Underdeveloped human capital and low domestic savings rates explain much of New Zealand’s child poverty and its stagnating economy-wide productivity.
Lifting New Zealand’s productivity is the major determinant of future per capita incomes. Productivity growth depends on higher savings rates and capital formation, combining with more advanced human capital.
Children’s Development Accounts (CDAs) can lift human capital at the individual level. If a CDA system achieves sufficient scale it can help lift economy-wide savings rates in productivity-enhancing ways.
What are CDAs?
CDAs are individualised savings accounts that support such purposes as education, and investment in business and other assets. They are accounts that can start at birth and grow in value over time. They are drawn on later in life, typically from around age 18.
Governments typically kick-start CDAs with an initial deposit, and may continue with ongoing contributions. Children and family members also make deposits, as can iwi, churches and other NGOs.
CDAs have affinities with asset-based welfare (see Sherraden, 1991; Bynner & Paxton, 2001; Zhan & Sherraden, 2011). However, asset-based welfare approaches have often focused on redistributing assets such as housing. CDAs go further and shift social expenditure that is currently for consumption into active wealth-creating capabilities.
For example, CDAs formed part of Singapore’s strategy to gear social policy to support economic development. Singapore avoided welfare dependency through investing in individual and family education, financial assets and in home ownership rather than subsidising consumption.
Singapore used asset-based policies within a wider cradle to the grave framework. This included baby bonuses, child savings accounts supporting school age education and health, post-secondary savings schemes, with funds later in life being transferred to adults’ Central Provident Fund accounts.
Singapore’s policies were supported by a culture of high savings, strong families and individual aspiration.
This meant people avoided poverty through their own efforts being supported by government, and without developing a culture of passive dependency. Government therefore aligned its social policy to its economic development strategy.
Some US states have used CDAs to encourage a savings culture among deprived children, with a special focus on saving for education. The UK, Canada, South Korea, Hong Kong and other jurisdictions have also used CDA-type mechanisms for similar purposes.
What problems do CDAs address?
CDAs address several inter-related problems:
CDAs enhance social mobility
Many New Zealand children reach adulthood with little or no savings. They often have limited aspirations relating to future tertiary education, business opportunities or home ownership.
Evolutionary psychology argues that early life experiences shape psychology and different life strategies. These range from risk-taking “fast life” through to “slow life” strategies (Del Giudice, 2018).
CDAs support a future-oriented slow life strategy. The implicit assumptions are to stay at school, avoid trouble, get a good degree, become a home or business owner, and don’t have children until you can afford them.
Child poverty and how to address it is a divisive issue. Some advocate higher family benefits, while others resent paying taxes to subsidise parents they see as irresponsible. However, almost everyone agrees that children should get a good start in life and have equitable opportunities.
Child poverty is cultural as well as financial. Its mindsets are mediated through families and transmitted through the generations. These mindsets persist through both cuts in family benefits and generous increases in them. Improving child and family wellbeing requires changed mindsets, starting with children themselves.
CDAs transfer resources to children, not to their parents. That is, they do not subsidise today’s family support. Instead, they build financial assets for children to draw on when they are young adults. This shapes children’s thinking towards the future. Their own future children are then born into more stable, secure and better educated households.
CDAs can complement benefits that address today’s household poverty. They can also substitute for them. For example, Working for Families (WFF) transfers could be invested in children’s future capabilities, equity ownership and net worth without parental intermediation.
Some NGOs such as churches and iwi have substantial resources and need a mechanism to support contributions to those they care about. Lobby groups that advocate increased taxpayer-funded benefits for low income families are sometimes criticized for cost-free virtue-signalling. Such groups can be challenged to make tangible financial contributions to CDAs.
There is strong international evidence on CDAs’ effectiveness (Elliott & Sherraden, 2013; Butrica, 2015). Sherraden et al (2016) show that CDAs positively affect ownership of university savings accounts and assets. They build educational expectations and other well-being indicators (Kim et al, 2015). Disadvantaged children especially benefit from CDAs.
Children with savings accounts have better attitudes to school and higher educational achievement. This includes better reading and maths scores (Elliott et al, 2010). CDAs can influence educational plans for the future from as early as primary school. Even small savings tagged for education dramatically lift university enrolments and completions (Elliott et al, 2013).
CDAs have positive effects on children’s socio-emotional development, with the effects greatest for children from low income families and with less educated mothers (Huang et al, 2014a). CDAs mean fewer behavioural problems, better academic understanding, higher motivation to study, lower school dropout rates, and better social functioning (Ko Ling Chan et al, 2018).
CDAs help build net worth that gives people more autonomy and choices in life. Benefits from net worth include imputed rents, bargaining leverage over service providers, and collateral for business investment. Net worth can be transferred to the next generation.
CDAs target a child’s psychology, however this radiates out more widely. Children’s savings accounts lift parental expectations that children will go to university (Kim et al, 2017; Rauscher et al, 2017). In Singapore, CDAs have enhanced parental views on the importance of children’s education, and fostered more positive attitudes toward saving (Chang-Keun & Chia, 2012). Huang et al (2014b) found that CDAs can also improve parental mental health.
CDAs can lift economy-wide productivity
New Zealand’s low domestic savings rates mean a high real interest rate, and a real exchange rate that weakens our tradeable sector. Too little capital is applied to labour, and labour productivity languishes. The tradeable sector is weakened, yet it is tradeable sector productivity that drives per capita income.
Higher savings rates can lift economy-wide productivity. This depends on the scale and composition of capital formation, the industry structure it can be applied to, and other factors such as migration and tax policy.
Together with other schemes such as Kiwisaver and the NZSF, CDAs can lift domestic savings and economy-wide productivity if they achieve sufficient coverage, scale and funds accumulation.
Arguably, Working for Families (WFF) subsidizes low wage work and a low skill, high employment labour market model. A thought experiment is to envisage channelling some or all of WFF into CDAs. This would gear social policy to economic development objectives. It would divert consumption subsidies into human, physical and financial capital formation.
The effects on short-term net parental incomes would initially be negative. However, upwards pressure on wage rates would encourage businesses to invest more in labour-augmenting technology, lifting labour productivity. This would in time translate into higher working incomes. The longer-term outcomes both for children from low income backgrounds and for economy-wide productivity could be transformative.
CDAs can contribute to macro-economic stability and international competitiveness
In 2014 David Parker advocated a Variable Savings Rate (VSR) mechanism through which macroeconomic stability and a more competitive exchange rate could be achieved through differential Kiwisaver contributions.
When the economy overheats the Reserve Bank lifts the OCR to increase interest rates and reduce inflationary pressures. The OCR is then reduced to counter recessions. The proposal was to use the VSR mechanism to lift or reduce Kiwisaver contributions rather than use OCR mechanisms.
The VSR proposal was visionary, but hard to implement. Kiwisaver is not universal. It was initiated as a retirement savings scheme, with options added allowing funds to be drawn on for home ownership and hardship reasons. Using Kiwisaver for yet another purpose risked further policy drift from its core retirement savings intent.
A universal CDA system could offer an alternative to the OCR mechanism through a variant of the VSR proposal. When inflationary pressures are rising the government could sequester surplus revenues into CDAs. This would help avoid higher real interest rates from a higher OCR. It would also help reduce short-term political pressures to spend surpluses in low value ways.
How should CDAs be designed?
Key CDA design features are:
Universality and progressivity
CDA policies should be universal and progressive (see Cramer & Newville, 2009). Universality means CDAs would be automatically created for every child from birth. Voluntary CDAs that require “opting in” result in lower uptake among disadvantaged families, defeating the policy purpose.
All children should have a CDA. This includes children from wealthy backgrounds. These children deserve respect, rather than being dismissed as “privileged”. Universality will bolster long-term support for CDAs.
Government contributions could be weighted to children from deprived backgrounds. Over the lifecycle, this counters Kiwisaver accumulations favouring the higher paid and the regressive effects of NZS (see Jeram, 2018).
Wide funnel for contributions, and a narrow funnel for draw downs
CDAs should have a wide funnel through which contributions can be made, and a narrow funnel through which funds can be drawn on.
It should be easy to put money into CDAs. Contributions from all sources must be made in the confidence that they will be invested in children’s interests and not be diverted to “other purposes”.
The accounts must only be drawn on after around the age of 18 and for specified purposes. These would be tertiary education, equity investment, business start-ups and any other such investments that expand productive capability and enhance net worth.
Contributions to CDAs might be specifically identified to make visible what government, family members and NGOs contribute. However, contributions should not be tagged rigidly for specific purposes such as study at a particular university.
One question is whether CDAs could be drawn on from age 18 to contribute to home ownership. Doing so might see CDAs duplicate rather than complement Kiwisaver. Home ownership builds net worth, however it does not expand New Zealand’s productive capabilities. CDAs might be best to focus tightly on an individual’s wealth-generating capacity, for example through tertiary education or business investment, including start-up businesses.
Decisions and impacts arising from the Tax Working Party, Kiwibuild, migration policy, and whether Kiwisaver should be compulsory will all have a bearing on whether CDAs should also be used to encourage home ownership.
A CDA system needs to be tightly focused and as simple as possible, with minimal administrative costs and fees.
Some CDA-type accounts have underperformed because of poorly conceived objectives. For example, they may be designed as anti-poverty measures for adults, not for children’s development. CDAs have also been used to foster financial literacy. However this and other mixed objectives can clutter their purpose and create a self-perpetuating administrative bureaucracy.
CDAs can encourage children’s savings through matching mechanisms and savings targets. However, matching savings and reward-based targets make CDAs vulnerable during financial downturns. For example, after the 2008 financial crisis the UK’s Child Trust Fund was abolished in 2010 as an austerity measure.
CDAs should not be given privileged tax advantages. Doing so could misallocate resources, and could lead to rich families using CDAs as tax havens.
CDAs overseas have been administered through multiple providers offering diverse options. This fragments funds and lifts administrative costs. It does give choice, however young children from poorly educated households can hardly be expected to make well-informed decisions on fund managers.
New Zealand’s small size as an economy and experience with Kiwisaver suggests that CDAs in New Zealand should be administered by one fund manager. As with the NZSF, one fund manager can achieve scope and scale economies. The fund manager needs to have access to administrative data, for example to ensure differential contributions go to children from more deprived backgrounds.
CDA fund management must be integrated into the New Zealand economy
The CDA fund manager must be deeply integrated into the New Zealand economy so that savings aggregate into capital accumulations that improve macro-economic performance and lift productivity.
New Zealand has a long history of giving birth to world class businesses, only to have them go offshore or be bought out and turned into branch offices of overseas companies. Deeper and more patient capital markets would allow knowledge-intensive businesses to grow and internationalize while retaining deep roots and capturing benefit streams in New Zealand. Over time New Zealanders would own more of New Zealand.
The CDA manager would therefore need to be a New Zealand-owned bank or fund manager, or a dedicated entity could be established akin to the NZSF.
There might appear to be conflicts between maximizing returns to children from CDAs funds being invested in international financial markets and the aim of deepening New Zealand’s capital markets.
However, domestic savings and investment schemes such as the NZSF, Kiwisaver and ACC have a home bias. This means they disproportionately invest in the New Zealand economy, while still delivering good investment returns.
CDAs should not crowd out existing public services
CDAs should not be drawn on for compulsory age education, health or other such services. To do so would be to risk weakening the government’s existing obligations for such services.
Resilience and adaptiveness
A CDA system will be resilient over the long-term if they are adaptive to fiscal and other shocks. Beyond an initial deposit, the government should not be locked into obligatory annual financial commitments that future administrations have a right to change.
Concentrated assets such as state-owned enterprises and the NZSF create risks that politicians liquidate them, as they are constitutionally entitled to do. Alternatively, they can use them for misguided pet projects.
Of course, investment banks in the lead up to the 2008 crisis did far more damage than politicians could conceivable do through, for example, investing in infrastructure or regional development projects.
However, CDAs only work in the long-term and so they need to be protected from political short-termism if they are to have a chance to work. Like Kiwisaver and unlike the NZSF, CDAs individualise assets and make them invulnerable to capricious government “takings”.
The core CDA system design must be resilient over time, however details of what fund contributions can be invested in must adapt over time. For example, if e-learning in future slashes tertiary education costs then a higher proportion of CDA accumulations might be spent on other purposes such as business equity investment.
CDAs should therefore not be fragmented rigidly into sub-funds tagged for specific purposes.
How could we make CDAs happen in New Zealand?
Few New Zealand politicians and senior officials come from deprived backgrounds. CDAs can only succeed over the longer-term, yet politicians and officials focus on the short-term.
CDAs are a long-term investment benefiting people who may not vote for 18 years. They have no strong voting constituency, and they will face opposition.
Beneficiary advocates will lobby for increased benefit transfers to parents, which may or may not benefit children.
Businesses employing low wage workers may sense the threat that CDAs are part of a wider strategy to wind down subsidies to low wage businesses and encourage upwards wage pressure.
Overseas-owned banks operating in New Zealand will oppose CDAs because they know there is a subtext of New Zealanders taking more control over their savings and financial industry.
However, the real barrier to CDAs will be myopic inertia and policy short-termism. This has seen New Zealand for decades sink inexorably in relative economic terms compared to other countries.
Visionary leadership for a CDA system is needed from those concerned with New Zealand’s long-term future. This needs to start with a focus on productivity, and be supported by a narrative for children. A CDA system works at the macro level of economy-wide capital formation and at the micro level of individual psychology, resources and human capital formation.
A CDA will welcome every child born in New Zealand as a mark of citizenship. CDAs will deliver resources for children and change their psychology to focus on their future potential. More highly skilled young people then enter the workforce and lift productivity at the micro-level.
A CDA system could make a profound and enduring contribution to our socio-economic wellbeing. Perhaps New Zealand has a few passionate, well-placed individuals that might champion and deliver such a system?
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