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4 December 2011 Eurogeddon and auserity

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While the coalition negotiations between National, ACT, United and the Maori Party continue on in their indeterminable way, the sovereign debt crisis in Europe deepens. Amid fears of  loan defaults by Italy and Greece, the credit rating agency Standard and Poor’s has downgraded 37 banks around the world including the four main Australian banks – and with them other New Zealand banking subsidiaries, the ASB, ANZ, BNZ, and Westpac. Although the banks say there will be little effect, over time it is likely there will be upwards pressure on interest rates.     

In light of the worsening global economic situation, there is an argument that the parties contesting the 2011 General Election should have put more focus on austerity measures. To see whether austerity programmes are as unpopular with voters as politicians may think, let’s examine what the research tells us about the track record of governments that have introduced tough austerity programmes. A report from Harvard University in 2010 examined the results of elections in 19 OECD countries over a 33 year period from 1975 to 2008 to see whether governments that imposed austerity measures got thrown out more often than governments that didn’t. Surprisingly, they found there was no difference - governments that focussed on cutting their budget deficits had a survival rate no worse than average.

When researchers burrowed down into the approaches used to balance the books, they found that those that relied primarily on tax increases were more unpopular than those that relied heavily on spending cuts: “In only 20% of elections in the countries that slashed spending did the government lose power, compared with a 56% rate of being booted out of office for governments which chose to raise taxes. Voters evidently dislike tax increases much more than they abhor spending cuts.” [1]

The paper concludes by saying that cash-strapped governments should not worry too much about losing office if they introduce strict austerity measures. While there might be riots in the streets from interest groups that stand to lose some of their benefits, the electorate at large tends to take a more balanced view of fiscal consolidation - especially if it is done through spending cuts rather than tax increases.

This was certainly the case in Canada in the mid-nineties, where, according to a new report from Reuters, the government transformed their “basket case” economy primarily on the basis of severe spending cuts.[2] Canadian ministers were told how much they had to cut and then told to come back with a plan on how they intended to do it. Cuts ranged from 5 to 65 percent of departmental budgets, with almost no area of government spending exempt. The point was made that unless whole programmes were axed, departments were likely to simply postpone spending with the result that the problem would be just as big as it originally was within just a few years.

As a result of their reforms, the Canadian government reduced spending by around 12 percent, interest rates fell, and the deficit - which had risen to 6 percent of GDP in 1994 - disappeared. The debt to GDP ratio declined rapidly from 67 percent in 1993, as the economy outperformed the rest of the G7 countries on growth, jobs and investment. Debt is now around 34 percent of GDP.

The Canadian public were right behind the budget cuts - families that had cancelled holidays and taken on second jobs to make ends meet in the recession couldn’t understand why the government thought it could get away with living beyond its means. As a result of their severe fiscal restraints, the reforming government won two more elections to return majority governments – a rare feat in those days.

The lesson for the John Key and his National government from all of this is that if the global economic situation worsens, they should not be afraid of introducing an austerity budget to severely rein in government spending. In fact, in the cold hard light of day, the state of the government’s books - with a forecast budget deficit of $10.8 billion or 5.1 percent of GDP, and forecast gross Crown debt of $79.8 billion or 37.7 percent of GDP - almost demands an austerity programme. And while New Zealand's government debt at 37.7 percent of GDP remains well below that of Greece at 132 per cent of GDP, Italy at 129 percent, Portugal at 107 percent, France at 97 percent, and Spain at 72 percent of GDP, given our narrow trading base and the fact that our main markets are now feeling the effects of the European sovereign debt crisis, there is no room for complacency.

So what should be the direction of an austerity budget?

At the top of the list would have to be National’s welfare reform programme, which they claim will produce great benefits including saving taxpayers $1 billion over four years.

At the present time the social welfare system support 550,000 New Zealanders - 328,000 working-age adults and 222,000 children. It is an indictment of the system that of the 12 percent of working age adults who are presently living on benefits, over half have been on welfare for at least five years. For the able-bodied, welfare was designed to provide temporary support, not lock them into permanent dependency on the state.

Over the years the benefit system has expanded to entrap many people who could and should be working in state dependency. This problem is now intergenerational and is harming children. When children grow up in benefit dependent households that do not value marriage or commitment, where no-one works for a living, where education is not treasured, and where substance abuse is commonplace, they are extremely vulnerable - their potential in life limited by a hand-out system that destroys lives.

National’s welfare plan is based on many of the recommendations of the Welfare Working Group. Their goal is to provide long-term support for those who are genuinely unable to fend for themselves, while refocussing all other beneficiaries on work. There will be a big increase in work testing, benefits will be restructured and simplified, the incentives to have more children on welfare will be curtailed, and drug addicts and alcoholics will be forced to either get treatment or lose their benefits. In conjunction with these changes will be a serious crackdown on the benefit fraud and abuse that has long riddled the system.    

In looking at the sort of fundamental economic changes that are needed in an austerity programme, the government should have a  goal of reducing government spending back to what it was in 2005, when it was an affordable 29 percent of GDP. In conjunction with spending cuts, a comprehensive boost to the economy would be generated through reducing the red tape and compliance costs that severely inhibit business growth. Following the lead of Canada - which has reduced company tax to 15 percent - a further reduction in company tax from 28 percent to below 20 percent would give New Zealand export businesses in particular the competitive advantage they need to help them overcome the handicap of distance from our international markets. In addition the government’s spending cuts would enable personal tax rates to be lowered closer to 20 percent thus easing the financial burden on many households and raising living standards.

Any austerity package serious about offsetting the global downturn and boosting growth would have to include suspending the Emissions Trading Scheme. Scrapping the ETS was promoted by ACT, New Zealand First, and the Conservatives in their election manifestos. Instead of an ETS that was designed as a mechanism to reduce emissions in industrial nations - not a sparsely populated rural economies like New Zealand - the NZCPR has long advocated a national project like planting Kauri forests on Department of Conservation or Council land (utilising the help of local long-term unemployed) as New Zealand’s commitment to reducing greenhouse gases - if one is deemed to be necessary for competitive trade-related purposes. The present ETS has added unsustainable costs onto every New Zealand household through rises in the price of fuel and power that have flowed on to increase the cost of most other goods and services in our economy.

With carbon prices collapsing both here and in the European Union, it would be far better for the government to suspend the ETS now in the name of austerity, rather than wait for the total collapse that will occur once the Kyoto Protocol expires next year. Scrapping the ETS, would not only relieve the cost burden on kiwi families, but the forecast cost of $1.5 billion for the provision of ETS credits in the budget could be cut as well.

During the campaign John Key talked of the need to “make the boat go faster”. In light of that, surely the government should be reversing its decision to privatise the massive wealth found within New Zealand’s coastline to corporate iwi. Instead it should be retained for the benefit of all citizens. Retaining Crown ownership of the foreshore and seabed would also save $1.6 million from the budget - the cost that taxpayers are being forced to pay corporate iwi to prepare their claims for our coast!

In looking to the future, I asked this week’s NZCPR Guest Commentator, journalist and former editor of the Dominion, Karl du Fresne if he would provide a roundup of the election. In his final paragraph he picks up on this same theme of wanting National to do more:

“Will the Key government show more daring in its second term than it did in the first? It has the excuse that the global economic crisis calls for bold action, but it could just as easily argue – and probably will – that a period of international uncertainty is no time for making radical changes that might create anxiety. So while we can expect modest reforms in such areas as welfare, youth wages, accident compensation, partial privatisation of state assets and the Resource Management Act, no one’s brac ing themselves for tough action to curb the state spending binge that began under the Helen Clark government and has continued largely unabated under National. Stability is likely to remain National’s soothing mantra.” To read Karl’s commentary, click here >>>

In light of the worsening global situation and the fact that history respects governments that cut costs in difficult times, one can only hope that National finds the intestinal fortitude to take the bold steps necessary to put HMS New Zealand back on a course to growth and prosperity. The economic threat is very real, and New Zealand is far too heavily dependent on just a few commodity markets to ignore the warnings. We urgently need to increase export growth but we can’t do that until the government introduces an austerity programme that prioritises the removal of barriers to entrepreneurialism and wealth creation.

This week’s poll asks: Are you more likely or less likely to vote for a government that cuts costs to balance its budget? Click here for poll >>>  

FOOTNOTES:
1. Economist, Vote for Agony 
2. Reuters, Lessons for US from Canada’s “basket case” moment

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