Thursday, 26 May 2016

No drama - and that's fine

First thing I'd say about today's Budget is that I hope the central economic forecasts work out as expected. If we do indeed get annual economic growth of close to 3% a year, low inflation, and the unemployment rate gradually falling to 4.6% by 2019, we'll be doing quite nicely, thank you. The growth numbers aren't as hot if you do them on a per capita basis, as you really ought, but even so 1.3% a year isn't too shabby. And a 4.6% overall unemployment rate does a power of good for getting more marginal groups into employment.

The Budget is one of the few places where people can get some sort of feel for one particular facet of the economic outlook, namely what is likely to happen to business profits in coming years: we don't yet have a Statistics NZ measure (most other countries do), but fortunately Treasury has to forecast them to get a handle on likely company tax. For agriculture, it's not pretty, as you'd expect given the loss-making level of dairy prices in particular: agricultural profits are expected to have dropped by 5.6% in the March year just finished, and to drop a little more (‑1.6%) in the year to next March, before snapping back smartly in the years to March '18 (+29%) and March '19 (11.5%).

For non-agricultural businesses – the bulk of the economy – profits went up only 2% in the year to March '16, are expected to grow only slowly in this current year to March '17 (+1.0%) and to do rather better in the following two years (+8.75% and +7.25%), though it's far from a profits bonanza. Currently, our share market is trading on a historically high valuation: that is partly down to low interest rates making equities relatively more attractive but (if these Treasury numbers play out) it may also be down to unrealistically optimistic expectations on corporate profits.

There were no big tax or spending initiatives, and that's good. We may have more of a splurge next year as an election looms closer, but not this time round: on Treasury's measure of the 'fiscal impulse', this year's Budget was effectively neither expansionary nor contractionary. And that's okay: “steady as she goes” is – mostly – fine. Outside emergencies, we don't need abrupt, unsignalled change in fiscal policy. We certainly don't need populist Finance Ministers splurging to win elections, or running perennial deficits to build taxpayer-funded clientèle constituencies, which has been the fiscal downfall of a number of European exchequers. And the fact that our government finances are now in good shape by developed economy standards is a tribute to a succession of Steady Eddies in both major parties – not that they get much credit at the time from the squeaky wheels demanding public grease.

It's good to know too that the fiscal surpluses look reasonably robust to whatever the economic outlook eventually throws at them. As usual, Treasury runs some alternative 'better' and 'worse' scenarios, and even on the 'worse' outlook, the fiscal outlook remains solid. There are borderline deficits/surpluses for a couple of years, and then surpluses re-emerge in 2019 and 2020. And you can see other evidence of fiscal responsibility elsewhere in the Budget data. Since the last major economic update last December, for example, expected tax revenues over the 2016-20 period have improved by $3.6 billion, which in some hands would have been an excuse for a knees-up: in fact,  expected spending has been revised down by an equal $3.6 billion.

I've qualified the fiscal outlook as “reasonably” robust, because there's still one factor in the background that's flattering the accounts, and that's our export prices. Sure, dairy prices are at a low ebb, but overall the country is still benefiting from export prices that are still substantially above their historical averages when compared to the cost of the things we import (our 'terms of trade'). Maybe they'll stay there. But maybe they won't. If they didn't, our fiscal picture would look more like this.


The dark blue line shows the fiscal deficit, adjusted for the state of the economy (the 'cyclically adjusted balance', or CAB), as a percentage of GDP. As a general rule, it's a much better guide to the true state of the fiscal books than the headline number you'll see in the newspapers, but at the moment it doesn't make a lot of difference as both the headline number and the cyclically adjusted number are showing the same thing: a modest surplus gradually turning into a more substantial one. But the dashed line shows what the deficit would be if our export prices compared to our import prices dropped back to where they've been on average over the last 30 years. We'd still be in deficit – not a big deficit, and even from this downbeat perspective we'd be back to breakeven by 2020 – but it's just worth remembering that, while we have been good fiscal managers in recent years, and genuinely do have some room to manoeuvre if we want more spending or less tax or less government debt, we still wouldn't want to go mad about it.

The tweak around the edges I'd have liked to have seen would have been more infrastructure spending, partly because we're short as things stand, partly because I think it's part of the answer to getting that 1.3% per capita growth up to something  more substantial, and partly because borrowing costs are exceptionally low, so it's an excellent time to borrow to pay for assets with a long-lasting payoff. And one of the handout blurbs was headlined “$2.1 billion investment in public infrastructure”, which sounds at first blush like it got adequate attention.

But that's a total over four years ($700 million in opex, $1.4 billion in capex): per annum, it's not a lot in the great fiscal scheme of things. And it's also hugely dominated by the upgrade to the IRD's computer systems, which are going to cost a scarcely believable $1.4 billion ($1.06 billion opex, $350 million capex). Some of the rest is merely keeping pace with the growth in population (new schools are required, for example) or replacing and strengthening Canterbury infrastructure. There's very little left that you would regard as a genuine increment in the amount of infrastructure per capita – and little or nothing specifically targeted at the biggest infrastructural deficit of all, the one in Auckland.

More positively, it's good to see that Treasury plans to make at least some use of current exceptionally good borrowing terms. There are plans for a new 20-year bond to be launched later this year. That's a start, but other countries are way, way ahead of us in taking advantage of the current global borrowers' market. Switzerland has just done one for 42 years, France for 50, and Belgium (!) and Ireland (!!) have managed 100 year issues.

Overall? There were some nice micro measures (like funding for more apprenticeships and other aids to get people into jobs) – there may even have been too many micro programmes. But it was also missing a few things: there was a good deal of faffing, but less substance, on housing and multinationals' tax, and it should have done better, even within an overall conservative setting, on infrastructure. But, as I said earlier, not enough credit is given at the time to Finance Ministers who steer a steady course: another year of continuity and responsibility is a good outcome.

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