The government’s extraordinary measures to halt Covid-19 and support the economy have had extraordinary public support. Tony Burton argues that the hard choices about who pays for it will be far less popular.
I have lived with a skeleton since the lockdown. It’s white and shiny and takes up half the space in my living area. No one died, though it is a bit creepy at times. The skeleton is the empty frame of a half-built kitchen left behind when the work stopped at the lockdown. For my household bubble, it has been a nuisance having the fridge in the bathroom and having to cook on a barbecue. However, Treasury modelling released on Tuesday suggests this is a mild inconvenience compared to the economic trauma all of us will face over the next few years.
Jacinda Ardern showed an understanding of both epidemiological maths and public sentiment when she decided our Covid-19 response should include a lockdown. Close to 90% of New Zealanders support her, yet the choices she must make as we move into the next phase of the crisis will not have anything like that unanimity of support. They will ultimately decide which generations bear the brunt of paying for the extraordinary stimulus.
Professor Neil Ferguson, whose study in the UK is the basis of the scary epidemiological maths, has suggested that “as many as half to two thirds” of those who die with coronavirus would have died by the end of this year regardless of whether or not they caught the disease because most fatalities are among people at the end of their lives or suffering from underlying health conditions. Some healthy people die, as they do every year from the flu, but the main beneficiaries of the lockdown are physically vulnerable people who are no longer working.
New Zealand’s approach prioritised the lives of the vulnerable over the economy. To do this, most people in work have indefinite leave and an advance on future wages. So far, $12bn has been committed for these advances, mostly spent on subsidies equivalent to 80% or more wages. When finance minister Grant Robertson described this as “one of the largest response packages in the world on a per capita basis”, it was not political hyperbole. In December 2019, as part of a normal budget process, he set aside $3bn for extra non-capital expenditure (“operating allowances”). Most of that would have been spent on increases to public sector pay and other maintenance of the system, so $12bn on a new initiative is a colossal spend.
The Treasury report released on Tuesday provides an economic background to help “weigh up the implications of fiscal and regulatory policy decisions”. It is presented with 2019 as the baseline followed by the current year and four “out years”. In the graphs below, GDP (incomes) is in the left-hand graph and unemployment rate on the right. In both, the solid blue line is the projection without Covid-19. The black lines show what happens with increasingly severe lockdown conditions (see here for a full summary.)
The wooden skeleton in my house gives a more human sense of the economic dislocation implied by the graphs. The end of the lockdown will not see work immediately restart on our kitchen. Even a return to level one would mean a week or more of organising plumbers, joiners, painters and polishers. The planner estimates a further six weeks before the backlog of work is cleared. That is the best-case scenario, with children back in school, contractors working without distancing restrictions, and imported items (like floor polish) all available. More likely, we will be living with that skeleton for months. A single household kitchen, already planned and budgeted for, is considerably simpler than many economic activities. It is easy to see why the delays and dislocation created by the lockdown mean it will be well into next year before incomes and employment start to recover.
Macroeconomic modelling for government is as much a team activity as rugby. The Treasury analysts must have worked under extraordinary difficulties to produce this report in a lockdown. However, for a paper on “fiscal and regulatory policy decisions”, it is strangely quiet about both. There were simple things they could have included to make it policy-relevant. For instance, they could have estimated debt to GDP ratio and the cost pressure created by servicing more debt.
A clue to why these results are in their format: this is how they are normally shown in budget documents. They would have been fed into longer-term fiscal models to put numerical estimates on hard choices about debt, spending levels, and the tax rates needed to make them sustainable. The suspicion must be this paper was created to “manage the authorising environment“. That is, to present scenarios with no policy content to soften up the public for the unpalatable choices that need to be signalled in the 2020 budget.
What could these policy choices look like? There are at least two issues that urgently need to be addressed. There certainly won’t be 90% support for any of these policy options.
Most obvious is how to deal with the cost of the wage advances. In the short term, when faced with a worldwide economic calamity, increasing debt is a reasonable approach. Sometime after the election in September (but well within the time covered by budget forecasts), a decision needs to be made on what overall debt level we will target and if the extra costs associated with that debt are to be covered by reducing other spending or increasing taxes.
These are the kind of extraordinary times when the government might consider extraordinary responses. Will they recognise the main beneficiaries of the lockdown are over-65s and revisit a capital gains tax or consider a surcharge on New Zealand Superannuation? Both would more evenly distribute the financial costs among generations. Given New Zealand First is in the coalition, and will be implacably opposed to anything touching superannuation, the government is more likely to look at higher taxes for middle and upper-income earners ($48,000 to $70,000 per year and more than $70,000 per year respectively).
The other big economic issue is a potential crunch in the labour market. The optimistic Treasury scenario has the unemployment rate tripling this year and staying high for years after that. Getting people back into work is going to be a priority. Unfortunately, there is a structural shift in the labour market pushing up employment costs. Partly this is an unavoidable consequence of closing borders. Travel bans and quarantine regulations will make skilled migrants think twice about coming here and dissuade many seasonal workers in the agricultural and service sectors.
More important in the longer term will be the incentive impact of increasing 2020 benefit rates in line with 2019 wage rises. This is hitting at the same time wages will be falling for two years. The normal response – in-work payments to improve incentives – are expensive (think of the billions spent on Working for Families) and further add to the hard fiscal choices. If we do not deal with the problem then higher unemployment will become the new normal.
Higher taxes and benefit incentives are scary for politicians, far scarier than any skeleton. The next stage of the policy to deal with Covid-19 is going to be very unpopular.
Long after a vaccine has been distributed we will likely still be arguing over who bears the financial costs of our response.
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