Is New Zealand saving itself to death?

How important are savings to economic growth? Would you gamble billions of dollars on the answer? This is the challenge facing the New Zealand government after the launch of a radical new savings plan last year.

Known as “KiwiSaver,” the scheme is voluntary but generous subsidies mean that only the very poor or very foolish will not sign up. The government provides a NZ$1000 kickstart and a NZ$1000 annual tax credit, and soon employers will have to contribute 4% of the employee’s salary, tax-free.

All of this adds up to a bonanza for those who contribute to their own accounts. At certain levels of income, it will soon be possible to receive NZ$3 in subsidies for every dollar invested, so it is no surprise that the New Zealand public loves KiwiSaver.

Yet, as economists regularly remind us, there is no such thing as a free lunch. The total cost of KiwiSaver subsidies will soon reach NZ$2 billion a year at the very least. This is more than the New Zealand government spends annually on its entire defence force.

Why are New Zealand politicians so determined to force higher savings? KiwiSaver reflects a fashionable view in some quarters that higher savings are a panacea for small economies like New Zealand. They boost investment and domestic ownership of firms, the argument goes. Yet in its haste, the government has failed to properly prove this case or to consider the costs as well as the benefits of such a hands-on approach.

A higher rate of national saving will only boost growth if the extra money is used on more and better investments in the local economy. It is the quality that matters, because there is no point funding projects that won’t deliver the returns. Japan provides a good example of this: it has a glut of national savings, but poor returns have seen its economy struggle.

The crucial question for New Zealand is how its extra saving will be used. Will it generate a better return than it would have in the absence of such generous subsidies? The case is not convincing.

The kind of distortion that comes from subsidising saving is rarely good for an economy, because it warps rational decisions and pushes money into less productive investments. For many New Zealanders, it is now more rewarding to invest in KiwiSaver than to save in other ways, such as by paying off debt or a mortgage, buying shares, or investing in a business. In fact, some financial advisors say it is now logical for people to borrow money on a credit card to take part in KiwiSaver.

The seldom-considered costs of these distortions make KiwiSaver a risky and uncertain proposition. They also help to explain why there is evidence from around the world that higher savings are a result of growth rather than a cause.

In any event, government attempts to boost savings rarely succeed. A range of studies shows that saving incentives do change behaviour, but usually by substituting one form of saving for another.

Perhaps the biggest problem with KiwiSaver is how it affects retirement policy. New Zealand already has one of the most generous age pensions in the OECD, with universal provision and no income or asset testing. With KiwiSaver on top of this, many New Zealanders will reach age 65 and retire to a higher income then they enjoyed in their working life.

This represents a fundamental shift in consumption patterns for today’s young workers. A boost to retirement income doesn’t necessarily make people better off; it simply rearranges when they spend their earnings, which may lower their lifetime utility as a result.

Most people need less money to live on when retired, because they have less debt, less active lifestyles, and no dependent children. In contrast, it is in the younger years when families struggle the most, as they bear the costs of raising children and paying off a mortgage.
This is a strange time to be shifting today’s income into preparation for retirement. Many families are currently grappling with rising fuel, food, and housing costs, and will struggle to devote 4% of their salary to KiwiSaver. Retired people face similar pressures but, even without having participated in KiwiSaver, they still enjoy an average standard of living higher than any other group in New Zealand society.

Younger workers will understandably question the burden they now carry. They must pay for the age pension for the current generation of retired workers and at the same time save for their own retirement through KiwiSaver and fund the generous public subsidies.

In summary, KiwiSaver represents a major hands-on role for the government, and a deliberate transfer of wealth in three ways. It shifts wealth from early life into retirement, from productive forms of saving into less productive investments, and from taxpayers to those who can afford to save (and who tend to be the wealthiest in society).

In their haste to embrace savings, New Zealand politicians seem to have overlooked these unintended consequences. In doing so, they have placed New Zealand in the unenviable position of being an economic guinea pig for the rest of the world.

Phil Rennie is a New Zealand policy analyst at the Centre for Independent Studies. Get the full version of his paper KiwiSaver or KiwiSucker? at www.cis.org.nz.