The imperatives of the polictical economy

Politicians often strike difficulty at the point where politics meets economics. Policy that appeals to the average voter often doesn’t appeal to the people who generate the revenue that pays for it.

For the moment – and probably the next two years, because the economy is running above-trend – this is not an issue for the government. But going into the next election economic growth will be dropping below trend.

Economists often find it hard to understand why ordinary people run counter to the iron laws of economics. They puzzle over elections that back policies they think are bound to work against the optimisation of economic growth and thus against ordinary people’s best interests. This is most economists’ view of the 1999 election.

Ordinary folk think that for 15 years they been preached at about price signals, cutting business costs, restructuring, the need to let the market run. They think that has filled the pockets of fat cats, most of them faceless foreigners milking our assets. They do not believe economic reform has benefited them. They want the government to remedy that.

Labour and the Alliance are responding. Both in tone and in specifics they are providing what Helen Clark has taken to calling a “correction” to the “extremes” of market-led policies. Treasurer Michael Cullen has gone so far as to say those policies could never have succeeded and he produces productivity and GDP per head figures to back up his claim.

Really? Economists generally agree that potential GDP growth – that is, growth that can be sustained on average over the business cycle – is now in the 2.75%-3% a year range. That is well above the 2% track in the 1960s and 1970s and even above the United States. On the face of it, that looks like success. During the 1990s unemployment has nearly halved and real wages have been growing.

Not enough, says Cullen. He wants potential growth to be 4% – that is, 1% a year more than the current track over the business cycle. That way we get richer faster and the government, while sticking to spending around 35% of GDP, can redistribute larger amounts of lolly in education and health services and help for the old and poor.

To get this extra 1% the government will regulate a little more (on ACC, labour relations and safety for more workplace harmony and on telecommunications and electricity for better infrastructure) and spend a little more on education and research and on helping bright ideas get business legs and export potential turn into reality.

That’s no more than most European countries and Australia do now – in fact, less than most. So investors, especially foreign investors and even funds managers, should be comfortable, Cullen argues.

The way investors see it, however, is that the government is going in the opposite direction from Europe and Australia. They have more regulated economies and higher tax rates. But they are reducing both. However mildly, this government is increasing regulation and has put taxes up.

This is part of the reason for a flight of foreign (and some local) funds out of the sharemarket this year.

Now we get to Catch-22. New Zealanders don’t save enough to finance the investment needed for 3% growth, let alone 4%. We have become dependent on foreigners’ savings to the tune of $5 billion a year or so. Michael Cullen aims to siphon off through tax $1.5 billion or so a year by 2003 into a super fund, but that still falls far short of providing for our needs – and it rules out tax cuts.

If foreigners lose faith, investment will falter and so will job and wage growth. If that happens ordinary voters won’t be pleased. They will forget they supported the policies in the 1999 election and that in early 2000 they showered enthusiasm on the government. Voters judge governments by outcomes.

But, and here’s the rub for any economists tempted to preach a day of reckoning, economists themselves tell us outcomes are likely to improve over the next two years. Even if growth slows in election year, voters may well still be telling themselves they were right in 1999.

If that happens politics will beat economics in 2002. Good politics will seem to be good economics – as it seemed for 40 years until Sir Robert Muldoon ran the ship aground in the 1980s. And, who knows, by then Cullen’s stimulants might be working.

Economics might claim unchallengeable laws. But sometimes politics is magic. For a while.