Tag Archives: Government Spending

New Zealand election: economic impact of new Government’s policies.

Since the election businesses seem to be unsure of the new direction of government policy and therefore this has led to a reduction in business confidence. This is not unusual especially with a change of political ideology and the more left leaning government which could make things – regulation, taxes etc – harder for businesses. The government plans to cancel next year’s scheduled tax cuts even though it would have added 0.4% to GDP. This could be partly offset by an increase in expenditure on Working For Families and the free tertiary education for first year students.

The new Government plans to spend more than the national government which is not unusual considering its position of the political spectrum – see graph. This will be partly funded by tax revenue and borrowing $7bn more over the next four years – this is a borrowing and spend fiscal stimulus. The impact of this spending will be influenced by the fiscal multiplier.

Fiscal Multiplier.
It refers to the change in GDP that is due to a change in government fiscal policy – taxes and spending. For example, if increased government spending of $1bn causes overall GDP to rise by $1.5bn, the multiplier effect is 1.5.

There are problems for the new Government in that:

1. Some of this extra spending will go on imports and this will mean an outflow of money from the New Zealand economy and therefore making no contribution to GDP. Remember that GDP expenditure approach = C+I+G+(X-M).

2. There is also the crowding out effect – this is when government spending fails to increase overall aggregate demand because higher government spending causes an equivalent fall in private sector spending and investment. This could include: extra spending on public healthcare leading to less spending on private healthcare; government employment creating labour shortages for firms; and government employment creating labour shortages for firms. Crowding out can also happen indirectly via fiscal stimulus increasing interest rates and consequently the exchange rate making exports less competitive and imports cheaper.

Ultimately the government debt must be repaid by the use of government revenue from taxation. A labour coalition government usually increase taxes during their time in government and this has the tendency to discourage private sector investment. The government’s borrow-and-spend plans will not necessarily make the economy any larger in the long-run but it is expected that government spending (G) will be a larger share of the economy with consumption (C) and investment (I) having a lower share – see graph below. Interesting to note the government spending as a % of GDP for Labour and National – goes up as a % of GDP when Labour are in office and goes down as a % of GDP when National are in office.

Source: Westpac Quarterly Economic Overview – November 2017

Government debt as % of GDP – New Zealand amongst the lowest in the OECD.

In 2015 New Zealand’s government debt as a % of GDP was amongst the lowest amongst the OECD countries coming in at 35.6% – NZ$86.1bn. This gives the government the ability to borrow billions of dollars to stimulate growth in the economy and fund necessary infrastructure projects. This is important when a recession phase is threatening the economy. In 2015 the median level of debt to GDP was the Netherlands with 77.5% and Australia was 67.7%. The UK and the USA had debt to GDP of 112.6% and 125.9%. The standout countries are Japan with debt of 234% of GDP and Greece at 182%. High amounts of debts are only become a concern when the debt is mainly funded from overseas and issues in non-local currency and the country is unable to alter its exchange rates. For Japan a lot of the debt has been issued internally and been bought by the Bank of Japan (central bank) but this is not the case for Greece as they have had significant help from other countries.

Govt debt as % GDP

Does aggressive or cautious fiscal stimulus lead to higher debt-to-GDP ratio?

With low interest rates globally and liquidity trap conditions a more expansionary fiscal policy has become more prevalent for most governments. However the level of severity of fiscal policy – aggressive fiscal stimulus v cautious fiscal stimulus – is important with regard to a country’s debt-to-GDP ratio as recent experience shows. A paper by Alan Auerbach and Purity Gorodnichenko of University of California Berkeley found that short bursts of expansionary fiscal stimulus doesn’t necessarily lead to higher debt-to-GDP ratios or to higher interest rates. They noted that in some instances markets revised down their worries about creditworthiness in response to large scale stimulus.

Other research by Brad De-Long University of California Berkeley and Larry Summers Harvard University seems to support this view. Their research suggests that long periods of cautious growth eat away at an economy’s productive potential as investments don’t get finished and healthy workers drop out of the labor force.

In future the level of stimulus and its time periods should be automatic and proportionate to the severity of the downturn. Examples could include:

  • Labour tax rates could be linked to unemployment figures so that pay packets jump the moment conditions deteriorate.
  • Funding to local governments could be similarly conditioned, to limit painful cutbacks by municipalities.
  • To prevent a scramble for worthwhile, shovel-ready infrastructure projects, governments could make sure to have a ready queue, so spending could easily scale up in a downturn.

Sources:

  • The Economist – The Borrowers – 9th September 2017
  • BERL: New Zealand among lowest government debts in OECD – 26th September 2017

Lower taxes don’t necessarily help those on higher incomes

Robert Frank, author of the Economic Naturalist and The Darwin Economy, wrote a piece in the New York Times on the influence money has on determining the outcome of political decisions. Wealthy donors to political causes will want to make sure that policies implemented by the authorities will mean lower taxes for them and less regulation for their businesses. As their income goes up this will only increase the monetary contribution they can give to demand greater favours.

This invariably leads to greater inequality and eventually may become so acute that even those politicians who have large funding from the corporate sector won’t succeed against opponents who seek major reforms. However, lower tax rates can have both positive and negative impacts on wealthy donors:

Positive – lower taxes mean greater disposable income and more consumption in the private sector.
Negative – budget deficits and the reduced quality and quantity of public services e.g. roads, schools, hospitals etc.

Those on higher incomes have been insulated from the declining quality of public sector goods and services by being able to pay for the equivalent in the private sector – schools, hospitals etc. But with a declining middle class it might be harder to recruit productive workers in addition to a reduction in demand for goods and services. Furthermore there are consequences of poor public goods/services that cut across the inequality of income and affect everyone:

* poor roads, bridges and general infrastructure
* electricity shortages/ blackouts (remember ENRON in California)
* effects of reduced investment in nuclear power that could be detrimental to safety

Scenario – 2 Societies with differing degrees of government and private spending

Frank asks which country would be happier? As improvements to cars are quite costly above a certain value and can be viewed as only minor, most people think that the BMW drivers are better off, not to mention safer. Furthermore the BMW drivers are less likely to feel deprived as societies don’t often mingle.

Frank concludes by saying:

So if regulation promotes a safer, cleaner environment whose benefits exceed those broadly shared costs, everyone – even the business owner – is ahead in the long run.

US debt ceiling reached on 16th May. “Extraordinary” measures not unusual.

A hat tip to colleague Errol Tongs for bringing to my attention that the US debt clock exceeded the $14.2 trillion well before the 2nd August deadline – see US debt clock on 16th May below. This did not mean an immediate end to spending or borrowing, as the Treasury took what they term “extraordinary” measures, such as moving money around, until the 2nd August when the government would default on its debt.

On the 16th May Tim Geithner (US Treasury Secretary) officially reported that the federal government has met its statutory borrowing limit of $14,294,000,000,000.

Extraordinary Measures – not unusual

The emergency steps taken by the Treasury include the following:

1. Suspension of new issuance of State and Local Government Series securities, or “SLGS,” which are generally used to finance infrastructure projects.

2. Halting reinvestments in the G-Fund (a federal-employee pension fund) and suspending new investments in the Civil Service Retirement and Disability Fund.

3. Suspension of daily reinvestment of Treasury securities held as investments in the Exchange Stabilization Fund (ESF). This allows the U.S. to intervene in the foreign exchange market to prevent any damage to U.S. exports and the economy.

However these actions are not unusual when you take into condsideration what has happened over the last 15 years. Take a look at the chart below from the Government Accountability Office report to Congress on the Debt Limit.

– SLGS have been suspended 6 times
– G-Fund investments on 5 occasions
– ESF – 4 times

US growing debt load and who is paying.

Both the Democrats and the Republicans said a debt-ceiling increase had to be accompanied by spending cuts, but they couldn’t agree on the scope of those cuts. The agreement raises the debt cap by up to $2.4 trillion in three steps. It cuts $917 billion in spending over 10 years and creates a congressional committee to close the deficit by an additional $1.5 trillion. Republicans are perturbed over the cuts to defense spending – of the initial $917 billion in spending cuts, $350 billion come from defense.

The graphs below (from the Wall Street Journal) show the growing debt load of the US Treasury and those countries that are buying up US Treasury Securities.