• Public Spending Matters

    The National government has never hesitated to put cuts in public expenditure firmly in the front of its shop window. “Smaller government” is in many senses the defining objective of John Key’s administration.

    In adopting this stance, our government has made common cause with right-wing politicians across the western world. From David Cameron’s Tories in the UK to Angela Merkel’s insistence on euro-zone austerity to Mitt Romney’s Republicans, all have sought recovery from recession and a brighter future by reducing the role of the state.

    None has been deterred by the obvious difficulty, now more than ever confirmed by recent experience across the globe, that cutting government spending in a recession means a smaller economy and a longer and more arduous route to recovery – and that means as well a sterner struggle to reduce government deficits.

    But an apparent absence of economic rationality is not the only reason for questioning the government’s sense of priorities over this issue. Ministers seem to assume that not only does cutting public expenditure help the economy, but also that it can be done without losing anything of value.

    They largely escape criticism for this because most people have only a partial view of the value of public spending. They make a clear distinction between spending for essential purposes, which they define as those that suit their own interests, and all other spending which they deride as a waste of money. The difficulty is that, not surprisingly, everyone has a different view on which areas of spending fall into which category.

    The further problem is that when government support is provided, it is so quickly seen as a natural part of the landscape that it is scarcely recognised as such. So, we are constantly told by those whose activities depend hugely on the help they get from government that the best thing government can do is to “get off our backs”.

    Recent events, however, remind us yet again that – contrary to so much popular wisdom – most government spending goes to purposes that matter greatly, both to those who are directly helped and to our efficiency, health and integrity as a society.

    Sometimes, for those who care to learn, the lesson is especially direct and painful. If government cuts back on inspecting mines, mine safety is jeopardised and miners can lose their lives. If bio-security border controls are not adequately maintained, destructive bacteriological pests from overseas, like PSA, can decimate a hugely valuable export industry.

    If our public service is under-resourced and under-valued, mistakes are made. Standards that we should expect to be maintained are not met; we find, for example, that the privacy of those who reveal their most personal details to government agencies is betrayed or negligently misplaced by an Accident Compensation Commission or an Inland Revenue Department or a Ministry of Social Development.

    And that is on top of the inexorable erosion of services that must now make do with reduced resources – from the defence forces and the police to schools, health care and community law services. Those who rely on those services, and that means most of us at some time or another, may not recognise what is happening until a crisis point – the collapse of a platform at Cave Creek, for example – is reached.

    The damage done to our public service is not just financial; the impact on morale and professional competence means that we are trying to maintain a first-world performance with what threatens to be a third-world standard of public service. We can go on with this process of attrition, but do we understand how gravely we handicap ourselves as a modern economy if our public administration is significantly weaker than in comparable countries?

    It is already the case that the government seems increasingly accident-prone. There is a sense that ministers are poorly directed from above and poorly served from below. The whole process of government seems to be unravelling.

    This sense of drift has its origins at the top. We can gain an inkling of what lies behind this from a little-noticed remark made by the Prime Minister in a television interview earlier this year in which he said that “any tax sucks money out of the economy. There’s a limited amount of money in the economy. So when you put up a new tax, or you tax people more, then it sucks that money out.”

    Let us put to one side the dubious assertion that “there’s a limited amount of money in the economy”; the really interesting part of Mr Key’s brief foray into economic theory is his apparent belief that money raised through taxation, and then spent on public purposes of various kinds, is somehow no longer part of, or of any value to, the economy.

    If it is “sucked out” of the economy, where does he think it goes to – into the stratosphere? And are all of those elements that are critical to our living standards and that are paid for out of taxation, of no economic value? If that is his belief, then perhaps his emphasis on cutting public spending becomes easier to comprehend, if not to support.

    Bryan Gould

    17 October 2012

    This article was published in the NZ Herald on 23 October.

  • The Death Spiral

    There are times when one can’t help feeling sorry for the government. After two years of framing economic policy to please the credit rating agencies – last year’s budget was virtually dictated by Standard and Poor’s – their reward has been a warning last month that our credit rating is on negative watch.

    That blow has been followed by the revelation that the government’s deficit has blown out by $2 billion more than forecast. This intrusion of economic reality may not be welcome but it has been salutary.

    The government’s response so far to these twin developments has been to maintain a stiff upper lip, and to continue to target a return to surplus by 2016. Others have not been so restrained. The air is thick with urgings – from the Reserve Bank, the Treasury, the Business Roundtable, and not least the Herald’s own leader-writers and columnists – that the government’s deficit must be cut and cut faster.

    It is hard to see these warnings as anything more than a knee-jerk reaction to what people think they heard, or wanted to hear. They see or purport to see a substantial connection between the threatened downgrading of our credit rating and the size of the government’s deficit.

    A careful reading of Standard and Poor’s statement, however, reveals that the government’s deficit (which remains perfectly manageable by international standards) played only a minor part in their expression of concern about our credit rating. Their focus was on the country’s external deficit – our propensity to finance an inflated consumption by borrowing from overseas.

    It is true that the government’s deficit is an element in the country’s overall deficit but it is not the element that is of particular concern to S&P. What worries them – and they are quite explicit about this – is that, if and when a substantial recovery finally materialises, our appetite for imported consumer goods will re-emerge with a vengeance and we will be back to our bad old habits of borrowing to finance a persistent trade deficit.

    The real import of their warning is that they see nothing in our current policy settings to suggest that we will avoid this all too familiar outcome. They fear that any revival in economic activity will see the application of the decades-old “remedy” of high interest rates leading to a yet higher dollar, with consequent damage to savings and exports while we binge on artificially cheap imports. Sooner or later, they warn, the willingness of overseas lenders to fund this rake’s progress may be exhausted.

    But, say the deficit hawks, the external deficit, our poor savings record, and the narrow base of our export sector – all of which are fingered by S&P as causes for their concern – are problems for the future. Surely – whether S&P say it or not – the one thing the government can do to help is to get its own deficit down faster than planned, even if that means painful cuts that might impact the most vulnerable?

    Let us be clear. All other things being equal, it would clearly be beneficial for the government to eliminate its deficit as soon as possible. And the government is quite right to seek savings in respect of public spending that may be wasteful or poorly directed.
    But if cutting the deficit is the first and over-riding priority, we need to be sure that it would produce, in today’s context, the desired outcomes – and it is a pity that this realisation did not dawn before the government’s finances were further weakened by tax cuts that mainly benefited the better off.

    But there is no evidence that simply taking the axe to government spending would help matters. The main reason for the government’s increased deficit is that tax revenue – already depressed by the recession – is much lower than forecast, and that in turn is a direct consequence of the slowness of our economic recovery. To cut government expenditure, thereby further depressing demand and eventually tax revenue, is not the most obvious solution to this problem.

    The paradox is that, as many of us warned at the onset of the recession, the greater the priority and urgency given to cutting the deficit, the more persistent it is likely to be. The most effective course for a government worried about its deficit is – while maintaining proper controls over potentially wasteful spending – to play its part in ensuring that the level of economic activity rises.

    As it is, we are in danger of getting caught in a downward spiral. Our export income is being depressed by the high dollar. The consumer is facing higher fuel and energy prices and the threat of continuing job losses, and uses any margin of spending power to pay down debt. The business sector is struggling with inadequate demand and therefore keeping tight tabs on employment and investment plans. If the government, too, cuts its spending further, where is recovery to come from? And how do we ensure that recovery, when it comes, does not take us straight back – as S&P warn that it will – to the problems that have dogged us for decades?

    Bryan Gould

    15 December 2010

  • Leaning Against the Market

    When Lord Myners proclaimed this month that “there is nothing progressive about a government that consistently spends more than it can raise in taxation” he gave support and comfort to one side of an argument that is at the heart of the new government’s agenda – what to do about the government deficit.

    Lord Myners’ intervention was all the more significant because it came from someone who, just a few weeks ago, was a minister in the Labour government. He weighed in on the side of those who seem to assert that the first priority of the new government must be to get the deficit down; but he may have also given us a clue as to why Labour’s position on this issue during the election campaign was so confused.

    Most commentators agree that the global financial crisis has prompted an overdue resurrection of the reputation of last century’s greatest economist. But, for Lords Myners it seems, Lord Keynes may never have existed. He continues to exhibit an unreformed attachment to one of the most common fallacies in economic thinking over the past thirty years.

    It is a common assumption in right-wing thinking that the government should be regarded as merely an individual person or corporation writ large, and that it should therefore always act as a prudent individual would do. Although most individuals would plead guilty to the charge of borrowing in order to build or acquire an asset (like a house), the government – according to this view – must never spend beyond its means. In a recession, when individuals stop spending and investing, and the government’s tax revenues therefore decline, the government must also slam on the brakes.

    This view is especially ironic when a large element in the government’s indebtedness is the money provided to bail out failed institutions, and especially banks, in the private sector. But, more importantly, it completely overlooks the responsibility of governments during a recession to lean against the logic of the market.

    As Keynes saw, a government that behaves in a recession as everyone else behaves will simply make the recession worse. It is the special role of government in that situation not to retrench but to use its huge resources, its ability to create new money through “quantitative easing”, and its responsibility to take the longer view and to act in the common interest, in order to stimulate the level of economic activity so as to shorten the recession and thereby restore its own financial position as soon as possible.

    A government that ignores that responsibility and focuses narrowly on its own short-term financial position is likely to see the recession last longer with inevitable longer-term consequences for its own tax revenues and finances. A braver government that lives with a deficit as its contribution to a counter-recessionary strategy will see its tax revenues recover faster and – paradoxically, it may seem – bring the deficit under control sooner than it would otherwise have done.

    None of this means that government spending should be let rip. If the deficit is to be effective in bringing the recession to an end, the spending must be economically worthwhile. The new government is quite right to scan the whole of its expenditure so as to eliminate wasteful, unnecessary or ineffective spending. The spending that is undertaken must not be focused on consumption but on encouraging investment, employment and improved productivity. The goal must be investment in an improved economic performance for the future so that a double bonus is obtained – an immediate counter-recessionary boost to the level of demand in the economy that takes the form of a counter-cyclical stimulus to longer-term productive capacity.

    To follow this course requires political courage and political leadership. The Lord Myners of this world are always quick to condemn a departure from what passes as orthodoxy. It is not something that should be sub-contracted to officials. The new government has received plaudits for setting up the Office for Budget Responsibility and George Osborne has now announced greater regulatory responsibilities for the Bank of England. But these agencies cannot be expected to take the tough decisions about the overall course of the economy that are now necessary. That is what we elect governments to do. The new government must step up to the mark.

    Bryan Gould

    16 June 2010.

    This article was published in the online Guardian on 14 June.