The Savings Question
Keith Rankin, 13 June 1998
(a) The International Context of New Zealand's Currency Crisis
The recent fall in the value of the New Zealand dollar to a realistic level was precipitated by the ongoing high balance of payments deficit on current account.
While a nation's current account deficit may be caused by a shortage of savings, it may also have other causes. In a globalised financial environment, capital flows to wherever savers think they will get the best returns. Some have a long-term focus. Many, probably most, have a short-medium term focus. For savers in the later group, it is high and/or falling interest rates that act as the magnet.
While interest rates may be high because of a rate of savings inadequate to fund all current investment projects, interest rates may be high for other reasons, eg monetary policy. Furthermore, much capital export goes to nations which are seen as successful; these nations typically do not face a shortage of domestic savings. If there is a net inflow of capital into a country, then there will be a balance of payments deficit, regardless, of the savings rate in the recipient country.
There are two broad situations in which a net capital inflow occurs, even though the rate of domestic savings is adequate to meet the nation's investment needs.
The first is when a capital inflow is used as a means of raising a nation's exchange rate in order to offset domestic inflation with deflation in the tradeable sectors. This has been the case with New Zealand for most of the post-1984 period. Ultimately, the problem is rooted in the source of the domestic inflation (ie, for New Zealand, the transactions costs arising from the reform process), and is compounded by a method of fighting inflation that adds to the domestic cost of doing business; ie that adds to the very inflationary pressures that it is supposed to be fighting.
The second situation is where the inflow is not sought by the government of the receiving country, but the government does nothing about it, typically because it believes that the (global) market knows best. There are two things governments can do to deal with destabilising net capital inflows; capital inflows that are not needed to fund the quality investments that the nation needs.
The first is to put up barriers to capital imports (eg taxation measures), making some of those foreign savers prefer other investments. The second is for the government or central bank to export an equivalent amount of capital to that of the excess inflow. Indeed, it is this latter measure that should become a routine feature of global stabilisation; national authorities neutralising the macroeconomic impact of capital imports (while enabling the favourable microeconomic benefits of foreign investment), and in the process stabilising their exchange rates. It is the responsibility of those countries with rising exchange rates to stabilise the world currency markets by exporting capital. In that context, actions by central banks to deliberately push up exchange rates must be seen as destabilising to the global economy.
Asians are prolific savers (really "hoarders", meaning non-spenders). Yet many of their national economies have been plagued by balance of payments deficits in the 1990s. The excessive volume of the world's savings that migrated to Asia has contributed to much poor quality investment. On the other hand, Americans, like New Zealanders, have a consumption rather than a hoarding culture. Yet it is the American economy that has done best in the 1990s. Its progress has been "investment-led" rather than "savings-led". As a result, its investments have been, in general, of high quality (see recent article The Vice of Thrift in The Economist 19 March 1998, and my "Savings: a Social Vice").
(b) The Intranational Context
The "Reforms" since 1984 have forcibly altered the balance of savings activity in New Zealand. Low income people now save the most, through withheld income; through forced savings. In particular, the 1991 Employment Contracts Act and the associated benefit cuts (which have had a major impact on the net incomes of the low paid and beneficiaries), plus the high incidence of direct and indirect taxation borne by the low paid and beneficiaries, have all been the equivalent of a huge compulsory savings scheme. It is because of those cuts to the disposable incomes of low income New Zealanders that the savings accounted for as "government" and "corporate" savings have become possible. The rhetoric of increased household savings can be interpreted as a push for policy changes that place further inroads into the spending of low income New Zealanders.
It is true that New Zealand has suffered from huge amounts of socially wasteful spending on imports - perhaps the most visible example of such conspicuous consumption is the prolific importation of expensive four-wheel drive vehicles as urban status symbols. A taxation policy that removed much of the disposable income which funds such imports might reduce the balance of payments problem, but only if the net inflow of foreign capital is held at much lower levels than have prevailed since 1984.
In fact, that net inflow of foreign capital came to an end in 1997, hence the beginning of the fall in the market value of the New Zealand dollar. The big worry now is that the reduction in spending that must follow will in fact be borne by those who have already been subject to forced savings, low-income workers and beneficiaries. And that those who have been conspicuously consuming may continue to do so. Certainly, policies of giving increased tax benefits (such as the $22 per week "tax cuts" of July 1998) to the conspicuous consumers while giving minimal additional benefits to those on low incomes only serve to increase the extent to which New Zealand's poor subsidise both rich New Zealanders and the foreign residents who have acquired many of New Zealand's public and private assets from their past savings.
New Zealand's labour and capital should be fully employed servicing our ongoing foreign liabilities, and not sitting unemployed. We should only be entertaining raising our national savings rate when our factors are fully employed. The immediate solution is to get New Zealanders working, and earning. More earnings equal more savings, even if the savings rate does not rise.
One final point. New Zealanders do save far too much of their income on residential property, especially their own. One of the main reasons for this is that the component of GDP labelled "ownership of dwellings" is not taxed. The result is a large hidden subsidy - ie benefit - to those with equity in the properties they dwell in. The subsidy is paid in proportion to residential equity; it is unaccounted income to New Zealand's richer and older residents, and it causes residential property values to be significantly higher than they would be in the absence of the subsidy.
Rankin File | 1998 titles