The Macroeconomics Of the Superannuation Fund

This was a note I prepared: 24 February 2002.

Keywords: Macroeconomics & Money; Social Policy;

Unfortunately the debate on the superannuation fund established by the Labour-Alliance Government in 2001 has largely ignored its macroeconomic effects. This paper takes the orthodox position that a government has to manage its fiscal position, including its deficit or surplus. There is no necessary rule – such as that propounded by the US right – that sets an a priori level for the fiscal position – such as the government should be in exact balance.

The Historical Perspective

The judgement from historical experience, underpinned by a theoretical perspective is that the New Zealand government should run a surplus on its current account. For most of the post-war era it did. Except in periods of extreme stress (or manifestly incompetent management) current revenue exceeded current outlays. The surplus was then invested in the state owned enterprises – electricity, communications, transport … – which however required more funds than the current surplus (and depreciation) provided. The government borrowed to fund these businesses’ investment, and so its overall position on current plus capital account was a deficit – it is was a net borrower.

The point here is not to defend the effectiveness of the investment in state owned enterprises, which is a growth and efficiency issue. The point is that for macro-economic purposes the government usually ran a current account surplus (a.k.a. the ‘internal’ current surplus), which was invested in productive enterprises. When the government divested itself of these enterprises it was no longer required to invest in them. Now they went directly to the financial market to raise funds, so that the macro-economic pressure on economy did not change much. (There is a second order effect from the balance between public and private financial paper, but that need not bother us here. Privatised Telecom’s bond may be judged by the market as only a little different from a government bond.)

Following the prolonged fiscal reorganisation of the 1980s, the 1990s saw the return of the current government surplus which had dominated the post war era. In my view – I set out the macroeconomic theory below – that surplus remains as necessary as it was in the past. In particular it is not available for current consumption (either as higher government expenditure, say on education and health, or higher private expenditure, say with lower taxation or higher social security benefits). One of my anxieties is that because the debate has ignored these macroeconomic issues, and the theory set out below, it will lead to fiscal irresponsibility, and ultimately fiscal instability and poor economic performance.

The Theoretical Perspective (1)

The following macroeconomic theory is orthodox. (I shall mark the one step which is not wholly accepted). Basically the argument is that given the poor domestic savings record (relative to total investment) the New Zealand economy needs a government current surplus to reduce the balance opf payments deficit which will contribute to New Zealand’s growth prospects.

The analysis begins with the standard national accounting identity that output (GDP = Y) is the sum of a series of expenditure comments.

Y≡ C + G + I + X – M,

where the relevant variables will be defined below. The equation can be rewritten

M – X ≡ (I – ((Y – T) – C)) + (G – T)
M -X ≡(G – T) + (I – S).

That is the deficit of the current account of the balance of payments (Imports (M) less Exports (X))
the deficit in the public sector (Government Spending (G) less Taxation (T)) plus the deficit in the private sector (Investment (I) less Private Savings (S)).(2)

The import of this is that a smaller government sector deficit (or a larger government sector surplus) will contribute to the reduction of the current account (external) deficit.

There are a number of reasons why a smaller external deficit (all other things being equal) may be preferable, but they are often of second order.(3) There is a compelling first order reason. A large external deficit is associated with a high real exchange rate. A high real exchange rate discourages the tradeable sector. (The inverse of the real exchange rate is a measure of the profitibility of exporting and import substitution. (4))

In my view – it is the theme of my book In Stormy Seas – a competitive tradeable sector is the key to the growth performance of a small open multisectoral economy such as New Zealand. First it can grow faster than the economy as a whole as it penetrates overseas markets. Second this fast growth is usually the result of new technologies and other productivity improving activities (which, it must be added, feed from the tradeable sector into the domestic sector). That the New Zealand producers are competing against foreign ones forces them to adopt new and best techniques in a way that need not happen in the sheltered economy. Third, the tradable sector generates and conserves one of the most scarce of all resources – foreign exchange – which is demanded by consumers (and in New Zealand’s case investment) as the economy grows, and a shortage of which can choke of growth. (5)

Thus by maintaining a current internal surplus, the government can contribute to economic growth by keeping the external deficit down, and so increasing the profitability and ultimately the growth, of the tradeable sector which drives the growth of the economy. (While Keynesianism is often associated with deficit financing, this policy prescription – as distinct from the prescription that the surplus or deficit must be managed – only applies in particular circumstances, and arose when governments were large investors in enterprises and infrastructure.)

IIt should be noted that the history, and implicit in the application of the theory, makes the behavioural assumption an inability of the private domestic sector to fund the private investment required for economic growth. While we have exaggerated the failure of private savers (because the rhetoric ignores there is an interaction between the household saving on which it focuses and business savings which it ignores) there seems to have been a deterioration in the last fifteen years, which suggests a higher current internal surplus may be required. (6))

Implementing the Strategy

What we have seen here is that the New Zealand government needs to run an internal current surplus as a part of its economic growth strategy. The practical issue is what it is to do with the surplus. Aside from consuming it, and damaging the growth prospects, the viable strategies include:

1. Invest it in state owned enterprises. This was the strategy until the mid-1980s. It is not possible now because there are not the same depth of SOEs. (There is also the issue as to how wisely the government invested in the past, and to what extent it could more effectively invest in the future. One of the reasons for the government divestment of the SOEs was the lack of confidence in the ability of the political process to invest efficiently.)

2. Pay off government debt. This has been largely the strategy of the 1990s, and was probably a prudent thing to do given the high government debt. But eventually there will be no government debt to pay off, and in any case some public sector bonds are almost certainly necessary for the efficient working of the monetary system. (The government could go on to accumulate significant foreign assets. Probably this is impractical – leaving aside the domestic consequences – given that there will arise an almost irresistible public clamour to spend them.)

3. The government invests directly or indirectly in private enterprises. This strategy happened in the past through such mechanisms as the State Advances, the Rural Bank, the DFC, the contribution of the funding of Tasman and NZ Steel and so on. (Nationalisation may also seem to be another example, although strictly the purchase itself is portfolio rearrangement.)

This option has to be considered, not for ideological reasons of public ownership, but because prudent macroeconomic management requires it. Indeed I would greatly regret if the issue became an ideological debate over nationalisation, rather than a technical one of the best way to bet the macroeconomic balances right.

Any investment of the government surplus arising from these macroeconomic considerations in the private sector should be largely on the basis of commercial criteria. If there is a belief there is a need to subsidise or provide incentives for some particular enterprise or industry, this should be done with another policy instrument (and that should be transparent). (8) Moreover, any investment should be relatively conservative and low risk. As good a model as there is for such investments is a pension fund, especially if there is separation between the managers of the fund and the government.

I do not know whether the logic of the analysis set out here had any influence of the thinking during the development of the Cullen proposed superannuation fund. However as I understand the institutional arrangements, the outcome is not inconsistent with the pragmatics set out above. This does not mean the scheme is macroeconomically perfect, and cannot be fine tuned. But the broad structure seems sound.

There are potentially three other advantages to the arrangements. First the government has on its books an item which reminds us that we have a growing problem of funding New Zealand Superannuation (and, more generally of providing for the elderly) as the population ages. The amount is not an actuarial representation of the actual situation, but at least there is an institutionalised marker.

Second, the scheme does not interfere with private provision.

Third, the fund and its investments are less vulnerable to political interference, especially of the form in which the public wants the funds to be used for a (temporary) increase in consumption by selling off the investments. That the funds are instead being used for New Zealand ownership of New Zealand enterprises offers an understandable alternative that would be supported by many New Zealanders (and New Zealand businesses).


The public debate over the scheme has been largely in terms of it as a pension scheme for individuals. As such it has missed the macroeconomic implications of the scheme, which on the basis of the above analysis seem to be largely beneficial.

If the aim of the fund is to increase the prospects of the nation being able to handle the growing numbers of elderly in the future, the greatest gain is likely to be from the improved macroeconomic management of the economy.

1. The analysis here has been simplified (e.g. there is no government investment nor public non-taxation revenue, the flows are measured net), but the conclusions are robust to such simplifications.
2. Private Savings (S) = Total Income (Y) less Taxation (T) less Private Consumption (C)
3. Lower overseas debt means the gap between domestic production and national income is smaller.
4. Although import substitution can be important in principle, I do not see many prospects for efficient import substitution in practice at the moment, so the remaining account focus on exports.
5. While the views expressed in this paragraph do not seem particularly contentious, I am not sure they are as vigorously held as I hold them.
6. The so-called ‘Ricardo’ effect in which public saving is offset by private dis-saving has little behavioral credibility.
7. It is tempting to suggest the investment should be solely in the tradeable sector. Such a strategy should be eschewed insofar as it offers low cost funding to exporters. Their profitability should be governed by the exchange rate, and I do not see a case for additional support. If there is, it should be transparent.