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Government is Now the Solution

Published : 23 December 2015 Author : Harry Notaras Comments :

For many years since it was put by Ronald Reagan in his First Inaugural Address there has often been a predisposition to see government action as problematic rather than remedial. To the extent that this has been the case it has been more to do with control of Government rather than Government activity per se. In Australia as elsewhere in the world there has always been a large role for government as seen by the statistic that approximately a quarter of GDP is generated by Government activity. Nevertheless, there is a constant overriding tendency to limit the degree of government activity.

 

This is about to change. Or at least, it should.

The Policy Problem

Government is now the solution to our problem

We have stumbled into an economic cycle that our current policy prescriptions are having difficulty in nudging back to a full capacity utilisation mode as has typically been the case for the post-war period. The need to adjust policy prescriptions is clearly at hand. This has occurred at least once before in this long period of prosperity that has characterised the post-war. It occurred at a time when a constant reliance on Keynesian style fiscal policy eventually led us and much of the world to the period of stagflation during the 70’s. A couple of oil shocks also helped in that process.

 

The similarity of that time with the present is that one arm of economic policy was forced to do the heavy lifting. Monetary policy was largely off limits as a result of monetary controls that were in place for largely ideological reasons. These included interest rate controls, exchange rate controls and a severe moral suasion aimed at regulating banking activities. Can anyone recall dichotomy between savings banks and trading banks?

 

Another similarity is that we have arrived at a time where the limit to using a single arm of policy has been reached.

We are unable to conjure up the negative real interest rate necessary to spur economic activity by increasing demand.

The problem is no longer stagflation but deflation. Whereas stagflation can be characterised by the crowding out of private activity by less productive government activity as a result of too much government expenditure and is essentially a supply side problem. Deflation is characterised by the absolute lack of crowding out and the existence of a demand vacuum.

 

To switch to a policy of increased government expenditure in order to take up the economic slack would invite howls of protest given the stance taken by governments of all persuasions over the last few decades. However, there is an elegant solution to this.

The Policy Solution

It is time to reconsider the idea of the Balanced Budget Multiplier as a mechanism to pull the economy out of the funk into which it is slowly sinking. This is a simple idea taught in undergraduate economic courses that shows that if government expenditure and government revenue is increased in equal measure, the resulting increase in economic activity is greater than that increase in government activity. The benefit of this is that there should be no spiralling out of control of government debt.

 

For this to work successfully a couple of refinements would need to be considered.

 

First, the additional source of government revenue should come from a wealth based tax where possible. This makes very good sense because one of the main reasons that taxes are levied so heavily on income or consumption has to do with liquidity. It is easy to levy tax at those points because that is the point at which cash is transacted and levying a tax on that transaction is relatively easy. This easy approach has run into disincentive effects. This problem can be overcome with the reimposition of estate taxes, some effective taxation of superannuation to make it more equitable, and finally by including the family home, or at least part of it, into the asset testing for the pension. The last point may necessitate the provision of reverse mortgage facilities by government until the private sector stepped in with realistically charged products. All of these proposals have made into the media in the last year.

 

The imposition of these taxes would have a powerful impact on the investment behaviour of households. The so called property ladder is the finite obsession of those wanting to create wealth at a retail level with the consequence that so many are now priced out of the housing market. Altering the taxation arrangements of those assets would allow attention to be diverted to infinite income producing activity.

 

Secondly, expenditure should be predominantly aimed at increasing the productivity of our economy. This would include the construction of needed infrastructure. Infrastructure Australia is an Independent Statutory Authority with a mandate to prioritise and progress nationally significant infrastructure. It would probably benefit from a closer association with the Department of Treasury and could use the economic modelling capability of the Treasury to help it in its work.

 

With interest rates so low the world awash with capital and so much under-utilised capacity a better environment for this type of expenditure is difficult to conceive.

The Policy Challenge

What is needed now is the economic debate which is threatening to take place but is still in a very embryonic stage so that these reforms can take place. In order to take the debate forward a dose of courage is needed. Saying more should be spent on this or that particular spending priority is a staple of politicians. What is now necessary is to go beyond the obvious arguments that can be put for particular expenditure proposals. The task is to rise to the challenge of unlocking the enormous amount of wealth that has been locked up in private hands and use it to create productive assets that will increase the income producing capacity of this country and pull us out of our current funk.

 

Government is now the solution to our problem.

 

 

Harry Notaras

Harry Notaras ABS Business Sales

Business Broker - ABS Business Sales

Phone: 07 3368 4010

Mobile: 0434 344 282