomorrow.

This means that we now have more in our savings accounts than we've borrowed. This is for the first time since net debt records began in 1972 that we have been in the black.

We have buried the legacy of the imprudent Think Big era, which saw government debt surge to unhealthy levels. In fact we are now just one of seven countries in the OECD to be in a positive net financial asset position, the top half of the OECD indeed.

It means that we are in an excellent position to face both the expected slower growth in the short-term, but also the rising spending pressures expected from an ageing population over the more medium term.

But just as we were cautious in the up-turn, it is important that these hard won gains are not squandered through imprudent revenue or spending decisions.

It is clear that, after an extended period of exhilarating growth, the economy has slowed down as a number of imbalances are corrected.

There are some aspects of the economy that will stand us in good stead:

- We still have record low unemployment, and around three hundred thousand more people in jobs than six years ago;

- We have succeeded in reducing poverty in New Zealand in the last five years, and along with it the costly social problems that are associated with it. Whereas other economic downturns risked pushing a significant number of people into very real hardship, New Zealand families are now in a much more robust position;

- We have experienced strong household income growth, which shows no sign of reversing, and should continue to underpin strong domestic demand;

- Finally, we have much stronger regional economies in places like Northland, Gisborne, the West Coast, and Nelson-Marlborough. Whereas in the past, these areas tended to be very hard hit by a faltering rate of economic rate, nowadays they have more diversified economies and are better placed to see out some inclement economic weather.

On the other side of the coin:

- We are facing labour shortages across the economy, but particularly in some key manufacturing and construction industries;

- Inflationary pressures remain uncomfortably strong, in the form of the tight labour market, the ongoing strength in the housing market;

- Increasing petrol prices are also inflationary, but have a strong dampening effect on domestic spending too. There are some estimates an extra $1.5 billion will be spent on petrol and diesel this year alone.

- Our annual current account deficit widened to 8.9 percent of GDP in the December quarter and is likely to expand further in the near term.

- Finally, although the recent drop in the dollar is welcome, it may take six to twelve months before many exporters benefit.

The consensus is that 2006 will be a year of very flat economic growth. However, most commentators see the economy coming out of its cyclical trough in 2007. This is due to expectations of a falling dollar, leading to improved export receipts, a slow decline in the current account deficit, and an essentially robust global economy.

There are of course risks around this optimistic scenario; the main one being the question of the world oil price, and the likely impact of that on our trading partner economies. One has to say that this is a year to practice caution.

It is important for New Zealanders to realise that this temporary reversal of our economic fortunes is accompanied by a comparable reversal in our fiscal position. I have been criticised for running large surpluses in recent Budgets, and throughout I have pointed to the forecasts which show the government’s accounts moving inexorably into a cash deficit situation in the out years.

That day of reckoning is now close. There is likely to be another very strong operating surplus in 2005-2006, boosted by some excellent performances by Crown financial institutions and by the sale of Meridian’s Australian assets at a large profit.

However, the forecasts clearly show this will be the last big operating surplus for some years.

For some time I have been bemoaning the unwarranted attention on the operating surplus as an indicator of the cash available to the government for spending. It's something National has been quite mischievous about.

In fact we will be moving into a significant cash deficit situation totalling around $7 billion over the next four years which will require some additional borrowing.

There are two important conclusions to be drawn from this:

First, this is not the time for any kind of fiscal adventurism on either the revenue or the expenditure side.

And second, the fluctuations in our fiscal position simply accentuates the good sense of managing across the economic cycle, rather than doing as some past governments have done, and loosen fiscal settings during the good years, only to be faced with the prospect of harsh fiscal tightening when the cycle turns south.

We are now seeing the reward of banking the surpluses of recent years. Prudent fiscal management has seen debt fall to levels which gives us more flexibility during periods of slower economic growth.

As a result there is no need to risk worsening the downturn by slashing spending; and crucially there is no threat to our ability to maintain our capital investment programme.

The government has an enviable record on investing in infrastructure, and the Budget will show that, due to our careful fiscal stewardship, we are able to maintain that without missing a beat.

The simple fact is: had I heeded the many calls over the last three years to use the surplus to cut taxes I would now be preparing a black Budget, one that cuts back on roading and transport investment, rolls back progress on things like industry training and scientific research, and attempts to make cuts in health and education.

As it is, we have established a fundamentally strong fiscal position, and that means that Budget 2006 can chart a sensible path towards long term goals, rather than having to focus entirely on stopgap measures to address the current economic downturn.

That long term direction can be summarised in three themes; economic transformation, families young and old, and national identity. Time does not permit me to expand on the latter two themes, so I will focus my comments today on economic transformation.

Before we start, we need to understand the difference between economic reform and economic transformation. Economic transformation is the ongoing process of change and improvement that will create an economy based upon a highly skilled workforce, the application of leading edge technology, a sound infrastructure and an innovative exporting culture.

Many New Zealanders have come to associate economic transformation with economic reform. The belief was that, if we reformed the economy by selling off state assets and wholesale deregulation, a new more prosperous economy would emerge spontaneously. It was rather like the belief that, if you lose some weight and take up jogging, an Olympic medal will fall into your lap.

There are still a few purists around who argue that any deficiency in economic performance must be met by ramping up the pain level selling more assets and cutting more regulations.

What we have learned is that economic reform is about preparing the ground, clearing away obstacles and building a platform for growth. That job has largely been done; but it is not the same as growth itself.

Transforming an economy involves the hard work of addressing all the issues that will allow us to have sustainable economic development and growth equal to or better than that of other developed countries. That is not a one-off exercise; rather it is an ongoing process whose various components will change over time.

The two key areas where we must do better are productivity and exports. Recent data suggests our productivity growth has been better than previously thought. But it is still not high enough to allow us to see real income growth which is significantly faster than comparable countries.

Building our productivity over the next five years means getting better traction on some of the fundamentals of our economy. The first of these is infrastructure.

Roading is a major part of that. The government’s aim is to introduce greater certainty into the road construction programme while continuing to boost the use of public transport, at least in the major cities.

But there is more to infrastructure than roads. As businesses seek to enhance customer service and exporters seek to overcome the disadvantages of our geographical isolation, telecommunications infrastructure becomes a key to growth. Broadband offers enormous potential to transform our business models and add more value to what we produce and how we distribute and market it.

Yesterday's announcement by my colleague Communications Minister David Cunliffe shows that this government will not tolerate market structures that allow major players to make an inadequate contribution to where we need to be: that is, among the top half dozen countries in terms of access, speed, price and quality.

I am confident the measures we are introducing will ensure many more New Zealanders and businesses will have access to fast, competitively priced broadband sooner rather than later.

Our infrastructure strategy will also embrace some other very difficult long terms issues such as water allocation and energy supply and pricing.

As for exports, we need to face the fact that we have scarcely moved our exports as a percentage of GDP for the last generation. We are significantly ahead of Australia, particularly in the extent to which our exports are based upon added value. But they are a poor yardstick given their enormous mineral resource base.

There is no silver bullet for strengthening our export performance. We need a coordinated strategy covering areas as broad as improving trade access, building alliances in marketing and distribution, supporting and mentoring new exporters, and developing our venture capital market.

The second element of economic transformation is skills and human capital. Here we have done and are doing a great deal. We have achieved massive growth in industry training and modern apprenticeships. We are now reforming the tertiary funding system so that it rewards institutions for engaging seriously with local employers on issues of quality and relevance.

The third element I wish to touch on briefly is support for business, especially support to invest in research and development, new equipment, skills and exports. In Budget 2005 we changed the tax treatment of R and D, increased depreciation rates for shorter lived assets, and lifted the tax allowance for expensing lower cost assets. Those changes continued an ongoing programme of partnership with business, which has seen the establishment of a more focused New Zealand Trade and Enterprise, the development of the VIF venture capital fund, the Small Business Advisory Group, and so on.

The business taxation review that Peter Dunne and I are undertaking will also be looking to provide a further boost in that respect.

To sum up, I make no apologies for the fact that Budget 2006 will offer more of the same. More of the same fiscal prudence. More of the same steady management of the economy. More of the same engagement with the long term drivers that will move our economy forward and strengthen our communities and families and our sense of national identity.

Our fiscal policy throughout the positive end of the economic cycle has put us in a strong position to weather the downturn. That will ensure that what we experience over the next year is indeed merely a breather, rather than a long, cold wait for a bus that may never come.

Thank you.

ENDS

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