Kiwiblog

Vincent Heeringa has published an article called The First 3,000 days:

Labour swept to power in 1999 promising to transform New Zealand into a world-class, knowledge-led economy. Instead, they reverted to ‘Old Labour’ habits of taxing, regulating and centralising.

Anyone remember their goal of the top half of the OECD?

Today, it’s Labour’s turn to look flat-footed. Its stuttering, knee-jerk reaction to John Key reveals a Cabinet empty of fresh talent and ideas.

Does he mean their policy of borrow and smear?

In ’99, Labour swept in with an agenda to transform the New Zealand economy. … Most importantly, it declared that ‘economic transformation’ would lead us to a knowledge-based, world-class economy. Optimistically, Labour promised to get us into the top half of the OECD by 2011.

Oh yes that’s right – all the buzzwords and goals.

Labour knew what had to be done to get New Zealand’s economy off the road to nowhere, but has done far too little, much too late. Despite a good start and despite being armed with full knowledge of what transformed the similar economies of Ireland and Finland, Labour surrendered the task through a lack of willpower and ideas. When it was time to step up, Labour reverted to type.

So long as there was enough economic growth to fund their spending promises, they saw no reason to transform the economy.

The greatest failure, in my view, is that Labour’s rhetoric about transformation has proven to be just that. Fancy talk. The Growth and Innovation Framework was dropped around 2004. Of the three major task forces established in design, ICT and biotech, only design continues. The science and research that was to emerge from such a framework has simply not occurred. In fact, the science system may be in a worse state than when Labour took power.

Once the high profile conferences finished, so did the strategy it seems.

But while the Australians have deployed public–private partnerships in infrastructure and state services, this government reverted to the old Labour policies of taxing, regulating and centralising. It now owns ACC, Air New Zealand, KiwiBank, KiwiRail and four power companies. The government has turned the idea of private ownership of strategic assets (even as partners with the state) into an anathema and hobbled crown entities with high dividends and restrictions on how they can raise capital.

No other left-wing Government in the OECD has such a hatred and aversion to the private sector. NZ Labour are miles apart from Australian Labor and UK Labour.

And whereas the Blair government re-energised its public services and brought in much-needed entrepreneurship and investment by working with the private sector, Clark’s Labour has simply added more bureaucrats. Total government spending has increased from 36.1 percent of GDP in 2000 to 41.4 percent last year.

It gets worse than that. The recent PREFU shows total government spending increasing to 45% of GDP next year. The tax increases in Labour’s planned mini-budget to cover this will be massive.

Heeringa then looks at individual indicators:

• Standard of Living: slipped from 20th to 22nd in OECD
• Productivity: annual labour productivity growth of 1.1% half of the 1990s and below OECD 1.8% average
• Savings: praises KiwiSaver but says why did they wait until 2007
• Innovation: NZ ranks just 25th in our ability to use innovation to develop new and unique products
• Tax: No tax cuts until 2008 – and a unnecessary tax increase in 2000
• Infrastructure: Not enough power due to planning restrictions, are extending copper network when fibre is needed.

So low marks all around. And Heeringa is no “hard right” commentator. If anything, a but Labour-friendly.

Hat Tip: Homepaddock

News that the Reserve Bank of Australia has dropped their official cash rate by a huge 100 basis points gives some inidcation of how weak various economies are.

NZIER released their quarterly survey of business confidence yesterday. On the basis of it they predict the recession will last for at least another two quarters. A net 32% of firms have reported a decline in trading activity and a net 13% expect trading activity to fall further in the next three months.

It is in that context, and the decade of deficits announced by Michael Cullen on Monday, that National have modified their tax package which will be announced later today. This is both necessary and responsible. The public want a tax package that takes account of the last few weeks, let alone the last few months.

The scary thing with the PREFU numbers is they were finalised five weeks or so ago, so do not include the latest shocks from the US. As the Herald says:

Party leader John Key yesterday admitted that the pre-election opening of the books by the Treasury showed a picture that was much worse than he had expected.

“We’d always expected a slowdown, but I don’t think anyone saw deficits for 10 years and such a deterioration in the accounts.”

The economic and fiscal update showed cash deficits forecast to reach $7 billion and budget deficits for the next 10 years. …

No-one at all was expecting it to be that bad.

Also behind the decision is the fact that the forecasts revealed by the Treasury this week do not take into account the tumultuous events of the past month, in which banks have collapsed, the US Government has approved an enormous bail-out deal for Wall Street, and the flow of credit internationally has virtually seized up.

Who knows where it will end. Now this is no reason not to have tax cuts at all – they are important as one factor in lifting economic growth. But some caution around size and timing is essential.

Prime Minister Helen Clark yesterday cast doubts on National’s statement that it had scaled down its tax cut plan.

“I believe they over-promised on their tax package and they are now using the excuse of the books to try and talk down expectations,” she said.

I am tempted to call the PM a moron for that comment, but I know she is not a moron so all I’ll say is she is playing dumb. If she really thinks a decade of deficits is simply an “excuse” then she is in la la land.

But here is what is really interesting. We have seen National says “Yes we will modify our plans in wake of the financial crisis” while Labour says it is not going to change anything. Dr Cullen ruled out any change to tax or spending in the PREFU lockup. At most they might delay some of WInston’s new bureaucrats. Labour are happy to have ten years of deficits and debt rising from under 20% to 30% of GDP.

Labour have had it easy for the last nine years. They have never had to make tough decisions, and now the economy is in reecession they have no idea and no plan as to what to do to prevent a decade of deficits. Their biggest problem for the last decade has been what new schemes to dream up to spend our money on – hey lets put a billion more into Working for Families, no no lets buy some trains for a billion, no no let’s give pensioners free bus trips, no no let’s give public servants a pay rise but only if they join the PSA etc etc.

Because the economy, helped by strong commodity prices, has been so strong they have been able to say no to measures that would boost labour productivity and economic growth. Many of these measures (such as RMA reform) will be unpopular with some lobby groups, so why bother to take the heat, when hey we have enough money without such reforms.

But now Labour has run out of money. They are content to run ten years of deficits. They are not willing to take any hard decisions about lifting our economic growth, let alone paring back any of their spending schemes.

We’ll hear later today what National’s plan is. I think it will be measured, significant and popular. It will of course be attacked by Labour and the unions. National could announce the second coming, and Labour and the unions will attack it. Hopefully at some stage, somone may ask Labour what their plan is? Their plan is to not change tax rates and not change spending significantly. Their plan is a decade of deficits.

The Dom Post editorial today:

Growth this financial year is expected to be just 0.1 per cent, and unemployment is expected to climb to 5.1 per cent next year. For the first time since 1994, the budget’s operating balance will be in deficit. Prime Minister Helen Clark appears to welcome an election based on the economy. That is unsurprising. She can point to nine good years and to a reluctance to spend more than was flowing in. She would no doubt rather talk about that than the anti-smacking legislation, the chilling effects of her Electoral Finance Act, or why she defended the indefensible actions of NZ First leader Winston Peters.

All good questions.

However, she should not assume the voters will agree that she and Finance Minister Michael Cullen are the best stewards of the economy. Instead, they face questions over whether they have spent the proceeds of the years of plenty wisely.

Government spending has grown strongly during Labour’s years in government, sustained by the ever-growing tax take delivered by good economic growth. However, there are legitimate doubts that the taxpayer has received enough in return when it comes to better health services, better education, and improved infrastructure.

A number of studies have shown that actual improvements in outcomes for what has been a huge amount of money have been marginal.

The spending has been large, but the quality of some of it has been questionable. A relatively minor example offered by National is a 112 per cent increase to 505 in the past six years in the number of public relations, communications, media staff and contractors employed by government departments.

Yep a doubling of the number of comms staff in six years.

John Armstrong does a nice summary:

It was only a few short weeks ago that Bill English was saying he wasn’t going to be spooked by a little bit of red ink in the Government’s accounts.

The Treasury’s pre-election fiscal update bleeds so much of the red stuff that the document looks like the aftermath of Dracula running amok in the blood bank.

The numbers in this horror story are truly awful. It is goodbye to operating surpluses for close to a decade. The forecasts for the separate cash deficit figure nearly double to $6-7 billion for the foreseeable future. Growth slumps. Unemployment jumps. These numbers will almost certainly get worse. The Treasury’s forecasts were done before last week’s maelstrom on Wall Street.

What a legacy to leave behind.

The update is a brutal reality check for parties making big election promises. In the short term, Labour has already gobbled up the allocation for new spending in next year’s Budget. There can be no pre-election bidding wars to buy votes. Post-election negotiations are now going to be hellishly difficult.

Yes – universal student allowances just died yesterday.

If a Labour-Green-NZ First Government was elected, I think they would find it almost impossible to govern without increasing taxes. There is less than $500 million available next year for new initiatives. Even a centre-right Government will find it hard to cope with that. I think it is inevitable there would be a range of new taxes introduced – they will carry through with the legislated tax cuts, but seek to increases taxes elsewhere – maybe even do another envy tax on people earning over $100,000.

In such an atmosphere of restraint, National’s unveiling of its tax cuts tomorrow seem about as tactful as someone cracking open the champagne at a funeral just as the coffin is being lowered into the grave.

The tax cuts needs to countered by savings elsewhere. A significant increase in the operating deficit is not a good idea. However tax cuts are still important as part of a package to life economic growth – higher economic growth is the way to avoid a decade of deficits.

Having slammed National for setting a debt-to-GDP target of 22 per cent, Cullen’s position has been undercut by the current debt ratio being forecast to balloon from 17 per cent to 24 per cent of GDP over the next four years.

And to keep increasing after that to over 30% of GDP.

If National’s tax cuts are reckless, so, by Cullen’s previous definitions, are Labour’s.

Cullen admitted as much by saying that had he known in advance what was going to happen he would have been more cautious about cutting taxes. However, he is refusing to withdraw the second and third phases of Labour’s tax package.

That was actually my question to Dr Cullen – would he have made the tax cuts he did, if he had these forecasts six months ago. He replied that he he would have been more prudent as he leaves recklessness to bloggers

Cullen is right that he can not directly reverse the tax cuts he has just passed into law. But I just can’t see how a Labour-led Government could live within these fiscal parameters. I suspect there would be a range of new taxes introduced.

That gives National carte blanche to go with its more generous package, which it says will be no more expensive than Labour’s because the extra cost will be funded by transparent savings in government spending.

Yes the key is having the whole package fiscally neutral or very close to it.

The bickering over tax has long made up for the lack of argument over wider economic policy. Yesterday changed everything. The election is no longer about tax. It is about which party can best convince the voters its policies will shorten the length and depth of that recession.

This is absolutely where the debate needs to go. There has to be an real focus on increasing economic growth.

John Key is the final speaker of the day. Some key points:

• If the fundamentals of the economy do not change, we will not become wealthier
• Cullen has worried too much about savings and not enough on growth
• Ongoing programme of personal tax cuts.
• Irish economy driven by world class education system, low company tax and good infrastructure
• No radical changes to monetary policy
• Domestic inflation too high due to capacity constraints
• Will have some local government reform but not second guess Royal Commission on Auckland.
• Size of the state does matter – 10,000 more core bureaucrats – but not just about numbers but efficiency.
• Are taking a hard look at role of Electricity Commission – do we need a bunch of engineers second guessing Transpower?
• 90 day probation period is not a right to fire clause but a right to hire clause. Is timid compared to many other countries.
• Most Chinese are more capitalist than anyone else we know
• At danger of becoming a giant educational facility for Australia

The conference is now ending. Yay. Seven stories isn’t a bad output if I say so myself.

We have five Finance Spokespersons after Winston pulled out. They are:

1. Bill English, National
2. Dr Michael Cullen, Labour
3. Russel Norman, Greens
4. Peter Dunne, United Future
5. Sir Roger Douglas, ACT

Each was asked three questions:

1. Will you cut company and personal tax and by how much and when?
2. Will you have a cap on government spending as a percentage of GDP?
3. Will you include labour and environmental restrictions in free trade agreements

Bill English

1. Yes we will lower tax rates. Details soon. Important to do so to put cash in pockets, but more importantly incentives to work, save and invest. Also want a more efficient tax system.
2. No as GDP goes up and down. Focus on quality of spending not a set target. Expect PREFU will show Crown is in deficit. So period of restraint needed. Govt spending excluding welfare growing at 8% per annum. Can’t carry on at that rate so will slow growth down, but will still grow in absolute terms.
3. Not desired, but US Congress turning protectionist and they may demand them so we may need to be flexible. Generally supportive of Govt work on FTAs.
4. Generally comment: no more cheap credit – growth will come from earning it and need to lift productivity.

Personally I think a target for expenditure as a percentage of GDP would be a very good thing.

Sir Roger Douglas

1. Could reduce personal and corporate tax to under 20%, maybe even 16%. Also could lower GST to 10%.
2. Need to say yes to this, so one can say yes to Q1 (he answered in reverse order). Says Govt expenditure should be held at rate of inflation of 2.5% and population growth of 1%. So an annual 3.6% increase only. Sounds good to me!! Any increase over 3.6% should be met with savings elsewhere. If we hold expenditure to 3.6%, each household will pay $13,000 less in annual taxes in 10 years time. Govt expenditure has increased under Labour by $17 billion, after taking inflation and population growth into account. That is $220 a week per household. What did you get for that $220 a week? Could you have spent it better yourself? No equity or fairness without efficiency in expenditure. Thinks expenditure of 25% of GDP is a good target.
3. Support free trade agreements without these restrictions

I have to say Sir Roger was brillant. He may get some very serious support for ACT if enough people hear him. Very smart to not talk about slashing expenditure but just propose keep spending to inflation and population growth. Families can relate to that.

Peter Dunne

1. Would cut personal taxes on April 2010 to 10% for income to $12K, 20% to $38K, above $38K at 30%. Supports income splitting. And align business and trust rates at 30%. Should do regular tax reviews, rather than wait 12 years between tax cuts (hear hear).
2. No set cap. GDP not sole measure of wealth of economy. Does have concern over current level of spending but more concerned about quality and direction of spending. Proposes merging some DHB functions centrally such as equipment purchasing. A spending cut may lead to a service cut – $50 million into IRD so it can answer phones quicker as an example.
3. Supports FTAs. Don’t need specific standards on environment and labour, as they are dealt with in the wider business environment. We are most trade dependent nation in the world.

Dunne did well also. Some nice specifics.

Dr Russel Norman

1. Wants a transition to a sustainable economy. More ecological taxes and reduce taxes on income. Incentive then to reduce scarce resource use and pollution. Wants incentives to use less water. Supports ring fencing of losses on investment propoerties. Not supporting a decrease in overall tax – just how it is made up.
2. Does not have a policy for a cap on spending. It is about efficiency.
3. Does support standards, but notes usually just involves consultative committees.
4. General comment on need to prepare economy for higher oil prices. No other party has policy around this.

Dr Michael Cullen

1. Lowered company rate to 30% and legislated for three rounds of personal tax cuts. Also increased depreciation rates and R&D tax credits.
2. No. Spending at he moment same as 99/00 as percentage of GDP. Goes up and down. A cap is artificial.
3. Yes will try and include these standards as agrees with Bill needed for US Congress
4. General comment on the need to lift exports from 30% of GDP. New tertiary funding policy is essential. Backed Clark up on how our bottom 30% of school leavers are very poor. Middle and top are both very good. More rail needed plus more roads. Also roll-out of broadband is important. Higher savings needed and our capital markets are very weak. Sustainability also important.

All five spoke well and knew their stuff. I do have to say I think Sir Roger was by far the best – both his level of detail, his forceful arguments and the actual policy. I would put Peter Dunne second best.

I don’t think Bill English came across that well. Not due to him (Bill was very much on top of the arguments), but because he could not give any details of the tax policy yet (which I think would have been popular). Would have been good though if National had decided to release some sort of business policy today, so there is something new. Maybe that will come in a later session?

Regulatory Responsibility Act

A question on whether they would support a Regulatory responsibility Act.

English says there is support for defining the principles of good regulation, and using the bureaucracy to fight the bureaucracy so regulations can not proceed without ticking all the boxes which justify the regulation. Also said very keen to reform RMA. Bottom line is would support some sort of RRA.

Douglas supports a Minister of Regulatory Reform and an RRA.

Dunne says ironic to use legislation to fight against legislative regulations. Thinsk local govt sector is more of a problem.

Missed what Norman said.

Cullen says will make process too bureaucratic.

Company Tax Rate

EMA Northern advocated cut company tax rate to 20% as lead to more investment and eventually more tax paid over ten years.  Cullen attacks dodgy modeling of EMA. Says we have had lower company tax rate for most of last 20 years than Australia.  English says 20% rate would be fantastic but priority for now is reducing personal tax rates. If we drop company tax rate to 20% without personl rates going down, many more people will alter their tax affairs to take advantage.

EMA’s Thompson replied that when company tax rate has been cut in the past, the level of company tax has still risen.

Infrastructure

Cullen made good point that not all infrastructure contributes to economic growth – new planes for Air Force for example. But roads do.

Dunne strong support of PPPs and infrastructure bonds.

English – planning debt 2% of GDP higher than Labour but still one of lowest in developed world. Govt is running cash deficits also. National’s infrastructure plan is a prudent investment. Also thinks Govt manages assets badly, and there is room for improvement. PPPs not just about money, but about getting private sector skills around risk and management. Bill much better on this stuff. Lots of people commented at the tea break that they thought not enough detail on the earlier stuff, but very strong on infrastructure.

Paul Walker blogs a list of 10 economic propositions accepted by almost all the top economists:

1. The market economy is the most efficient of all economic systems.
2. Free trade helps economic development.
3. Good institutions help development.
4. The best measure of a good economy is its growth.
5. Creative destruction is the engine of economic growth.
6. Monetary stability, too, is necessary for growth; inflation is always harmful.
7. Unemployment among unskilled workers is largely determined by how much labor costs.
8. While the welfare state is necessary in some form, it isn’t always effective.
9. The creation of complex financial markets has brought about economic progress.
10. Competition is usually desirable.

Walker concludes:

Sorman closes this piece by noting that one of the hardest ideas to translate into language that public opinion will accept is the fact that even the best of all possible economic systems is still imperfect. Markets are one of the many human institutions that are the result of human action, but not of human design. But they are based on people and without perfect people you are unlikely to get perfect markets. But for all these imperfections, we have yet to find a better economic system.

Market economies are indeed not perfect. But as Paul Walker says, no-one has found a better system. It reminds of the Churchill quote about how democracy is the worst possible way to choose a Government – except for all the other ways!

Bill English delivered a well received speech on the economy to the conference. The key focus will be his comments on debt, so I’ll deal with them at the end and cover the other stuff first. First his summary of the economic picture:

On the negative side:

• The economy will continue to struggle.
  
• Inflation is high.
  
• Interest rates are high.
  
• The business outlook is grimmer than it has been since 1988.
  
• There is considerable uncertainty about some parts of the investment market, given the collapse of many finance companies.
  
• Oil prices are much higher than they were a year ago and, despite some short term relief, are likely to remain high.

On the positive side:

• Commodity prices are at an all-time high.
  
• Provincial areas are doing reasonably well, and the further south, the better.
  
• The dollar is dropping, pushing up export incomes.
• The economy is tilting more towards the export sector.

A good round-up.

First, we are going to have tax cuts. New Zealanders have been taxed too high for too long.

Even the Labour party has grudgingly conceded the argument. But it has come awfully late to the party. Australia is in its sixth year of significant personal income tax cuts and has signalled further cuts to come. It’s time we got started.

Tax cuts will put some cash in people’s pockets and that’s good. But the longer-term reason for cutting taxes is to improve the incentives to work, save, and invest – and that’s what National is committed to doing.

This is worth remembering. Tax cuts are great in that people get to keep more of their own money. But having tax cuts leading to higher economic growth is the bigger goal – for that is the way we get better services, and have more money.

Secondly, New Zealanders are not getting value for money – their hard-earned money – from government services. Too much is caught up in a burgeoning Wellington bureaucracy designed to make the government feel big and ministers to feel powerful.

And commercial property prices in Wellington keep going up.

Thirdly, we will cut red tape.

This is easy to say and hard to do. People wonder how we can be in favour of small workplaces, soundly build houses, and yet achieve it with fewer rules.

We will do it in two principled ways.

We will use bureaucracy against the bureaucrats. Let officials and ministers jump the hurdles, fill out the forms and incur the cost of compliance before they can have a new regulation. We will also attack specific costs, like complexity in the tax system, the time and costs of the RMA, and the extensive new rules and bureaucracy under the new Building Act.

Fight fire with fire – I like it.

Fourthly, we will introduce national standards in education.

Almost 10,000 young New Zealanders leave school every year without the basic competence to learn more skills….

We will introduce national standards in literacy and numeracy. This will be a spur to taking the best teaching practise from schools that are succeeding and spread this across the whole system. If every child is assessed and taught appropriately, we can help the thousands who now miss out.

This will take time but again we will not lift economic growth without improving our education outcomes.

Finally, we will lift the quality and quantity of New Zealand’s infrastructure investment, to remove the blockages that are currently holding our economy back.

New Zealand under Labour is virtually the only country in the developed world that refuses to use private sector financing and risk management techniques to help spend taxpayers’ money effectively and make it go further.

Over the next 10 years, central and local government will spend between $60 billion and $70 billion on infrastructure. We can do it badly or we can do it well. Let’s do it well.

That’s a lot of money!

So now let us look at the reports of deficits and borrowing – from NZPA:

But deputy leader and finance spokesman Bill English told delegates National was prepared to borrow more to fund infrastructure.

He said New Zealand had one of the lowest levels of debt of any developed country and “additional borrowing” for infrastructure would boost economic growth.

Any increase in debt for infrastructure would be transparent and voters could trust National to be a “conservative” manager of the economy.

“So that will be extremely clear cut and rather hermetically sealed.”

Mr Key argued that increased borrowing overall — ostensibly to fund infrastructure — could be separated from National’s tax cuts.

“What effectively will be happening is you will be able to see exactly what our tax cut programme costs, exactly what Labour’s cost, exactly what we are delivering, what differences or priorities we’ve chosen over Labour’s.

Now one is going to hear a lot of rhetoric around this, so I am going to try and explain the situation by looking at a normal company’s accounts.

A company has three major financial statements – the income and expenditure, the balance sheet and the cash flow.

The income and expenditure is the measure of profitability and to a degree of sustainability. The difference between the two is your profit/surplus or deficit/loss. Asset purchases, borrowing, investment in infrastructure doesn’t directly show up here. However depreciation on assets does show up as an expense, as does interest on any borrowing. So if you borrow too much, you will face pressure on your surplus, as interest costs go up. In the bad old days before Ruth, interest on borrowing was something like over 20% of all expenditure.

In the 11 months to May 2008, the surplus is $5.3b and the underlying surplus (excluding one offs) is $7.3 billion. These are forecast to reduce massively in the next few years due to a weaker economy which means less tax, plus tax cuts plus increased spending.

Interest expenses are currently $2.8b out of total expenditure of $66.8b – so less than 5% of expenditure. However the Crown also gets revenue from investments it has – and they totalled $3.0 billion. So in fact the Crown made $200 million more from investments than it paid on debt.

You do want to make sure interest expenses do not get too high – but as Bill English said we do not have a debt or interest problem at the moment – we have a productivity problem.

So you do want the income and expenditure to be in surplus, or at worst for any deficits to be temporary – with there being a surplus over the medium term.Companies really want to be profitable every year without fail. A country isn’t quite the same – instead of paying dividends through profits, you pay dividends through tax reductions.

Next we have the balance sheet. These are your assets and liabilities. Many major transactions happen here, and don’t even directly affect the income and expenditure. If you buy a frigate for $1 billion then you simply have an increase in assets of $1 billion and an increase in debt of $1 billion or a decrease of the cash asset.

Now many asset purchases are funded through borrowing. Why would you do this? Well a couple of reasons. The first is if one gets the value from an asset over 30 years, then it is fairer to spread the cost over 30 years.

The second, and more important arguably, is that the value you will get from the asset, is greater than the cost of the interest of borrowing to purchase it, so that the company/country as a whole becomes more profitable.

Let’s take an example of say a polling company. You may want to buy 40 computers with CATI software on them at a cost of $400,000. But you don’t have $400,000 in the bank. So you might borrow $400,000 which will mean an interest cost of $32,000 a year. And if they are expected to last for 10 years depreciation of $40,000 a year so it will add $72,000 to your annual expenditure.

But having that software may mean you can call people 30% faster. So if your annual wages bill was $500,000 it shrinks to $350,000. Hence the $72,000 a year expenditure leads to $150,000 of savings and you profit increases by $78,000.

So what this means is borrowing for infrastructure and assets can be both fair and a good way of increasing profitability,

But it does increase risk. If you lose some customers and revenue drops, then you have fixed costs with interest and depreciation instead of variable costs such as wages, and your chance of going bust is higher.

Hence it is not universally good or bad to borrow for asset purchases. It depends on how much existing debt you have, and what you are going to buy with any borrowing.

Finally we have the cashflow. This is where you track the cash in and out from both your operating account and your capital account (plus some others). Now there are linkages. If you have a small cash surplus in your operating account and a larger cash deficit in your capital account, then you have an overall cash deficit. And as I said before the more cash you borrow the more it adds to expenditure.

But there is a difference between cashflow for operating and capital. It is quite normal for there to be a cashflow deficit in the capital account – an expanding business often is purchasing assets faster. The challenge is whether the borrowing on those assets overwhelms your operating account.

If we look at the Government, Dr Cullen himself is saying he will run a cash deficit – he will (just) have a cash surplus in the operating account but have a cash deficit in the capital account. Bill English is saying he will have a larger cash deficit – but again it seems in the capital account primarily. They have not ruled out a cash deficit in the operating account, but if so it is expected to be minor and temporary.

Until we see the actual figures from National in October, it is silly to get too worked up about it – after all Cullen is already running something like a $10 billion cash deficit over three years. The issue is not the size of the cash deficit per se – but what impact it will have on net debt (gross debt is far less important than net debt) and what impact it will have on interest. And most of all what is the long-term forecast in terms of the operating surplus.

Bill Ralston writes:

For the next couple of years, expect to see higher unemployment, longer queues for food banks and more mortgagee sales – in short all the usual side-effects of a depressed economy. For Gen X and Gen Y, who have never experienced those conditions, there will be real anger, politically. Even if Labour survives the election it will experience a savage backlash among younger voters.

Cullen’s budget is still to come and he may move swiftly to ease the burden people face, but there has been little evidence of joined-up thinking in Labour’s approach in recent months.

Yes, there is the prospect at some point of some modest tax cuts aimed, according to Cullen, at low income earners. Yes, Helen Clark did decide to delay the implementation of some of the punitive taxes on petrol for a couple more years.

But the majority of mortgage-belt New Zealanders, who languish largely ignored in the hard-pressed middle-income bracket, have little hope of relief. The Government’s ill-conceived emissions trading scheme is set to soak billions of dollars out of households and small businesses and large corporations and agriculture will get a free ride for many years.

This has been a brilliant fair-weather Government, cruising through calm economic times. Conditions have changed yet it seems incapable of changing course. Batten down the hatches, guys, it can only get worse.

Bill forgot to mention that billions of extra taxes the Government will collect through the ETS. It may be the biggest tax hike of all times!

No Right Turn blogs that he believes the NZ First advertisements do breach the Electoral Finance Act as “a reasonable person would regard it as an encouragement to vote for NZ First”. I agree. As Idiot/Savant says it is not a survey, it lays out policy and encourages approval of it.

Poneke has more on the BBC story on climate change which got modified. The reporter denied he did it under pressure, but an activist has blogged she successfully pressured him to change it.

The visible hand in economics looks at fixed vs floating exchange rates.

The DAFT Party has a solution for China over Tibet. It is to rename China to Tibet, and declare they are all Tibetians. The PRC Government should see the sense of this now they are running a market economy – you replace a tarnished brand with a more positive brand!

Bernard Hickey has video and a blog post on Alan Bollard’s speech suggesting we are talking ourselves into a recession. Bernard says we’re not, and if we do have a recession, it is because we deserve it! Them’s fighting words! It’s a lengthy excellent post with many graphs.

The BNZ has made a gutsy call and says:

The BNZ says there is a greater than even chance that a recession will happen in the second half of the year.

“We have become victims of an almost perfect storm,” Mr Toplis said.

It has resulted in New Zealand businesses and consumers being pummelled by a combination of a global credit crisis, falling house prices, record fuel costs, a strong Kiwi dollar, high interest rates and the effects of the drought.

He warns that indicators such as the rapidly slowing housing market are just precursors and the credit crisis is only beginning to be felt by the wider economy.

Households are struggling under the weight of higher mortgage repayments and businesses are faced with rising debt-servicing costs as banks pay more to borrow overseas.

Household disposable income will be eroded by rising costs for food, electricity and rates, Mr Toplis says.

Transport companies and supermarkets say record fuel costs will have to be passed on to consumers.

“The economy is now very poorly and may well stay that way for some time to come,” Mr Toplis says.

Some of the factors are local, but the global economy isn’t looking too flash either.

A leading economist did a presentation to the Business Roundtable Retreat on Friday. It was Chatham House Rules so I can report some of the detail – but not who said what. It was an analysis of the trends and issues in the economy, and then some possible solutions.

• The 90 day bill rate predicted to drop in 2009 to 6% but then to increase and stabilise at 7%
• A small increase in the unemployment rate reaching 4% in 2010
• The equilibrium level of inflation may have increased from 2% to 2 1/4 to 2 1/2 per cent.
• Migration to Australia would continue and this would be of the relatively “more productive” New Zealanders. This isn’t a judgement on education levels or intelligence as much as recognising they are people with “skills established in this economy” so generally more productive here than any replacements.
• Mining in Australia is only 7% of GDP and 2% of their workforce so incorrect to credit the minerals boom for their economic growth.
• The big challenge for NZ is to increase our productivity, and it is hard to do this with a declining talent pool. Hence we have a vicious circle – the more people who leave, the harder it is to increase productivity so incomes can increase to keep people here.
• Agricultural Protectionism is a real issue and hurting the agricultural sector
• Multilateral trade deals and plurilateral trade deals are better than bilateral deals
• NZ needs to shift focus in trade deals from purely agricultural access to also have investment rights in agricultural processes and storage facilities.

He also did a very nice summary of one of the problems with the current macroeconomic model. Basically, if I recorded it correctly, it is:

1. Increasing Inflation –> Increasing Cash Rate
2. Increasing Cash Rate –> Increasing Interest Rates
3. Increasing Interest Rates –> Increased NZ$
4. Increased NZ$ –> Decreasing Exports
5. Decreasing Exports –> Decreasing Economic Growth
6. Decreasing Economic Growth –> Decreasing Investment
7. Decreasing Investment –> Decreasing Productivity Growth
8. Decreasing Productivity Growth –> Decreasing Aggregate Supply
9. Decreasing Aggregate Supply –> Increasing Inflation

In one sense it is an argument why it is important to keep inflation under control from the beginning, but it does highlight a weakness in the current monetary policy cycle. Whether there is a better solution though is the real question.

It was suggested that the RBNZ targets should have the emphasis on targeting inflation over the medium term removed, as it has led to timidity with the RBNZ late to act, with the consequence being inflation and interest rates stay higher for longer than they otherwise would have been.

He also highlighted some ways to increase productivity:

1. Encourage people to stay in NZ
2. Increase the returns for effort
3. Reform and reduce tax levels
4. Get rid of redistribution policies which just redistribute money back to those who pay it, and adds a deadweight cost to the economy
5. Reduce the rate of growth in the public sector relative to the private sector
6. Make it easier for employers to release lower productivity staff

Now people can make arguments against each and every one of these on grounds of social justice or fairness etc. I mean for example I wouldn’t advocate being able to get rid of staff at whim. But the point the economist was making is that if you don’t do these things, you will find it harder to increase productivity growth. So it is all a trade off – if you do not do any of the above you’ll watch the gap with Aussie grow even faster.

There is also a list of what not to do:

1. Don’t discourage the able from staying
2. Don’t discourage more effort
3. Don’t discourage investment
   1. Don’t ignore property rights
   2. Don’t have costly planning requirements
   3. Don’t increase the regulatory burden
   4. Don’t impose climate change policies which have large risks for investors

It was clarified this wasn’t an argument for having no policies to mitigate climate change. It was for uncertainty and risks to be minimised.

And again people can argue for or against each of the above – it was just a reminder that there is a cost to productivity growth if you do discourage effort and investment etc.

To some degree it was a bit gloomy.  The vicious cycle with migration and the impact of monetary policy on productivity growth make it very clear that closing the gap with Australia will not at all be easy.  It won’t just happen by chance without a change in policies.  And there will be no one or two simple things to do – it will only happen as a result of taking action in a dozen different ways, each incrementally helping increase productivity growth.