The case to borrow and invest

Bernard Hickey argues Labour should respond to Auckland's man-made infrastructure disaster the same way National responded to Christchurch's natural disaster: by using its strong balance sheet to borrow and build.

John Maynard Keynes, the ultimate Keynesian economist, is reputed to have said: "If the facts change I change my mind, what do you do sir?"

It's clear now the facts have changed for the Labour-led Government, but it has yet to change its mind.

Prime Minister Jacinda Ardern and Finance Minister Grant Robertson showed how the facts had changed for the Government yesterday in their first attempts to prepare the ground for the Budget on May 17.

"I had to dampen down my [expectations] when I saw the state that the last government left core services like health and education," Ardern told her post-cabinet news conference yesterday after a particularly long cabinet meeting focused on allocating funds in this year's Budget.

"I always said from the beginning we thought it would be bad. We didn’t know it would be this bad, and what the public is seeing is just a snapshot," she said.

Ardern previewed the Government's plan to grab back the news agenda over the next month with various further insights into what it found smoking under the budgetary hood when they arrived.

The public has already seen a few wisps of smoke.

News in recent weeks of raw sewage running down the walls of leaky buildings at Middlemore hospital and exhausted midwives quitting in droves across Auckland is just one of the signs. There are many others in Auckland and elsewhere to indicate our largest city has just suffered a population shock that is now generating an infrastructure crisis. It has been worsened by five years of squeezed health, education and public transport budgets that saw district health boards and schools spend money on operations rather than infrastructure.

The National Government decided after the initial splurge of spending in the wake of the Canterbury earthquakes that it needed to get back into surplus quickly and stop borrowing so it implemented a series of 'zero' budgets in 2011 and 2012. It then kept a lid on spending growth throughout the period of very strong population growth from 2013 onwards. Most of that population growth from migration was a surprise, but some of it was a deliberate decision. Most of the population growth hit the upper half of the North Island and an already-stretched Auckland in particular.

New Zealand's population grew by over 430,000 to 4.9 million in the last five years, mostly from net migration, but also from relatively high birth rates in Auckland and the upper North Island. Auckland's population grew 215,000 over a time when the Government was refusing to help fund the City Rail Link and at a time Health Minister Jonathan Coleman was forcing DHBs to run operational surpluses. They have since revealed they skimped on capital spending to do that.

Auckland's population shock on top of decades of infrastructure under-spending and a budgetary squeeze from Wellington has created a man-made crisis. There is now a shortage of at least 50,000 houses, four light rail lines, dozens of school rooms, hundreds of hospital beds, several mental health wards and at least one major prison. A significant increase in demand for mental health services from the existing population (a phenomenon seen globally) added to the pressure on public services over the last five years. At least $50 billion of infrastructure spending is needed in the next decade, including at least $14 billion in health.

Ardern was asked yesterday if the health system in Auckland was crisis, in the same way the housing market there was declared by Labour to be in crisis. She didn't go quite that far, but made the comment that: "It feels systemic."

'What do you do madam?'

So what should the Government do when it's clear the facts have changed underneath it? As Keynes might ask, what do you do madam?

Essentially, Ardern and Robertson said yesterday would just make do within the current Budget Responsibility Rules they signed up to with the Greens before the election. These rules force the Government to reduce net debt as a percentage of GDP from around 23 percent to under 20 percent of GDP within the next five years by running budget surpluses. To be fair to the Government, that is two years slower than the debt track the previous Government was on and includes the re-purposing of billions of dollars worth of income tax cuts to bolster the health and education budgets. But it's also clear these rules are stopping the Government from responding properly to the crisis.

Robertson admitted as much when defending the rules.

"The package will be an important step in rebuilding those public services, but one budget cannot make up for nine years of neglect," he said.

He rejected suggestions the Government should further delay its debt repayment track.

"They are rules we clearly set out, we campaigned on them. I believe we can do the things we need to do to begin rebuilding the critical public services New Zealanders need with that framework," he said. 

The Government has therefore chosen not to respond by using its balance sheet to borrow to build the hospitals, schools, roads and rail lines needed to cope with 2-3 percent population growth, which is showing no signs of slowing.

Put simply, the 2018 Budget won't property address the systematic under-spending on infrastructure that has led to this man-made crisis in Auckland that is spreading to the likes of Hamilton, Tauranga and Wellington. The only major city that is not facing this crisis is, ironically, Christchurch. Its house prices have been broadly flat in the last five years because the Government in Wellington pumped tens of billions of dollars into replacing the pipes and roads and other public infrastructure to support the population.

No one batted an eyelid when the National Government responded to a natural disaster that wrecked a city's infrastructure by borrowing tens of billions of dollars to build those pipes and roads and schools and houses and hospitals in Christchurch. It rightly used the Crown's balance sheet.

So why is the Government refusing to use its balance sheet again to respond to this population shock-driven crisis?

The now National Opposition argues that New Zealand needs to have a strong government balance sheet so it could cope with a 'rainy day' of another earthquake or Global Financial Crisis, and because household balance sheets are over-loaded with mortgage debt. Effectively, the Government has had to compensate for the fact households were enabled and forced to load up with debt to buy expensive housing.

A man-made crisis

The trouble is in deciding what that rainy day looks like. Is it a magnitude 7 earthquake in Wellington? Or is it a doubling of congestion time on Auckland's motorways? Is it collapse in key worker recruitment (police, nurses, midwives, teachers) in Auckland because of unaffordable housing and congestion? Is it employers unable to find people to grow their businesses because there are no houses, schools and hospitals to support them?

At what point does a man-made crisis have the same effect as a natural disaster?

Prime Minister Ardern answered one half of the question yesterday when she described finding a systemic crisis that spilling out across all aspects of public services such as health and education.

She didn't provide the second half of the answer, which is to use New Zealand's unusually strong government balance sheet to fix the problem.

The Opposition would argue in response that the world's bond vigilantes, who hold more than half of New Zealand Government bonds, would punish us with a spike in interest rates that would push households and the economy over the edge.

But that narrative is worth challenging.

So far this year, the New Zealand Government has borrowed $1.15 billion through the issue of bonds ranging from seven years to 20 years at a weighted average 2.74 percent. Global and local investors bid over $3 billion in these bond issues. It is now actually cheaper for the New Zealand Government to borrow than the US Government.

Ageing investors globally are crying out for bonds issued by healthy governments with healthy economies. They would have no problem whatsoever in gobbling up tens of billions worth of New Zealand Government bonds if it was clear the money was going to be invested in the concrete and steel to make a young and fast-growing economy grow even faster. Households and bank balance sheets are also in much healthier shape than many think. The interest costs of mortgages represent just eight percent of disposable income now, which is well down on the 14 percent seen in 2008. New Zealand's banks are much better capitalised and loan to value ratios have also been pushed sharply lower by the Reserve Bank's interventions over the last five years.

Moody's just gave New Zealand's AAA credit rating a giant tick and New Zealand's 35 percent gross debt to GDP ratio pales in comparison with the OECD average of over 80 percent. We have plenty of headroom to deal with a man-made crisis. There is nothing special about the 20 percent threshold the Government has focused on. It is obscenely low by OECD standards.

Politicians are often fond of comparing the Government's finances to a household's finances. The previous Government did just that when arguing for its 'zero' budgets in 2011 and 2012 and for its plan announced last year to reduce net debt to 10 to15 percent of GDP. It said the Government had to balance its books, just like any household, and save for a rainy day.

So let's use that analogy.

Just imagine the Government is a young family with two annual incomes totaling $260,000 and a debt to income ratio of 23 percent (ie household debt of 60,000). The family desperately needs a bigger car and a bigger house for the extra three kids that have just arrived. They need the car and house to ensure the kids grow up healthy and safe and are properly educated.

So they go to their friendly banker for a loan to build a new house and buy a second-hand people mover. The bank would not bat an eyelid at lending them three or four times their income to build that family home and buy that car. That's a debt to income ratio of over 400 percent. And the Government is worried about 20 percent? New Zealand could deal with this infrastructure crisis by increasing its net debt to 40 percent.

New Zealand is in exactly the same position as the wealthy family. It is a young and fast growing country with an opportunity to build the houses and schools and hospitals and public transport to grow up even healthier and more productive.

So why is it holding itself back?

The Government currently does not have much air cover to soften its Budget rules. The CTU has called for them to be dropped and both Marama Davidson and Julie Anne Genter have said the Green Party should not sign up to them again.

Back in 2014 and 2015 when Steven Joyce was resisting funding the Government's share of the City Rail Link, Auckland businesses became increasingly agitated at the Government's approach. They eventually lobbied for the Government to stump up the $1.5 billion needed to green light the project. Those businesses could see they would struggle to find workers for their offices and factories if Auckland's congestion crisis was not solved. They also saw opportunities to build commercial offices and apartment hubs around the stations.

All over Auckland and in many other parts of the country, businesses are crying out for staff who can afford to live and travel to their workplaces. They want those rail lines and hospitals and schools built so they can make their businesses grow faster and increase wages.

That affordable housing, transport, health and education is a crucial component in making an economy productive and healthy. New Zealand's business community should step up and demand what any banker in that situation would suggest: borrow the money to invest in a more productive future.

Newsroom is powered by the generosity of readers like you, who support our mission to produce fearless, independent and provocative journalism.

Become a Supporter


Newsroom does not allow comments directly on this website. We invite all readers who wish to discuss a story or leave a comment to visit us on Twitter or Facebook. We also welcome your news tips and feedback via email: Thank you.