Wealthy Individuals Do Not Hold the Key to a Stronger Economy

As the smoke clears, and the mirrors are packed away for another year, we can now make a more considered judgment of the 2010 budget. It should straightaway be acknowledged that the budget was a well-balanced and intelligent exercise, with something in it apparently for everyone. There may be a raised eyebrow as to why a Paul Reynolds of Telecom deserves an extra $3500 per week from the tax cuts, while the average family has to get out a calculator to check whether they will be better or worse off by a few dollars, but – on the whole – people see income tax cuts more clearly and place a greater value on them than they do on GST increases of the same monetary value. Politically, the budget will play well.

A similarly positive assessment can be made of the budget’s underlying fiscal stance. The deficit, about which there was so much alarmist talk a year ago, will keep on rising with a consequent boost to economic recovery, and yet is still projected to rise less and come down sooner than was earlier forecast. Indeed, the positive noises about the government’s finances lead one to wonder why we allowed last year’s budget to be so totally circumscribed by Standard and Poor’s narrow view of what was required. A more confident budget last year could have seen a stronger recovery today.

But what of the most important of the government’s stated budget objectives – the promotion of growth and a better economic performance? Here, the report card is much less favourable.

The budget seems to be driven by a view of how the economy works that is intuitive rather than reasoned or supported by evidence. The government believes, apparently, that if the wealthy can earn more and keep more of their wealth, they will work harder and invest more, and we will all benefit as a result.

There are many things wrong with this view. First, it is not supported by the evidence, and is contradicted by the experience of those countries which have tried it. It rests on the discredited “trickle down” theory, which flies directly in the face of the correlation, in countries like the US and the UK, between greater inequality and greater proportionate rewards for the wealthy on one hand, and on the other hand, a poorer economic performance, including more irresponsible behaviour and a greater propensity to financial meltdown.

The evidence suggests that if the spending power of the wealthy is increased, it does not “trickle down” to the rest of us through greater investment and a keener eye for new opportunities, but manifests itself instead in more ostentatious and unproductive consumption. If it is invested at all, it is directed into riskier and less worthwhile get-rich-even-quicker schemes, rather than into the substantial strengthening of our productive capacity through solid investment in the whole economy – investment that, to its credit, the government is trying to make in research, and needs to make in our economic infrastructure and in the education, skills and health of our workforce.

But the main concern about the budget approach is that it reveals a limited and out-dated understanding of how a modern economy works, though one that obviously commends itself to those like the wealthy whose interests it serves. The pages of Adam Smith might suggest that an economy comprises an agglomeration of unrelated individuals, each pursuing their own private interests to the general advantage, but that is not how a successful modern economy works. Economies are huge and complex mechanisms that respond to broad policy settings that determine major issues like competitiveness, profitability, investment and productivity. They are not driven by individual motivations but by responses across the board to broad economic realities.

There is little point in offering tax hand-outs to wealthy individuals, if macro-economic policy settings ensure that investment in productive capacity will not produce a worthwhile return, however it is taxed. The government shows no sign that, as we come out of recession, it will abandon overall policy settings that will once again knock the top off any recovery by burdening the whole economy with high interest rates and an overvalued exchange rate.

Why should we expect that offering additional discretionary purchasing power to a few wealthy people will do the trick, when the price competitiveness and profitability of everything we do is undermined because every domestic cost is raised in international terms to uncompetitive levels, with knock-on and adverse consequences for investment and employment, and in the end living standards as well?

That would be as sensible as expecting to win the Rugby World Cup off the back of a couple of brilliant individuals, while overlooking the fact that the rest of the team cannot pass, catch the high ball or throw the ball into the lineout straight. Missing out on the Rugby World Cup would be one thing, but we might also fail in our attempt to move up the OECD league tables if we can’t get the basic skills right and the whole team playing well.

Bryan Gould

24 May 2010.

This article was published in the NZ Herald on 26 May.