Expenditure Control

Expenditure control is a key tool for improving the fiscal position and helps address issues around the composition of economic growth. Our commitment is to live within the $1.1 billion operating allowance and future capital allowances. The capital allowance for the next four years is $1.39 billion per annum, which is different to the profile incorporated into Budget 2009. The Government is considering a new approach to resolving weathertight homes issues and has taken the prudent approach of keeping aside some resources for a contingency as it is likely that a solution will involve a Crown contribution.

Living within the allowances limits the near-term increase in debt, while providing the opportunity to make measured and permanent changes to expenditure programmes.

Budget 2010 has operated successfully within the combined operating and capital limits. A combination of baseline savings and reprioritisation means we are also redirecting a further $1.8 billion to higher-value spending across the next four years of the forecast period.

New spending is largely in health and education. The majority of Votes did not receive any new funding from the operating allowance. The Budget package also contains initiatives designed to contribute to our growth strategy, including around $1 billion over four years to support key infrastructure projects such as ultra-fast broadband and the electrification of the Auckland rail network. Further funding is going to support research, science and technology and other initiatives as part of the Medium-Term Economic Growth Agenda.

Continuing to remain within the $1.1 billion limit on new spending over time will become increasingly challenging but it is vital we succeed.

Controlling the growth in government spending will have real tangible benefits for the people of New Zealand. Gross debt[1] is forecast to increase by $24 billion over the next four years which will cost an increasing amount to finance, particularly given that New Zealand usually has higher real interest rates than other countries. Staying within the $1.1 billion operating allowance and future capital allowances will limit the build-up of debt and hence financing costs. Figure 2 shows finance costs peak at just under $6 billion per year, representing over $1,200 for every person in New Zealand. As conditions permit, we want to reduce this amount.

Figure 2 - Finance costs

Source:  The Treasury

Figure 3 - Net international investment position

Source:  Sources: IMF, Statistics New Zealand, Ministry of Finance Japan, The Treasury

Note: As at 30 June 2009.

Concerns around the world about sovereign risk emphasise the importance of maintaining the strength of the Crown balance sheet, particularly in light of New Zealand's high net foreign liabilities (see Figure 3). It is both government debt and total external debt that have raised concerns in countries like Greece and Portugal. New Zealand has one of the highest net foreign liability positions in the world - reflecting a combination of household, business and government debt. Low government debt before the crisis had been one of the offsetting considerations to both international investors and rating agencies when they were assessing the country's riskiness. It is important that the Government reduces its debt levels, and as discussed, the Government's fiscal and economic policy provides the opportunity for households to do the same.

The Government's fiscal actions can also have an effect on businesses and households because of the link between fiscal and monetary policy. The increase in government spending that occurred between 2005 and 2008 led to tighter monetary policy. This meant higher interest rates and a higher exchange rate than we otherwise would have had. Now, because the Government is reducing the fiscal stimulus created by government spending, monetary policy is likely to be looser than it otherwise would have been. That means lower interest rates and/or a lower exchange rate than otherwise.

Controlling the growth in government expenditure will allow productive resources to flow to those parts of the economy which are most able to enhance the country's growth potential.Figure 4 shows the recent poor performance of our tradable sector relative to the non-tradable sector. Growth in the non-tradable sector was driven by increasingly high government spending from 2005 to 2008. This put considerable pressure on interest and exchange rates, and by absorbing scarce resources hindered the growth of the export sector.

Figure 4 - Tradable and non-tradable GDP

Source:  The Treasury

Figure 5 - Operating expenses

Source:  The Treasury

The 2009 FSR identified the significant increases in spending that can occur outside the operating allowance, such as higher benefit costs. It is important that we get better discipline and accountability over this spending, while also allowing the so-called automatic stabilisers, such as spending on unemployment benefits, to help absorb shocks to the economy. We previously signalled that we were intending to investigate spending rules used in other countries to determine whether these approaches could help us achieve our spending control objectives. We found that these rules can be complex to implement as they usually have exceptions for cyclical expenditure and other volatile spending items. We have concluded that many of the objectives of the spending rules implemented by other countries are achieved by our cap on new spending. The current system is working reasonably well so additional or alternative mechanisms are not required. Instead we will reconsider various aspects of our current approach to fiscal management to improve our ability to scrutinise increases in expenditure which at present are not charged against the operating allowance.