16 July 2013

Treasury publishes twelve new Working Papers

Twelve Treasury Working Papers published today provide insights into work in progress and research on a variety of economic, financial, trade and social issues.

Three of these papers look at the impact of China on the New Zealand economy since the start of economic liberalisation in China more than 30 years ago:
• China’s Recent Growth and Its Impact on the New Zealand Economy
• The Outlook for China’s Growth and Its Impact on New Zealand Exports
• Empirical Evidence on Growth Spillovers from China to New Zealand

Analysis in four of the papers fed into the Treasury’s recently published report Affording Our Future, the 2013 Statement on New Zealand’s Long-Term Fiscal Position:
• The Requirements for Long-Run Fiscal Sustainability
• Population Ageing and the Growth of Income and Consumption Tax Revenue
• The Distributional Impact of Population Ageing
• Intergenerational Smoothing of New Zealand’s Future Fiscal Costs

The topics covered by a further five Working Papers include tertiary education, inequality, housing affordability, fiscal tightening, and the potential growth rate of the New Zealand economy:
• Private Returns to Tertiary Education: How Does New Zealand Compare to the OECD?
• Alternative Distributions for Inequality and Poverty Comparisons
• Housing Affordability in New Zealand: Evidence from Household Surveys
• Parameter Uncertainty and the Fiscal Multiplier
• Estimating New Zealand’s Output Gap Using a Small Macro Model

Summaries of the 12 Working Papers are below. The full papers are available at http://www.treasury.govt.nz/publications/research-policy/wp/2013.

China’s Recent Growth and Its Impact on the New Zealand Economy was written by Scott Bowman and Patrick Conway. This paper examines China’s recent economic expansion and traces the channels through which this expansion and the subsequent increased demand for commodities have impacted on the New Zealand economy, concentrating on exports in the past decade. It concludes that China’s expansion has had a large positive effect on our economy, mainly through increased merchandise exports, but also through service exports, merchandise imports and other channels.

The Outlook for China’s Growth and Its Impact on New Zealand Exports was written by Scott Bowman and Patrick Conway. This paper examines the sustainability of China’s economic growth and demand for commodities, and the impact that China is likely to have on the New Zealand economy in the next decade. The paper concludes that while there are cyclical risks to China’s economic performance in the medium term, these risks are manageable; China’s economic growth is likely to ease to a more stable and sustainable rate over the next decade. However, demand for commodities is likely to remain high over this period. A gradual shift in the driver of economic growth from investment to consumption is likely to transfer demand from hard to soft commodities. China’s growing share of New Zealand exports will continue to increase its contribution to our economic growth, despite a slowdown in China’s growth.

Empirical Evidence on Growth Spillovers from China to New Zealand was written by Denise R Osborn and Tugrul Vehbi. This paper provides a quantitative analysis of the impact on New Zealand of economic growth in China through the framework of an econometric model. The analysis compares the roles of China and the US both for growth in New Zealand and also for world commodity prices. The paper also investigates whether spillover effects from China to New Zealand have changed over the last two to three decades. It finds that growth spillovers from China are important for New Zealand, with estimates of the accumulated increase in domestic GDP from a one percent increase in output growth in China being in the range of around 0.2 to 0.4 percent. It is striking that growth spillovers are substantially greater from the US than from China, despite the latter's increasing importance in the world economy.

The Requirements for Long-Run Fiscal Sustainability was written by Robert A Buckle and Amy A Cruickshank. New Zealand is experiencing a changing demographic profile from one dominated by young people during the 20th century to one where the population is more evenly distributed across age groups. This has implications for the economy and society, including the government's fiscal position in the future and for the sustainability of its spending programmes. This paper discusses the link between the government budget constraint and fiscal sustainability, how fiscal sustainability can be measured and why it is important. It also examines the Treasury’s current approach to modelling the extent of fiscal adjustment required and options available to achieve this adjustment. The paper proposes criteria to evaluate potential policy changes to address these long-term fiscal challenges and suggests areas for further work.

Population Ageing and the Growth of Income and Consumption Tax Revenue was written by Christopher Ball and John Creedy. This paper investigates the implications of population ageing and changes in labour force participation rates for projections of revenue obtained from income tax and GST. It concludes that projected demographic and labour force participation changes are small, though not trivial. However, these effects are dwarfed by much larger changes generated by wage growth.

The Distributional Impact of Population Ageing was written by Omar A Aziz, Christopher Ball, John Creedy and Jesse Eedrah. This paper examines the potential distributional impacts of demographic change, particularly population ageing, and changes to labour force participation that are projected to arise over the next 50 years. The effects on aggregate measures of income inequality and poverty are examined, along with the way income tax, benefits and various forms of government spending (including health and education) are distributed across age groups. The results suggest that population ageing and expected changes in labour force participation, in isolation, do not have a significant impact on population-level measures of income inequality.

Intergenerational Smoothing of New Zealand’s Future Fiscal Costs was written by Ross Guest. The approach modelled in the paper is to raise the average tax rate at the start of the projection period (2015 to 2060) and keep it constant throughout the period in order to reach a net debt to GDP ratio of 20 percent. Tax smoothing implies that current generations will bear a greater tax burden, and future generations a lower tax burden, than they would under continuously balance budgets. However, for the baseline demographic projections, no generation is better or worse off by more than 0.7 percent of remaining lifetime income. Those born around 1960 fare the worst, and those born after 2020 fare the best.

Private Returns to Tertiary Education: How Does New Zealand Compare to the OECD? was written by James Zuccollo, Sholeh Maani, Bill Kaye-Blake and Lulu Zeng. Private returns to tertiary education in New Zealand are 8.9 percent, compared to the OECD average of 12.4 percent. The aim of this research is to better understand the key reasons for this gap. The paper finds that about half of the gap can be explained by the way OECD private tertiary returns are measured and elaborates on factors which contribute to explaining significant amounts of the remaining gap. The paper also notes that although New Zealand has low private returns to tertiary education compared to other OECD countries, the returns to tertiary-qualified New Zealanders are still significantly greater than for those without a tertiary qualification.

Alternative Distributions for Inequality and Poverty Comparisons was written by John Creedy. This paper provides an introductory review of the alternative possible income distributions which can be used when making cross-sectional evaluations of the effects of taxes and transfers using a household economic survey. In addition, ‘fiscal incidence’ studies attempt to allocate some government expenditure, such as health and education, to individuals as well as considering the distributional impacts of indirect taxes, direct taxes and transfers. The paper examines the difficulties involved in making inequality comparisons over time, and emphasises that care is needed to ensure that spurious comparisons are avoided.

Housing Affordability in New Zealand: Evidence from Household Surveys was written by David Law and Lisa Meehan. The aim of this paper is to inform debate on housing affordability by drawing out evidence from two surveys: the Household Economic Survey; and the Survey of Family, Income and Employment. It examines how patterns of house prices, expenditures, and home ownership have changed over time and across groups. A model which may be suggestive of whether or not an individual or couple is likely to find home-ownership affordable is also developed. This model incorporates information relating to four important influences of affordability: income; net wealth; house prices; and the structure of mortgage contracts (including the interest rate and mortgage term).

Parameter Uncertainty and the Fiscal Multiplier was written by Jamie Murray. The paper notes many governments have responded to deterioration of their fiscal positions by planning large consolidations. A question arises as to what extent these plans might reduce aggregate demand in the economy and slow its cyclical recovery. The paper also seeks to assess the circumstances under which the effects of fiscal tightening might be more or less severe than expected. To make this assessment the author runs fiscal policy simulations using a small estimated model of the New Zealand economy. The evidence suggests that policymakers should be sensitive to the prevailing economic environment when determining the fiscal stance, particularly when interest rates are close to the zero lower bound, and work closely with central banks.

Estimating New Zealand’s Output Gap Using a Small Macro Model was written by Kam Leong Szeto. This paper provides estimates of the potential growth and spare capacity of the New Zealand economy using a small macro model for the period 1994-2012. The new estimates suggest more spare capacity in the post Global Financial Crisis period than other indicators used by the Treasury. This finding suggests that the slow recovery in the economy after the financial crisis is partly due to weak demand in the economy. Another key finding is that all the methods point to the onset of the slowdown in potential growth occurring before the financial crisis. A possible reason for this is that growth over the 2000s ultimately proved unsustainable as it was associated with large build-ups of household debt that could not continue indefinitely. As a result, the economy is going through a protracted adjustment period.

The views, opinions, findings, and conclusions or recommendations expressed in Treasury Working Papers are strictly those of the authors and do necessarily reflect the views of the Treasury.

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