Gareth Kiernan critiques the reasoning behind the new Labour Party VSR policy - he has ten reasons why he is not a fan

Gareth Kiernan critiques the reasoning behind the new Labour Party VSR policy - he has ten reasons why he is not a fan

By Gareth Kiernan*

Firstly, credit where credit’s due.

In announcing its new monetary policy proposals, Labour has shown an admirable ability to think outside the square.

Past criticism of the monetary policy framework has implied that the Reserve Bank’s focus on inflation is too narrow and that it should take more account of other factors such as unemployment or the exchange rate.

Although Labour’s policy has pinpointed the current account deficit as an area the Reserve Bank needs to take more notice of, the Party has coupled this assertion with an exploration of alternative tools to interest rates for moderating the economic cycle.

And so they’ve arrived at the variable savings rate, or VSR for short.

In this brave new world, KiwiSaver would be compulsory, and instead of just using interest rates to slow growth and keep inflation under control, the Reserve Bank could also change the mandated rate of contribution to KiwiSaver.

More saving is the same as paying more money on the mortgage, leaving less for discretionary spending, resulting in slower growth in consumption and aggregate demand, right?

And the added bonus is that more saving will eliminate our current account deficit and stop so much of our money being sucked offshore by foreign-owned banks.

Unfortunately, there are a lot of problems with Labour’s idea and the assumptions behind it.

From the bottom up:

1. Should KiwiSaver be compulsory?

It seems inevitable that compulsion will occur at some point in the future, given that over half of the voting-age population is now in the scheme.

Of course, the main reason for KiwiSaver’s popularity is that we’re being bribed with our own tax money being given back to us. 

Advocates for compulsory saving believe that we’re too stupid or short-sighted to prepare for our retirements, but I’d suggest it’s more a case of responding to guaranteed government superannuation, saving via non-financial assets such as property, and age and stage of life considerations (apart from the KiwiSaver bribe, few savings and investments are going to match the implied return of paying off your mortgage). 

Instances of short-sightedness about retirement savings are probably less common today given the significant education programmes undertaken through the Commission for Financial Literacy and Retirement Income over the last 20 years.

Forcing people to save against their will is ultimately welfare-reducing for society as a whole.

One could argue that the current National Superannuation system funded via taxation is simply a form of compulsory retirement savings.

That being the case, any move to compulsory KiwiSaver should be offset by a reduced tax burden over time.

2. Does New Zealand really have a savings problem?

Data from the OCED shows that New Zealand’s household savings rate has improved from -9.7% in 2002 to +1.1% by 2013.

There were clear reasons for concern about the lack of savings during the first half of last decade, but behaviour has changed significantly over recent years.

3. How good is Australia’s compulsory savings scheme for their economy?

Labour costs in Australia are widely recognised as being relatively high, at least partly due to the savings requirements.

Ultimately these costs undermine Australia’s competitiveness on the international stage and potentially constrain economic growth over the medium-term.

4. Do compulsory savings programmes actually increase savings anyway? 

Evidence from Australia suggests that their scheme has had little net effect on the household savings rate overall, but has mostly led to the reallocation of saving from one vehicle to another.

Since KiwiSaver’s introduction in New Zealand, a similar outcome in saving behaviour here has been observed.

5. What effect do compulsory and limited-access savings have on the robustness of financing decisions?

In our view, the disproportionate flow of funds into certain investment vehicles reduces discipline around borrowing and lending activity.

In the middle part of last decade in particular, it seemed that virtually all investment opportunities within Australia had been exhausted. As a result, there was a flood of funds coming out of Australia particularly from private equity firms, looking for alternative investments.

Having free and functioning capital markets is good for an economy, but too much money sloshing around can see significant amounts of wealth being lost if economic conditions deteriorate and lenders to high-risk borrowers are left out of pocket.

Furthermore, varying the KiwiSaver contributions through the economic cycle is likely to mean that more funds flowing into equities and other investments during periods of strong economic growth when they are already relatively highly valued, exacerbating the lift in prices.

The reverse would be true in a downturn, with the inflow of new funds drying up as KiwiSaver contributions were pared back. This recipe is not one for mitigating swings in the economic cycle.

6. Is New Zealand’s permanent current account deficit really a problem?

Between 1951 and 1973 when New Zealand last ran a current account surplus, the country recorded current account deficits about three quarters of the time.  Given that this period is seen as a golden age for the New Zealand economy, the figures are perhaps a little surprising.

The reality is that a country is able to sustainably run current account deficits as long as the current account deficit is smaller than nominal GDP growth.

In other words, sustainability requires the level of overseas debt to increase no faster than a country’s income.

This measure of sustainability comes about because, unlike an individual who should theoretically balance their income and spending over a lifetime, a country’s “lifespan” does not have an end and so there is no requirement to repay capital.

7. Are our 'high' interest rates really caused by our rigid monetary policy framework?

Labour thinks so.

But looking at historical interest rate differentials suggests that, at least during the 1990s, our relatively high interest rates were a legacy of the high-inflation and high-risk environment for investors between the mid-1970s and late 1980s.

Over the last decade or so, our real interest rates (ie after adjusting for inflation rates) are much closer to overseas rates.

In fact, our real short-term and long-term interest rates have been lower than rates in the UK and the US over the last ten years.

8. How much of our mortgage interest payments go overseas?

The most recent data from the Reserve Bank shows that 30% of all bank funding is sourced from offshore.  So if we assume that increases to the official cash rate push up borrowing and lending rates roughly equally, then most of the increased mortgage payments from an OCR hike flow through into increased income for domestic savers anyway.  Implying that tighter monetary policy under the current framework leads to an equally large loss of New Zealand money overseas is misleading.

9. Does the export sector really need a lower exchange rate?

Labour believes that a lower dollar is necessary to improve the competitiveness of our exporters and boost our economic performance.  To be fair, Labour isn’t the only organisation that finds this logic appealing.

Calculations of what is a fair value for the exchange rate are problematic, but the reality is that much of the New Zealand dollar’s strength is attributable to the huge rise in export commodity prices over recent years.

The lift in export commodity prices has been so strong that returns to agricultural-based exporters have risen by 22% over the last five years, even with the 41% lift in the dollar over the same period.

The biggest struggle for exporters at the moment is for non-commodity manufacturers – a problem caused more by soft demand conditions in Australia than the high exchange rate.

Advocates of a lower exchange rate also conveniently overlook the significant implied loss of wealth a weaker dollar would imply.

Dragging the exchange rate down is not going to change the minimum wage worker’s pay rate of $14.25 per hour, but they will notice the effects when they turn up at the petrol station and are charged $3.20/l instead of $2.20/l.

10. What about compliance costs for businesses?

Last month our business adjusted all its wage and salary automatic payments for the changes to ACC levies at the start of the 2014/15 financial year.

That task was arduous enough, but imagine having to change every employee’s pay every six weeks because the Reserve Bank has shifted the KiwiSaver contribution rate by 50 basis points. The additional work for HR and payroll managers or accountants would be significant.


In short, we’re not fans. 

In his speech announcing the policy, David Parker talked about how, "to [some] people, monetary policy is sacrosanct, a kind of infallible article of faith, and they vigilantly guard against meaningful change."

Yet research over the last decade has shown that, apart from a few possible tweaks around the edge, that New Zealand’s monetary policy framework is best practice.

Yes, there have been clear flaws with central banking operations highlighted by the Global Financial Crisis, but these problems were more to do with the appropriate levels of supervision, transparency, and regulation around the financial system and its institutions.  In the wake of the GFC in New Zealand, the Reserve Bank has moved to alleviate many of these shortcomings.

Let’s also be realistic about how blunt an instrument the OCR is for trying to manage the economic cycle.

But to achieve the same amount of traction with changes to KiwiSaver contributions would make the OCR look like a razor blade in comparison.

Given that the OCR framework is transparent, reasonably quick to take effect, and has been set up to be highly independent, we’re happy to stick with it.


Gareth Kiernan is the managing director at Infometrics, an economic consultancy and forecasting service, and he manages the forecasting team. You can contact him here »

We welcome your help to improve our coverage of this issue. Any examples or experiences to relate? Any links to other news, data or research to shed more light on this? Any insight or views on what might happen next or what should happen next? Any errors to correct?

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Thank you ... I have said this VSR is a hare-brained idea  that stands for VERY STUPID REASONING .
Basically its says I dont pay the lender for his money if the price goes up  ..... I put it in my own Piggybank ( Kiwisaver)
If this was even remotely possible I can assure you it would have been done already
Just how it is supposed to work is beyond me , given we have to pay the providers of Capital a reasonable return ( interest ) rate in real money after adjusting for inflation .
Simplictically , that means the OCR  has to be inlfation PLUS the  risk free return rate on say, gilts ,
That return has to be as good as or better than our competitors for the same available money with the same risk profile.  
How we are going to somehow fund the banks by putting the money in Kiwisaver ........ well you explain that to me

Point 2 says that NZ's household savings rate has changed from  -9.7% in 2002 to +1.1% in 2013.   
Point 4 says that KiwiSaver's introduction has had little effect on household savings in NZ.
So where are we saving all this money, if not in KiwiSaver?   

New ideas are hard to accept sometimes and all the good ones seem to come from the left eg Kiwisaver, the cullen fund, working for families, etc.
I think the  basic idea with the policy is to take the money out  of circulation, as an interest rate rise does, and instead of it going to a bank and never coming back, it goes into our retirement savings which at some point we expect to get back (or better still, pay off the debt at the lower interest rate). What a great idea - unless you hold shares in banks (and that's not John)!

James please dont be like the other misguided souls, even the opposiiton politicains know that their  "it goes to overseas banks" is a crock. It goes to the investors who are funding the NZ borrowers that the banks are intermediaries for andf take the credit risk on. And 70% of them are people like my Mum who is struggling to survive on the 3% after tax if sh'es lucky that she getting now because borrowers have over borrowered.

Grant, don't get me started on the need for a CGT so that tax on savings will be uniform with other gains on capital..!
Good point on your mother though - I think previous stories said the OCR increases weren't all going striaght to savers. Some being diverted to shareholders.

James - name me a country with CGT that has delivered the so called benefits/intent of this tax.  Here's a hint - you won't.  It just leads to manipulation and avoidance.  And don't forget, if asset prices drop (which is not unlikely) there will be a tax deduction available.

I am not going to fact check each point, but I would suggest #2 is somewhat disingenious, as it is comparing National's best year with Labour's worst year. If you actually look at the savings rate over time, and I encourage everyone to do so for themselves
The savings rate has been rising at a fairly steady pace since 2002 and all that can really be said is National haven't done anything that has changed the effect of kiwisaver in a major way. You could argue we should be on average slightly higher in 2013 except for National relaxing kiwisaver a bit, but there is enough movement in the line that that is not prove yet.
Becuase of hitting this with the first thing I went and checked, I'm not going to pay a lot of attention to the rest of the article.

I would though point put to Gareth Kiernan "New Zealand’s monetary policy framework is best practice" that best practice is generally entrained past practice.

As it happens I am a big fan of a current account target as per Labour's proposal, but am not 100% convinced that Kiwisaver adjustments are the best means to achieve it. I believe there are other capital management tools that would be simpler.
That aside, your instincts on the article seem valid, with points 6 to 9 also very challengeable as follows:
6) A current account deficit may be "sustainable" when equivalent to nominal GDP growth, but sustainable implies no real growth in wealth over time; merely holding steady at best. To still have a significant deficit at times of the highest terms of trade ever seems reckless indeed.
7) Our after exchange rate appreciation interest rates have been very high. The NZD has appreciated 30% against the USD in the last 5 years. We have been paying foreign investors our interest rates plus ~5% a year. Say 8% per annum. That in a nutshell is why the NZD is grossly overvalued.
8) The author notes that 70% of extra interest payments stay onshore. A non trivial 30% therefore go offshore. Plus the bank dividends. Our mortgages went from $70 billion in 2002 to $186 billion in 2013. 30% at 5% interest rates of the extra $116 billion per annum is $1.74 billion per annum. Plus dividends. 
9) Yes the export and import substitution industries will be more competitive with a lower dollar. As an economist, to suggest otherwise, implies he has a hidden agenda. His maths of petrol going from $2.20 a litre to $3.20 a litre, given the imported non tax element of petrol is probably say $1, imply a 50% devaluation of the currency. The IMF suggest a 15% devaluation would be ideal.

[ silly smear deleted. Ed ]

If kiwisaver had been around and compulsory for the last 60 years the average baby boomer would now be retiring with hundreds of thousands of dollars if not millions. Anyone who thinks  compulsory savings don't increase savings rates is blind. 
The government can still make part of kiwisaver voluntary like it is now, it would only be the vsr that would need to be mandatory.  Considering all of that money either has to dissapear from the economy in the form of interest or to your kiwisaver account I can't see why anyone would choose the former. 
The only good argument you put forward is the changes in wages having to be made by employers. But maybe the vsr could be set once a year with the OCR being used for short term affect. 

4. Do compulsory savings programmes actually increase savings anyway?
"Since KiwiSaver’s introduction in New Zealand, a similar outcome (little net effect) in saving behaviour here has been observed."
Where are you looking Gareth - around the office?  For low and middle income earners who've been dealing with slow wage growth, constant inflation and housing affordability issues Kiwisaver has been an absolute godsend.  Many wouldn't have any savings without it.

#6 Insufficient attention to the current account deficit, I fear.
Considerable cash has arrived with increased immigration which can distort the exchange rate.
Look then at the composition of those arriving. While many may be returning citizens the rest are new residents. All of those have the potential to just be using NZ as a means to enter Australia and many of them will do so especially those from Asia who cannot enter directly. They will take their cash with them plus their untaxed NZ gains.

Yes I completely agree.  Whether or not you agree with Labours idea it puts a spot light on the main reasoning behind it.   


 Why are we letting privately owned banks charge us interest on money we allow them to create out of thin air!


  These guys have actually written the policy needed to take this privilege away from the banks in the UK.

Almost all of the points are completely flimsy and short-sighted; they do not stand up to even a moment's reflection or research. Eg point 3, that Australia's scheme leads to high labour costs and uncompetitiveness - in fact Australia has been one of the world's best-performing economies for 20 years and is now one of the richest countries in the world. In addition, because of changes to super introduced along with the savings scheme,  the Australian federal government will soon have greatly reduced pension obligations. Besides, Australia is not using a VSR as a macroeconomic tool, so most of the points often raised in relation to Aus. are irrelevant.
Point 6, current account deficit not a problem - then why do we have one of the worst net international investment positions in the world, about -70% of GDP; only Portugal, Greece etc are worse. Singapore, a country that uses a Variable Savings Rate as a macroeconomic tool, is at +224%, one of the highest in the world. (The article reminds me of articles by Iceland economists just months before the crash of why their current account deficits of 15% were 'sustainable'.) To study Labour's proposal in detail would involve a systematic study of international experience with a VSR, not what we are given here.
All the studies I have read indicate that New Zealand has persistent underinvestment, poor productivity growth, and our savers are overconcentrated in one (unproductive) area (housing). Congratulations to Labour for looking at the big picture.