Now that New Zealand is being battered by turbulence from the global financial crisis, the new government has set itself the task of developing a “more focused, efficient, and productive public service”. This is being sold as a rebalancing of resources away from bureaucracy and towards ‘front-line’ services. It is also committing itself to a substantial increase in spending on investment, some of which may be well spent within the government sector.

These focuses, and commitment to change, are a good opportunity to focus on culling projects of questionable value, and thereby directing investment into the most valuable activities. However, growing signs of a cavalier ‘across-the-board’ Razor Gang approach to culling government spending leave one with a sense of déjà vu. There appears now a serious risk that the current Government will repeat the mistakes of the early-1990s in a misguided drive to ‘balance the books’. We hope we are proven wrong.

The Government can mitigate the risk from increasing government debt by minimising waste in those activities that aren’t suited to market provision, and maximising the return society gets from the resources it steers to collective public investments. But the outlook for the government accounts within which the Government is having to make these judgements is not pretty. However, this fact reinforces the need for far-sighted leadership rather than slavish adherence to a now wholly discredited textbook.

Indeed, the one thing the Government should not do is be overly concerned about credit rating downgrades. The credit ratings industry (and the agencies therein) were complicit in the financial crises. Put bluntly, they have blood on their hands in the positive ratings they gave to the Collateralised Debt Obligations (CDOs) and other instruments that are now sitting as toxic assets on many institutions balance sheets. That officials across the globe continue to value their pronouncements defies belief.

The Treasury’s accounts for the seven months to January 2009 show the Government’s operating budget before gains and losses (OBEGAL) was a small surplus of $0.6bn. The operating balance was in deficit by $5.5bn for the same period. Although PAYE revenue and excise tax revenues were slightly ahead of the October Pre-election Economic and Fiscal Update (PREFU) forecast, the slowdown in consumer spending and employment growth are likely to chew into these revenue sources in the near future.

At the same time, gross sovereign issued debt climbed to approximately 25% of GDP. This was substantially higher than the PREFU forecast of 16.7% and the December Half-Year Economic and Fiscal Update (HYEFU) forecast of 17.5%. This reflects the anticipated deterioration in the fiscal position, and was partly driven by an increase in currency being put into circulation to offset tightening credit conditions in New Zealand. This deterioration is likely to add to the Government’s debt servicing expenditure.

We expect that the OBEGAL will reach a deficit of $1.0bn by June 2009. This is higher than the Treasury PREFU forecast, as our near-term tax revenue forecast is slightly more positive because of our higher GDP forecast. The gains and losses item included in our forecast is based on the HYEFU, and results in an operating balance deficit of almost $5bn.

Over the longer term, the OBEGAL deficit is forecast to climb to $3.1bn by June 2010 and exceed $5.1bn by the forecast horizon of June 2012. A recovery in the net surpluses of SOEs by 2012 is expected to help the operating balance, although the operating balance is still projected to be a substantial deficit of $3.8bn. This forecast depends on the objectives and incentives the Minster of SOEs creates for these enterprises, and the surpluses that they return.

In more general terms, the Government has a tricky balance to reach. It has to address legitimate concerns about how it can assist the market economy in the short-run. Running up public debt comes at a cost, and the Government has elected to stop pouring tax dollars into KiwiSaver as it sees the value of its investments evaporate. Yet, the benefit of being a long-term investor is that in the bad times there are some very cheap investments out there. While a few of them may be turkeys, good investment managers will identify high quality investments. By buying them when they’re cheap they’ll gain value and pay off in the longer term.

Therefore, ignoring savings opportunities now avoids higher government debt and its problems in the short-run, but may also miss the chance for bigger gains in the long run.

The agenda for action has to balance the short-run concerns about global economic turbulence with the long run opportunities it brings. It is typical for an economy to undergo substantial restructuring during recessions. Although it may look like the economy is falling apart, this government has a heavy responsibility to help put it back together so that the economy can deliver, in the words of the New York Times’ Thomas Friedman, growth in smarter, more efficient, more responsible ways.