Opinion: Let's debate changing NZ Super before we hit a fiscal brick wall

By Bernard Hickey Earlier today I spoke at a breakfast function for the Auckland University's Retirement Policy and Research Centre on New Zealand's pension system. I argued that New Zealand needed to debate whether it can afford its current universal NZ Superannuation system where anyone who retires at 65 receives 66% of the average wage. The current projections are that the percentage of national income to be chewed up by pensions and health care will jump to around 20% of GDP by 2050 from 10% now as baby boomers retire and get sick. Given the current policy settings, that burden will have to be paid for from the (much higher) PAYE taxes and GST receipts generated by those still in the workforce (Generations X and Y). I argue that the developed world, including New Zealand, faces a decade or two of de-leveraging after the credit boom of the 'naughty noughties', which will depress GDP growth and drag on house values, which were supposed to be the retirement buffers for many baby boomers. I argue that now is the time to debate the raising of the retirement age, the reduction of the pension from 66% of the average wage and the removal of the universality of pensions through the introduction of means testing. Prime Minister John Key has promised to resign if any of these changes are made. I think we can't afford not to have this debate, otherwise public debt will continue escalating to unsustainable levels in the same way as is happening now in Greece. New Zealand is currently lucky because its heavy indebtedness is currently borne by the household sector through the big four Australian-owned banks. This means we have avoided punishment by global debt markets, who see Australia's economy and its banking system as much safer and more robust than those in Europe and America. We're also lucky in that net public (government) debt is still much lower than other OECD countries. This gives us more leeway to have this debate and make these decisions before we hit that brick wall. Treasury forecast in its long term fiscal outlook released in October last year that net public debt would rise to over 220% of GDP by 2050 from around 20% now, if policies weren't changed. Since then the budget position has improved, but the net debt is still expected to rise above the 100% of GDP threshold seen as dangerous.

The main issue with NZS is its long-term affordability. Shortly after the present pension system was introduced in 1977 (accompanied by a lowering of the eligibility age from 65 years to 60 years, and a rise in the payment from 65% of the average wage to 80%), the fiscal cost rose to around 8% of GDP. The subsequent lowering of the relativity with wages and raising of the age of eligibility through the 1990s, fewer retirees and a growing economy have brought the ratio of total payments of NZS to GDP closer to 4%. But the accelerating ageing of the population suggests that by mid-century the ratio will return to 8%, or more. Unless there is policy change or an acceptance that this would mean increasing public debt, funding this would require cutting other expenditure, or lifting tax rates.

Many have argued New Zealand doesn't have a savings problem and our NZ Superannuation is simple and fair. They say New Zealanders have saved plenty and the higher pension burden won't disable the economy. The trouble now however is the intergenerational fairness argument. It is a 'pay as you go scheme' which means tomorrow's wage earners pay for tomorrow's pensions, rather than today's pensioners saving for their own retirements. Given mobile labour markets, this is not sustainable. We risk ending up with a hollowed out economy where pensioners and beneficiaries live off the increasingly burdensome taxes paid by the few remained PAYE taxpayers who aren't in Working for Families. A pay-as-you-go scheme is fine as long as there aren't too many demographic bulges. The hope has been that the strength of economic growth over the long term will smooth out these problems. Other solutions are a rise in immigration or a rise in the fertility rate to smooth out the age humps, both of which are problematic. I argued in today's presentation (see the charts below I used) that we cannot rely on strong GDP growth to solve this looming problem. The developed world will have to spend the next 10 to 20 years paying down debt in a slow grinding way. Banks will be reluctant to lend, indebted households will be reluctant to borrow and the capital gains-fueled rush into property is over. Regulators and shareholders will demand lower leverage levels, more bank capital and a multi-year withdrawal of debt from asset prices. We need a debate to tighten and reduce the size of the burden about to be placed on workers from 2020 onwards. The more time baby-boomers have to plan the better. Your view? I welcome your thoughts and insights in the comments below. Here is the presentation I gave earlier today.