Matt Nolan says that current account deficits are not bad in themselves, but the stock of debt needs to grow more slowly than the stock of assets

By Matthew Nolan*

In a recent opinion piece on the Herald, Bob Jones suggested that "saving is for fools", and in turn complained about Graeme Wheeler’s suggestion that New Zealander’s need to save more.

As is often the case, both sides are right, but they are merely talking past each other.

People should choose to save and invest based on their individual circumstances, but if there are issues with the nations “competitiveness” it is going to show up in the ways we save and invest.

To understand the issue, we need to hold back on morally attacking or praising savers and try to figure out what is actually going on.

Bob Jones is right that the choice about whether to save or spend from current income is up to the individual.

The Victorian moral desire for thrift, or ‘Keynesian’ push for unfettered spending, are both the result of a partial story – and they ignore the overarching point that it is people who decide whether to spend or save, and their decisions should be based on their own circumstances and the expectations they have for the future.

However, Graeme Wheeler wasn’t disagreeing with this. Like any good economist, he respects the choice of individuals.

Overseas borrowing

His comments were instead based on a simple fact, something Jones alludes to in his piece, that New Zealand as a whole appears to be saving a lot less than it is investing, and making up the gap by borrowing significant amounts from overseas.

On the face of it the link between savings and investment for a nation might seem strange, so let’s do some quick algebra to show how this is the case. For a country our GDP is a measure of our income. 

By definition GDP/Income (Y) equals consumption (C) plus investment (I) plus government spending plus net exports (X, where this is exports minus imports).

Government spending is on both investment and consumption, so we can just chuck it into those categories.  This leaves us with Y=C+I+X. Doing a little rearrangement shows that Y-C = I + X, this states income minus consumption equals investment plus net exports.

Now income minus consumption is savings, so savings is equal to investment plus net exports.

If we are saving less than we are investing, net exports have to be negative – in other words imports are greater than exports and we have a current account deficit !

Another way to think about it is that, if we want to invest more than we have available to invest (which is our savings) we need to borrow from overseas – and this borrowing is the current account deficit.

Current account deficits

Current account deficits are, in of themselves, fine.

If other countries are willing to lend to us to invest or consume, and we are willing to borrow at the given rate of interest, that is good.

After all, at a point in time some countries will borrow and some will lend. And unless we are exporting or importing from aliens the global current account deficits and surpluses will cancel out.

But the persistence of the large current account deficits in New Zealand (post-1975), has led many commentators to observe that the investments New Zealander’s have made don’t seem to be making much of a return.

Investing more than we save, for what looks like a “relatively” low rate of return has made many analysts consider something may be seriously amiss with the New Zealand economy.

Productivity

Combined with the fact that real interest rates in New Zealand are higher than most of the developed world, our relative productivity performance seems weak, and the real exchange rate appears high there is a sign that New Zealand as a whole is not saving enough and/or is willing to invest too much in non-performing assets.

Bob Jones appeal that housing and property has been a “good bet” in the past helps get to one of the potential causes of the problem – a systematic overspending on residential and commercial property.

Generally, economists aren’t saying to people “stop being naughty, spend less and save more”. Economists are asking if there is any failure that has occurred which has led to this persistently high interest rate in New Zealand – they are asking why there is such a large gap between what we save (which is low compared to much of the world) and what we invest in plant, machinery, and buildings.

There has been significant debate around what these issues are, and what should be done.

However, one area where there has been some consensus is the idea that tax settings in New Zealand strongly favour investment in residential property – and strongly dissuade other types of savings and investment.  Jones is right that people have done well out of property in recent decades, but a significant driver of this has been a transfer through the tax system. In so far as this is the case, the issue of savings isn’t a problem of individual choice, it is a problem of government policy and the incentives put in front of people.

The tax incentives

The way this works is that the tax system, by being biased in favour of housing (as regards to other investments) creates a wedge between the private return on housing and the total social return.

By favouring housing, and transferring funds to people willing to invest in housing, the tax system makes the private return from doing so higher than the actual value of the investment – leading to a situation with too much investment in housing.

In this way both Jones are the RBNZ governor are right – people are investing in housing because it gives them a “good return”, but the fact they are doing so isn’t good for us as a whole!

Sustainability

In truth, there is a lot more to the debate than just housing – and the role of housing might even be overstated. Furthermore, the goal is not to get rid of current account deficits – as long as we have economic growth, small current account deficits are sustainable well into the future.

The key thing is that the stock of debt is growing more slowly than the stock of assets.

The point is that the complaints of economists are not the product of us assuming stupidity, or telling people they are immoral. They are the concerns of a group who believes that there may be some policy relevant issues – for example the peculiar ways that the New Zealand tax system treats housing as an asset – which are hurting New Zealanders

Far from showing the Reserve Bank governor is out of touch, as Jones suggests, his willingness to discuss this issue illustrates that he realises how important it is for future generations of New Zealanders.

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Matt Nolan is a senior economist at Infometrics. You can contact him here »