A tale of two recessions

Two recessions, two fiscal responses. One blue, one red. Both extraordinary, but conventional and unsurprising. The latter was an opportunity missed; the former leaves an opportunity hanging by a thread.

The Government’s Rainy Day Budget response to COVID-19 is considerably different in nature to the response to the combined Global Financial Crisis (GFC) and earthquakes crises. However, in terms of size, the COVID-19 fiscal response is not as large as one might have expected for a one-in-a-hundred-year event.

We estimate and then compare the size and nature of the fiscal response to each of the two sets of crises faced by Aotearoa. Our estimates are established by modelling and constructing budgets that assume tax and spending remain constant as a proportion of Gross Domestic Product (GDP) over each period. For the GFC/earthquake crises, we then compare the modelled Government debt result with the actual outcome. For the COVID-19 crisis, we compare the modelled Government debt result with that projected by Treasury in the Budget 2019 documents.

Comparing the size of the responses

Our results suggest that over the five-year period 2008-13, the GFC/earthquake crises saw a fiscal response in the form of an increase in net core Crown debt of an estimated $62 billion. This was the equivalent of 33 percent of GDP in the beginning (2008) year.

Over the five-year 2019-24 period, we estimate the fiscal response to be an estimated $142 billion increase in net core Crown debt. This is the equivalent of 47 percent of GDP in the beginning (2019) year.

While the absolute size of the fiscal responses is noticeably different ($62 billion compared to $142 billion), its ratio to GDP provides a better reflection of the respective sizes of the two fiscal responses. In particular, 33 percent compared to 47 percent suggests the current administration and Treasury officials expect the COVID-19 recession to be less than one-and-a-half times that of the GFC/earthquake crises.

Many, including the International Monetary Fund, expect the COVID-19 crisis to generate the greatest economic slump since the Great Depression. Indeed, the Bank of England recently warned of Britain being on the verge of the worst recession since the great frost of 1709. New Zealand’s Minister of Finance has himself talked of COVID-19 being a one-in-a-hundred-year event for New Zealand.

In this light, we would have expected a fiscal response much larger than one-and-a-half times that of the response to the GFC/earthquake crises.

We note that the originally planned fiscal response to GFC/earthquakes was smaller than what eventuated after the event. Consequently, this administration and Treasury officials have severely underestimated the impact of COVID-19. Alternatively, they will be forced to add to the fiscal response over the coming months. We suspect both.

Composition of the responses are starkly different

Importantly though, while the comparative size of the responses is not that dissimilar, the difference in the composition of the fiscal response is without doubt stark.

The fiscal response to the GFC/earthquake crises was dominated by a reduction in tax revenue equivalent to 20 percent of base-year GDP. That is, nearly two-thirds of the fiscal response comprised the Government taking in less tax than it would otherwise have taken. This response was the net result of combined income tax cuts and an increase in GST, alongside reduced economic activity. On the spending side of the fiscal response, increased government spending accounted for the equivalent of 15 percent of base-year GDP.

In contrast, the fiscal response to the COVID-19 crisis is unambiguously led by Government spending. The projected increased government spending is the equivalent of 35 percent of base-year GDP. This accounts for more than three-quarters of the COVID-19 fiscal response. However, there is only a seven percent (of base-year GDP) reduction in tax revenue, a result of reduced economic activity as there are no projected tax rate changes.

In summary, the nature of the two fiscal responses unsurprisingly reflect the political hue of the administration of the day. The blue response preferred reducing the Government’s relative tax take, the red response prefers to lift the Government’s relative spending efforts.

Revenue and spending through two sets of crises

This comparison can also be reflected in the historical and projected track of revenue and spending. As illustrated below, the fiscal response to the GFC/earthquake crises saw a considerable reduction in tax revenue as a percentage of GDP. This reduction in tax revenue gradually recovered over the 2014-19 period. However, it is noticeable that tax revenues have subsequently remained below the levels of the pre-GFC/earthquakes period. With the onset of the COVID-19 crisis tax revenue is projected to fall further, as there are no tax rate changes signalled in Budget 2020.

In contrast, and as illustrated below, spending registered a moderate lift as part of the fiscal response to the GFC/earthquakes crises. However, the 2014-19 recovery period saw government spending as a percentage of GDP being continuously curtailed. This was New Zealand’s version of austerity, although a milder version than was experienced elsewhere. Arguably though, this period of mild austerity resulted in delivery levels for several social and public services being sorely constrained. While the Government’s financial debt was driven down during this period, the accumulation of social and community debt was felt by many of the vulnerable in our communities.

The COVID-19 fiscal response sees is a dramatic surge in spending to well above any level over the recent past. Notably though, spending is projected at these higher levels for a couple of years before falling back towards the historically familiar 30 percent of GDP mark by the end of the projection horizon. Should the outcome follow this track in spending, the implied constraints on public services for the purposes of driving down the Government’s financial debt will reflect yet another lost opportunity.

Conclusions

Both the 2008 National-led and the 2019 Labour-led Governments have adopted conventional fiscal responses to the crises they, respectively, faced. In particular, both responded to an imminent downturn or recession by significantly boosting the quantum of government debt issued.

Both fiscal responses were (or are), at best, moderate in terms of size.

• The 2008-13 fiscal response was initially inadequate. However, it was subsequently ramped up to become a fiscal response of the order of 33 percent of base-year GDP.
• The 2019-24 fiscal response appears initially inadequate at only 47 percent of base-year GDP, noting the one-in-a-hundred-year context for the latest recession. It would not be surprising to see a subsequent ramping up of this fiscal response.

The nature of the fiscal responses has been, as expected, clearly coloured by the political preferences of the Government of the day.

• The 2008-13 blue fiscal response was heavily dominated by a reduction in taxes collected by the Government.
• The 2019-24 red fiscal response is projected to be overwhelming dominated by an increase in spending by the Government.

The period between these two sets of crises reflected a fiscal stance focussed on reducing Government debt. This reduction was achieved through a programme of relatively mild austerity.

• Tax revenues increased in line with increases in economic activity.
• There was a considerable decline in government spending as a ratio of GDP.
• The consequential rundown in levels of delivery of social and public services have been reflected in various measures of ongoing infrastructure deficits.

The current fiscal response remains wedded to conventional thinking.
 

• The reversal of the Government spending boost over the projection horizon is remarkably quick and reflects a conservative approach to the role of Government.
• There is no change in the size of the Government’s tax take. The lack of a tax response is loading the increase in Government debt onto future generations. The Budget 2020 projections sees this burden as being met through the conventional approach of future spending cuts.
• Consideration of alternative financing methods to potentially take such debt off the balance sheet is missing.
• Sadly, this conventional fiscal policy response signals little appetite to transform the role of Government in the post-COVID-19 economy.

Transformation opportunity hanging by a thread.

• The additional fiscal response that will undoubtedly be required in the near term will provide one last opportunity to shift the dial on tax, spending, and balance sheet debt.
• To date though, the signals do not engender confidence that there will be a concerted and concentrated shift in both tax receipts and spending to ensure well-funded social and public services appropriate for inclusive and sustainable wellbeing outcomes for the communities of Aotearoa.