Have you read the PREFU yet?

Below is an excellent guest post from Andrew Coleman on the PREFU – pointing out one of the weird assumptions that the government is relying on to “balance the books”.

“Have you read the PREFU yet?” bellowed one of my colleagues as he sauntered down the corridor at Otago University last week. “Of course not – why would anyone do that,” was my glib response.

The answer, of course, is that the PREFU is one of the great components of New Zealand’s modern democratic process. It requires that the Government provides an internally consistent set of projections about the likely state of the fiscal position over the next four or five years. Internal consistency is a marvelous thing. It means if the government announces a tax cut, the direct and indirect implications of this cut for growth, tax revenues, and the government deficit are properly calculated.

It means if the Government projects a surplus, the assumptions on the evolution of different classes of government spending are clearly portrayed. In short, it provides transparency.

Internal consistency is hard work, and we should be genuinely grateful to the Treasury analysts who do this work. All the assumptions are clearly laid out for anyone and everyone to see. If the Government is going to balance the books by imposing significant real cuts on health and education expenditure, then it will be reported and no-one has any excuse for not being provided with the information or for not having a model able to do the complex arithmetic.

Actually, it does appear that the Government is claiming the books will be balanced because of significant real cuts in the health and education sectors. This is not directly mentioned in the Executive Summary, where the focus is on the predicted growth rate (2.9 percent per annum from 2012 to 2016) and the return to surplus in the operating balance in the year to June 2015. (Mind you, the summary does mention that core Crown expenses will decline as a percentage of GDP.)

Nor is it mentioned in the Economic Outlook, although it is again noted that there will be a falling share of government consumption in GDP. However, this section does forecast an increase in nominal wages of 16 percent between 2012 and 2016, in part because the consumer price index will increase by 10 percent over this period.

It is not even mentioned in the “Fiscal Outlook”, where it is noted that real government expenditure will decline from 34.2 percent of GDP in the year ending in June 2011 to 30.3 percent by June 2016. While this section notes that health, education, justice, and other core Crown expense classes will have growth that comes from projected allowances for new operating spending, it is a little coy on the size of these projected allowances. Mind you, it does note that total expenditure will increase in nominal terms, from $74.5 billion in 2012 to $78 billion in 2016, and that New Zealand Superannuation expenses will increase by $3.6 billion over the period due to the increase in the number of recipients and the effect of wage and price indexation.

No, to find out the change in health and education expenditure, one needs to look in the Core Crown Expense Tables, pages 107 –112. There it is revealed that in nominal terms health expenditure will rise from $13.75 billion in 2011 to $14.35 billion in 2012 (a 4.3% nominal increase) and remain at this level until 2016 – despite a forecast 10% increase in inflation between 2012 and 2016. Similarly, while there is a 5.3 percent increase in nominal education expenses between 2011 and 2012, from $11.65billion to $12.27 billion, thereafter nominal expenses are flat. (Overall there is a modest increase in primary, secondary and tertiary enrolment over this period, led by a primary school role increase from 480477 to 505442 ). The same story applies to law and order expenses (Police, Ministry of Justice, Department of Corrections etc): a 1.4% increase from 2011 to 2012, to $3.15 billion, and then no further increase in nominal terms. In each of these sectors, therefore, the PREFU projects a real expenditure decline of 10 percent between 2012 and 2016.

There, of course, lies the beauty of the PREFU process. All the information is provided, and anyone can analyse the numbers in a few minutes. It is clear, transparent, fantastic. One cannot praise this process too much.

I must admit a little skepticism that these projected reductions in real expenditure on health, education, and law and order are going to be achieved. They are of course valid projections: they outline expenditure patterns given announced policy, and announced policy doesn’t appear to make allowances for any wage increase in these sectors between 2012 and 2016 despite 10 percent forecast inflation and 16 percent forecast wage increases. And it is true that wages in the health and education sector increased faster than in almost any other sector during the last decade, so that average wages in these sectors aren’t low by New Zealand standards. (Indeed, the data indicate that the 32 percent of the female workforce that work in these two sectors had real wage increases 10 percent higher than those achieved in Australia between 2002 and 2009, which is in its own way remarkable) Nonetheless…..no increase in aggregate expenditure over a four year period despite 10 percent inflation is a little difficult to swallow. Either there are going to be some grumpy lecturers, teachers, doctors, and nurses, or a whole lot of layoffs, or…..well maybe the operating surplus won’t quite get balanced.

So Paul, I now have read the PREFU (and graded 312 first year exams). Thanks for the suggestion. It was great reading. (Also thanks to M for the hints.)