Austerity no antidote if rest of economy falls ill

Balancing the books by 2014 is an arbitrary goal masking an agenda, writes Peter Lyons.

We seem to have accepted the mantra of austerity economics with stoic resignation.

Politicians are able to get away with zero Budgets despite being elected to lead. Balancing the government books by 2014 is accepted as a worthy goal regardless of the sacrifices involved or the superficiality of this accounting nicety.

Meanwhile, this goal is used to justify a variety of dubious policies, larger class sizes in our schools being the most recent.

An economy is a complex integrated system. Balancing the government books means little if the rest of the economy is a shambles as a result.

John Maynard Keynes pointed out that the economics of a country differ from those of a household.

This can lead to apparent contradictions and paradoxes in what is prudent economic management for individuals as opposed to countries.

It is prudent for individuals to cut back spending, save more and reduce debt during tough times.

However, if everyone attempts to do this at the same time the effect is to plunge an economy into a deeper recession. As people cut back on their spending this reduces total demand in the economy.

Firms lay off staff and demand continues to fall. This leads to a downward spiral as occurred in many countries during the Great Depression in the 1930s.

Lord Keynes advocated increased government spending as the circuit breaker to arrest a deflationary spiral.

He acknowledged that this would lead to large government deficits but the alternative was worse - a very long period of shrinking or stagnant output, high unemployment and falling asset prices.

New Zealand is not at this point, but the risk is certainly there as shown abroad. It is very difficult for an economy to break out of a deflationary spiral because business and consumer confidence is so negative.

There is a general reluctance by the private sector to spend. The gap in demand needs to be filled by government.

This scenario is particularly relevant when a recession is global in nature as occurred in the 1930s. This reduces the ability of a country to export its way out of a recession.

New Zealand has been very fortunate in recent years that our main trading partners, Australia and China, have continued to prosper.

Critics of the Keynesian prescription point to the debt levels incurred by governments in adopting an expansionary spending policy during tough times.

Keynesians respond that government deficits are a natural outcome of recessionary times as tax revenue falls and spending on benefits rises.

Prudent economic management should ensure that during boom times government surpluses are used to reduce public debt accumulated during the tough times.

In a depressed economy the low interest rates provide the ideal opportunity for governments to borrow and spend on essential public infrastructure.

Government bond yields in New Zealand are currently at historical lows of 3%. Selling off high-yielding government assets when borrowing is so cheap also seems very odd.

The irony is that critics of Keynesian policy have constantly argued that government deficits will lead to higher interest rates as governments compete with private borrowers for loans.

This has not been the case in recent years either here or abroad.

The reason is that the financial sectors are awash with funds because people and firms are saving more, reducing debt and are reluctant to borrow because of the economic uncertainty.

The Keynesian prescription is not a recipe for reckless government spending. Public sector projects need to be subject to rigorous cost/benefit analysis.

But record low interest rates and a depressed economy make this the ideal time for infrastructure upgrades and initiatives rather than public sector cost cutting.

This Government's approach to economic management has been to set an arbitrary budget target and then use this to justify pruning the public sector.

There is no evidence to suggest that the public sector in New Zealand is bloated or inefficient compared with other nations.

The government deficits in recent years can be attributed to specific causes, some cyclical and others extraordinary.

The costs of the Christchurch earthquake and the finance company bail-outs are extraordinary items.

The cyclical aspects of the deficits relate to the stagnant nature of our economy over the past few years.

The largest area of government spending is social welfare and particularly superannuation.

This Government is unwilling to even discuss this crucial cost issue.

Slashing costs in the public sector reeks of ideology when the Government is deliberately ignoring the superannuation elephant in the room.

The New Zealand economy has been limping along at or near recession levels since 2007.

The government was running healthy surpluses prior to this.

Current government deficits are not leading to higher interest rates and are sustainable in the medium term.

By trumpeting a meaningless economic target, the Government has precluded the use of fiscal policy as an economic tool if there is another downturn.

Balancing the books by 2014 is an arbitrary goal being used to justify an ideological agenda.

Peter Lyons teaches economics at Saint Peter's College in Epsom and has written several economics texts.

 

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