Who would manage the economy better?

nospam@example.com (Dr Peach) — Fri, 09 Nov 2007 16:47:00 +1100

Your vote is your vote. But in response to some curiosity from both journalists and peach clients, I’ve decided to try to work through some issues in my own mind about which party might manage the economy better. At the moment the recent rise in interest rates has been the lightning rod issue of the economic debate. But economic management goes deeper. And better economic management is likely to give us better, more prosperous lives, whether that’s as a result of lower interest rates, or better services or lower taxes.

So here goes.

Howard should never have promised to “keep interest rates at record lows”. He said he didn’t – it only happened in his party’s ads. That’s a pretty shoddy excuse in any case – as if he doesn’t have control of and responsibility for the truth of his party’s ads. But it’s now been revealed to be untrue in any event. He actually used words like that on a radio program a few days before the 2004 election.

Still that’s what politicians do – on both sides of the political fence. They make promises that take risks with what can actually be delivered – as Paul Keating also did promising his infamous L.A.W. tax cuts.

A more interesting question is ‘would things be worse or better if the ALP had been in power?’. Or running the question forward ‘would an ALP Government manage the economy better than the Coalition in the future?’

I can think of one reason why they’d be worse and three reasons why they’d be better.

Because interest rates are used as the accelerator and brakes of the macro-economy, an economy with more spare capacity, an economy with more productive power is one with lower costs and so one with lower inflation and less need to tighten rates. The economy has been growing strongly and steadily now for 16 years.

That’s taken up a lot of slack in the economy – taking us quite close to full employment, and certainly to the brink of serious skill shortages. That means that as Rory Robertson of Macquarie Bank has said, “Fiscal policy and monetary policy look set to continue working in opposite directions”. Or in the words of the Secretary to the Treasury Ken Henry, policies that won’t grow the productive base of the economy will simply lead to money being redistributed - tax cuts that don’t generate productivity will simply be taken away by the Reserve Bank as higher interest rates to constrain the inflation that they’d otherwise produce.

I think the financial journalist Alan Kohler summarises the situation quite well in a recent column.

The reason I think Kevin Rudd and the ALP will be good for investors is not part of the election campaign, and probably won’t be: they are likely to be better managers of prosperity than John Howard.

Howard has squandered the booming budget surpluses of recent years on re-election rather than the national infrastructure. There have been huge transfers to middle class welfare designed to attract votes and belated, miserly, spending on national infrastructure.

Addressing the emerging problems, in skills and in infrastructure has been a more substantial part of the ALP agenda and rather an afterthought for the coalition.

That’s the short reason why I can think of more reasons the ALP would run the economy better than the current government. But there is one counter argument.

One reason why inflation and therefore interest rates would be worse under the ALP

Workchoices has been one of Labor’s ‘boo’ words in the election. I'm afraid I'm unmoved by all this unfairness it’s supposed to have unleashed. We have one of the highest minimum wages in the western world. That’s been maintained by the legislation. Workchoices has made it easier for firms to drive a harder bargain with workers on the terms of their employment, but not driven minimum wages lower – a reasonable compromise it seems to me when we’re still trying to reduce unemployment. Once we’re at full employment workers can decide what terms they’ll accept and if a firm won’t give it to them they can work for a firm that will. We’re already at that situation in many parts of Australia except for pretty low skilled workers.

That having been said, and for all the drama about how ‘radical’ Workchoices is and how it’s going in the dustbin, as right leaning economist Mark Wooden writes, the ALP’s IR policy is now fairly similar to the Liberals. Their ties to the union movement will nevertheless ensure that their policy will allow bosses somewhat less freedom than Workchoices and there are some worrying and unelaborated references to ‘multi-employer’ agreements that could enable ‘pattern bargaining’ in some industries which would be a large backward step.

Several reasons why the economy and rates would be worse under the Coalition

Firstly as Alan Kohler says above, the ALP would have spent more of the past revenue windfall on infrastructure which would be keeping the costs of living and working down.

Secondly that also goes for even more important infrastructure – skills and education. The ALP would have invested more in education and training which would have made our workforce more job ready as new jobs were created by the mining boom and the associated economic good times.

I have two more speculative thoughts – speculative because they’re based on what I think the ALP would have done in power, (based on how they acted last time) rather than on any promises they made in Opposition.

The media game these days gives such advantages to the incumbent government that virtually all successful Oppositions have been small targets. Howard became PM by being a small target before the 1996 election – and a conviction politician afterwards (though mostly on cultural rather than economic matters). Being ahead in the polls, like Howard was in 1996, Rudd is following the same ‘small target’ formula.

Government revenues have exceeded expectations by tens of billions of dollars a year for several years now, largely as a result of the mining boom. That’s led economists to worry about simply passing those dividends back to people as tax cuts. With an already overstretched economy they feed directly into inflation. Also permanent tax cuts based on what could be temporary revenue can be imprudent.

My guess is that an ALP Government would have cut taxes too. But it would have paid more attention to its advisors’ concerns. So in addition to direct tax cuts, it might have cut taxes by making payments directly into people’s superannuation accounts – which constraining its inflationary effect by locking the money away from immediate consumption.

And it would have continued to build compulsory super which would continue to take the pressure of interest rates. One of the reasons the New Zealanders have interest rates a percent and a half higher than ours is their lack of compulsory superannuation.

So that’s my professional opinion of who will run the economy better in the future.

And if you think differently, perhaps you’re right. And whoever’s right, we live in a democracy so whoever you vote for, make sure you exercise your hard won democratic right to keep politicians you like (or dislike least!) in Canberra!

Postscript: The bulk of the words above were written in the forth week of the campaign. But in the fifth week (thank God there are only a few more days to go) a substantial additional difference opened up between the parties – reflecting the last of my comments about the ALP. I had previously expected them to squeak in with less spending than their opponents, but only by a tiny margin. The difference now looks like being around $10 billion or one percent of annual GDP can be expected to have a genuine effect in keeping interest rates lower.

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Who would manage the economy better?

One reason why inflation and therefore interest rates would be worse under the ALP

Several reasons why the economy and rates would be worse under the Coalition