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Dr Muriel Newman

Looking Ahead

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This year’s budget is to be released on Thursday. It will be delivered against a backdrop of increasing global economic uncertainty, particularly in the Eurozone. Greece is unable to form a government and a withdrawal from the Euro is looking increasingly likely – maybe even from the European Union itself. Youth unemployment has hit 50 percent in both Greece and Spain, while the number of people out of work in the Eurozone as a whole is at a 15-year high of over 17 million. There are concerns over Spain’s banking system, Portugal is sinking deeper into recession, Italy is still not out of the woods, and France has just elected a socialist President who believes that he can spend his way out of his country’s economic woes.

Dr Roger Bowden, a former Professor of Economics and Finance at Victoria University and this week’s NZCPR Guest Commentator, is keeping a close eye on events in Europe. In his article The Euromess, he explains:

“Francois Holland, the President-elect of France got there on a platform of renewed public spending. Things like 50,000 additional teachers and civil servants, restoring the pension age, urban renewal, and infrastructure projects. All very Keynesian and good, as a way out of recession. But how to finance it? Yes, you can tax the rich, but there’s not all that many of them, and they’ll make themselves even scarcer once the tax is announced. How about printing money? That’s hard, because the French central bank can’t do that without the OK from the European Central Bank. So unless he can tap into the Eurozone for the money, it will mean issuing more French sovereign debt. But there’s already so much out there; indeed the interest bill is the second largest sink for government spending behind education, and the sovereign debt ratio at 89 percent is well north of the agreed 60 percent target.”

The experience of Eurozone countries should act as a clear warning to governments around the world that poor economic management cannot be sustained in the long term. When consumption is funded from debt, taxpayers will eventually be forced to face the consequences.

In fact, poor economic management by political leaders should not be tolerated by voters – simple as that. Just as households must live within their means, so too must governments because it is taxpayers, not spendthrift politicians, that have to deal with the consequences. The corrections that will inevitably be required – in the form of spending cuts and a reduction in entitlement programmes – can be ugly.  Unfortunately too, it is often not profligate governments that bear the brunt of public anger at spending cuts, but reforming governments that are forced to deliver unpopular belt-tightening policies.

This was certainly the experience in Sweden. Originally a wealthy, relatively low-taxed country, the foundations of Sweden’s economic decline were laid in the 1930s through the introduction of a cradle to the grave welfare system. Over the years this was expanded to a point where the country had become a textbook case of ‘European economic sclerosis’ – economically vulnerable to recession due to a very high taxes and a huge regulatory burden.

The inefficiency of Sweden’s bloated public service was renowned. It was said that if efficiency was improved to match that of Ireland or Britain, public expenditure could be reduced by a third for the same service. Swedish doctors were reported to be seeing only four patients a day on average – down from nine in 1975. This was less than in any other OECD country, and less than half of the average. One reason was that a Swedish doctor spent between 50 and 80 percent of his time on administration.1

By the time of the 2006 general election, Swedish voters were finally ready to oust the Social Democratic government that had been in power for 65 of the previous 74 years, in favour of a coalition government led by The Moderate Party. Since then, Sweden’s reforms have been on-going. Their focus has been to reduce the size of government and balance the budget. Tax cuts have been at the centre of the reform programme along with a reduction in welfare-spending.

Finance Minister Anders Borg is using tax cuts to encourage Swedish entrepreneurs – who had left in droves during the big-government era – to return home. In a feature article in The Spectator last month, Borg explained that economic recovery depends on entrepreneurs. If cutting taxes for the rich encourages risk-taking, it has to be done: “In most cases, the company would not have been created without the owner. There would be no Ikea without Ingvar Kamprad. We would not have Tetra-Pak without Ruben Rausing. They are probably the foremost entrepreneurs we have had in the last few decades, and both moved out of Sweden.”2

He explained that most entrepreneurs were not rich when they were starting out: “No, but they were becoming rich. If you have a high wealth tax and an inheritance tax, people emigrate because it becomes too costly to own a company. Ownership is a production factor. Entrepreneurs are a production factor. Yes, these people are rich and you can obviously argue that we want to encourage social cohesion. But it is also problematic if you drive out entrepreneurs from your country, because they are the source of job creation.”

By reducing government spending and lowering taxes, the Swedish economy has rebounded, delivering 6.1 percent growth in 2010 and 3.9 percent last year, when it ranked at the top in Europe’s list of fastest-growing economies. This sort of recovery would be impossible under the stimulus spending and higher taxes being advocated world wide by parties of the left.

While Borg is now highly regard as an extremely capable Finance Minister, New Zealand’s Roger Douglas held that honour back in 1984, when he instigated a series of market-led reforms that rescued New Zealand from a state of virtual bankruptcy. In spite of the disingenuous rhetoric of the left, most of the changes he introduced remain intact. Given the backdrop of international economic turmoil, I asked Sir Roger how we should judge Thursday’s budget. Following is his response:

The 2012 budget day is nearly upon us. From what the Minister of Finance Hon Bill English has said, it’s clear that he does not intend to tackle New Zealand’s fundamental problems. Big spending items like student loans, working for families, superannuation, education, health, and welfare will be tinkered with but not fixed. Once again there will be not only a deficit of courage but more importantly a deficit of imagination.

Here are ten principles the Minister of Finance Bill English should take into consideration:

Principle One: There is no free lunch
Each dollar of government expenditure has come from your wallet. Governments should only take an extra dollar from the private sector if they can show that it will return more to New Zealand than it would have returned had it been left in the private sector. People change their behaviour in response to taxes – they may work fewer hours, structure deals differently to lower their tax burden, or even break the law to avoid paying tax. These losses are known as deadweight losses. The Treasury has estimated that raising $1 in revenue in fact costs $1.20 at the margin. What this means is that Government spending must deliver benefits over and above the dollar value of the spending to be worth the cost.

Principle Two: All spending has an opportunity cost
$1 for roads, is $1 less for health. When the Government spends money, the question is not ‘does this spending have benefits?’ but is instead ‘does this spending have more benefits than any alternative way of spending money?’

Principle Three: Incentives matter
After free physiotherapy was introduced as part of ACC in 2004, expenditure rose by 1400 percent. Promises of ‘free’ services, like doctor visits, healthcare, or transport for superannuitants, always end up costing far more when paid publicly than they ever would if paid for by the individuals themselves. The thing we need to remember is that if we get the incentives wrong, Government spending will be forced to rise and cover the cost. But if we get the incentives right – which invariably involves allowing prices to determine consumption – then we can harness what individuals do for the public good.

Principle Four: Share the necessary adjustment equitably
We must stop spending beyond our means, but the only way to do that is to distribute resources away from domestic consumption towards international exporting. That means less Government, and more private enterprise.

Principle Five: Demographics matter
The costs attributable to one generation should be paid by that generation, not loaded onto the next in an unsustainable way. Steps need to be taken now to ensure that over the next 40 years appropriate levels of personal funds are put aside to ensure that retired people can live with dignity from their own personal savings. Unless this step is taken, the welfare of retirees will depend on the whim of politicians in Wellington.

Principle Six: Focus on the dollars
We need to ask the hard questions about big-spending items and consider all the options on the table. That is best achieved by asking: Does this department need to exist? If so, what are its functions, and do they need to be continued? For those functions that remain, can we make them contestable, with private contractors able to bid and drive down costs, while improving efficiency and productivity? If not, how can we structure the department to achieve our goals without creating waste and poor incentives?

Principle Seven: Productivity matters
The cause of wage growth is productivity growth. Productivity growth is not a result of working harder or longer – it is caused by one of four things: capital investment, technology development, upskilling and education, and quality public institutions. Encouraging people to produce goods in more efficient ways and making businesses more competitive is the key. In addition, Government needs to realise that cutting a dollar of waste releases that dollar to be usefully employed elsewhere. Cutting waste has realbenefits – be it in higher wages, better jobs, or better goods and services.

Principle Eight: Reduce transaction costs
Reducing ‘transaction costs’ will enable New Zealand to achieve higher levels of economic growth. Greater investment in key infrastructure will allow us to expand our productive capacity, and stripping away man-made barriers to growth, such as tariffs, will enable us to gain from trade. Excessive regulation often acts as a man-made barrier to growth by preventing people from producing goods and services. Once again the effect is to increase the price of goods.

Principle Nine: Reduce tax
Tax is necessary to raise revenue for Government spending. If we continue to indulge the whim of every special interest group with tax money, then taxes will be high. But if Government spending can be kept under control, then taxes can be low. Tax reductions create better incentives for people to work and save.

Principle Ten: Place a real limit on government expenditure
The basis of a free society is limited Government. The most obvious interference in the life of the ordinary person is the capacity for Government to forcibly take money from them and spend it on projects – would you rather have subsidies for the racing industry, or a tax reduction of $50 a year? Unless we restrain that capacity, we can be sure that power will be abused and the size of Government will expand.

In considering the forthcoming budget – and those that lie ahead – there are two main options: a larger state, higher taxes and more control for meddling politicians in Wellington, or a future of low taxes, personal responsibility, personal freedom and prosperity. Which do you chose?