Listener 23 June 2001.

Keywords Macroeconomics & Money

Most of the public comment on the government’s May budget was on the lack of growth of social spending. This overlooked that in a typical year the government has a little less than a billion dollars extra to spend from economic growth, after allowing for price and population increases. After some has been spent on really urgent items (like increasing bio-security) and necessary repairs to failed past policies (the cervical smear program) there is perhaps $750m left. That total is less, say, than the spending that advocates for Education or Heath or Social Welfare are each demanding for their sectors alone. Inevitably many (quite reasonable) demands are not met. Their advocates are irate, but rarely suggest cutting back on other government expenditures or raising taxes. Last year was unusual because the incoming government raised income taxes and so had more than normal to spend. This year (and in most years) it did not, so there is not the same expansion on government spending.

Unless the government makes significant spending cuts somewhere else (unlikely) or it plays with mirrors, spending will remain tight. (My view there is little room to cut spending other than by privatising its burden so it is borne by households. That is not this government’s social philosophy. The exception might be in distributional spending. I am not advocating the incomes of the poor should be cut, but a lot of spending increases in recent years have been poorly targeted.)

The interesting element in the budget is the government seems to be revealing a different account of the production side of the economy from that held by the preceding Labour and National Governments. The past view rested on the theory that all the useful information between economic actors is encapsulated in market prices, providing the government interference in the pricing system is minimal. This is a good starting point but it soon becomes evident it is not the whole story. The production process of an economy is far more complicated than what standard price theory allows. That shifts the policy problem to whether a government can improve the production process by interventions additional to the price system.

If this all seems a bit theoretical consider that when Equiticorp bought New Zealand Steel off the government in 1987, the CEO, Alan Hawkins said ‘we could see that, in accounting terms, it was a good deal. [But] there was no way we could assess the steel plant as a manufacturing operation because none of us had any experience in the industry.’ For the financiers, ignorance of the production process did not matter, because all they needed to know was captured in the financial accounts. This criticism of financiers having a poor knowledge of production is a frequent explanation for the failure of the British economy to grow as fast as the rest of the OECD. It is said they neglect long run investment opportunities in favour of short run gains. Certainly the record of Britain and New Zealand is financier dominated economies dont grow very fast (but arguably the US is a contradiction).

The conclusion might be that the government becomes an investor in the economy where the financiers tend to fail. The venture capital fund, incubator support, and the spending on research and excellence are examples. The government is aggressively attracting business to set up in New Zealand, for investors dont know the advantages unless they are told. (The potential size of physical infrastructure budget seems too horrendous to contemplate.)

There also seems to be interdependencies between the production processes of firms which the market prices do not signal. (Economists call them ‘externalities’.) They occur in technology and information, the labour market and physical infrastructure. Again we see the government trying to enhance these activities.

Now of course the government can overdo its interventions (as Muldoon did), although today’s desperate shortage of government spending limits that. Moreover – and let us be clear about this – many of the government initiatives will fail. For instance, most of the research budget will not, in the end, enhance economic growth. But some will, and their returns should more than pay for the failures. (We would of course prefer to avoid zero return research, but noone can tell which is which until the research is done.)

The government enhancing the production process is not new. Not in New Zealand, for that has happened throughout our history (with the 1985 to 1998 period the longest exception), and it happens everywhere else in the world too. It is not only a broadly correct strategy but a courageous one. The inept policies of the previous fifteen years mean it will take some time for New Zealand industry to get back onto a strong sustainable growth path. In the interim the government is expending precious political effort and scarce public dollars on investing in industry with, probably, little immediate return. The easy strategy would be to blow it all on what the public lobbyists are demanding, and which the public desperately wants. The government is judging the public wants the prospect of long run prosperity even more.