Reflections and Projections - Cullen
Cullens speech to the financial planners seminar. Reflecting on the past year and looking forward in terms of the government’s intentions and the likely shape of events in 2001 and beyond
Thursday, February 8th 2001, 12:43PM
It is my pleasure to be able to participate in this conference. This is my first major public speech on the economy this year. As such it is a good opportunity to look back over the past year and to look forward in terms of the government's intentions and the likely shape of events in 2001 and beyond.
I say "likely shape" very deliberately. One of the assertions I most frequently hear is that business and the financial sector look to government to provide certainty in terms of the business and financial environment. I think it has to be very clearly stated that that certainty can only be provided in terms of the government's own intentions and actions.
It is beyond the capacity of government, or indeed anybody in the modern world, to offer absolute certainty. That is true of even the world's most powerful economy. It is certainly even more true of New Zealand.
We have seen a great deal of volatility over recent times. Not just volatility in terms of such subjective measures as business confidence but also in the actual and real environment within which business has to operate.
From the Asian crisis, through the hype of Y2K, to fears over policy changes, to the uncertainty over the whether the Japanese economy will ever lift off again to a stronger growth path, to the recent concerns over the nature and extent of the slowdown in the US economy, we are surrounded by uncertainty. Perhaps the fundamental lesson that many of us have yet to learn is that we have to accept and plan for a significant level of uncertainty, even when things seem most settled.
For example, only a year ago the emerging consensus was that the US economy had entered a new high phase of productivity and therefore economic growth. Some were even predicting the end of the business cycle as far as the US economy was concerned. This all looks very silly already as we rediscover the normality of much about the US economy.
These external factors are, of course, crucial for New Zealand. Changes in the world economy obviously have a strong influence on our economic prospects. Though, having said that, we also need to remind ourselves that we are such a small part of that world economy that very small changes in our world market share can still see us grow strongly even if world growth slows.
Sadly, the opposite has been the case for much of the last forty years. Had we even kept pace with the rest of the developed world we would now be a far wealthier country than we are. Which also serves to remind us that some of the explanations for our relatively poor performance are, at the least, less than completely convincing.
For we have done worse than countries with both lower and higher tax rates, more and less rigid labour markets, lower and higher social spending as a proportion of GDP, and less and more regulated economies. Focussing on these issues to the exclusion of all else is rather like the daily media game of describing the changing value of the New Zealand dollar without reference to what is happening to other currencies such as the Australian dollar and the Euro. The real explanation of what is going on is thus left out as people try to explain movements in purely New Zealand terms.
In the same way, the government is convinced that the major challenges that we face as a nation in terms of improving economic performance lie in different areas of need than those which have often dominated public policy in the last decade.
Last year we had some difficulty for much of the year in conveying that message as clearly as we would have liked. Arguments over policy changes in accident compensation and industrial relations dominated relations with the business community for the first three quarters of the year in way which led to a sense of frustration on both sides.
But by the end of the year the seeming stand off had been replaced thanks to a great deal of effort and goodwill on both sides. As a result we have seen strongly rising business confidence which is reflected in a stronger outlook for this year. The main threats we face are external - pre-eminently a Japanese economy which continues to struggle to recapture its past strength and the uncertainty over the extent of the slowdown in the US economy.
Whatever the short-term impacts of these two external factors - which, in my view, will not be as serious as a few commentators think - it is crucial we do not take our eye off the ball as far as the real issues we have to deal with are concerned. Indeed, whether we are looking at the short, medium, or long term requirements we end up specifying the same core issues which need to be addressed to improve our performance. Thus while external circumstances and the uncertainty surrounding them will impact rather unpredictably on us in the short term, that fact should not have any significant impact on the agenda the government should be following.
The agenda which will be pursued this year will, amongst other things, include the following:
- reducing compliance costs for business
- support for exporters
- attraction of investment for growth
- active business development policies
- the promotion of human capital and
- lifting our savings performance
Obviously this is a very large agenda and, while all of it is of some relevance to financial planners, some aspects are much more important from your perspective. Easily the most important is savings and I will come back to that in a few minutes but first I will deal quickly with a few other issues which may be of particular interest.
The attack on business compliance costs has both a general and a specific focus. The general focus is reflected in the work now begun by the panel under Alan Dunn. But from my perspective there is a special interest in a focus on the taxation side of compliance costs. A discussion paper on the compliance and penalties regime will be issued in a couple of months time. But other work will extend well beyond that discussion paper and I have asked Paul Swain as Associate Minister of Revenue to take special responsibility for these matters.
Particular attention is going to be paid to simplifying business taxation for small businesses.
Also on the agenda as far as taxation is concerned is progress on the so called triangular tax issue with Australia. I am sure we will make sure progress, but whether as much as we would like we shall have to wait and see.
Finally, in terms of taxation, is the vexed question of research and development. There still seems to be some misunderstanding of the proposal in the discussion document issued last year, particularly a failure to recognise that the present arrangements will remain available for those who want them.
The Australians have just decided to make
their system even more complicated and targeted. This will benefit
some companies and especially those with an overwhelming scientific
bent - but will be much less helpful for small to medium sized
companies with an innovation emphasis. We should certainly not
emulate the Australian model but find simpler and more broadly
based solutions to encouraging research and development.
The government will certainly remain keen to attract new companies into New Zealand, especially where that involves value-added or high level production. Already there has been a shift towards more business-specific investment attraction and I expect this to continue. The recent approval for the Nissui participation in Sealords, for example, was very much influenced by the value-adding strategy that was an explicit part of the application for approval.
In that respect it should be noted we have established an Inwards Investment Fund to lower barriers for potential investors.
The single most important issue on the government's agenda this year as far as this group is concerned is superannuation and savings policy.
The New Zealand Superannuation Bill is now in the hands of the Finance and Expenditure Select Committee on which all political parties are represented. Most, I believe, are going to make a genuine effort to come to grips with the Bill and, hopefully, to seek common ground.
Sadly, that will not be true of all. I see that the ACT party is starting to behave in a rather silly and childish way. Mr Prebble has tried to get all 1800 people on his mailing list to send in a form style submission to try to tie up the select committee for ever and a day while the usual nonsense is being talked about politicians running the fund.
Given all the agony we have been through over superannuation over the last thirty years, I would have hoped for something better. But the other parties - including National - are, I believe, taking by and large a more mature approach after some initial quibbling.
It is, therefore, worth my while to emphasise again the basic features of the scheme and its underlying intentions.
The basic intention of the scheme is to provide a sensible and secure basis for the long term provision of the first tier of retirement income. It is not designed to be an answer to all retirement income needs.
The state's responsibility is to ensure a basic adequate standard of living in retirement. It is clear that the state cannot, and perhaps should not, do more than that. But neither can it, or should it, do less.
Often the claim is heard that the government should send the message that future retirees will have to rely upon themselves, that the state will not be able to afford any sort of adequate pension.
Against this two points need to be made. The first is a simple economic one. That is, if we collectively cannot afford an adequate pension then most of us will not be able to afford it individually either.
The second is that, on present projections, the long term future cost of public pension provision is no more than some European countries pay right now. It is important not to terrify ourselves and, instead, to maintain a sense of proportion.
The political reality is that the state will always bear the final responsibility for ensuring retirement income adequacy. A government which tries to escape from that responsibility in New Zealand will escape into opposition. It is a point I have made many many times over the years: any long term answers on superannuation have to take account of the power of the ballot box. And neither present nor future superannuitants are going to vote themselves into poverty.
Having settled that, it is important to recognise the virtues of some aspects of New Zealand Superannuation as it is at present structured. Because it is a flat rate payment it most perfectly meets the test of basic adequacy. Schemes which relate first tier provision to previous earnings end up providing for some, but not others, a level significantly higher. This means they are both more expensive, costlier to administer, and perpetuate into retirement inequalities in working life which, I would argue, it is not the government's role to do.
Our proposed scheme preserves that flat-rate structure. It also preserves universality which means it does not act as a disincentive to private pensions.
But by engaging in substantial partial prefunding it goes a good deal further. It greatly smooths the demographic transition - indeed leaves open the possibility in the longer term of increasing the amount of prefunding so as to reduce future reliance on taxation as the source of funding. And it establishes a clear connection between savings and future income provisions.
That, I believe, is more important than many have so far recognised. I would argue that three factors in our present retirement income framework have contributed to the low and declining level of private savings in New Zealand.
The first has been the uncertainty over New Zealand Superannuation. Economists would argue that uncertainty ought to lead to more savings as individuals move to fill the gap.
We have tested that theory to death in New Zealand without any sign at all that it is true. We should not be surprised. Faced with no clear indication of what to do many have reacted by doing nothing. What is needed is certainty over the future level of New Zealand Superannuation so people have clear and achievable targets for private savings.
The government's proposal goes further in meeting that objective than any other proposal in the public arena. Certainly its major alternative: compulsory private savings on some defined contribution basis does not and cannot do any such thing.
The legislation to set up the scheme consists in three parts.
Part One sets out the entitlements, Part Two establishes the governance arrangements and Part Three sets out a process for other parties to sign up to either or both of Parts One and Two.
I am aware that the governance provisions will be of interest to this audience. Briefly, Treasury will be responsible for calculating each year the required annual contribution to the Fund on a forty year rolling horizon.
In most years, the government would be expected to accept the Treasury's recommendation. Where it did not, it would have to explain why the shortfall and how it planned to make that shortfall up in later years.
The Fund will be managed by a separate Crown entity board called the Guardians of New Zealand Superannuation. They will be responsible for determining and executing the investment strategy for the Fund, and will be required to manage it on a prudent commercial basis that seeks to maximise returns without bringing undue risk to the Fund as a whole.
The legislation protects the independence of the board from political interference. It provides explicitly that the board must have regard to rather than give effect to any directions from the government.
The Guardians will be held accountable for the performance of the Fund. They will be required to issue an annual Statement of Intent that sets out the expected performance of the Fund over the next year, the key risks to that performance and the actions they plan to take to manage those risks.
They will also prepare an annual report,
and will be subject to independent reviews of their performance
at least once every five years.
I believe that once the provision of the public pension is put on to a secure footing and people know what they can expect from the state, they will be more motivated to increase their private retirement savings.
But to encourage that happy development, we may have to address a taxation system which has never been very savings friendly and has become less so over time.
Changing the present regime is not going to be easy. I would be less than honest if I claimed that either Treasury or IRD is keen to change the present taxed-taxed-exempt regime for private superannuation. It is possible to frighten oneself very severely with the likely fiscal cost of a change which would see all savings at present in the TTE regime moved into an alternative such as TEt (taxed-exempt-partially taxed).
But no-one, not myself and not the savings industry, is planning to do that. Discussions are occurring about how and what sort of changes can be made. But let me be blunt - the present system is broken and does need fixing.
Our savings record is very poor, and our long term savings record even poorer. It is pointless to bemoan the loss of New Zealand ownership of New Zealand assets unless we are prepared to generate more of our own investment needs.
But therein lies the third problem, perhaps the hardest of all. For, even if we lift our savings record, more of those savings will be invested in New Zealand only if we lift our overall economic performance and therefore offer comparable returns on savings.
This is not just a matter, however, of stronger growth. The taxation and compliance costs regimes with respect to superannuation do themselves influence the returns to savings.
Thus I come back to the central importance of an informed debate on taxation and savings this year. That has to be conducted within the constraints of fiscal reality and responsibility - including the government's plans for partial prefunding of New Zealand Superannuation.
I have made clear my own preference is to move towards removing the tax on the earnings of funds - thus achieving both high net returns and greater competitive neutrality - as one option that may exist alongside others. At the same time, I am determined that by the end of the year we will have made progress on compliance costs issues.
Thus it is my hope that 2001 will be the most decisive year in the history of superannuation and private savings in New Zealand's history at least since 1938 and the passing of the Social Security Act. Or, of course, it could be another year of wasted opportunity and bickering. It is up to all of us which it will be.
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