Dancing with the elephant in the room

Debt is not to be ignored, but does need to be understood

Like most elephants, debt tends to always dominate when in the room. Hence, a clear-headed understanding of the role, impacts, and consequences of debt is invaluable in its presence.

Yes, debt can be a friend to the economy and the community that it serves. Or, it can be an enemy.

Debt incurs obligations and responsibilities and, importantly, these obligations and responsibilities carry over time. Debt can, therefore, potentially limit choices and enforce priorities that may become burdensome for future generations. Debt can also, however, build strengths and capabilities that may equip future generations to tackle challenges and enable their enjoyment of future opportunities.

Sadly, though, (probably similar to our understanding of elephants) our collective understanding of debt leaves a lot to be desired.

For example, and true to form, the collective gaggle of assorted commentariat, advisors, lobbyists, media, and politicos continued to highlight the outlook for government debt on the release of the Half-Year Economic and Fiscal Update (HYEFU).

The picture tells a more nuanced story. Treasury projects net external debt to deteriorate by more than 8 percentage points – over 5yrs – from 49.7% of GDP in June 2024 to 58.1% of GDP in June 2029.

Net external debt of New Zealand as a % of GDP

If our grandchildren are to truly thank us for the legacy we leave them, then we must unveil a level of economic nous that unfortunately remains currently well hidden in the tribal dialects of both the political and the economic narratives.

It is the nature of the debt, and who it is owed to, that makes a huge difference to conclusions and legacy arguments.

In this context, there are two distinctions that are critical to understanding the role of debt in the economy of Aotearoa:

• the distinction between government debt and external debt

• the distinction between financial debt and economic debt

A starter for 10

The diagram below depicts the economy of Aotearoa (the black oval) as a subset of the economy of the world. Further note, the economy of Aotearoa is divided into two parts

• the New Zealand government (also called, the public sector)

• the rest of New Zealand, including individuals, families, whānau, households, iwi, businesses, banks, other corporates (also called, the private sector)

Components of external debt and its relationship to government debt

To improve our understanding of debt in this context, there are three sets of financial transactions that matter.

1. the New Zealand Government can borrow from other organisations within New Zealand – including from individuals, family, whānau, households, iwi, businesses, banks, corporates. These transactions are represented by the light blue arrow going from RESTOFNZ to NZGOV. Importantly, these transactions DO NOT cross the international border between Aotearoa and the rest of the world.

2. the New Zealand Government can borrow from organisations in the rest of the world, including foreign businesses, banks, institutions, corporates and the like. These transactions are represented by the red dotted arrow going from RESTOFWORLD to NZGOV. Importantly, these transactions DO cross the international border between Aotearoa and the rest of the world.

3. New Zealand organisations outside of Government (including households, iwi, businesses, banks, and corporates) can borrow from the rest of the world – including from foreign businesses, institutions, corporates, banks, and the like. These transactions are represented by the red dashed arrow going from RESTOFWORLD to RESTOFNZ. Importantly, these transactions DO cross the international border between Aotearoa and the rest of the world.

Consequently

• external debt is the total of the borrowing that the nation of New Zealand owes to organisations and institutions of other nations. This is the combination of the second and the third set of financial transactions noted above, and is represented by the red dashed arrow and the red dotted arrow going to Aotearoa. Importantly, external debt includes all debt of organisations and entities (public and private sector) in Aotearoa owed across the international border to the rest of the world.

  • another, equally valid, way of understanding external debt is recognising it as the accumulation over past years of the nation’s shortfall in income from exports required to pay for imports. That is, the difference between the nation’s export earnings and the bill for imported goods and services that are required (and/or demanded) by households, businesses and government. Note additionally that, over time, the accumulated bills also include interest payments on previous year’s shortfalls.

• Government debt (also called public debt) is the total of the borrowing that the New Zealand Government does. This is the combination of the first two sets of financial transactions noted above, and is represented by the light blue arrow and the dashed red arrow going to NZGOV. Importantly, Government debt comprises a combination debt owed within Aotearoa and owed across the international border to the rest of the world.

These two¹ different types of debt have different characteristics. Importantly – and this can not be over emphasised – external debt involves future obligations and payments that cross the international border to the rest of the world. Due to this peculiar characteristic, external debt is of significantly more consequence for legacy considerations.

From a financial perspective, paying off (or just managing) external debt requires inflows of (or attraction of) foreign currency into the New Zealand economy. The necessity of these inflows (or ongoing efforts to attract foreign currency) can potentially compromise future priorities.

Or, additionally, to reduce any dependence on external debt it is helpful to reduce the annual shortfall between export income and import payment obligations. This can acts to focus resources on economic activities in the export sector as well as those competing with imports.

Economic impacts

It is appropriate to now shift from a purely financial perspective to a broader economic perspective. As always, any economic analysis should begin with the bedrock foundation of all economic activity – the productive resources of the nation. These include (but not a comprehensive listing)

• the physical structures and natural endowments

  • the bricks and mortar

  • machinery and equipment

  • energy, communications, and transport infrastructures

  • land, water, forests, and fisheries

  • ecosystems and climate

• the skills and knowledge of the people and communities

  • education and training levels of workforce and experiences

  • entrepreneurial spirit and appetite for innovation

  • diverse and equitable opportunities for all to participate and contribute

• the culture of activity and the trust in institutional authority

  • agreed and accepted laws and rules of behaviour

  • inclusive formal and informal networks

  • strong and secure community connections

Economics revolves around the choices and decisions we (individually and collectively) make over the resources that are inherited from previous generations, and then utilised, exploited, extracted, maintained, improved, degraded, replaced, and/or embellished, and in turn left for future generations.

As noted earlier, financial debt carries obligations and responsibilities that (over time) can potentially limit choices of – and enforce priorities – for future generations.

Economic legacy (or debt) can be viewed in terms of improving or impeding choices, decisions, and priorities over the use, utilisation, availability of and access to future economic resources.

Enter the real elephant

The real productive resources of the nation are not reduced by the Government debt that is held by other New Zealanders. This component of Government debt is represented by the first type of transaction referred to earlier and reflected by the light blue arrow in the earlier figure. This debt may involve inter-generational transfers of financial assets and debt, but the resources themselves (and decisions relating to them) remain within the borders of Aotearoa.

However, the quantum of financial debt that is held by the external sector – that is, the nation’s external debt – leads to significantly different conclusions/consequences.

The choices and decisions as to priorities around the allocation, utilisation and use of productive resources for individual and collective New Zealanders can be (sorely) compromised by the level of the nation’s external debt.

Firstly, the allocation of economic resources that is required by the export sector is a decision/priority that is taken out of the hands of future generations if we leave a legacy of large (and/or unsustainable) financial external debt. For example, productive resources we may wish to allocate to domestic consumption and/or to investment is de-prioritised in favour of allocation to exports (or import-competing sectors) in order to pay-off (or limit the growth of) external debt.

Secondly, the allocation of resources to meet the obligations of significant external debt may force concerning short-term decisions – where such short-term decisions have long-lasting deleterious consequences. Examples (but in no way comprehensive) of such concerns could list the following

• energy resources devoted (diverted) to aluminium production for export

• water resources devoted (diverted) to produce dairy commodities for export

• resources and concessions devoted (diverted) to build tourism attractions in regions

• resources devoted (diverted) by our tertiary (and some secondary) education providers to attract international students

• acquiescence in the face of film makers requesting special labour legislation and other favours in return for the promise of a stream of export income

• external entities deciding harvesting decisions in the forestry sector despite a need for added-value processing opportunities and/or workforce development in some regions of Aotearoa

While ownership of many of these productive resources remains in New Zealand, decision-making authority (in terms of priorities for the allocation of economic resources) are severely hampered by overbearing external debt².

The above examples illustrate the way we have increasingly been encouraged (cajoled, directed, or – blatantly – told) by other agents – who may not share the same values or priorities of New Zealanders, or of future generations – as to where our productive resources should go. In some instances, resource decisions around extraction and exploitation have proceeded in direct contradiction of our professed kaitiaki roles.

In essence, the level of external debt that New Zealand has accrued over many decades has depleted the nation’s economic sovereignty.

Thirdly, the ownership of productive economic resources may also cross the national border in the face of heightened external debt.

For example, beachfront properties (or high-country retreats) may have to be foregone to attract ‘high-wealth’ individuals promising ‘job-creating investments’. Similarly, energy generation infrastructure may be attractive for some offshore entities. And ownership of property assets are increasingly attractive for retirement village operators, or aged residential care providers, or early childhood education providers.

Once transferred to overseas agents, such a legacy does indeed deplete the productive economic resources available to future generations of New Zealanders.

The assertion that the public debt is what we pass on to the next generation is simplistic at best, dangerously incorrect and misleading at worst.

External debt represents the legacy of ability to decide upon, and make choices around, the productive economic resources that are passed on to the next generation. External debt is the true elephant in the room.

Takeaways

When the shadow of debt enters the room, ask

1. What debt is being talked about? Government debt or external debt? Because the answer to that simple question leads to critically different consequences in terms of economic impacts down the road.

2. Is it only financial debt that is being considered, or should the broader economic debt (or legacy) enter the conversation?

Faced with the legacy of consistently high levels of external debt as in Aotearoa, note

1. Austerity programmes aimed at reducing government debt is unlikely to improve that legacy. Moreover it could well, as it has in past experiences, make it worse – as feared by many and reflected in a recent open letter from economists.³

2. Earning income from exports in order to meet obligations for import payments (or reducing said import bill through import-competing activities) must lie at the heart of any economic prescription. But, these efforts must be sustained, and be sustainable, over the long term. Hence, the question of the appropriate use, utilisation, maintenance, improvement and enrichment of productive resources can not (and should not) be put aside when debt enters the room.

The fundamental structural imbalance (between export revenues and import payments) in the economy of Aotearoa (as reflected in the chart below) has persisted for many decades.

The shortfall in income from exports and that required to meet payments for imports (and for interest on previous external debt)

The connection between managing external debt and tackling this structural imbalance needs to be recognised.

In contrast, we have continually been fed trite and economically illiterate proclamations by leaders of varying hues about ‘balancing the books’, or ‘bringing down debt’. The legacy of such short-term myopia is seen in the rapidly dwindling ability to decide the future use of our economic resource base.

External debt will be with the people and communities of Aotearoa for some time. To halt the erosion of our economic sovereignty requires decisions around nurturing and managing productive resources to be applied to sustainable activities. This will ensure a legacy of resources that builds strengths and capabilities to equip future generations to tackle challenges and enable their enjoyment of future opportunities.

1. There is also a third related debt – known as private sector debt – which is the total of the borrowing that is undertaken by the New Zealand private sector. This is the result of the third set of financial transactions noted above, minus the first set of financial transactions. This is represented by the dashed red arrow going to RESTOFNZ minus the light blue arrow going to NZGOV.

2. There are further ‘sovereignty limiting’ impacts from overbearing external debt. For example, New Zealand is effectively forced to adopt inflation-fighting monetary policy through an ‘independent central back’ to ensure the flow of foreign currency is one that comes to mind. But that is for another note.

3. The reference in the letter to the hollowing out of capacity and capabilities is particularly appropriate here. Also appropriate is to note that productive resources include the people and their communities. Redundancies accompanying austerity programmes actively and severely undermine the chances of leaving a legacy of strong communities with a skilled and knowledgeable workforce fuelled by an appetite for innovative spirit and entrepreneurial endeavour.