Why the hype about saving?
Tue 8 May 2007 by David Grimmond.

New Zealand does not have a long term saving problem.   With open capital markets, the decision to save or borrow is purely a financing decision, and one that is driven by the price of credit.   The international price of credit is very low at present.  Taking advantage of these low prices is a rational response by New Zealanders.

The more important question is: how well are we using this cheap credit?   Here the answer is not so clear.   There are some strongly performing firms and industries in New Zealand.   But there are also many distortions to price signals, a lack of competition in key markets, high compliance costs for businesses, and a large and poorly performing public sector.1

Addressing these growth issues is far more important for the future wellbeing of New Zealanders than promoting saving schemes.   This is particularly the case for schemes like KiwiSaver that will largely benefit higher income earners and the savings industry — neither of whom require special assistance from the government.

Adding up the debt

New Zealand is an indebted nation.   At the end of 2006, New Zealand’s net international liability was $143 billion or 89% of GDP.   A current account deficit of $14 billion (or 9% of GDP) in 2006 implies that New Zealanders continue to rely on other people’s savings to fund investment in New Zealand.   These are the figures that are used to imply that New Zealand has a savings problem.

The current account deficit is definitely high.   But so is the differential between New Zealand interest rates and those overseas.   The bill rate in New Zealand is close to 8%.   In Japan it is closer to 0.5%.   Even with exchange rate risk there are plenty of people who are willing to invest their money in New Zealand, which via the intermediary of New Zealand banks, have lowered the cost of credit for New Zealanders.   If people want to lend us money at ridiculously low rates it is not surprising that we should pig out on such cheap money.

Ultimately the national debt position reflects financing decisions.   Despite whatever you might hear, New Zealanders are savers.   National savings can be calculated as the sum of physical investment and the current account balance.   In 2006, physical investment in New Zealand accounted for 24% of GDP.  This figure means that even with a current account deficit equivalent to 9% of GDP, New Zealand as a whole was saving around 15% of its income in 2006.

Perspectives on saving

The issue then is not whether we save, but what is the appropriate level of saving?   This question is not one that has any clear answer.   The appropriate level depends on our individual preferences for saving for the future as distinct from spending today.   These preferences are, in turn, influenced by the return we expect from investment projects and the relative cost of borrowing.   We can fund investment projects from saving (i.e. deferring current consumption) or borrowing (foregoing some future consumption by the amount that we spend on interest payments).

Much of the debate about saving seems to imply that saving is a moral issue.   If you save you are preparing for your old age, which is good.   If you borrow money, you are neglecting your savings obligation and are going to be a drain on society in the future, which is bad.  Although there may be some situations where this is true, in general, saving and borrowing is about how we decide to finance current and future consumption.

A crucial reason why we are an affluent society is that we generally have considerable choice about how we organise our finances.   We do not have to fund all our activities out of current income, we earn income from our savings, and we can borrow money to purchase large items like cars, houses and businesses.   What matters is not how much we are saving or borrowing at any one point in time, but how wisely we use these funds.

Many strong-performing businesses consistently rely on borrowed money to fund their investment activity.   If these businesses did not borrow, they would not have expanded their operations as fast.   They would have missed profitable opportunities.   Although they maybe perennially "in debt", it is the wisdom of their investment that drives investor sentiment about the company, not their indebtedness per se.   Debt only becomes an issue if the investments do not perform, and they then struggle to service their debt.

On this criteria, how does New Zealand Inc measure up?   In 2006, our foreign debt servicing cost was $7 billion, which is a large sum, but represents just 4.4% of GDP.   There is no question that New Zealanders can afford to service their offshore borrowing.   If we have a problem with this borrowing it is not about the affordability, but about whether the economy can generate the returns to justify the cost.   Most recently, in 2006, when nominal GDP increased by just 4%, it does not look like we have made a great use of these borrowed funds.   There are two ways of rectifying this situation — do we look at borrowing less or improving the returns on the investments?   It is our view that too much of the debate has been about raising savings and too little on improving the returns from savings.   The government’s current KiwiSaver initiative is a case in point.

A hard way to raise savings

It seems unlikely that KiwiSaver will bean efficient means of raising national saving.   As it stands it requires bribes to encourage people to lock funds into the scheme, which means, from a national perspective, that the scheme will need to outperform other existing saving vehicles just to break even.   If the mooted plans to offer further tax incentives materialise, the scheme will be made yet more attractive to upper and middle income earners.   These people pay the most in tax already and so will gain the most advantage from a tax link — but are these really the people that are likely to have a saving problem?

From a national perspective it is the returns net of administrative costs that are important.   The savings industry has already spent millions preparing for the introduction of the scheme, most of which has been spent on dealing with administrative and legal issues.   The willingness for all this spending indicates that the savings industry can spot a gravy train when they see one.

Few commentators expect KiwiSaver to raise national savings.   It may initially raise savings, but increasing gross savings does not guarantee a net increase in savings — the scheme can not stop people from borrowing elsewhere.   Investing in the KiwiSaver scheme will be worthwhile for many people, but it does not mean that their overall level of saving will necessarily increase.

Ultimately if you want people to save more you have to make it in their interests to do so.   This means either increasing the returns from total saving or discouraging consumption spending.  The government already has two broad instruments that could influence saving incentives in a transparent and direct way: it could reduce the tax rate on interest income and it could increase the GST rate.   A combination of the two could increase private savings in a fiscally neutral way.   Higher saving would reduce the extent that we borrow from overseas, but would still not address the more important issue of increasing the returns from investing.

[1] Labour productivity in New Zealand grew by 1.2%pa in the 14 years from 1991 to 2005.   Statistics New Zealand estimates that labour productivity growth was 2.3%pa in 63% of the economy (primary, manufacturing and the non-public service parts of the service sector) over this period.   The implication is that labour productivity fell by 0.7%pa in the public service sectors of the economy.

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