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The 2015 Budget: How will the economy be affected?

Do you want to know more about what key commentators have to say about the 2015 Budget? Please read below the commentary piece from Professor Norman Gemmel, Chair in Public Finance at Victoria University of Wellington.

Incumbent governments regularly like to claim too much credit when the economy does well, while opposition parties heap undue blame on them when things turn sour. This year’s Budget documents contain the usual self-congratulations for a growing economy and the effectiveness of recent and future policies. The mandatory Opposition invective followed and more can be expected over coming days and weeks!

So, can we disentangle the reality from the rhetoric?

First, the Budget Economic and Fiscal Update (BEFU) figures suggest a national economy performing strongly over the last year from a below-trend starting point – the long legacy of the GFC. Real GDP forecasts suggest this will continue for the next few years – barring any major shocks of course.

But output gap forecasts suggest that by the end of 2015 the economy should be back on its long-term GDP track; that is, at full potential GDP. This would normally imply much less scope for a continuation of the high growth, but the output gap forecast seems at variance with two other key indicators of capacity utilisation – unemployment and interest rates. Unemployment is forecast to remain above pre-GFC levels for several years ahead, while interest rate and inflation expectations show no sign of capacity constraint concerns any time soon.

The recent elevated GDP growth rates have largely come from a combination of the Christchurch rebuild - much of it publicly-funded - and keeping other public spending in check to allow more resources to flow into private sector investment. This year’s Budget promises to persist with both of those boosting factors, but as the economy moves closer to its speed limit, these higher growth rates can’t be sustained.

Nevertheless, over the next 1-2 years, the Budget could potentially impact on the economy in three ways: short-run macro stabilising effects; long-term productivity effects; and microeconomic reform effects.

Short-run macro stabilising effects

‘Stable’ and ‘strong’ might reasonably describe national economic performance, but it is clear that regional differences – mainly Auckland and its run-away house prices – are a concern. Independent monetary policy seems to be set increasingly with Auckland specifically in mind – a dubious approach when this clearly does not represent what is happening across the country.

The fiscal Budget, however, is a more targeted instrument, and the newly announced tax on residential property investment and other housing policies, are a clear attempt to target ‘the Auckland problem’. But these Budget changes are probably best seen more as insurance against a possible adverse future ‘shock’ (most likely to originate overseas if it happens at all) than a concerted effort to re-align current regional imbalances.

Long-term productivity effects

Aside from tackling the alleged Auckland ‘housing bubble’ (which is far from demonstrated in my view), if the Budget is to have any impact on longer-term growth it will mainly come through improved productivity performance. Will the Budget help?

Most economists would argue that long-run trend productivity growth is largely beyond the influence of governments, though catching-up on best practice technology could potentially help boost New Zealand productivity over many years. This aspect at least is amenable to policy whether through the impact of regulations or the public sector’s own performance.

But in at least one aspect the Budget might actually hinder higher productivity. The various policies announced to keep welfare reforms on track and extend the ‘social investment approach’ across Budget headings may help to improve the efficiency and fiscal costs of those public services and benefits. But, to the extent that this helps low productivity beneficiaries or students into work, it may drag down overall average productivity across the economy. This is not to say they are a bad idea; simply that they may not enhance long-term productivity performance in either the public or private sectors.

Microeconomic reform effects

Previous English Budgets have introduced microeconomic reforms designed to improve the efficiency of the public services, such as through public asset sales or the ten ‘better public service’ performance targets. With the exception of additional health service spending, this Budget takes what might be characterised as a ‘helicopter drop’ of a few millions of dollars across the public service, more to improve social outcomes than to generate efficiency gains.

In combination with an annual operating allowance held at $1 billion till 2017, the required squeeze on public expenditure will be a hard line to hold, even with any public sector efficiency improvements. And whether ‘real’ public service output is maintained (allowing productivity to rise), or simply falls in line with spending, is unclear. Until we have better measures of public service performance, answering that question is likely to remain elusive. On a positive note, the latest (February) data on the ten public service targets show marked improvements in several performance outcomes. These indicators may be hard to evaluate but they do provide a new level of accountability.

By Professor Norman Gemmell
Chair in Public Finance, Victoria Business School
Victoria University of Wellington

PwC-sponsored Chair in Public Finance at Victoria University of Wellington.

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