Government should take short-term equity stakes in Covid-19 afflicted companies – rather than free money, says Alex Duncan.
Before the Covid-19 crisis, government debt was around $64 billion, or about 20% of Gross Domestic Production (GDP). Achieving this took years of hard political graft and fiscal discipline by governing parties on both sides of Parliament.
It is just as well, because these past efforts have provided the government a balance sheet capable of supporting the economy now. Parliament in mere weeks has permitted spending of up to $50 billion of which $20 billion is already committed. If the remaining $30 billion is spent, government debt will rise to around 36% of GDP. That level of debt would be near maximum prudent limits. We pushed similar boundaries in the early 1980s when sovereign debt reached levels of 40%.
Lenders seek assurance that debt can be repaid. Protecting our sovereign credit rating is therefore critical. If debt climbs to 40% of GDP, governments would have less leeway to deal with another natural disaster or GFC, or to fund social investment such as education and health care.
It is therefore important that additional expenditure is invested wisely to grow the economy and increase future government revenues.
A step in this direction was, to the government’s own surprise, unintentionally passed last week. The law change established a small business loans scheme that was widely welcomed. Loans carry 3% interest, unless repaid after the first year, and need not be repaid until 5 years.
The size of the loan is linked to the number of workers employed in an enterprise, with a maximum of $100,000 for those with 49 workers. About 500,000 enterprises will be eligible for these loans. They employ more than 900,000 workers and account for about one third of GDP. The scheme’s likely cost is not yet known, but could be billions.
IRD has a challenge to figure out how to operate the scheme and eligibility criteria may need to be tightened. Some businesses that draw on the scheme will go bust. Many others will benefit from the loans and repay them. Future taxpayers will therefore have a chance of recovering much of the amounts lent, rather than the certainty of higher taxes if assistance is provided to businesses as cash grants.
Larger enterprises that employ 50 or more employees will also be critical to our economic future. Like their smaller counterparts, these larger enterprises also contribute about one third of GDP, but employ more workers (1.2 million).
The government’s balance sheet could also be used to support the growth and recovery of larger enterprises. Once again, it is tempting to offer cash handouts. But this, too, will place a heavier burden on future taxpayers and risk well-connected businesses being favoured. Funding could, instead, be provided in the form of minority equity stakes across a broad range of sectors and enterprises.
The government already takes an equity-like stake in nearly every large or small New Zealand business. Every time a business claims a GST refund on new equipment, taxpayers become silent equity investors. If success ensues, the resulting GST payments add to government coffers. If the investment is written off, the government has lost the GST refund paid out when the investment was made.
The government would, in effect, joint venture on commercial terms with a wide range of businesses to execute strategies and drive innovat
ions that reflect new realities. Examples include natural resources, biotechnology, transport services, media and film, job-rich manufacturing, IT services, construction and, yes, tourism but not as we’ve known it.
The directors of companies in which the taxpayer invests would be subject to strong fiduciary obligations. Market rules would also apply to companies that are listed. Importantly, the wide dispersion of minority equity stakes would reduce risk and create valuable options by facilitating innovation across a broad range of activities.
A well thought-through institutional structure needs to be developed to operate the already announced SME loan scheme and a minority-equity investment programme. Minority equity stakes would need to be managed and monitored to protect politicians and investors from perverse lobbying. The government already has the experience of the NZ Super Fund and ACC, both of which have a track record of managing investment portfolios.
The government would not, however, be a long-term holder of the equity under this scheme. The continued need for equity would be reviewed periodically (after a longer period initially) with a view towards a schedule of equity withdrawal. The cash returned would be applied to reduce Crown debt to levels that prevailed before the current crisis.
A strategy along these lines has a long lineage and is peculiarly apt for New Zealand. In the words of King Solomon, “send your grain across the seas and in time profits will flow to you. But divide your investments among many places, for you do not know what risks lie ahead”.
Alex Duncan is a Principal of Finology, an advisory firm. Previously he held senior corporate finance roles at Fonterra, as a Corporate Finance Partner in Arthur Andersen and an official in the NZ Treasury during a period of significant tax reform.
The source of information on small businesses is drawn from the material shown in the link below and published by Ministry of Business & Employment in June 2017. While the data used little dated, it is still useful as a broad indicator:
The source of the fiscal numbers are drawn from the website of the NZ Institute (Dr Bryce Wilkinson) and the Website of the Controller and Auditor General below:
The quotation of King Solomon is drawn from the Book of Ecclesiastes Chapter 11 verses 1 & 2 (New Living Translation)
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