Listener 9 June 2001

Keywords History of Ideas, Methodology & Philosophy; Macroeconomics & Money

Every country has its own deeply held and specific cultures, arising from the particularities of its history and geography. Economics is prone to overlook this proposition because it aims to provide a ‘scientific’ theory of economic behaviour which is culture independent. A nice example of the resulting difficulties will be found in US economist Todd Buchholz’s New Ideas from Dead Economists. One chapter is devoted to ‘The Public Choice School: Politics as Business’, centred on the work of Nobel economic prize-winner James Buchanan, who like Buchholz lives in the Washington conurbation near the centre of the US government. The theory was very influential in New Zealand’s public sector reforms from the late 1980s.

Buchholz considers its relationship with Keynes’ policy prescriptions, puzzling why such a great mind overlooked the ‘obvious’ insights on which public choice theory is based. The reader soon becomes aware that Keynes is assuming a quite different system of public administration with a different underlying culture. Washington is not London. The theory presented by Buchanan and his followers is culture specific not universal. Yet our public sector reforms were based on US assumptions, ignoring our British public service cultural inheritance. If we persist with the US approach, we will drive out the notion of ‘public service’ out of our public service, with a continuing loss of efficiency and effectiveness.

But before then, we may have wrecked the economy by slavish imitation of a different economy. Again it is the US one, whose particularity is well illustrated by a famous, albeit joking, motion proposed at an US economic conference in the 1950s: ‘since monetary policy is slow to react on the economy while fiscal policy is quick to react, and since the Fed (the US Reserve Bank) can act quickly but Congress (parliament) acts slowly, then the Fed should be put in charge of fiscal policy and Congress in charge of monetary policy.

It is, of course, the other way around. Every month or so the Fed, led by Alan Greenspan, changes interest rates if it is judged necessary. Meanwhile President Bush struggles with Congress to change tax levels. The Governor of our Reserve Bank can act as quickly as Greenspan (although he has less room to manouevre because we are such a small economy). But our parliament can change tax rates quickly if it wants. (For instance, the incoming Labour-Alliance Government raised income taxes within months of taking office.)

As the US slides into recession (one hopes it wont be something worse) their policy debate is how to use interest rates to slow the decline. That is because they cannot quickly change their tax and spending levels, so their use is irrelevant to the current crisis. This biases the economics debate away from fiscal policy. If we listen only to the US debate, without the realisation of its culture specificity, we will not use our fiscal options effectively – options which the US does not have. (If while driving, the brake cable on your foot-pedal snaps, use the handbrake and gears. But dont tell everyone with an effective foot-brake to ignore it.)

To put this in a context with may be only months away. This column has regularly advocated fiscal conservatism. Too expansionary government expenditure puts pressure on the balance of payments which kills long run economic growth, and it adds to the inflationary pressures. Moreover the column readily acknowledges that if real interest rates are high, then a persistent government deficit is unsustainable (because debt servicing will explode). Even so, there is no law of economics which says the government should always run a budget surplus. Sometimes it may be necessary to run a deficit for a few years, especially if the world recession is prolonged. (Glory be, that our low government debt ratio makes this strategy much easier than, say, Japan.) We need to discuss this possibility now so as to have answers to such questions as: when to run a deficit? What is a prudently sustainable level? How much through lower taxes? How much through higher spending? What should any higher spending be on? (For instance what priority should be given to physical and social infrastructure?) We are not going to get answers from US economists (although some of their work provides insights). We are going to have to think for ourselves.

Suppose New Zealand had a gun problem. We could invite US experts to tell us what to do. They would come from an environment where their Congress – and Constitution – has ruled out effective gun control laws. The expert advice would be biased towards better architecture which would make it more difficult to shoot people, training people what to do in the presence of gun toters, teaching peaceful folk how to use a gun in emergencies …

But we dont have the US Constitution and we have an effective parliamentary system, so we can implement effective statutes, run a proper registration system, enforced by an efficient police force, without having to introduce a myriad of ineffective second and third best policies. Why not do the same for economic management?