Part 2: New Zealand's public sector financial sustainability context

Public sector financial sustainability.

In this Part, we discuss the international and national context for public sector financial sustainability and the arrangements in the public sector for fiscal responsibility.

International drivers

International forces have a major effect on our national and public sector financial sustainability. Paragraphs 2.3-2.9 set out some of these forces.

Economic changes

From 2008, the Global Financial Crisis has had ongoing recessionary effects on economies, up to and including the spectre of nations defaulting on their debts. New Zealand has escaped the worst of this, mainly because of relatively tight Australian banking laws. However, both private and public wealth and income have suffered from the recessionary effect.

Most OECD countries have experienced declines in real wages, even though productivity has been increasing. Research evidence is mounting that relative poverty (that is, income inequality) within a country is associated with a wide range of undesirable outcomes and consequent public costs.4

A growing problem of under-investment in public infrastructure is emerging, with cities world-wide struggling to cope with increasing populations and/or ageing or unsuitable infrastructure such as water reticulation, sewerage, and roading. This problem is not yet critical in young, low-population-density, stable countries such as New Zealand and Australia, but even here the investment required is forecast to be substantial.

Environmental changes

The rapid increase in the world's population, increasing consumption per capita, and the diminishing availability and quality of renewable resources are putting greater pressure on the environment's capacity to sustain human activity.

Also, from the early 1990s, the reports5 of the Inter-Governmental Panel on Climate Change have shown increasing certainty that temperatures will rise steadily in the 21st century. Extreme weather events are expected to increase, local weather patterns to change, and communities (including a number of small Pacific Island populations) to be displaced. The effect on the financial sustainability of nations and local governments is likely to be significant.

Population changes

Many countries experienced the post-World War II baby boom, particularly in the Western world. However, although the baby boom was a spike in birth rates, it was followed by a decrease in ongoing fertility rates, making the demographic change structural, not temporary.6 Largely because of a "mini-baby boom" in the late 1980s, New Zealand's demographic trend has been assessed as less severe than that of other OECD countries.7

However, the size of the baby boom relative to future generations is such that a decreasing proportion of the working-age population (reducing from 66% to 58% of the total population during the next 50 years) will be supporting an over-65s group that will double as a proportion of the population (from 13% to 26%).8 Work since the 1970s has, in particular, clearly foreshadowed current concerns with public sector financial sustainability9 and the affordability of universal superannuation. Combined with the growth in health spending – at faster than Gross Domestic Product (GDP) growth – and not solely related to the ageing of the baby-boomers, population change is putting greater pressure on the sustainability of public sector finances.

Factors that differentiate New Zealand

Paragraphs 2.11-2.17 set out some unusual factors about New Zealand that will affect our public sector financial sustainability.

High, but reducing, natural renewable resource availability and quality: New Zealand has the world's fourth-largest exclusive economic zone and is highly ranked in terms of water availability and protected land, grasslands, and forests. However, our renewable resource capacity per capita is reducing, and our surplus capacity will halve in the next 40 years if current trends continue.

Mediocre economic performance: Partly because of our isolation and despite some useful enablers such as good education and ease of doing business, private sector productivity improvements have remained modest during the last 50 years. Our economy is largely based on the ability to "harvest water" through milk, forestry, and other agricultural products. We remain a resource-based, or emerging, economy and have not translated favourable commodity prices into investment in better-value additions through, for example, processing raw products. Although our economy looks like that of a developing country, our social and political structures, and expectations, are clearly those of a developed country. Public sector financial sustainability is at least partly dependent on building a better match between our economy and our social and political features.

High and increasing private debt: New Zealanders as a whole have spent more than they have earned for all but four of the last 55 years, as measured by the current account deficit.10 Household debt is high and rising. It is comparable with some of the more stressed OECD countries. Overall, external debt has been at 70-80% of GDP since 2000, and our household debt to income ratio has risen from 100% to 140% between 2000 and 2012.11

Good government, strong fiscal governance, and low public debt: Our public sector has a solid reputation for innovation and excellence, and is not expensive by any standards. Broadly, education accounts for 20% of government spending, health 20% and rising, transfer payments 40% and rising, and all the rest of government activities the other 20%.12 Public sector net indebtedness is low. The Government's net external debt was hovering around 10% of GDP from 2000 till 2008 but, because of the global recession and the Canterbury earthquakes, has since grown to 25% of GDP – still a modest level by international standards.

Increasing income inequality and some disturbing social trends: New Zealand has moved from being one of the most equal countries in the OECD in terms of market income 30 years ago to being one of the least equal today. There also appear to be an increasing range of at-risk groups, centred mainly on youth (as shown, for example, by high youth suicide, teen fertility, and unemployment rates).

Some readers have expressed an interest in the data behind the views expressed in paragraph 2.15. Please see the OECD website, specifically the country report from 2008 and the 2011 inequality report. Further relevant OECD data has also been collated online, which makes it easier to compare data for different countries and different years.

A high overall level of well-being and life satisfaction: On the other hand, New Zealand rates highly on levels of tolerance, interpersonal trust, and life satisfaction. This may help us retain the social capital needed to effectively address the negative states and trends identified above.

Looking to the future, and at the level of economic, social, and environment drivers, there is also relatively good news for New Zealand. Subject to the environmental risks and poor social trends summarised above, although our isolated ocean location has a significant effect on our costs of production, it may also protect us from some of the worse potential social and climatic effects during the 21st century.

Public sector fiscal responsibility arrangements

The Fiscal Responsibility Act 1994 sets out principles of "responsible fiscal management" based on reducing debt to, and maintaining it at, "prudent levels". The Government defines "prudent levels" and has the flexibility to depart from the principles temporarily, along with a requirement to state the reasons for the departure and the path back.

New Zealand's gross public debt burden substantially reduced during the two decades after the Act was passed. It reduced from about 70% of GDP in the early 1990s to 20% in the late 2000s (net public debt went from 50% to 0% during the same period).

In 2004, the Public Finance Act 1989 was amended to require the Treasury to prepare a statement on the long-term (at least 40 years) fiscal position at least once every four years.

The Treasury's first two statements were published in 2006 and 2009. They were primarily technical assessments of the Government's fiscal position and projected debt, with discussion of options for reducing spending to contain debt. Although these statements received some media and political attention, the Treasury does not consider them to have been as effective as they could have been in promoting consideration of the long-term issues.

The Treasury has begun a much more consultative development process for the next statement, planned for later in 2013. The process has included obtaining input from large government departments, working in partnership with Victoria University of Wellington, forming an expert panel, holding a public conference in December 2012, and conducting a public survey.

In the local government sector, legislation since 1989 has required local authorities to prepare long-term (at least 10 years) financial plans that, since 2006, we have audited.

4: See Wilkinson R and Pickett K (2010), The spirit level: Why equality is better for everyone, Penguin, London; and Stiglitz J (2012), The price of inequality: How today's divided society endangers our future, Amazon Kindle edition.

5: See Assessment Reports available at

6: World Bank public data (2012).

7: State Services Commission (1998), Strengthening strategic management: Summary of fiscal modelling work, Occasional Paper No. 4, and (2001), Medium-term fiscal modelling: Update report, Occasional Paper No. 14.

8: Statistics New Zealand (2012), National population projections 2011-2061.

9: See, for example,

10: Nana G (2012), The new year and "a new normal", New Zealand Institute of Economic Research presentation at New Zealand Institute of Chartered Accountants seminar.

11: Reserve Bank of New Zealand (2012), Financial stability report, May 2012.

12: See, for example: New Zealand Government (2011), Better Public Services Advisory Group Report.

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