Labour’s $360m Budget and election problem

There are two kinds of bad news in the political economy. Bad news that swiftly gets better, and bad news that sticks around. Both will affect the election and potentially blow a hole in the Government’s coffers. Coronavirus, or Covid-19 as it’s now officially known, is bad news – that much is obvious. Which kind of bad news it is isn’t clear.

The economic forecasts vary wildly. Westpac has reduced its forecast of Marchquarter GDP growth to 0.1 per cent, from 0.7 per cent. ASB agrees, shaving 0.6 per cent off its forecasts. The bank’s economists think the economy will shrink this quarter, but only by 0.1 per cent.

ANZ and BNZ believe the economy will shrink by 0.5 per cent over the first two quarters of the year. BNZ even has a ‘‘possible not probable’’ scenario, where the effects of coronavirus and drought lead to a technical recession in the first half of the year.

The Reserve Bank released its forecasts last week. It had predicted the economy to grow by 0.7 per cent this quarter. It’s now scaled that back to 0.3 per cent, a hit of 0.4 percentage points.

In back-pocket terms, it doesn’t look like the contagion will spread beyond affected industries. Noone is predicting a downturn anywhere near what we experienced in 2008.

But the problem could get worse. While 28 per cent of exports go to China, and 48 to the rest of Asia (excluding Japan), our second-largest trading partner, Australia, is also very exposed to China. A hit there would hurt us too.

To paraphrase the great diplomat Klemens von Metternich, when China sneezes, the rest of the world catches a cold.

The question of whether we can afford such a downturn is a non-starter – we absolutely can.

In 2018, Treasury wonks ran through some economic disaster scenarios. The darkest scenario was a recession, somewhat like the last one, slashing nominal GDP by $92 billion over five years. The Crown gets whacked with a $127b bill, the combination of lower revenue and higher expenses, but net government debt rises to only 33 per cent over five years, 15 per cent higher than forecast in 2017.

To put that in perspective, last year Treasury published a paper saying the Government can get away with net government debt sitting at 30 per cent in regular conditions – that gives the Government enormous headroom to absorb a crisis, should it need to.

The current crisis will affect the Government’s books far less severely. One per cent of the economy is roughly $3b. Of that, the Government taxes roughly 30 per cent. A downturn of 4 per cent would cost the economy $1.2b and the Government $360 million.

On those numbers, the Government can easily absorb the shock. Its operating allowance for the May Budget is $3b, enough to take the burden.

The problem is that revenue is only one side of the story. Expenses will go up too, as people laid off by struggling firms claim benefits. This is known as the automatic stabiliser – and it’s a good thing. As the economy shrinks, the government steps in to fill the breach, pumping money through the economy until it lifts. Then, as the situation returns to normal, higher tax receipts allow it to pay down the debt it took on during the crisis.

The problem for the current Government isn’t an economic one. It’s political. The automatic stabiliser will only add to the $900m deficit Treasury has forecast this year.

It should spend in addition to this – but it may be reluctant to, given the word ‘‘deficit’’ has wrongfully become analogous to fiscal mismanagement. The real question is whether the Government believes it has the political room to pump up spending now that it needs to.

The solid growth Treasury has forecast from 2021 onward would soon see any such deficit evaporate. Most commentators also believe the economic recovery from coronavirus will be as quick as the shock itself.

Unfortunately for the Government, even if it does the right thing and spends, there’s a decent chance voters won’t see the results until after the election.

The Government should be more worried about Statistics NZ’s unfortunate timeline for reporting GDP numbers. Pollsters say one of the biggest factors influencing how people vote is whether or not they feel the country is on the wrong or right track. GDP growth is a big factor in that decision.

Last year the GDP figures were made public on September 19 – the date of the election this year. The 19th falls on a Saturday this year, so Statistics NZ will have to make the highly political decision of whether or not to report the numbers just before or just after the election.

No-one is predicting a downturn anywhere near what we experienced in 2008.