Public Sector Finance Forum

Today I’m going to talk about getting better public sector performance from public spending which is coming under increasing pressure.

In the time available, I want to cover three things briefly:

• The evolving frameworks for New Zealand’s fiscal policy
• The short- and long-term challenges we are currently facing
• The tools we are using to combat these challenges.

My key message is that these challenges will be faced by the incoming government, and by subsequent governments. These challenges are not going to get easier. Past governments have asked for better performance from the public sector, and for better information about that performance, and sad to say, in many cases we haven’t got what we asked for.

These challenges are going to put the acid on us, the policy makers, present and future, and on you, the public service, to lift productivity, to achieve better outcomes from limited resources. Demographic and other likely changes are going to put huge pressures on these resources.

We will be living in interesting times.

One side of this is maintaining a sound fiscal position. That’s something the private sector notices only when it is absent. As anyone knows who attempted to run a business during the late 1970s and 1980s, fiscal instability, resulting from either uncontrolled expenditure or unstable government revenues, or both, is bad for business and bad for everyone’s confidence.

It creates an environment of uncertainty, where firms and individuals know that governments may have to alter tax policies, or increase debt, to fund essential services.

A credible programme of prudent management of public expenditure and revenue provides an underpinning of stability and security. It is an important consideration for credit rating agencies and finance markets when they assess sovereign risk and determine interest rates.

From both historical and international perspectives, New Zealand’s fiscal position currently reflects best practice for macro stability and sound public finances. On-going surpluses, low debt and growing net worth mean that fiscal policy can ride through, and smooth, shocks that temporarily reduce economic growth.

We have done well in achieving and maintaining fiscal stability over the past six years. It’s worthwhile reflecting that this hasn’t always been the case, it takes hard work, and countries can see their fiscal surpluses reverse quite quickly. History is littered with examples of such fiscal train wrecks, and we in New Zealand have contributed some of our own.

Remember the lack of resilience in the economy in the 1970s when the oil price shocks hit and our trading patterns changed with the entry of the United Kingdom into the EEC. And then there was the on and off spending over the electoral cycle during the 1970s and the early 1980s. These factors introduced uncertainty and variability into the New Zealand economy. The result was a steady upward rise in government debt.

A decade ago, the government of the day introduced the Fiscal Responsibility Act. It aimed to improve fiscal management and bring a longer-term focus to budgeting. The Act has two planks: increased transparency and greater accountability and has some similarities to the Reserve Bank Act governing monetary policy.

Unlike in some countries, the NZ fiscal policy framework is set around principles, rather than legislated rules. The government assessed that detailed legislated fiscal targets were not flexible enough to remain credible in changing economic circumstances and over time could distort decision-making. The evidence then seems to have been well supported by more recent experience.

If imitation is the sincerest form of flattery, we can take heart that similar approaches to the FRA have subsequently been adopted by Australia and the United Kingdom.

And how have we done over the past six years using this framework?

As you are aware, we have run a conservative fiscal policy over this time. We also have been helped by a buoyant economy, which often outstripped everyone’s expectations.

So with some luck and a lot of good management, we have made significant progress in reducing gross public debt from 35 per cent of GDP in 1999 to 23.5 per cent in 2005. Since 2001 we have been building up assets to pre-fund some of the pension liability and help smooth the way through the years when we will have a rapidly growing proportion of older people in the population. The accumulated assets in the New Zealand Superannuation Fund have reached $6.6 billion, or 4.4 per cent of GDP, in 2005.

As the New Zealand Superannuation Fund continues to grow, its necessity as a piece of public policy is gaining wider acceptance, as is its positive impact on liquidity in the New Zealand capital market.

According to the pre-election update forecast, the result of our stewardship is that by June 2006, the New Zealand government will, for the first time ever, move into a net positive financial asset position, including all financial assets of the core central government.

The fiscal framework has helped us control core government spending relative to GDP, so that we now spend less than in 1999, down from 33 per cent to 31 per cent.

That shrinking of government has occurred at a time when most OECD countries either held government expenditure steady as a proportion of GDP, or increased it slightly.

Over the short run, we face some challenges to maintaining the fiscal position. We are expecting a slowing of economic activity.

Other things being equal, this should mean a slowing of revenue and a rise in spending, if unemployment rises. I say, “should mean” because this slowdown has been just around the corner for a number of years and economic growth and revenue have stubbornly kept on going, despite the best efforts of our forecasters. But if they’re right this time, then the fiscal position could be under stress over the next couple of years, for the first time since the late 1990s.

The short-run slowing of revenue growth means that we have to consolidate spending after the launch of large initiatives like Working for Families.

For the longer term, one of the most important threats to fiscal stability remains the on-going demographic transition – the growing proportion of older people in our population. By 2050, the proportion of people over 65 in our population is expected to more than double from the present proportion.

This is the result of low fertility over the past 30 years and rising life expectancy and the expected continuation of these patterns over the next half century or so. Demographics, however, is only part of the story. Some of the rise in health care costs comes from an older population, but much is driven by technology and the rising expectations of the population. So it’s less about ageing and more about policy choice.

Our public finances show we are far better placed to deal with these challenges than we were six years ago. We have run surpluses to bring down the debt-to-GDP ratio. A low debt ratio is a cushion against economic shocks. The New Zealand Superannuation Fund is designed to help us smooth the transition to greater demands on the public pension system.

The solution to these pressures in the near term and further out lie in good performance, good policy and maintaining fiscal control.

Part of the solution is to improve the performance of the public sector in delivering health services, social support, transportation and so on. The legislation being discussed at this forum gives us new tools for boosting this performance, and new ways of measuring how well we are doing.

Another part of the solution is to think hard about policy responses to the effects of the ageing population. As a society, are we saving enough to support our retired population through the decades to come? Should we start to make further changes to our policy settings now to ease the burden later and give people time to plan for the changes?

We face the challenge of setting short-term fiscal intentions which will align with and help to achieve our long-term objectives and prepare us for the challenges of an ageing population. For the longer term, our fiscal framework will require retuning our objectives to meet changing circumstances.

The effect of the ageing population on the fiscal accounts in the third and fourth decades of this century means we need to clarify the preferred movement of debt after 2015-20 and to think about a sustainable level of spending to GDP through this period.

To close, these short- and longer-term fiscal challenges will be faced by the government formed after this week’s election and by subsequent governments. These challenges are not going to get easier. Present and past governments have asked for better performance from the public sector, and better information about that performance, and in many cases we haven’t got what we asked for.

These challenges are going to force us, the policy makers, present and future, and you, the public service, to lift productivity, to achieve better outcomes from limited resources.

Thank you.