The Budget – Credit Ratings, AI, Defence and … Productivity?

VIEWS FROM OUTSIDE THE APIARY: IAN FLETCHER

Hard to find much to write about, here, I thought – especially in contrast to the recent steep tax-raising budget in Australia. Yet I think there are four interesting points we need to watch.

Firstly, the country’s credit rating. This was a budget aimed at not annoying the electorate while appeasing the rating agencies. There are three major internationally recognised credit rating agencies: S&P Global Ratings (S&P), Moody’s Ratings (Moody’s) and Fitch Ratings (Fitch). 

Ian Fletcher.

The credit rating agencies issue short and long-term ratings for both domestic and foreign-currency debt. Right now, two of the three agencies have our (very good) ratings on negative outlook, because of likely future borrowing.

Why does this matter? When the government issues bonds, a lower rating means it must pay higher interest to attract lenders. With central government debt sitting at high levels, an actual downgrade can significantly increase annual debt-servicing costs – the Treasury estimates a downgrade could add up to roughly $200 million annually to the cost of refinancing government debt. 

 That’s not much, overall. But there’s also a ‘benchmark effect’. The government’s credit ratings act as a baseline for the entire country. If the government’s rating drops, it effectively raises the "floor" for interest rates nationwide. New Zealand banks raise a significant portion of their funding in offshore markets. If the government rating falls, these institutions face higher borrowing costs, which they pass on to consumers as higher interest rates for business loans, mortgages, and credit. Higher mortgage costs would be bad news politically as well as economically.

Hence the budget bravado about an ‘early’ return to surplus (no one believes that; it’s basically showing off). Globally, interest rates are rising anyway (mainly the result of demographic change as rich countries age and spend their savings). So interest rates are going up anyway.

Which leads to the second interesting point: big cuts in the public service. This is pure cost-cutting. The idea that ‘AI’ will somehow magically pick up the slack is a distraction.

 No one really knows how to measure public sector ‘productivity’. Nor is there much evidence that AI (however defined) helps. One study over a six-year period concluded “that there is a surprising lack of evidence on the effectiveness and impact of AI tools, even from a purely technical standpoint” (the Ada Lovelace Institute). It seems lifetime technology costs are often left out of the case for AI, and institutional context matters a lot – so that increased output in one area can just bog down if other areas aren’t able to cope. If it’s any consolation, private companies are finding the same thing.

But one thing we can be sure of, public service headcount will fall, leading to real savings in operational costs. Not all public servants are created equal, and some of this will be a good thing. But there will be bad outcomes as well as good ones. What I’d note is that local government is under huge pressure too (witnessed by rates rises and the debate on rates caps). The result is likely to be cuts in all layers of government at once. This is quite a risk, and a big implicit bet that things don’t go unexpectedly wrong in the coming years. Good luck with that.

The third interesting area is defence. Lot’s more money – and given the “freeloader” jibe aimed at New Zealand by the US as I write, this is probably the minimum we could have got away with. The truth is we are a defence freeloader, mainly on Australia, not the US. So, it’s very interesting to see where the extra money goes: a lump for housing and wages (both scandalous at present, and given recruitment shortfalls, totally justified). But then there’s the purchase of sea-going drones. This is curious. One purchase is for persistent (ie at sea a long time) drones to help surveillance in the Pacific to our north. The Australians do that too, and it feels like typical me-too behaviour by New Zealand.

But the second one is a surprise: drones that can operate from ships in Antarctic waters. I’ve written before that the militarisation of the Antarctic is the gravest strategic threat we face. I’ve also noted that the passage (and live firing) by Chinese warships in the Tasman recently gave us a serious home-waters defence challenge for the first time.

So, what do we make of this announcement? Surface vessels in the Southern Ocean can be tracked by ships, planes and satellites. That’s existing technology. The new acquisition is probably only really additionally useful to find underwater targets: submarines. The question is, whose submarines do we think we might find?

Finally, productivity. This is the area where this budget is silent. It’s the topic that I’ve written about the most over the years, and where our collective national denial is strongest. The budget setting process – for any government – would be a whole lot more fun if we were richer. But we seem to have very few ideas how to get there. Some commentators are now talking about this, but really just to lament the fact, not to consider options. That’s a start, sort of.

Let’s start with a single proposition: we can’t get more productive in the private or public sectors just by cutting things. This is not an argument against efficiency. And I certainly believe (on the basis of 40 years’ experience in five governments and in the private sector) that governments work best when you keep them lean.

And a second proposition: we know from innovation theory and studies that intelligent demand (ie demanding, critical customers) is an important part of any productivity story. We have a low-wage economy. Many consumers are anxious, not curious. And we have a distorted housing market, because we treat houses as financial assets, not places to eat and sleep. The result is low demand levels, a lot of defensive spending, low savings rates and a lot of not-so-hidden poverty. Higher wages might be a solution, not a problem.

Ian Fletcher is a former head of New Zealand’s security agency, the GCSB, chief executive of the UK Patents Office, free trade negotiator with the European Commission and biosecurity CE for the Queensland government. These days he is a commercial flower grower in the Wairarapa and consultant to the apiculture industry with NZ Beekeeping Inc.