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Welcoming Address to Affording Our Future Conference

Published 10 Dec 2012

Speech delivered by Gabriel Makhlouf, Secretary to the Treasury, at the Affording Our Future Conference held in Wellington on 10 December 2012.

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The speech is available in Adobe PDF and HTML formats. Using PDF Files

Good morning and welcome everyone to the Affording Our Future 2012 conference.

I’d like to start by acknowledging two people who have made the next two days of analysis and ideas-sharing possible:

First, thank you to Professor Norman Gemmell, the Chair in Public Finance at Victoria Business School. The school is our co-sponsor for this conference.

Second, I would like to express the Treasury’s appreciation to Professor Bob Buckle, Pro Vice Chancellor and Dean of Commerce at Victoria University. Professor Buckle has chaired the External Panel of academic specialists and commentators that has met in the run-up to this conference.

The External Panel’s contribution is vital, because the specialist expertise and outstanding level of peer review that they bring is essential to the Treasury being able to produce a robust and independent Long-Term Fiscal Statement, as we are required to do at least every four years under the Public Finance Act.

I’d like to talk briefly about the overarching perspective that the Treasury brings to this process, in the form of our Living Standards Framework, which we first published in 2011, and have further developed over the course of this year.

The framework talks about five dimensions of living standards across which we assess the impacts of policy: economic growth, sustainability for the future, reducing risks, social infrastructure, and increasing equity. You will see that we have framed many of the analytical pieces that have been published in the run-up to the conference around these five dimensions.

A Global Structural Change

Clearly the sustainability dimension of the framework is particularly significant when it comes to thinking about one of the most profound shifts in the structure of the global economy, population ageing.

As Professor Buckle has recently pointed out, for the most part the fact that our population is ageing is exceptionally good news. People are living much healthier, longer lives than ever before in human history.

In October, the Secretary-General of the United Nations noted that the fastest growing population segment worldwide is older people. By 2050, the population globally aged over 60 years will be larger than the global population aged under 15 years, according to the UN Population Fund.

This is a remarkable situation.

And the Secretary-General’s conclusion is that population ageing will leave no community, family or person unaffected and will progressively challenge us to think carefully about how we as individuals live, plan, study and work through our lifetimes.

Population ageing has been underway for well over a century, and the reason we are talking about it today is that it will start to make a significant fiscal impact over the course of the century we’re now in.

The main reason why ageing matters so much for fiscal policy is that many of our main social policy settings were established at a time when the demographic structure was quite different. For example, a girl born in 1950 could expect to live to 71 on average, if the mortality rates of that time had stayed the same through her life. At the turn of the century, female life expectancy by this measure had grown to 81. And looking ahead, a girl born in 2060 has a projected life expectancy of 90 years. So in a little over a century, female longevity by this measure will have risen by about 20 years, or more than 25 percent. For boys, the picture is similar: a boy born in 1950 could look forward to a life of 67 years on average if mortality had stayed at the rates of the early 1950s. This moved out to 76 by the turn of the century and is projected to reach almost 88 years for a boy born in 2060. That’s a change of more than two decades in 110 years.

And much of government spending now is in areas where demographic trends are going to have a major effect. The two areas with the greatest demographic effect are NZ Superannuation and health which currently account for more than a third of core Crown spending between them - 14% of all core Crown spending currently is on New Zealand Superannuation payments and one fifth is on health (which is affected by ageing, but less so than NZ Superannuation is); Of the rest, education takes 17% of the total, and (non-NZ Super) welfare 18% which leaves the remainder (defence, administration, transport, cost of borrowing and the rest) with the residual 30% of current spending.

New Zealand and New Zealanders are not alone – this is a process affecting societies all around the world. Where we are perhaps unusual is that Parliament has specifically set up a process for establishing transparency about how much our policy settings will cost us over the long term.

Role of the Treasury

As I mentioned earlier, the Treasury is required to prepare a Statement looking out at least 40 years, and to do so at least every four years. Our report is due with Parliament again before the end of October next year.

Putting together the report requires careful consideration of the likely pressures on funding education, health, retirement income, welfare and so forth, and an assessment of the future revenue stream to governments in the decades ahead.

We think it is vital to put the quality of our work under the microscope, as well as to do our best to encourage an informed, evidence-based debate about the fiscal challenge that we will face as a nation.

So for us at the Treasury, the Long-Term Fiscal Statement is about much more than publishing a document with projections on the potential cost drivers that may reasonably be expected to affect different areas of Crown-funded activities.

It’s also about a meaningful process of engagement with New Zealanders, old, middle-aged and young, on issues of significance to them and to their families.

And that process doesn’t end with publication next year. We hope that future Statements will be further staging posts in an ongoing dialogue about fiscal sustainability.

We want to encourage a balanced and serious discussion

For the Treasury to be able to communicate effectively with New Zealanders, we know that we must try to demystify technical terms and explain what we mean in non-technical language. So I wanted to comment briefly on how our long-term projections are derived.

Projections are not forecasts. When an economist prepares a set of forecasts, she or he is giving a best estimate of what is expected to happen in the economy, generally over a period of a few years at most.

Projections are exercises in extending forward historic spending and revenue patterns into the future. This includes modelling how they interact with a range of assumptions including population changes and changes in labour force participation rates.

Importantly though, it also involves an underpinning assumption that there will be no change to existing legislative and policy settings. So the projections that you see are not the Treasury saying what it thinks will happen in practice.

For example, we expect that governments, lenders and the population as a whole are unlikely to tolerate ever-rising debt levels. Rather, what the projections give us is the magnitude of the challenge involved in getting back to prudent levels of debt over the long term.

The Treasury does not articulate a “preferred option”

I’d also like to be clear that Long-Term Fiscal Statements do not focus on the specifics of short-to-medium term fiscal strategies. That is not their function.

The current Government’s Fiscal Strategy is to return to surplus and reduce net Crown debt down to low, prudent levels by the early 2020s. This goal has not changed over the past two decades.

Our modelling assumes that the Government’s fiscal strategy is implemented until the end of the current parliamentary term.

Beyond that, in the 2013 Statement, we intend to develop a number of different packages of potential policy options. We expect to use these packages to show how different spending and revenue levers might be designed to strengthen the Crown’s fiscal position, while enabling assessment of the packages’ different implications for the dimensions that underpin living standards.

However, we will not recommend a preferred package. Rather, we hope that they will help illustrate the types of trade-offs that will be needed in the decades ahead.

Conclusion

There is no question that, over the century before us, the profound, permanent and structural change in the population will open up both opportunities and challenges. Some of these we can reasonably anticipate, others even our best efforts will no doubt fail to predict.

Over the next two days you will hear presentations on some of the cost drivers to government-funded services.

The Treasury assumes that as life expectancies increase, people will continue to become healthier and participate longer in the labour force.

The development of new medicines and procedures, ever-rising public expectations for the latest services and products available in richer societies, and international competition for skilled health professionals, are expected to elevate health costs. And of course population ageing also plays its part here too.

Government spending on health care is an important part of our long-term fiscal challenge because it is both large and growing. Health makes up a fifth of current government spending, and health costs have been increasing faster than our national income for most of the last fifty years.

Our initial projections are that, assuming no change to existing policy settings and entitlements, state spending on providing health services could rise from the equivalent of 6.9% of GDP in 2010 to 11.1% of GDP in 2060. And countries right across the OECD are facing similar challenges in managing their health expenditure growth.

Spending on NZ Superannuation, meanwhile, is more certain because it is driven by what is happening to the structure of the population – demographic change will push the gross cost of paying for NZ Superannuation up from the equivalent of 4.4% of GDP to 8.0% over the same period.

Addressing these issues will be easier the earlier action is taken. This will allow us to take small, remedial decisions that build on the foundation of fiscal prudence that the Government has laid down. Delay risks leaving future generations carrying a growing probability of having to make bigger, more abrupt policy adjustments later on.

You will have the opportunity to discuss and challenge presenters’ assumptions about the drivers, and extent, of future cost pressures.

You will be able to consider the implications of demographic change for economic growth, for macroeconomic stability, for equity and for our social infrastructure – both within generations and between generations.

Can I thank you all sincerely for being here and extend my appreciation especially to the excellent line-up of speakers and discussants.

I look forward to meeting as many of you as I am able to do over the next two days and I wish you an extremely interesting and fruitful conference.

It is my pleasure now to ask Professor Buckle to address you.

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