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Spending in the economy

by Paul Dalziel

Having enough spending money is important to people. The government tries to manage the economy to ensure people only spend as much as the country earns. But New Zealanders love to spend.


Spending and investing

At the heart of a market economy is the act of spending. No one can earn income unless someone decides to spend. Sharp changes in the total amount of spending in an economy can cause severe problems. If spending falls, income falls and the number of people unable to get a job can increase. If spending grows too quickly, consumer prices are likely to rise, which can cause distress to people living on fixed budgets.

Personal spending

A large part of the economy is devoted to making it easier for people to spend. Consumer choice is wide in New Zealand – policy reforms in the late 1980s increased shopping hours, increased access to imported goods and increased the availability of credit to households.

Communication technology has created new ways to buy and sell goods, leading to online shopping sites such as New Zealand’s popular Trade Me website, and new forms of payment such as EFTPOS (or debit card cashback) and the online use of credit cards.

Spending power

In 1987/88 private consumption spending by households worked out as $17,860 per person (in 2007/8 dollars). Twenty years later, it was $24,459, an increase of 36.9%. This figure suggests that young people had significantly more spending choices in the 2000s than their parents two decades before.

National spending

The government pays close attention to spending in the economy as a whole, and tries to ensure its decisions about taxation, and its own spending, do not disrupt spending growth.

Between 1989 and 2009 the Reserve Bank of New Zealand regularly adjusted monetary policy. It aimed to keep the level of total spending close to the country’s capacity to produce. It raised domestic interest rates when it judged spending was growing too fast, and lowered interest rates if it judged spending growth to be too slow.

The type of spending is also important. People spend for personal consumption, but they also invest money in things like new factories, transport systems or broadband technologies that may help generate new incomes.

Spending can be done by government, or, if it cuts taxes, private citizens get more to spend. People can choose to save money rather than spend it.

Public and private spending

In 2008 the largest category of spending was private consumption spending. This included household spending on items such as food, clothing, transport, education and recreation, as well as the cost of housing. Private consumption was 58.8% of gross national expenditure in 1987/88, and 57.9% in 2007/8.

In the 2000s total government consumption was much lower than private consumption – about one-third of the level of private spending. Government consumption included spending by ministries, departments, offices of Parliament and Crown entities (including the Accident Compensation Corporation, Transit New Zealand, the New Zealand Fire Service Commission, public schools and hospitals) as well as spending by city councils, district councils and regional councils.

Government consumption did not include spending by government trading organisations such as power companies, as these traded like commercial firms.

Fixed capital formation

Spending on investment is also significant. In New Zealand private and public gross investment includes ‘fixed capital formation’ – spending on new buildings, new motor vehicles, new plant and machinery, roading and land improvements – and the construction of new homes. It does not include spending on replacing assets that have worn out and are no longer productive.

Fixed capital formation expands the capacity of an economy to be productive, and is an important source of economic growth.


Spending in difficult times

The ‘Great Depression’

In October 1929, the New York Stock Exchange crashed after a decade of spectacular gains. The total value of shares was halved in just two months, and continued to fall until recovery began in the middle of 1932. The impact of this shock spread through the whole United States economy and to the rest of the world, including New Zealand.

New Zealand’s export receipts fell by 37% between 1929 and 1931. Local unemployment rose sharply to around 12–15% of the workforce (in the United States it reached 25% in 1933).

The multiplier effect

The fall in spending by overseas buyers of New Zealand exports from 1929 to 1931 reduced the incomes of local farmers. The farmers in turn reduced their spending, causing falls in the income of other New Zealanders. This push-on process is known by economists as the multiplier effect.

The multiplier effect continued in the 1930s as more and more people reduced their spending in line with their falling incomes. Businesses cut back on production and laid off workers as a result of the loss of sales, brought about by falling levels of total spending. The economy became trapped in depression.

Not all suffered

New Zealanders’ experience of the 1930s depression varied. Some people were destitute, and others were relatively unaffected – a few even did well. Sales of newly available or expensive goods like electric water heaters and stoves, cars and fashionable clothing increased during the 1930s.

The 1930s depression shocked people because for a long time the economy did not seem capable of recovery. Wage rates fell in the face of high unemployment. Product prices fell just as fast, fuelling unemployment.

The depression shaped the lives of the generation that experienced it – it was a watershed in New Zealand’s economic development and brought to power the first Labour government in 1935, which designed New Zealand’s system of social security.

Keynes’s influence

Economist John Maynard Keynes published a book in 1936 that proposed a solution to the depression. The general theory of employment, interest and money launched a new branch of economics, macroeconomics, which studies the overall picture of economies.

Keynes highlighted the role of spending in sustaining economic activity and employment. He thought that in periods of falling spending by the private sector, the government should increase spending on public works such as new roads, railways or public buildings. If it did, total spending could be stabilised, and economic growth maintained.

This theory became the foundation of economic policy in New Zealand and elsewhere immediately after the Second World War, but was challenged by the phenomenon of ‘stagflation’ that emerged in the mid-1970s.

Spending and stagflation

Following a war in the Middle East in October 1973, the world price of oil tripled. Oil was a significant import for New Zealand, and the economy was hard hit. The world recession which followed the oil price rise made trading conditions more difficult for New Zealand exporters.

The New Zealand government was reluctant to reduce domestic economic activity, so it borrowed money for public works, to maintain overall spending levels, following the Keynesian model.

However the economy stalled and unemployment began to rise, and there was a sharp increase in consumer prices – instead of reducing unemployment, the extra spending led to domestic prices rising at more than 10% per annum. The resulting combination of economic stagnation and high inflation came to be known as ‘stagflation’.

Changing markets

The economic changes had affected the amount of spending on New Zealand products, and producers needed to respond to changing markets – for example to lessen the emphasis on agricultural products for export to Britain (which no longer protected New Zealand’s products in its markets), or to move to less energy-intensive technologies.

The reason why increased public spending led to stagflation was not well understood at the time. Until farmers and businesses responded by adapting production, increased government spending added to inflationary pressures in the economy. Stagflation continued off and on until 1984 when economic reforms were introduced.


Economic reform from 1984

The 1984 Labour government introduced an extensive programme of economic reforms. These aimed in part to improve the responsiveness of New Zealand producers to changes in the spending patterns of domestic and overseas consumers. In the 1990s the National government extended the reforms.

Licences, quotas, and tariffs

Before the late 1980s, consumers in New Zealand were restricted in their choices. Importing consumer goods into New Zealand generally required a licence from the government, and a wide range of goods had quotas that restricted how much could be imported in any one year.

Working class prunes

 

In the late 1950s Prime Minister Walter Nash was directly involved in deciding import quotas. His approach was satirised at the time:

‘The Prime Minister would … say that no extra tinned salmon was needed. Someone would say, “But many women use salmon with their Sunday salads.”

‘“So they do. X extra tons. Now prunes. Many working class families eat prunes. Y extra tons.”’1

 

A key objective of the reforms was to open up the domestic economy to the global economy. The government began phasing out import licences in 1984. This process was completed by 1992.

This left tariffs as the principal form of border protection (a tariff is a tax imposed on imported goods as they enter the country). The government began reducing tariffs. The average tariff rate in 1981 was 28%. By 1999 it was close to 5%, and 95% of imports (by value) were tariff-free. Tariffs were frozen for 6 years, then there was a further programme of reductions between 2006 and 2009.

Shopping hours

Over the 20th century governments reduced shop opening hours, requiring shops to close at 9 p.m. during the week, and to remain closed on weekends. Hours were liberalised in 1980 to allow Saturday (but not Sunday) trading.

In 1990 the government repealed the Shop Trading Hours Act 1977, removing previous restrictions on trading hours, apart from those requiring shops to be closed on Good Friday, Easter Sunday, Christmas Day and before 1 p.m. on Anzac Day. This opened the door to Sunday and late-night trading. To provide some protection to employees, it remained illegal to pressure a worker to work on Sundays, or at night between 9 p.m. and 7 a.m. In 2016 the government amended the 1990 Act to give territorial authorities the ability to decide whether shops in their districts could open on Easter Sunday.

Access to credit

New Zealand’s financial system before 1984 was one of the most regulated of the developed countries. Interest rates were controlled by the government, and financial institutions like banks were expected to observe credit-growth guidelines set by the minister of finance. The government actively discouraged growth in consumer credit. These and other restrictions were removed soon after the 1984 general election, giving New Zealand consumers access to more credit than ever before.

Spending since 1984

These changes helped to produce substantial changes in spending behaviours by New Zealanders. Shopping became an important leisure activity. Retail shopping malls could provide customers with access to the latest branded products from around the world and were open in the evening. Weekend markets attracted customers with specialist stalls offering local produce or arts and crafts.

Footnotes
    • Quoted in Keith Sinclair, Walter Nash. Auckland: Auckland University Press, 1976, p. 308. Back

Spending stabilisation

Over time, an economy’s capacity to produce goods and services typically increases. To maintain full employment without inflation, policy makers try to keep total spending growing at close to the same rate as production. This is not easy – credit can finance sharp changes in expenditure growth.

A. W. H. (Bill) Phillips was a New Zealander who refined Keynes theories on the stabilisation of spending, and produced a model illustrating how his policies worked. After the Second World War he went to the London School of Economics. He had trained in electrical engineering, and he used the way electricity feeds back as a model for large booms and busts in an economy, so he could develop policies for moderating spending. Governments were able to see more clearly where to spend money in the economy and what the effects would be.

MONIAC

Bill Phillips designed the extraordinary MONIAC machine to illustrate how his stabilisation policies worked. It was a hydraulic model of the economy, with flows of water representing spending and money moving around different sectors in an economy. In the 2000s a working example was on display at the Reserve Bank of New Zealand in Wellington.

Reserve Bank

In the 1990s and early 2000s the Reserve Bank was largely responsible for stabilising spending growth. It did this by implementing monetary policy targeted at maintaining price stability. If inflation was expected to be too high, suggesting that total spending was moving ahead of the economy’s capacity to produce, the bank would move to slow down expenditure growth by raising the official cash rate (OCR) – the interest rate that commercial banks have to pay to borrow cash reserves. This rate fed through to all interest rates in the economy. Increased interest rates encourage businesses and households to reduce their spending.

If there were no inflationary pressures in the economy, the Reserve Bank would lower its OCR, to encourage more production. In 2008 when the world economy slowed the rate dropped dramatically.

Investment

From the late 1990s there was ongoing concern that New Zealanders did not save enough to finance domestic spending on investments, such as new factories, transport systems or broadband technologies. New Zealand borrowed overseas for some investments.

There was also concern that New Zealand workers spent too much on current consumption, and did not save enough for their retirement. The ratio of people who have retired to people in employment is expected to increase sharply over the 2010s and 2020s. The Labour government responded to this concern in the early 2000s by building up assets in the New Zealand Superannuation Fund and by encouraging workers to save through a subsidised ‘Kiwi Saver’ savings scheme.

Non-savers

People’s saving for retirement varies according to their year of birth. Those born between 1920 and 1939 save less than those born before or after. During their peak earning and saving period people born then were living in good economic times. This seemed to lessen their incentive to save.

Tax cuts

There was ongoing debate about whether the government should reduce its own spending to match any drop in revenue that would come if they lowered tax rates. Tax cuts mean people have more to spend, and can change the ratio of private- and public-consumption spending. But poorer people can find it hard to afford things like schooling and going to the doctor. In 2008 the government spent millions of dollars on education and health, but also introduced tax cuts.

Spending and social services

There has been debate about how governments can help households who are living in relative poverty. The spending power of low-income households was increased through income support, provided through the Ministry of Social Development. If people are off work due to an accident, they receive income support through the Accident Compensation Corporation.

In 2007, the government introduced the ‘Working for Families’ programme to provide tax rebates to workers in lower-paid jobs who had families, increasing their spending power.

During the decade of reforms from 1984 to 1994 the government reduced the level of transfers to people receiving income support (in the 1991 benefit cuts). Social security beneficiaries – people on the dole – were not eligible for the Working For Families programme. Critics argued that this trapped children in poverty, harming their physical and social development.


Hononga, rauemi nō waho

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How to cite this page: Paul Dalziel, 'Spending in the economy', Te Ara - the Encyclopedia of New Zealand, http://www.TeAra.govt.nz/mi/spending-in-the-economy/print (accessed 14 July 2020)

He kōrero nā Paul Dalziel, i tāngia i te 11 Mar 2010, updated 16 Sep 2016