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11  Conclusion

11.1  Modelling refinements

This working paper has explained the modelling approach and key assumptions in the 2009 Statement and provided more detail around the results. Changes in the modelling approach from that used in the 2006 Statement have also been highlighted. In particular, the modelling framework for expenditure on public services has been refined. Parameters for public sector productivity and non-demographically-driven volume growth have been introduced, allowing expenditure on public services to be decomposed into price and quantity components. This innovation ensures our assumptions about service output levels are transparent, and allows some flexibility to test different assumptions about public sector productivity.

The framework for expenditure on public services has also been standardised across spending areas - in contrast to the 2006 Statement, where health care expenditure was modelled differently from other areas. Using the same framework brings some consistency to the way drivers of government spending are modelled, while still allowing scope for the values of various parameters to be adjusted for individual policy areas.

Future Statements are likely to continue to refine the modelling approach and key assumptions. Some further areas to explore are listed below.

  • The feasibility of including feedback loops between spending and revenue choices and economic variables could be investigated. Currently, the only feedback lies in the alternative scenarios involving an increase in tax revenue, where we model a consequent negative impact on economic activity. Examples of other potential feedback loops could include the links between tax and labour force participation, education spending and productivity, and NZS and savings levels.
  • Assumptions about the economy's capital stock could be developed to accompany assumptions about long-run labour productivity growth.
  • The analysis of uncertainty could be further refined. For example, the high and low scenarios around some parameter values could be standardised using percentiles of distributions of past realisations of data series, where these are available. The use of stochastic simulations could also be considered.
  • The implications of modelling different productivity assumptions (Baumol's cost disease) between private and public sectors could be explored with. In particular, the implication and increasing relative price for publicly-funded services.
  • The base case parameter values used for the non-demographic drivers of expenditure on public services could be varied between different spending areas, where there is a case to depart from the standard public-sector wide assumptions, for example, a higher or lower value for the productivity of services, or non-demographically-driven volume growth.
  • Climate change represents an area where further refinement of the model may be needed in future. The economic and fiscal implications of future climate change commitments could be significant for New Zealand, and include the costs of meeting an emission target through mitigating emissions or purchasing carbon credits. As noted in the 2009 Statement, the Emissions Trading Scheme is assumed to be fiscally neutral over time, in line with the Government’s indicated intention. Future versions of the model could be updated to reflect unfolding developments in this policy area.

11.2  Policy conclusions

This paper provides some general conclusions that can inform discussions about the challenges and choices, and associated trade-offs, that must be faced to ensure a sustainable fiscal future.

  • Make early changes. The longer adjustments are delayed, the larger those adjustments will need to be in future. A number of adjustments, starting early, would be sufficient to maintain the fiscal position. Making early incremental policy change reduces the risk of eleventh-hour decision-making, and gives people time to adjust.
  • Keep debt under control. If current policies lead to increasing debt, the resulting financing costs can quickly spiral out of control. Future generations will find it difficult to set their own spending priorities, or meet unforeseen challenges, if a large part of future revenue is required for servicing debt built up by previous generations.
  • Encourage workforce participation. Demographic shifts mean all developed countries will be competing for labour and skills. Policies that encourage people to enter work, to stay in New Zealand or to return after their overseas experience, will help grow the economy and the tax base. Particularly important will be tax settings that spur employment, and policies that encourage older people to continue paid work that suits them.
  • Focus on growth. Stronger economic growth means the country and individuals will be wealthier, resulting in a larger tax base. Decisions about fiscal settings should consider the impact on growth - this is particularly relevant for the overall level and mix of spending and tax. Many publicly-funded services contribute to economic activity in the private sector, so ensuring the right services are delivered as efficiently as possible can contribute to a more productive economy. However, while stronger growth helps, it will not solve the fiscal problem.
  • Keep spending under control and lift public sector productivity. This would involve governments pursuing an ongoing strategy that includes:
    • Reprioritising within existing spending – discontinuing poor value spending and reprioritising the existing $64 billion spending base towards relatively more cost-effective services. All policies should be open for examination, since excluding some areas reduces flexibility and means that larger changes in spending will have to come from other areas, or from higher tax and debt. Reprioritising existing spending can also reduce demand for new spending.
    • Setting a high threshold for new spending – any new spending being based on clear evidence of cost-effectiveness. It is easier not to introduce a poor-quality programme than to remove an existing one. Public sector chief executives have an important role in ensuring governments receive robust advice on the cost-effectiveness of policy initiatives.
    • Securing a cost-effective mix of price, volume and quality for services – striving to get the same service for a cheaper price, targeting entitlements based on need or ability to pay and ensuring the quality standard is fit for purpose.
    • Looking at institutional arrangements – ensuring that institutions, including those that make spending decisions or deliver services for the government, are incentivised to use resources in cost-effective ways and manage spending pressures within current resources.
    • Managing public expectations – publicly debating what services the government can reasonably afford to provide, and to whom, given the negative economic consequences of higher taxes or debt.

Fundamentally, a sustainable fiscal position requires that spending and revenue not to deviate from each other for long periods. Returning from our current position of deficits to one of surpluses will require tough decisions about reprioritisation, which will then need to be followed by equally hard decisions further out. The trade-offs become harder and the changes required get more severe as each year of inaction passes.

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