Part 1

Overview

Main themes

Where are we?

New Zealanders – the people and the government – are not saving enough. Unless we make some rapid changes, we are risking a major economic disruption likely to leave practically all New Zealanders worse off. It's as if we are standing on top of a cliff that may collapse dramatically or crumble slowly. Either way, it would be a bad fall. We need to move back from the brink – and fast.

In recent years, we have saved considerably less than we have invested. Foreigners have filled the gap by lending us money, attracted by our relatively high interest rates, or by investing here. When a New Zealander takes out a mortgage or a business loan, much of that money is likely to have come from overseas. And that's okay, as long as it continues. But there are various scenarios under which foreign lenders and investors may change their minds and stop dealing with us or raise the cost considerably:

• A lowering of the credit rating of the New Zealand government or New Zealand companies. Standard & Poor’s recently put New Zealand’s foreign currency rating on negative outlook, which cautions that the rating might be lowered.
• The outbreak of a serious agricultural disease, such as foot and mouth disease.
• A natural disaster, such as a major earthquake, flood or eruption.
• Any other change – such as a sharp drop in dairy prices – that reduces the world’s confidence in the New Zealand economy.

In the wake of the global financial crisis (GFC), lenders and investors are more alert to the problems that can arise – and investor sentiment can change quickly.

Furthermore, a lot of the foreign debt in New Zealand is short-term. If a majority of the foreigners investing here decide to pull their money out the next time their loans roll over, we could see an abrupt drop in funds available for mortgages and other loans and investments. This would lead to a long list of economic woes, including: rising interest rates; a shrinking economy; large job losses; falling values of property, shares and other assets; and reduced government spending on such things as benefits, pensions, health services and public sector wages – which would probably be driven down along with other wages.

While some people might think they would like higher interest rates or cheaper houses, the overall economic damage would badly affect everyone. We just need to look at what has happened recently to the Irish economy or to the US mortgage market, or indeed to the New Zealand economy in the wake of the 1987 share market crash, to get an idea of what could happen. We don't need that again here.

Let's be clear – a “sudden stop” in the New Zealand economy is not inevitable, but it is a very real risk. And, if it doesn't happen, our position will simply continue to deteriorate gradually instead of crashing.

Unfortunately, national saving is not the only problem with the economy. For a long time, growth in productivity and exports has been much too slow, and the same can be said for incomes and living standards. Since 1987, the only income increase for the lower-income half of the population, after adjusting for inflation, has been through increased government transfer payments – which is pretty shocking really. So there is a lot to be done now, to start sorting all of this out.

How did we get here?

The numbers tell the story:

• New Zealand has had a current account deficit every year since 1974. Put simply, this means our total payments to overseas for imports of goods and services, interest (on borrowed money) and dividends (on foreign money invested here) have been greater than our total overseas earnings – from exports of goods and services and interest and dividend payments to us. Unfortunately, export growth has been hindered by our relatively strong exchange rate – buoyed by our high interest rates.
• Increasingly, we owe money to the rest of the world. Our net foreign liabilities (NFL) – the total New Zealanders and the government owe to foreigners minus our total foreign assets – are sitting at 85% of gross domestic product (GDP). What’s more, about 90% of the NFL is in the form of debt rather than equity, making it easier for foreigners to take their money away.
• Our NFL of 85% of GDP is similar to the level of Ireland, Portugal, Greece and Spain, all of which are going through dramatic and painful economic adjustments. While there are some important differences between New Zealand and those countries, their difficulties are still a stark warning of what could happen here.
• The New Zealand government’s share of the NFL is relatively small, which is helpful, but it is now growing rapidly. The bulk of the debt is in the private sector. In the last 15 years, household debt has doubled relative to our incomes. Much of this borrowing has been in the form of mortgages to buy increasingly expensive houses – both homes and rental properties. Borrowing to buy farms has also been high.

What should we do about it?

Continuing as before is not a viable option. We are vulnerable – some say “highly vulnerable.”

To reduce our vulnerability, we need to:

• Increase national saving by some 2% to 3% of GDP from its current gross level of 17% of GDP, by increasing government, household and business saving.
• Improve the quality of savings and investing – through better asset choices, higher returns and so on. This involves changes such as reducing serious tax distortions, much better disclosure on financial products and their fees and performance, and improving their efficiency and returns. Financial education also needs a lot more work.
• Boost productivity, particularly in government services.
• Grow exports and production of goods and services that substitute for imports – so that we buy less from overseas. This will reduce the current account deficit and, in turn, the level of NFL.

In fact, there has already been some progress in recent months. As a result of the global financial crisis (GFC), we have reduced investment, consumption and imports and increased debt repayment, so that the NFL-to-GDP ratio has already fallen from a peak of 90% to 85%. However, these changes are considered to be mainly a short-term response to the immediate situation and are likely to reverse when growth resumes. We need to make changes that entrench the new behaviour – and take it further.