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Funding infrastructure through debt- another perspective

07/08/2008

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Scoopit!

Now much has been made by some of John Key’s willingness to increase government borrowings as a percentage of GDP. Indeed his opponents have labelled it Muldoonist, hilarious amongst other things.

Yet in an article titled – A time to borrow, a time to spend – Keith Rankin a political economist and economic historian, who lectures in economics at Unitec, his website here, writes in the Herald to day as follows:-

Helen Clark and Michael Cullen are describing National’s proposal to borrow in order to fund infrastructure projects “incredible”, meaning foolhardy and irresponsible. (“Key unveils plan to borrow, PM dubs it ‘hilarious”‘ – NZ Herald August 4, 2008.) All Clark and Cullen are doing is showing how out of touch they are with economic reality.

Adam’s emphasis.

A little later, Rankin writes:-

Governments need to spend more and borrow more precisely when the private sector is spending less and borrowing less. This was the most important lesson of the Great Depression in the 1930s.

It is fair to say that not all historians would agree, but governments applying stimulus or Keynesian policies may be said to have done better, than those which cut programmes.

He goes on to say that Ruth Richardson in effect prolonged and/or extended the 1987-1992 recession. Then he writes, and Adam enjoyed this comment which no doubt caused a great gnashing of the molars in the Beehive:-

Helen Clark and Michael Cullen are the true fiscal heirs of Ruth Richardson. Their cure for our present crisis is another dose of Ruthenasia. These are the pro-cyclical policies that give us prolonged recessions and unsustainable expansions.

Again Adam’s emphasis.

He concludes his article with this comment:-

One could quite correctly say that it would be quite irresponsible of the Government in 2008/09, whichever parties it is comprised of, to not borrow on financial markets to fund the infrastructure, healthcare and education investments that the New Zealand economy needs for its long-term growth.

Adam thought the piece was worthy of consideration, especially given the negative comments made by Labour about National’s plans. He would voice some concern on the question of the healthcare and education investments as to the nature of such investments. He thinks such investments should meet the test discussed in another post mentioned below.

It was interesting to read this item today, as a short time previously Adam had been to a Wellington Regional Chamber of Commerce breakfast where the speaker was John Key. More on this in another post.

Broadly Adam thinks that controlled borrowing is not wrong in this instance.

What does he mean by controlled, well an interesting recent post –Debt for infrastructure – and the issue is? at The visible hand in economics – postulated two necessary conditions:-

borrowing allows us to fund expenditure that provides economic growth, without having to introduce taxes that limit this growth (although note that future taxes would have to be higher to pay for the borrowing – so we only have a net benefit if growth stemming from the capital investment exceeds the cost of the eventual tax increase!).

However, there are a couple of issue that I hope any government will remember before going into debt to build up infrastructure.

  1. Only the “right sort” of investment will be beneficial. Fundamentally, the rate of return must be high enough to justify the debt AND the government must be aware of how their investment activity will crowd out private investment.
  2. Ultimately the tax system still has to be balanced over the economic cycle.

These make sense to Adam.

No doubt the debate will continue.

He thinks that Key is very much a pragmatist, whilst Clark and Cullen are far more ideological. This may cause their responses at this time to be seen much more through the prism of their political belief system.

We live in interesting times.

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