Monday, May 2, 2011

Not the time for tweaking

The following article appeared in today's issue of the Dominion Post:

Around the world, many countries are struggling to successfully navigate the pathway to fiscal sustainability. Even where economies are technically recovering their overall fiscal situation usually remains fragile. This means that higher growth as the economic cycle matures is not guaranteed to close budget deficits. Because those deficits are structural in nature, they will require cuts in Government spending and/or increases in revenue to bring them back to at least more sustainable levels or, preferably, put the country’s accounts back into surplus.

The challenge and the imperative to get this job done properly was recently demonstrated by rating agency Standard & Poor’s putting the AAA credit rating of the United States on “negative watch”. While not a credit downgrade yet, the agency has signalled a 33% chance of going down that track.

It is well worth remembering this downgrade happened to a country whose dollar is the world’s reserve currency. Because of that status, there is always strong demand for United States debt instruments but there are limits - even for America.

The timing of the announcement was unusual in one respect. President Obama, in one of his best political speeches yet, had recently signalled his intention to cut the US budget deficit by $US4 trillion over the next 12 years. That’s just a tad shy of the $US4.4 trillion the Republicans wanted to cut off the deficit over the next 10 years.

Superficially, that may sound like political agreement but that is certainly not the case. The Democrat’s program includes spending cuts and tax increases while the Republicans would rely solely on spending cuts. More than eighteen months out, the first shots have been fired in the 2012 Presidential election.

On reflection, that is why the timing of Standard & Poor’s announcement perhaps made more sense than first thought. They were sending politicians a clear message to just get on with it.

Our own Budget is scheduled for May 19. Over the last two years, we have given the government, in the wake of the Global Financial Crisis, high marks for turning around the deteriorating trajectory of the budget deficit and key debt ratios. They have also managed to pass some important reforms of the tax system since being elected.

We have, however, given them low marks for recognising far less dealing with our long-term fiscal challenges. This is essentially the long-term sustainability, or more crucially the unsustainability, of some of the larger expenditure items. The scale and urgency of those challenges are increasing because the economy remains soft, the devastating Christchurch earthquakes hit and the well-reported finance and insurance sector bailouts impacted.

Now appears to be the ideal time to get on with the critical job of ensuring greater sustainability around expenditure. “Reprioritisation” has already become the 2011 budget buzzword. That will inevitably mean compromise which is always challenging in a highly charged political environment. As demonstrated in America, this is not a time for political pragmatism here – it is a time for hard decisions to be made in a timely fashion. 2011 is not the year for simply Budget tweaks.

The National-led Government is signalling they get it. Carefully managed pre-Budget hints indicate high-cost policies such as Working For Families, Student Loans and KiwiSaver are all in for some change.

I want to focus on another area of government expenditure – support for economic growth.

Globally, governments struggle to articulate their role in supporting economic growth. As a result, many countries end up with a multitude of agencies and programs providing nothing more than an uncoordinated scatter-gun approach to economic intervention, the sum of which doesn’t really add to economic growth. New Zealand is no exception.

“Re-prioritising” some of these programs seems a no-brainer. However, reprioritisation needs a framework to work out what is and what isn’t a priority. That framework is lacking in New Zealand.

In terms of supporting the innovation system, politicians need to understand how it works and what appropriate roles the government can play to support it.

Here is a starter-for-ten. Innovation happens in firms, not in government. The role of government is simply to create the right environment for innovation and for entrepreneurs to be able to commercialise those innovations. The strength of the individual parts of the innovation system is important, but so too are the linkages between the system and the wider business community.

In that regard, one of the best announcements in Budget 2010 was the $20m allocated to building those connections. Support for economic growth does not necessarily have to be expensive.

Traditionally, every Budget gets a nickname though usually for the wrong reasons, as demonstrated by the so-called “Black Budget” and “Mother of All Budgets.” The 2011 Budget needs to buck that trend. Given the circumstances, the electorate will respect a government which makes hard decisions provided they are consistent with a well articulated plan for a better future.