Submission to Select Committee Inquiry Into Monetary Policy
SUBMISSION FROM BRYAN GOULD TO THE
FINANCE AND EXPENDITURE SELECT COMMITTEE’S
INQUIRY INTO THE FUTURE MONETARY POLICY FRAMEWORK
Introduction
1. The Select Committee is to be congratulated on undertaking this inquiry. Concern has been mounting over recent months about the impact of current monetary policy. That concern has been expressed by a wide range of observers, including the Governor of the Reserve Bank himself (initially, in a speech in South America in 2006), the Minister of Finance, spokespeople for the major productive industries, and a substantial majority of those who usually comment on the performance of the New Zealand economy. It is entirely appropriate and opportune that the Select Committee should reflect the breadth and depth of this concern by conducting a full inquiry into the changes that might – and perhaps should – be made in the current policy stance.
2. The recent actions of the Reserve Bank in intervening in the foreign exchange markets show not only that the Governor has begun to look beyond his usual range of policy instruments but also demonstrate an increasing lack of confidence – both on his part and on that of others – in the efficacy of current monetary policy. As I will argue later, a high – not to say appreciating and over-valued – exchange rate has been an important element in current counter-inflationary policy; to intervene to restrain its rise is to counteract one of the main elements of the current strategy and to undermine one of its principal and intended impacts.
3. New Zealand has often been prepared to lead the world in challenging current orthodoxy. The recent expressions of concern and the holding of this inquiry suggest that we are again taking a lead – this time, in recognising the limitations of monetarist orthodoxy and actively seeking other policy options to supplement or in some cases replace some of the instruments of monetary policy. Where we now go, other countries may well follow.
4. In seeking those other options, it is important to recognise that all policy measures bring with them downsides and uncertainties. What is being sought is not perfection, but measures and a policy framework which will be more effective and less damaging and which will overcome – at least in part – the limitations and drawbacks of the current policy stance.
How Monetary Policy Is Supposed To Operate
5. Monetarist theory suggests that monetary policy offers a painless, effective, and value-free method of controlling inflation. Inflation can only occur, so the theory says, if the quantity of money in the economy is allowed to increase. Inflation can therefore be controlled by controlling the growth in the money supply. The current monetary policy framework shows that our policy-makers have bought into this apparently simple proposition. Experience shows, however, that it is not as straightforward as it seems; it takes no account, for example, of differing rates of velocity of circulation or differing rates of demand for money, and it reflects an essentially static and often retrospective view of how the economy operates.
6. The real problems begin, however, when the attempt is made to control the money supply. It used to be thought that policy-makers could act directly on this issue – first, by defining money for policy purposes and then pursuing measures to control the quantity of money that was available. Money (and particularly those forms of money that owe their existence to the creation of credit) turned out, however, to be a slippery concept. It proved impossible to fix a definition of the money supply which would remain useful, since new forms of money that fall outside a given definition would inevitably develop. In the end, monetary policy no longer depends on defining money but rests rather on controlling the speed and direction of changes in the money supply by altering the price of money (however defined) through fixing interest rates.
7. Raising interest rates (which is the usual monetarist response to increasing inflationary pressures) is intended to restrain inflation by deterring borrowing through raising its cost. In principle, this should work, and in the past has done so, at least to some degree. There is also a second-order consequence of raising interest rates which is also intended to have a counter-inflationary effect. Higher domestic interest rates will – all things being equal – attract an inflow of short-term money (“hot money”) from overseas. That increased demand for the currency will raise its value (providing, incidentally, a further attraction to foreign investors); the higher currency will then further restrain inflation by restricting the profitability of economic activity at the margins, and – by reducing the price of imports – exercise a downward pressure on all prices in the internationally traded goods sector, both at home and overseas.
8. These counter-inflationary effects are predicted by monetarist theory to have little or no impact on the real (as opposed to the financial) economy. Any changes in the inflation rate or in the value of the currency brought about by monetary measures are assumed to have only a temporary or marginal effect on the real economy, which will rapidly adjust to the new conditions; and since it matters little to the real economy, policy-makers may as well choose a low or nil rate of inflation which – it is assumed – will encourage confidence and therefore investment.
9. The relatively simple business of fixing the price of money is said to be a technical task which can be safely entrusted to technicians (that is, bankers) who – unlike politicians – it is hoped can be relied on to make objective and non self-interested decisions about interest rates. Again, the current monetary policy framework shows that policy-makers are happy to comply with this simple view by entrusting the battle against inflation to a single official with a single goal and a single instrument for achieving it. The validity of this view is now very much open to question. Moreover, very few seem to have noticed that the consequence of this approach is that the major – indeed, only – macro-economic decisions are thereby removed from the democratic arena and are made by unaccountable officials. Very few, either, understand that the effect of excluding elected governments from macro-economic policy is to leave most important decisions to the market – and the global market at that – so that government intervention is precluded.
Why Has Interest Rate Policy Done So Much Damage?
10. The comforting assumption that the real (or productive) economy is unaffected by high interest rates has been contradicted by experience. In the end, raising interest rates is just another way of deflating the economy, and all experience shows that deflation is inimical to growth, investment and productivity. In deflationary conditions, elements of production are by definition taken out of use. While out of use, they increasingly lose their value. Plant and equipment become obsolete, the unemployed lose skills, and market share is forfeited to competitors, never to be regained. Once the economy adjusts at a lower level of activity to the loss of those productive elements, further deflation will be needed to maintain the counter-inflationary effect – the very reverse of the virtuous cycle of growth and productivity that policy-makers seek.
11. The deliberately destructive effect of high interest rates is an essential element in the current counter-inflationary strategy. Its destructiveness is exacerbated by the fact that it is the only instrument available. The Governor of the Reserve Bank is given almost exclusive control over macro-economic policy but is allowed only one single indicator and goal – the inflation rate – and one single instrument – interest rates – for achieving that goal. Macro-economic policy is dangerously founded on an excessively narrow view of how and for what purpose it should operate, but its impact is damagingly wide. However obvious a particular inflationary factor might be, however narrowly and precisely its causes may be identified, the single crude instrument of interest rates is trundled out and has its destructive effect across the whole economy. So, a high rate of asset inflation in, let us say, the Auckland housing market will prompt an interest rate hike that depresses incomes and activity across the whole productive and wealth-creating sector.
Why Is Using The Exchange Rate As A Counter-Inflationary Instrument Such A Bad Idea?
12. One deliberate counter-inflationary effect of higher interest rates, as we have seen, is to promote an appreciation in the value of the currency. The theory (particularly as developed by a school of economists called the International Monetarists) is that this provides the elusive “transmission mechanism” between controlling the money supply and bearing down on inflation, and that it does so by compelling domestic prices to fall in line with cheaper imports.
13. As with so much of monetarist theory, the reality is somewhat different. The use of the exchange rate to combat inflation means that it can no longer do its proper job of clearing the market at a price which will enable us to balance our trade and to develop our economy in ways which will encourage us to enlarge our areas of comparative advantage. And, although there will always be siren voices to say that cheap imports are a boon, that foreign travel is made cheaper, and that we should not try to compete on price, the damage to our productive economy from an over-valued exchange rate is now widely understood. Even so, the calamitous effect of the constant reality (and threat) of over-valuation is usually understated.
14. The exchange rate converts all domestic costs, including labour costs, into international prices. The immediate effect of a rise in the exchange rate is to raise all costs and to force those selling into international markets (including our own) either to hold prices stable (expressed in a foreign currency) and accept a consequent reduction in margins, or to maintain prices in New Zealand dollars and suffer a fall in market share. The most likely outcome is a combination of both. With declining profits as a result of lower margins and sales, the first impact is on the ability of the producer to pay wages, and invest in new capacity. In some cases, as we have seen, the squeeze is so acute that companies either fail or move offshore.
15. The second-order effect (on the assumption that the enterprise survives at all) is that the producer generates less income and is therefore less able to invest in new product development, buying new equipment, skill training of the workforce, developing new markets, after-sales service and so on – all those expensive elements that go to make up non-price competitiveness. The quality of New Zealand products falls behind those of other countries that do invest in these vital areas, making it even less possible for New Zealand producers to surmount the disadvantage of declining price-competitiveness – and all this, very often, against the background of ill-informed advice that they should not try to compete on price, but concentrate on quality!
16. In the long run, the constant or regularly recurring reality (and threat) of over-valuation of the currency is so harmful to investment and confidence that there is actually a change in the culture. As a country, we cease to be interested in making new wealth, because it is just too hard. We concentrate instead on manipulating existing wealth and on creating higher values in existing assets like housing. Our best brains go into the professions or domestic industries like retailing, where there is less threat from international competition, and shy away from the internationally traded sector, where the real prospects for growth lie. Anyone who does succeed in productive industry either goes overseas or sells the business to overseas owners. It is hard to think of a strategy that is more certain to frustrate the government’s stated goals of encouraging enterprise, investment and productivity.
Why Are Interest Rates No Longer Effective To Control Inflation?
17. Much of the damage caused by monetary policy might be excused if it actually succeeded in controlling inflation. Increasingly, however, we are handicapping ourselves severely in terms of our international competitiveness in the interests of trying to control inflation with a blunt instrument that no longer works. Indeed, there are grounds for thinking that higher interest rates and a higher exchange rate might actually make inflation worse.
18. An obvious first point is that interest rates actually raise prices rather than lower them. It is assumed that higher interest rates will reduce economic activity (and prices) by making borrowing more expensive. But what if the higher costs produced by raising interest rates are simply absorbed into the cost and price structure, with the result that everyone goes on as before, but at a higher level of costs and prices and therefore of inflation? This is just what might be expected of an economy where price competitiveness has become a chimera, where wealth is made by manipulation rather than improved productivity, and where the emphasis is heavily and increasingly on consumption rather than investment. That seems to be, unfortunately, exactly our situation as a consequence of current policy settings.
19. This is particularly true of the housing market. Much has been made of the high proportion of homeowners with fixed interest mortgages. This may well be significant in explaining the short-term ineffectiveness of higher interest rates in damping down the housing market, but there may also be a somewhat longer-term effect. Homeowners have now lived with constantly rising interest rates for some time now, and the housing market has continued to boom. They are now enured to small interest rate increases, and believe that more expensive mortgages are just another cost increase which will be easily absorbed into the cost structure and will be offset by continued capital appreciation. Indeed, by increasing the replacement cost of existing housing, the effect of higher financing costs may well be inflationary.
20. In any case, what else are New Zealand investors to do, when the returns from productive industry are so uncertain and the housing market offers by far the best chance of a capital gain? It is little use lecturing them for failing to save. Economics is a behavioural science and people will respond to the economic realities they find.
21. One such economic reality is the constant invitation to spend and consume provided by a New Zealand dollar which currently buys 15% more than it should. Why should the consumer invest or save when over-valuation makes imports so cheap? Again, a government that urges a change in behaviour should look to its own role in setting the current pattern.
Why Have We Persisted So Long With Failed Policies?
22. We now find ourselves in a policy cul-de-sac. The high interest rates that are our chosen instrument for controlling inflation are not doing the job but they are pushing up the value of the dollar. The over-valued currency and the consequent loss of competitiveness produce an unsustainable current account deficit – now at or near record levels. In order to finance that deficit (which is made worse by high interest payments to overseas lenders of “hot money” and by repatriated profits as more and more of New Zealand’s productive industry is sold overseas), we have to attract yet more short-term money. This requires even more excessively high interest rates which is where we started and which makes any further circuit of this particular vicious circle look like a counsel of despair.
23. Why, then, have we persisted so long with what is manifestly failing in its purpose and which could only have the desired effect at the expense of crippling what remains of our economy? The answer is that monetarism is a political doctrine rather than a prescription for effective economic policy. An illuminating light is cast on this issue in a paper written for the Reserve Bank by a leading American monetarist economist, Professor Laurence Ball, when he was a Visiting Fellow at Victoria University in 1996. In his paper, “A Proposal for the Next Macroeconomic Reform”, Professor Ball asks why we rely so much on monetary policy which is, he says (quoting Milton Friedman), notorious for the “long and variable lags” in its effects, and is poorly focused in that its adverse consequences are particularly felt by the productive sector. The answer he gives is instructive. The preference for monetary policy as opposed to other measures is not because it is effective, which it is not. It is that monetary policy has been handed over to officials who are immune to political pressures. Professor Ball seemed unconcerned about the undemocratic nature of this reasoning.
What Is Now To Be Done?
24. The foregoing recital of the deficiencies of the current monetary framework demonstrates the urgency of making a proper evaluation of other options. Our inquiry is into improvements that might be made rather than a search for perfection. A failure to find the ideal should not excuse us from settling for something better. There are several steps that could be taken to improve the efficacy of our counter-inflationary strategy and to do so while mitigating the worst of the adverse effects of current policy.
Fiscal Policy
25. The most important step that could be taken is to widen the instruments available to policy-makers in their efforts to control inflation. Principal among these is the use of fiscal policy – taxation and public spending. There is ample evidence that – as Professor Ball conceded in his 1996 study – fiscal policy is more effective than monetary policy as a counter-inflationary weapon. It is quicker-acting and more easily focused. For these reasons, it is able to deal directly with inflationary pressures without causing anything like as much collateral and unintended damage to the rest of the economy.
26. The argument is not that fiscal policy should replace monetary policy altogether. It is rather that fiscal policy should be used as an important supplement to monetary policy and that the two strands of policy should be properly integrated and made consistent with each other. The use of fiscal policy would mean that the excesses and inappropriateness of monetary measures could be mitigated.
27. The major argument against the use of fiscal measures – as Professor Ball pointed out – is not that they are ineffective but that past experience has shown that politicians cannot be relied upon to use them appropriately. They will, it is argued, defer a tightening of fiscal policy, or unwisely loosen it, if this suits the electoral timetable. This argument, it should be noted, can also apply to monetary policy. Politicians are not averse to escaping responsibility for dealing with inflation, by handing it over to officials, if that means that they will not then be blamed for the outcomes. Governments will usually welcome, too, some degree of exchange rate over-valuation, since it will produce a short-term “feel-good” factor by providing a temporary and unsustainable boost to living standards. This is a particular issue in New Zealand with its short election cycle.
28. The objection to the irresponsible use of, or failure to use, fiscal policy by politicians is in any case easily overcome. The provisions of the Fiscal Responsibility Act, by ensuring that fiscal policy is properly explained and debated both in Parliament and, as a consequence, in the media, already make it difficult for politicians to avoid their responsibilities. As a consequence, New Zealand governments have taken a very cautious approach to fiscal policy over recent years, and a decision to treat it as a more important counter-inflationary tool would very much heighten this parliamentary and public attention. The continued use of the Fiscal Responsibility Act very much removes the political objection to the use of fiscal policy and leaves us free to evaluate its use on purely economic grounds.
29. An increased number of available counter-inflationary instruments would have a further and very important and beneficial consequence. It would offer the opportunity to widen at the same time the objectives of macro-economic policy. The use of fiscal policy and other measures in addition to monetary policy would allow – indeed, virtually require – policy-makers to consider other economic goals as well as the single narrow goal of inflation. This would be a very important step forward. It would not mean that a lower priority should be given to inflation, but it would allow issues such as full employment, the level of public services, the competitiveness of our productive industries, – indeed, the whole range of macro-economic issues – to enter the policy picture.
30. With a wider range of counter-inflationary instruments available and a wider range of goals as the proper purposes of macro-economic policy, it would of course no longer be possible or even appropriate to hand responsibility for such policy over to a single unelected official. The Minister of Finance – in Parliament – would have to resume responsibility for macro-economic policy. This would not only be a considerable step forward in the effectiveness of the policy but it would also mean a major advance in restoring proper democratic control and debate over the most important decisions taken in the economic policy arena.
Selective Credit Controls
31. Once the decision was taken to end the dangerous reliance on monetary policy as the sole counter-inflationary instrument, the way would be clear to use other weapons and to target them for maximum effectiveness. What is clear is that the major inflationary factor in our current economic situation has been the rising level of bank lending, often made for the purposes of buying residential property; private sector credit has risen nearly sixfold over the past twenty years. Rather than disadvantage the whole economy in a vain attempt to deal with this problem, it would be more sensible to act directly on the issue by requiring the banks to tighten their levels of lending and the purposes for which they lend. This is not technically a difficult exercise. The banks would not like it but they cannot expect the rest of us to bear the burden for resolving a problem for which they are largely responsible. One of the advantages, incidentally, of an inquiry of this sort is the opportunity it provides to hear advice from sources other than the usual range of economists from the banking sector.
Action On The Housing Market
32. A further and related step would be to act directly on the housing market. A number of measures have been contemplated – a mortgage interest rate levy, a capital gains tax on second homes, changes to tax relief in respect of properties bought to let – and, while all have their disadvantages and of course their opponents, it is not beyond the wit of policymakers to identify measures that would – perhaps even if applied only in the short term – take the heat out of an overheated housing market. This would “knock the top off” the inflation problem – again, without burdening the rest of the economy unduly.
Encouraging Saving
33. Much has been made of the failure of New Zealanders to save, and particularly to invest in the New Zealand economy. As suggested above, this behaviour is no more than should be expected from the current policy settings. New Zealanders are provided with every incentive to spend, particularly on imports and on housing, but with little reason to save and invest. A scheme such as KiwiSaver is very much to be welcomed, in that it promises to remove some of the spending power from the economy in the short term (thereby fulfilling some of the purposes of a tightening of fiscal policy) and it also offers the possibility of increased investment in the New Zealand economy; its effectiveness, however, would be greatly extended if it was working with the grain of economic policy rather than against it. The changes to macro-economic policy suggested above would greatly increase the efficacy of KiwiSaver and similar schemes.
Other Issues
34. An increased emphasis on macro-economic policy, as recommended here, would allow a significant change in the general approach to inflation and other economic issues. Monetarist theory takes an essentially static view of a given economy. It assumes that each economy has a naturally occurring requirement for money and that any increase in the money supply above that level must be inflationary. The emphasis (in theory, if not in practice), is therefore always on restriction. Little account is taken of the propensity to grow and expand (and therefore to require more money) which efficient economies constantly demonstrate. This is surely selling short the power of a market-based economy to improve its performance under the right macro-economic conditions and demonstrates a priority given to the interests of asset-holders as opposed to new wealth creators. Supporters of monetarism as an economic policy doctrine may be surprised to hear that they demonstrate no faith in the dynamism of the market, but that is the reality of our current situation.
35. An economy where credit for investment (as opposed to consumption and housing) was relatively inexpensive and available, where the exchange rate was monitored to preserve and improve competitiveness, and where incentives were provided for investment and productivity gains, would be one which not only freed itself from many of the current burdens (including the ticking time bomb of an unsustainable current account deficit) but which optimised its counter-inflationary strategy by encouraging growth, investment and efficiency gains and thereby garnered the benefits to inflation of falling unit costs – the very reverse of the deflationary orientation of current policy. To put the same point a different way, an economy which was encouraged by the macro-economic context to deploy its creative energy in expanding capacity, improving productivity and increasing export competitiveness would help to avoid the build-up of the inflationary pressures we currently suffer in our constrained domestic economy.
36. Domestic policy along these lines could be accompanied by lending support to international action to damp down exchange rate volatility (which has been at least as damaging to the New Zealand economy as the much-lambasted “stop-go” cycle of demand management policy) and to require more responsible international investment. There is an increasing level of international support for such action, and no shortage of proposals, from people as diverse as Joseph Stiglitz, George Soros and Paul Krugman. New Zealand, which has taken greater risks than any other advanced country in throwing itself upon the mercy of an international free-for-all, would have much to gain if international currency and investment markets operated on a more structured and less volatile basis.
Conclusion
37. We should not doubt that this inquiry and the concerns that prompted it signal an end to the simple certainties that interest rates are the only instrument we need to control inflation, that this is the only purpose of macro-economic policy and that the task should be the sole prerogative of an unelected official. We have much to gain from establishing a wider base for macro-economic policy, with a wider range of goals and a wider range of instruments. This short paper can do little more than sketch out some of the possibilities if we once have the courage to challenge current orthodoxy. The deficiencies of that orthodoxy are now all too apparent. We should no longer close our minds to those other possibilities. I hope to have provided a few signposts to some of the ways forward.
Bryan Gould
17 July 2007
My Vision for New Zealand
The following article is a commissioned contribution to be published in a book edited by Dave Breuer of Anew New Zealand.
As most New Zealanders are quick to acknowledge, New Zealand has established – in its relatively short history – one of the most effective democracies in the world. The record is indeed a proud one. Universal suffrage, votes for women, equality before the law, the welfare state, human rights, race relations, are all areas where New Zealand has been amongst the pioneers of reforms which the rest of the world has been keen to emulate.
Yet even this proud history is not sufficient to guarantee to us a fully functioning democracy, one capable of equipping us to face and overcome the increasingly evident and serious challenges to our well-being and even survival, both here in New Zealand and across the globe. My fear is that without that robust and effective democracy, we – and others – will fail those challenges. My vision, on the other hand, is that New Zealand – true to our distinguished traditions – will find the means to restore a democracy effective enough to ensure that the challenges are met, both for ourselves and for others to follow.
The essential value of a democratic system of government is that it counteracts the natural tendency of all societies to allow and indeed promote the concentration of power in just a few hands. Left to themselves, most societies will operate so as to advantage the strong, the wealthy, the intelligent, the well-born, or even the plain lucky, who will then use that advantage to entrench and increase their power still further, to the detriment of others. The crucial decisions that are then taken will be made in an increasingly narrow sectional interest – that of the rich and powerful – rather than in the wider interest of the whole of society.
The great virtue of democracy is that it provides a counterweight to this natural tendency, by ensuring that political power at least is more fairly and evenly distributed, and that there are therefore certain limits as to how far the powerful can pursue their own limited interests without regard to the interests of society as a whole.
But what should we make of an apparently democratic system of government where power has indeed concentrated in just a few hands and where that concentration has occurred in places that are beyond the reach of our elected government? Should we say that we are content that we have the forms of democratic government, even though the substance has been hollowed out so that our elected government cannot ensure that they take important decisions in the general interest and are accountable for those decisions to the whole of society?
My contention is that this is exactly the dilemma we face, and that neither in New Zealand nor elsewhere do we have a functioning democracy such as to protect the wider public interest – now and into the future – against the accumulation of power into fewer and fewer unrepresentative hands. This is a situation fraught with danger. How has it come about?
It has happened because the wealthy and powerful have discovered a means of circumventing elected governments. Whereas once, an international investor (and in a global economy, it is the international investor who holds the most important purse strings) would have to comply with the requirements of the government of a country in which it wished to operate, now – by virtue of the unlimited movement of capital across national boundaries – the boot is on the other foot. A government which does not toe the line, in terms of what is wanted by a potential investor, will simply be told that the investment will go elsewhere.
Few governments have the power or will to defy this blackmail. Most will meekly comply, to the point that a measure that is regarded as likely to deter overseas investment will never see the light of day, let alone be put in place. The result is that the ability of governments to protect and advance the interests of their citizens has now been significantly diminished. And, as people sense that their governments have lost power, they in turn lose faith in democracy.
So, economic policies are framed to satisfy current orthodoxy, so that central economic decisions are taken out of the hands of elected governments and handed over to unaccountable bankers and officials. Policies are shaped to meet the needs of big business, tax rates for the wealthy are progressively reduced, spending on social and environmental issues is pared back, rules restricting the repatriation of profits are relaxed, the protections provided to workers are weakened, the fruits of prosperity accrue largely to the already wealthy, rules to protect the environment are bent, restrictions on cross-media and foreign ownership of the media are abandoned.
None of this happens openly – as an acknowledged consequence of the preponderance of one interest over all others – but is done piecemeal, each step part of an inexorable reduction in democratic protections against the overweening power of international capital.
Without our realising it, the political landscape has changed. A political revolution has taken place without a single vote ever being cast for it. The choices offered to voters have been narrowed. It is now the undemocratic global market, not political democracy, that makes the important decisions. A single global economy and market is, by definition, one in which there is no role for government, democratic or otherwise, since government intervention would mean that the market operated differently in one country as opposed to another, and there would no longer therefore be a single market. The danger is that – left unregulated – that single market does not recognise the public interest. It rewards instead the greedy and short-sighted minority.
It is not only the domestic political agenda that has been transformed. The dominance of increasingly unrepresentative and powerful international investors – narrowly focused and short-sighted enough to believe that their wealth and power allows them to ignore the threats that assail the rest of us – means that the undemocratic distortion of the political process now has wider and wider consequences and increasingly affects global issues. In matters like global warming, or religious tolerance, or third world debt – all arguably central to our very survival as a species – it is not humanity’s, but international capital’s interest that prevails.
This barely remarked yet profoundly threatening development presents all of us with a huge challenge. New Zealand, which has so often led the way to democratic reform, has the chance to fight back, not just in the interests of our own democracy, but as a beacon light for others to follow. Never has the need for democracy, for the broadest possible basis for critical decisions, been so pressing.
So, what can we do? Our main task is to restore a fully functioning democracy. We can begin by raising the level of awareness, so that people understand what is happening, and how high the stakes are. We can then demand from our politicians that they reclaim for us all the power that they currently pretend they have – the power to make the important decisions in our interests – and that they meet the obligation to be held accountable for those decisions. We should assure them that they will have our support if they have the courage to take on these challenges.
We should consciously rebuild a sense of the value of our democracy, not in the abstract but as a practical guarantor that decisions will not be taken over our heads by distant, unrepresentative and irresponsible forces. That means, among other measures, having the courage to insist that our governments restrict the freedom of overseas investors to buy up whatever they choose, so that we cease to have any say over what is done in our own country. It means reclaiming the freedom to set our own requirements as to how and in whose interests our economy should be run, and what laws should protect our citizens, so that those wishing to operate here comply with our wishes rather than the reverse.
It means placing economic policy under the control of our elected governments rather than bankers. It means acknowledging that governments have a vital role in identifying important issues and acting to deal with them, rather than leaving them to the global market to decide.
As we begin the fight-back at home, we should also work with other like-minded countries and governments to change the way in which international financial institutions work, to establish rules to govern international investment, and to control the flows of capital so that the power of international capital to defy and override elected governments in their quest for profit at any cost is limited.. We must ensure a fairer distribution of capital around the world and promote international cooperation in the interests of humanity rather than of maximising profits for a few.
My vision for New Zealand is not a pipe dream. It is rooted in our history and in our attachment to democracy. What is needed is the political will – and a sense of urgency.
The Globalisation Bell Tolls for us All
The decision taken in New York to close the Colgate Palmolive factory in Petone and supply the New Zealand market from production in Australia and elsewhere is the latest demonstration of just how far this country has lost control of its own economic destiny.
Successful New Zealand companies – Trade Me, 42 Below, Ihug – are snapped up by overseas investors. Failing New Zealand companies, like Feltex, are bought at a knockdown price by overseas competitors and the domestic workforce forced to accept poorer wages and conditions. Overseas owners of our basic infrastructure threaten, as in the case of Toll Holdings, to limit the service they deliver in the interests of maximising their profits. Even the most New Zealand of New Zealand companies, like Air New Zealand, propose to take large chunks of their operations offshore, and invite foreign contractors to deliver supposedly cheaper services by driving down wages and conditions.
In most of these instances, it is the workforce that pays the immediate price. But none of us escapes. Workers may lose their jobs and suffer wages cuts, but we all bear the loss of that growing volume of profit that is repatriated – profit produced from our economy but, by virtue of increasing foreign ownership of that economy, benefiting others. We all bear the cost of the high interest rates needed to attract the “hot money” without which our record current account deficit could not be sustained, a deficit made larger by precisely those selfsame high interest payments and profits repatriated across the exchanges. And we all suffer the loss of control over our economic lives as a result of decisions increasingly made in boardrooms which may hardly know where New Zealand is, let alone care about it.
These are high prices to pay for our enthusiasm to offer ourselves up to the global economy. Whereas once, an overseas company wishing to operate in New Zealand could be required to meet conditions stipulated by our government – conditions designed to protect the workforce, and consumers, and our social and environmental interests – our governments are now powerless to stipulate anything. If they should indicate any wish to establish minimum protections for our interests, they will smartly be told that the investment will go elsewhere.
Now, as the economic and industrial news reinforces every day, our ability to establish our own conditions and pursue our own policies in the interests of our own people, has well and truly slipped through our hands. We have sold so much to foreign interests that we have little left to sell. We are no longer able to take the decisions needed to protect what is left. We are rapidly being absorbed into the economy of Australia, and – if not Australia – then further afield, without a single democratic vote being cast.
Overseas interests now dictate a whole range of policies. Wage rates are increasingly set according to the benchmark of Chinese wages. Tax rates have to follow the Australians. Employment and industrial relations law, health and safety legislation, rules about the re-investment of profits, have to comply with the requirements of overseas investors, not of New Zealanders. Even environmental issues – so much in the news following the Stern Report – are determined according to the wishes of overseas operators. When a carbon tax was proposed in order to meet our Kyoto commitments, it was rapidly scuppered by the threat from Comalco and others to move their plants elsewhere.
It is not, in other words, only economic power which has moved decisively out of our hands. It is political power as well. The political debate is now shaped and constrained in the interests of a small, self-interested and ideologically unrepresentative group of immensely powerful investors who could never have secured support for their extreme positions if they had had to seek a democratic mandate.
Their influence extends as far as deciding what the macro-economic policy settings should be and how they should be decided. This week, we had yet another meeting of top businessmen to consider the question of how we, as a country, could improve our economic performance. The best they could apparently come up with, as a “big idea”, was that the removal costs of people appointed from overseas should be tax-free!
No one apparently questioned the policy settings which are largely dictated by international capital and which mean that central issues of economic policy are decided by unelected officials, that the chosen instruments – like tinkering with interest rates – are increasingly ineffective as a counter-inflation strategy but do great damage to the real or productive economy, and that the economy as a whole is forced to pursue a dizzyingly damaging course up and down an exchange rate roller coaster.
No one would want to put up the shutters, or to see a “fortress New Zealand”. But we should surely be debating the question as to whether our wholehearted readiness to hand over our economic fortunes to the whims of a more and more concentrated number of international investors is not exacting too high a price in terms of lost economic benefit and diminished democratic control over our own future. Isn”t it time – if democracy is to mean anything -to restore the power of governments to govern, in all our interests?
Bryan Gould
2 November 2006
This article was published in the New Zealand Herald on 7 November 2006
The Democracy Sham
In The Democracy Sham: How Globalisation Devalues Your Vote, Bryan Gould considers the impact of the global economy on the democratic process in a number of countries, including New Zealand and Britain. He shows that international capital is, by virtue of its freedom to move at will across national boundaries, now able to dictate to democratic parties and elected governments the economic and other policies they can and cannot pursue. The result is that the political choice offered to voters has, without their realising it, been narrowed and constrained and the voice of the left has been muted and virtually extinguished.
Bryan Gould explains the development of the global economy and the reasons for its current hegemony. He shows that the orthodox justifications for globalisation – that it has delivered better economic and other outcomes for both the world economy and individual countries – cannot be supported, and that it has, on the contrary, produced a global slowdown and unsustainable inequalities and instabilities on both the international and domestic scale.
He looks at the political implications of what he describes as an historic shift in the balance of power between capital and labour, and at the failure of parties of the left to mount any effective resistance. He concludes by considering the steps that could and should be taken to restore balanced and sustainable economic development in the world economy and a fully democratic choice to voters in countries as diverse as New Zealand and the United Kingdom.
The Democracy Sham: How Globalisation Devalues Your Vote is published by Craig Potton Publishing in September 2006.
National Radio Interview
Bryan Gould was interviewed by Chris Laidlaw about The Democracy Sham on New Zealand National Radio on the morning of Sunday, 10 September. Excerpts from the interview appear below.
“What I am concerned to do is to dispel the notion that the social and political and environmental downsides [of globalisation] that are becoming increasingly apparent can be offset by economic considerations…in other words, the economic story is not a good one either. National governments have found the going tough and internationally the economy has grown quite slowly since globalisation and has been marked by tremendous inequities and uncertainties and instabilities.
If we’re drawing up a balance sheet, and we can show that it’s not very strong on the economic side, that then frees us to look at the political and environmental and social consequences that I think are inimical to the kind of world economy we’re trying to develop.”
“It’s not surprising that people have on the whole been persuaded that globalisation has meant better times because for some people it has. What you have to ask is, but which people? It turns out that those who have done well, both globally and within national economies, have been the top ten or twenty per cent. They are able to develop the myth of better times for all by virtue of their ability to influence the way the media treats these issues. The facts show that many people – certainly those below the median point and some of those even above it – have not done well out of globalisation, and that’s true in strictly economic terms as well as in terms of controlling their own lives and influencing events close to home.”
“I wrote the book to answer the question as to why, when there is so much unhappiness about particular aspects of globalisation across the political spectrum, these concerns have so little political traction. The answer is, I think, that people have lost touch with the sort of analysis that I have tried to develop. They tend to look at third world poverty or threats to the environment or the loss of control to multinational corporations as separate, individual and discrete issues rather than as manifestations of the huge loss of control that has flowed from the ability of international capital to dictate to elected governments what the political agenda should be. So, without people being aware of it, the political debate has been narrowed, so that no major party, either in power or seeking power, dares to pursue a policy, either economic or flowing from economic policy, that would discomfort the international investors on whom they think they depend. So, even quite liberal or radical governments, like the Labour government in New Zealand, tailor their economic policies to suit international investors.”
“Thirty or forty years ago, overseas investors would have to negotiate terms with the elected government of a country in which they wished to operate. That government would specify the terms that were needed to reflect the interests and needs of their electorate. Today, the free movement of capital around the world means that international investors – and that means in reality fewer and fewer but bigger and bigger – can roam the world looking for the most congenial conditions, with the result that across the globe wage rates are driven down, and the treatment of profits becomes ever more favourable because competing governments feel that they must do what is required of them if they are to secure the investment they need.”
“One of the many downsides of increasing globalisation is that there are fewer and fewer companies [in a country like New Zealand] flourishing and maintaining their headquarters in New Zealand….That means that fewer and fewer decisions about our economy are being made in New Zealand and that decisions about how workers should be treated and where investment should be made are being made by people who don’t even know where New Zealand is, let alone care about it. And there are some severe economic consequences as well. One of the major burdens overhanging the New Zealand balance of payments is the huge proportion of our economy accounted for by repatriated profits and the interest we pay to [purveyors of “hot money”] in order to finance our deficit.”
“You can’t argue that the huge power of international capital will be deployed to secure the best outcomes from the viewpoint of the international investor, which means that only market values and market forces that impact on the bottom line will be taken account of, and that they will then sit back and allow governments to come along and change those outcomes. This is not a play exercise. International investors want certain outcomes and they will insist on getting them. They might allow a little cosmetic exercise at the margins but they are not going to allow claims for social justice to override the infallible market. The deliberate objective of free market economics is social injustice. The dice must lie where they fall.”
“I think it’s quite possible that the pendulum [of intellectual fashion that would normally allow a change of policy in the light of increasing dissatisfaction with globalisation] may have got stuck because of the power of international capital and the international media, which are just a subset of that same group, to dominate the agenda.”
Rates Reform
Recent and prospective rate increases have prompted a renewed debate in New Zealand about the financing of local government. The following article by Bryan Gould was published in the New Zealand Herald on 30 August 2006.
In the London of 1990, the poll tax protesters were on the streets and created a political and public order crisis that eventually forced Mrs Thatcher from office. I was at the time the Shadow Secretary for the Environment, responsible not only for Labour’s assault on the poll tax, but also for devising the Labour alternative.
Mrs Thatcher was just the most high-profile casualty of what has always been one of the most sensitive of political issues – the role of local government and by whom and how it should be paid for. Rates have always been one of the most resented taxes but attempts to replace them have usually – as in the case of the poll tax – been disastrous.
Very few would dispute the case for local government. Bringing decision-making closer to the communities affected by policy decisions has always been seen as worthwhile. Most people want to have the power to influence decisions in their locality rather than have them taken by some remote bureaucracy in central government.
New Zealand has a rather more centralised system of government than is commonly found in most Western democracies. We have a unitary (as opposed to a federal) state and the powers of local authorities are less extensive here than in countries like the United Kingdom. One of Mrs Thatcher’s weapons in her battle against a recalcitrant local government that stubbornly resisted her so-called reforms was to transfer power from the local to the central tier of government, but there would not be much support for a further limitation of already limited local government powers in New Zealand.
If the role and value of local government are not widely disputed, and if the price paid for failing adequately to carry out its functions is painfully evident in our major cities, the remaining question is – how is it to be paid for? There will always, of course, be room for critics to say that money is wasted and that local government should be reined back. But we also know, or should do, that one person’s wastefulness is another person’s essential service. No one likes paying for public services, but a stance that produces continuing demands for better local services while refusing to pay for them is hardly realistic.
So, are we stuck with the rates? Mrs Thatcher’s disastrous experiment with a poll tax is unlikely to be repeated. Local income taxes are generally resisted as an unwelcome addition to an already heavy income tax burden. Local sales taxes create unnecessarily cumbersome and unhelpful differentials between regions which would be seen as ludicrous in a small country like New Zealand.
There are of course many potentially thorny issues about how rates are calculated and levied – what should be the basis of valuation, who should carry it out and how often, what rebate schemes should be put in place – but a property-based local tax as an alternative or complement to income and sales taxes has long been recognised as a valuable widening of the tax base and has proved over centuries to be pretty resistant to challenge. Rates are fraught with difficulties but have so far been seen as preferable to any alternative.
One of the aspects of rates most commonly resented is the impact they have on those – often the elderly and retired – who are property-rich but income-poor. The plight of the elderly widow forced by an excessive rates bill to leave her family home was one of the most powerful images used in Britain to make the case for replacing the rates with the poll tax.
When I faced up to these issues in 1990 and proposed Labour’s alternative to the poll tax, I came up with a solution that solved some of these fundamental problems. I wanted to stick to the tried and true property tax as the basis of financing local government, but I proposed that its impact should be moderated by taking account of people’s income. Modern computerisation, even 15 or 16 years ago, made this eminently possible. The income tax code based on the income tax return that people made in any case could easily be applied to the rates bill so as to reduce that bill where income was low in relation to the rateable value of the relevant property.
Unfortunately, my colleagues misunderstood my proposal and were spooked by what they saw as an income tax element to be added to the rates. They feared the reaction to what they thought might be seen as the introduction of a second tax or a local income tax. As a result, we missed the chance to reform the rates. Some say that the episode cost me the Labour leadership when I came to contest it a year or two later. It is interesting that a renewed British dissatisfaction with the Council tax (as the rates are now called) has led to a revival of interest in my proposals.
It may be that in New Zealand in 2006 a serious and considered reappraisal of local government financing will come up with still more far-reaching reforms. But no one should bet against the survival of the rates in one form or another.