The economy

One of the biggest election issues this year is likely to be the economy. Over the last nine years the economy has grown strongly. In part due to good luck, with high prices for our exports, partly due to the reforms of the 1980s (the growth we saw under Labour was a continuation of a trend which started in 1991), and in part, because Labour kept the main elements of the reforms of the 1980s in place, and was very cautious dealing with the economy.

However, thanks to the global credit crunch, this has changed. Unemployment has started to rise again. We also face problems with high inflation, a official cash rate as high as 8.25%, inflation set to reach 4.7% (well above the 1-3% target range) and a slowing of economic growth to under 1% in 2009 forecast. Other bad features forecast include a doubling of unemployment to 6%, a 13% drop in house prices with the lowest level of house sales in 18 years, and a fall in the value of the New Zealand dollar. Many households in New Zealand are strugling with high food and petrol prices, the high interest rates putting pressure on their mortages, and with these projections things don’t look like they are going to be much better.

None of the above is Labours fault. Sure, Labour could have cut taxes earlier, not bought in redistributive schemes like Working for Families, and so forth. But the reality is that we live in a very globalised world, and do a lot of trade with other countries. This means that circumstances beyond our control have a big impact on our economy. There was nothing that Helen Clark could have done to stop the global credit crunch from occuring, and she is just as much the victim of bad luck now, as she benefited from good luck in the strong growth over the last nine years.

However, economic growth does not come from itself. While government policies have limited effects on growth in the short run, they can set the foundation for better conditions in the long run. But there are limits to what can be achieved. Creating a good business enviroment (low taxes, low levels of regulations, little corruption and stable macroeconomic conditions) as well as investing in infrastructure needed and resources (the most important economic resource is of course people, who need good educations to preform well in a high skill based economy), are the main things. Obviously economic growth needs to be balanced against other concerns like looking after the poor and the enviroment. However, economic growth will make these tasks a lot easier (and basically any other task in government). The reality is that you can not afford to spend much money on social welfare, on health, or education, or fighting climate change, with a failed economy. That is why improving the economy should be central to every Parties plan for New Zealand’s future.

I am not an economic expert (I only took 2 first year papers and one second year paper at university on economics) but I do know the basics. A good plan to improve the New Zealand economy (long term) will consist of:
*Creating a low and flatter tax system, with the abolition of redistributive tax rebates (such as working for families).
*Investing heavily in education, transport and communication networks.
*Reviewing, with the aim of reducing red tape, the Resource Management Act, and all other bureacratic regulations.
*Mantaining the independence of the reserve bank.
*Create competitive markets where state monopolies exist, such as ACC.
*Aim to sign free trade agreements with more countries like the United States.
*Aim to keep markets as flexible as possible, so they can easily adjust to changing market conditions.

In the short run, make progress on all the above. But mantain medium governemnt surpluses (funding tax cuts through cuts in spending) to give the government flexibility, and avoid putting more pressure on inflation and/or overheating the economy, and try not to let interest rates fall too soon or fast (high interest rates are good for punishing people who live beyond their means. On the other hand, in keeping our dollar high, they hurt our exporters).

Enough on my ideas. Back to the real world. The great worry facing the economy is that we could be looking at stagflation in the worst case scenario. In any case, with high inflation and a high OCR, Keynesian style fiscal stimulation is not what the economy needs now, and as Bernard Hickey blogs, the 2008 budget could do more harm than good. Sadly, with this election likely to be a bribe war between Labour and National (like the last), things aren’t going to improve anytime soon.

Onto the political implications. No doubt the tax cuts in the budget were one massive election bribe. The New Zealand public is demanding them to help them in their financial distress. Sadly, although they could help long term, they are not the answer. The risk is that if New Zealanders go and spend all their extra tax cut money, it will push inflation up, the OCR up, the dollar up (huting exporters) and eventually cause a recession. Even if this doesn’t happen, the improvement to peoples financial circumstances from tax cuts will not be overwhelming, and quickly eaten up by rising petrol and other (perhaps more food) price increases. The key to improving peoples wellbeing in the long term is not a one-off tax cut, but long term wage increases driven by growth in productivity.

I don’t see much of this message from National. Instead, don’t be the least bit surprised if they use tax cuts as a massive election bribe to buy their way into office, like they tried to do last election. The political risk for National is that they will get voted into office now with people thiniking about how they will spend all their new cash, with inflation eating it up almost as soon as they get it. At the same time, all the predicted forecasts (higher unemployment, inflation, low growth e.t.c come to pass). People quickly forget about the tax cuts, blame National for the economic downturn, and return Labour in 2011. There is no doubt that Bill English will have his work cut out for him, with the bad shape the economy is in.

I strongly believe that reruning the 2005 campaign of using tax cuts as an election bribe, while it may work this election (a big if), will hurt National in the long term. Instead National should talk down its tax cuts, promising they will be modest, and not to expect too much from them. When they do come out, they should be identical to Labours, with a few minor alterations to the top tax brackets, like removing the 39% rate, cutting the company tax rate and only minor adjustments above Labours promises to the lower thresholds. They should not be sold as a bribe, but as part of a wider package at lifting New Zealand’s economic growth. A emphasis should be made that we are facing tougher times, and the higher petrol and food prices are here to stay. Nationals first budget should keep with this scheme, think long term, and be a real chance for National to stamp its mark upon the economy. And should include spending cuts, and the clear message that we must be prudent with our finances to help us through the tough times. Above all, national should avoid blaming Labour for the bad economic conditions (as things will not miraclously improve once National takes office). Sadly, I will be most surprised if my approach is taken.

Ultimately, time will tell what happens to the economy, and what National does. I really hope for the best, especially for those low income families struggling under the conditions, but fear the worst.

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