The New Zealand Initiative Senior Fellow Dr Bryce Wilkinson shared his thoughts on Budget 2020 and the impact of Covid-19 on the economy with the Epidemic Response Committee:
Thank you, Mr Chairman, it is an honour to be invited to assist the Committee today.
First, I want to compliment those involved in bringing this Budget together. Doing so was a formidable task. The time frame was short; there were, and remain, grave uncertainties about the full nature of the virus, and the country was in lockdown.
My introductory remarks aim to make two points.
The first is to stress the importance of better public health preparedness. I assess the indicated lost national income from the virus and put it in the context of potential lives saved and sickness averted.
The second concerns fiscal policy and recovery strategy. The principles for recovery that Dr Oliver Hartwich set out to this Committee on 23 April provide the backdrop to my remarks (see HERE).
Treasury’s estimates of the lost national income and lives saved
Treasury projects that real GDP will bottom out in the year ended June 2021 at 5.6% below is level in the year ended June 2019. That would be the biggest two-year decline since 1951-1953.
This ‘before and after’ comparison understates the income loss because it does not take account of forgone real GDP growth.
A better estimate of the national income loss due to the virus can be inferred from the change in Treasury’s real GDP forecasts between December 2019 and Budget 2020.
Based on the Treasury’s main Budget 2020 forecasts, real GDP in fiscal year 2021 will be 11% below the December 2019 forecast. For the five years to the year ended June 2024, the cumulative projected lost GDP represents 27% of 2020 real GDP.
How does that compare with lives saved from the lock-down? We do not know because we do not know how much of that 27% loss would have occurred if there had been no need for the lockdown because our public health system as better prepared.
On 9 April the New Zealand Initiative published a research report in which I calculated that it could be worth spending 6.1% of one-year’s GDP to save 11,600 lives, were we sure that those lives were at risk and could be saved, and if the values the epidemiologists were putting on those lives were reasonable. There were many other caveats.
The projected loss of 27% of the value of one-year’s GDP is more than 4 times the loss of 6.1% of GDP.
That is suggestive, but anything but conclusive. International tourism would have slumped anyway and participation in sociable group leisure activities reduced. Researchers will be debating these issues for decades.
Economic and fiscal strategy for recovery
The great clamour in the community currently is for more money to spend. They are turning to government by default.
But the only way for the community to generate greater income is through job creation and productivity growth. This has to come overwhelmingly from the private sector.
People with energy and enterprise do not need government to lead them. They need to be freed up to find what other people need and do their best to satisfy that need productively.
Government regulations that make it harder to employ people, hard to put housing developments in place and hard to raise overseas capital hold them and the community back.
In contrast, as I read it, the core of the recovery strategy in Budget 2020 is government-led spending.
Specifically, Budget 2020 provides for $50 billion of additional spending “to deliver COVID response and economic recovery”.
All of it is to be funded from borrowing. The cumulative fiscal deficits between 2020 and 2024 using the OBEGAL measure total $100 billion.
Former Treasury Chief Economic Adviser, Professor Norman Gemmell, fears that there is too much wasteful spending in this budget. I see too little evidence that the programmes are supported by rigorous assessments of costs and benefits.
Good intentions are not good enough when spending taxpayers’ money.
Wasteful and ill-justified spending thwarts the community’s desire for higher real income.
Why do I think that a government-spending led recovery strategy is likely to have disappointing results?
It important to understand that when government borrows money in order to give away to assist economic recovery it is effectively taxing those it is not assisting. It is a bit like trying to pull oneself up by one’s bootstraps.
There is no first-round effect on national net worth or national income. Instead, Crown net worth falls and private net worth rises. There has been no wealth creation, only a redistribution of national net worth.
The recipients of any transfer payments or tax reductions know who they are and what they have gained, but the losers do not know their share of the loss. That depends on unknown future government tax and spending decisions.
The knowledge that there is a large future cost to be allocated creates uncertainty for those considering longer-term investments. More generally, people know that costs are being deferred, but they do not know the extent to which they will bear the burden.
The message to the public would be more transparent if the government’s media statement said something like:
“we are increasing future tax revenues relative to operating spending by around $50 billion in order to fund our planned recovery spending.”
The government wealth transfer shifts purchasing power within the community.
The second-round effect might be to increase consumer spending and reduce national saving. That could see some businesses and entrepreneurs struggling to fund the resources they need to re-establish their businesses.
Meanwhile, the productive people and capital that government employs in its capital projects cannot be employed at the same time for other business recovery and job creation purposes.
The argument that private spending will be inadequate to effect private sector recovery makes no sense for the traded goods sector at least. New Zealand’s ability to supply the world is miniscule relative to global demand.
There can be issues of competitiveness, but again productivity growth and eliminating unnecessary constraints are the answer. The adequacy of transport and other infrastructure is important, but again, the quality of such spending matters.
For those with a sense of history, there are other reasons for doubting the reliance on a government spending-led recovery strategy.
New Zealand engaged in deep deficit spending from the mid-1970s to the mid-1980s, following the quadrupling of world oil prices. Stagflation and a public debt spiral with rising unemployment were the result.
Stagflation was a body blow at the time to the economics profession’s confidence in Keynesian economics.
In 1981 364 UK economists were proven to be wrong in 1991 when they declared that Margaret Thatcher’s deficit cutting would deepen the depression.
The same Keynesian forecasting failure happened in New Zealand when Auckland University economists declared that the Hon Ruth Richardson’s 1991 Budget could only deepen the recession; and Japan ran large fiscal deficits in the 1990s to try to stimulate the economy, but with disappointing results. Its enormous public debt problem remains.
Much of the western world converted the global financial crisis into a fiscal deficit and debt problem. New Zealand and Australia did relatively well, yet now Budget 2020 is defending high public debt levels for New Zealand on the basis that we are catching up with the worst of them.
The bottom line is not that all government spending is bad. It is instead that government spending needs to be rigorously assessed to ensure it provides value for money. So do government regulations. Businesses need to be freed up to change resource use and create jobs. Governments should aim to keep regulatory and tax barriers low rather than high.
Thank you again for this opportunity to present.
The speech can be read on the New Zealand Initiative website HERE.