Why compulsory savings won’t cure our ills

Gareth MorganEconomics

It is unfortunate but true that many myths have been peddled by successive governments in relation to KiwiSaver.

The latest policy offering from the Labour Party reflects a poor understanding about the limits of KiwiSaver and related issues. This is a major flaw in the comprehensive economic policy it announced last week.

Myth one: compulsory private savings schemes solve a country’s indebtedness.

Don’t be so sure. Despite being hauled out whenever the issue comes up, Australia’s compulsory scheme hasn’t had any major impact on its national indebtedness.

It is widely understood there (but not here) that in response to compulsion people can simply alter the types of the things they save into – if a bit more compulsory savings is imposed, then they save less in other ways. The composition of private savings simply alters.

There has been one important positive effect from compulsory savings in Australia – an increase in financial literacy. That is not to be sneezed at, but supporters in New Zealand claim far more for it than educational payoffs.

The claims being made in New Zealand of the Australian example are far greater than the facts.

Myth two: private savings and government savings are unrelated so boosting the first increases overall national savings.

The only way you get a sustained reduction in national indebtedness is to have a game- changing shift in both private and government savings. Policies that simply switch spending from the government to individuals do nothing to achieve this.

Forcing New Zealand’s working poor to save more just means there will be more claims on Work and Income for hardship allowances, as one example.

So one dollar saved privately is offset by more money spent by the Government. Of course, the offsetting consequences for government spending are buried in Budget documents and can’t compete with the rosy image of success provided by rising KiwiSaver balances.

Only fundamental changes will affect national indebtedness and these relate to improving the quality of public and private investment in New Zealand, lifting the quality of our workforce and management, and increasing the efficacy and efficiency of government spending.

Myth three: governments (and their agents like the Reserve Bank) can fine-tune the economy by manipulating compulsory contribution rates.

Governments have a long history of trying to manage business cycles by manipulating tax rates (a compulsory contribution too) but there is overwhelming historical evidence from across the world that shows they do a poor job of it.

Business cycles aren’t easy to pick for anyone (indeed there is very little evidence to suggest any financial sector whiz can do it consistently either). Invariably government officials recognise the economy is booming too late and hit the brakes just when the economy is slowing anyway, worsening the downturn’s severity. An added problem is that the consequences of changing contribution rates are hard to anticipate – people’s reactions aren’t that predictable and there can be long lags in their response. So it is hard to know just how hard to hit the brakes. Hit and hope is the general idea.

All of these problems would beset the Reserve Bank were it given the job of manipulating Kiwisaver contribution rates for the purpose of managing business cycles.

There is a good reason governments around the world shifted to using monetary policy (influencing interest rates or managing the money supply) to manage business cycles in the 1980s and have kept at it ever since. Compared to manipulating tax rates, monetary policy tool is capable of greater flexibility and the effect tends to be easier to predict.

A powerful aspect of monetary policy is that it affects confidence quite predictably (for example, people start to worry about the value of their house) and that can have a big impact on private saving behaviour.

The effect on confidence can be equally or even more important than simply removing a few dollars from the household budget each week.

It seems unlikely that changing KiwiSaver contributions will reliably alter confidence in the same way and thus it will be slower to work against the business cycle (if it works at all).

Myth four: KiwiSaver benefits all New Zealanders and disadvantages no-one.

The poor often aren’t members of KiwiSaver because they can’t afford to save and those not working don’t even have access to an employer contribution. The rich don’t need the sweeteners, as they would have saved anyway.

So KiwiSaver is really just a scheme for the middle-class. The fact the Government tops up private savings by $500 a year for those who save $20 or more a week means it is a middle-class tax grab. So yes, some people are hurt by the scheme – those who could do with the tax money.

There doesn’t appear to be any proof that KiwiSaver has prevented anyone from behaving “irrationally” either, “saving” them from their own poor saving habits. Before KiwiSaver there was no overwhelming evidence that people were saving too little. Poor people weren’t saving for retirement and, given the presence of universal NZ Super, that was completely rational (the poorest New Zealanders get more from NZ Super than they ever received during their working life, so it would be mad to sacrifice income received early on).

People with mortgages were quite right to focus on paying down debt than putting aside savings for retirement (the post- tax return to their retirement savings was less than the interest they saved by paying down their debt faster).

Kiwisaver has changed the calculation for some because it gives access to an employer contribution which they wouldn’t otherwise get and there is of course that government top-up. Were the level and eligibility of NZ Super to change, so would the rationale. But there is nothing to suggest KiwiSaver was addressing mass irrationality. There was no obvious “market failure” at work.

Myth five: New Zealand’s national indebtedness can be resolved without addressing fundamental structural issues about the economy.

There are a host of structural or inbuilt challenges facing the economy and these are the reason the currency can reach uncomfortable heights.

A key issue is the poor quality of New Zealand investment and the tax drivers of that. New Zealand needs to invest whatever savings we have access to (our own or that of foreigners) in businesses that have a sound basis. That way we can start exporting more and importing less, eventually producing a trade balance that is more than capable of paying our ongoing national interest bill and then some.

Instead, because no government yet has been willing to do the right thing around tax, an unnecessarily large chunk of New Zealand’s savings is stored in increasingly opulent and essentially unproductive housing which goes beyond its occupants’ shelter needs. Similarly, a lot of land is underused because it generates untaxed benefits for its owners. The obvious solution is to extend the definition of taxable income to non-cash rewards from all stores of wealth (as outlined in our 2011 book The Big Kahuna).

There are other structural issues that need addressing too.

To its credit Labour did deliver a comprehensive packag, which did include useful tax reforms (ring-fencing property losses being one example). However the policy package would have been strengthened had it been based on realism rather than myth.

Why compulsory savings won’t cure our ills was last modified: December 15th, 2015 by Gareth Morgan
About the Author

Gareth Morgan

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Gareth Morgan is a New Zealand economist and commentator on public policy who in previous lives has been in business as an economic consultant, funds manager, and professional company director. He is also a motorcycle adventurer and philanthropist. Gareth and his wife Joanne have a charitable foundation, the Morgan Foundation, which has three main stands of philanthropic endeavour – public interest research, conservation and social investment.