Circulated to colleagues

The Minister of Health has announced that he expects Health New Zealand to take out ten-year contracts with private health providers to deliver surgery. This is structural outsourcing; it is a form of privatisation (although, no doubt the minister would deny this claim).

Whether such long-term outsourcing is efficient is a complicated issue. We have yet to see the policy advice the government received while the public discussion on the policy is just getting underway. It will probably focus on the extent to which the outsourcing will undermine provision in the public hospital system.

This note has a more limited ambition. It explains why a fiscal strategy decision, which has nothing to do with the quality of healthcare, forces a government towards outsourcing or privatising the provision of healthcare.

In summary, the restriction on the government’s measured level of borrowing (and the associate level of government debt) results in it seeking indirect ways to provide the capital requires. One way of doing this is leasing the capital from the private sector. The proposed surgical outsourcing is even more indirect. Private health providers supply the buildings and equipment together with the personnel who would work in the public health system if there was not the outsourcing.

This analysis does not require the private provider to be more efficient than public provision – some would argue it is more costly. All it requires is that the public sector is constrained from borrowing to provide the capital.

This paper explores the issue from first principles. Insofar as it has a conclusion, it suggests that New Zealand needs a new public debt strategy which is neutral to outsourcing. Perhaps it needs to be emphasised that the paper does not challenge the need for a public debt strategy; its focus is on the need for a new one.

New Zealand’s Debt Strategy

The asymmetry in the borrowing transaction is well illustrated by an interchange between Keynes advised New Zealand’s Minister of Finance, William Downie Stewart (Jnr) during the Great Depression. New Zealand should borrow as much as could to offset the downturn, but if Keynes were a lender he would probably not be prepared to advance New Zealand any more.

Each lender has to make an assessment of the borrower’s ability to be able to service and repay the loan in the future. The lender is likely to be more cautious about that prospect than the borrower. Arguably the financial cost to the lender of a failure is greater than the cost to the borrower. (However, the human cost may be less, although this is not a major consideration for financial markets.)

This superior position of lenders frames the New Zealand’s debt policy.  The Government judges that its net debt to annual GDP ratio should not exceed 50 percent (based on its chosen measure). Because it sees the need for a margin for emergencies – like the Great Depression – it targets 30 percent. Currently the ratio is about 40 percent as a result of the emergency generated by the Covid pandemic and is not expected to fall much in the next few years.)

In my view a 20 percent margin for emergencies is reasonable, so I focus on the 50 percent ratio. I take it that largely comes from discussions with credit rating agencies and larger lenders and accept that, as Keynes indicated, their judgement is decisive even if it were  irrational (which it need not be).

I have never been in an assessment meeting with representatives of a credit rating agency but I have had discussions with a number of those that have. (A credit rating saves each lender going through the same process of assessing the risk of default. The grade awarded help sets an industry-wide benchmark – the higher the grade, the lower the risk and the lower the likely interest rate, not only for the government but  for all international borrowers in its jurisdiction whose interest rate is the government one plus a margin for their additional private sector risk).

I am told that the raters are sophisticated and knowledgeable, whose questions can put the New Zealand team under considerable pressure (which those who have told me, to their chagrin, is usually justified). They do not just look at the government defined debt ratio (which has varied under different regimes) and include the NZ Superannuation Assets in their assessment. Moreover, they do not just look at the government balance sheet but private debt as well. On accessions they have been pointed about the substantial offshore borrowing by the private banking system, judging that it could affect the ability of the government to service debt. (This was well illustrated during the GFC when the banks, with the threat of being unable to rollover their offshore debt because of a deterioration in the liquidity of foreign exchange markets could have turned to the Reserve Bank forcing it to do the borrowing. (Subsequently, there have been a number of measures to reduce this particular exposure, which the credit agencies no doubt take into account, but I do not recall any public discussion about the threat prior to the GFC which leaves open the possibility that there is another such threat that we are not discussing today.)

I am certain that the credit rating agencies are tetchy about borrowing for consumption. I’d like to think they accept that such borrowing is temporarily justified during an emergency as occurred with the GFC and  the Covid pandemic just as you are during a household crisis. But they expect the government (and the household) to stop such borrowing and indeed to repay some of the incurred debt once the crisis is over, reducing the level of debt.

In my assessment we have not done this since the Covid pandemic and I would be astonished if the credit rating agencies thought differently. For these purposes it is unnecessary to assess whether the over-consumption is from government spending or household spending. In any case, unfortunately neither the accounting practices in the government’s financial statements nor the SNA accounts make this easy to assess.

Borrowing for Development

Credit rating agencies are more benign towards funding investment for development (providing the jurisdiction does not have the reputation of politicians syphoning off funds for their personal use). Particularly attractive are funding projects which might be privatised since this gives the lender further security. However most such projects would be attractive to a direct commercial lender; infrastructure typically is not easily privatised.  

Again there are caveats, such as the investment may not directly generate the revenue to service the debt. This means there will still be limits to how much lenders are willing to advance. Recall that Vogel was very aware of this; his publicity insisted that New Zealand’s total debt was not high. Matters have not changed much since.

At this stage one could discuss the funding intricacies of the Ardern-Hipkins government three waters proposal. Funders were even asked to advise which of the various options was most acceptable to them. It also seems likely that the Treasury, in particular, was keen to keep the funding arrangements off their book; one wonders whether that would deceived the credit rating agencies and assuming the likelihood it would not have, how they would have treated the substantial projected borrowing. (Since the water companies would have been able to raise revenue by water rates and levies, the lenders may have been more comfortable making advances.)