Key and Cullen equally mistaken on government spending

The low level of NZ's wages compared to the rest of the world became an issue at the last election, and for many of us -- inclusing especially those New Zealanders currently considering packing up and heading for greener pastures -- it still remains one. At the same time, both the Blue Team and the Red Team were found saying rather silly things about government deficits and government spending last election and since.

Unsurprisingly, the two things are linked. Goverment spending and government deficits both reduce investment and reduce real wages. Of these two, the greatest imposition is government deficits.

On the latter point, Team Red was and still is on the side of spending. Granting tax cuts, said the Red Team, would simply see people "fritter away" the hard-won Cullen Surplus, whereas retaining the loot in Government hands would see it 'invested' wisely. Indeed, As Colin James noted after this year's Budget, "The government wants you to think of [the 2006] Budget as the 'investment Budget.' That's right: spending is investment." According to this view, it is only government spending that constitutes investment -- the rest of us will presumably just use our spare cash to roll up and snort coke off glass-topped tables, while those troublesome journalists insisting on tax cuts for themselves will be using it to wallpaper their smoking rooms.

Meanwhile, Team Blue were on the side of deficits. They were and have continued to insist that tax cuts are absolutely necessary, but unlike libertarians and Alan Greenspan they failed to realise that tax cuts require concomitant spending cuts. Spending cuts are still as unpopular with the Nats as pork at a Muslim wedding, which was the reason Team Blue's John Key was found to be planning a new programme of increased government borrowing to help pay for tax cuts -- excuse me: to help invest in infrastucture. At this legerdemain of course, the ghost of Sir Robert Muldoon was seen to nod approvingly.

Both teams then view government spending as 'investment.' Key compounds the error by viewing government deficits as an investment. Both views are are mistaken. Governments do not 'invest' money, they consume it. Real investment comes from real savings, private savings -- and deficits consume those savings with no real productive return. George Reisman explains:

Government budget deficits are financed partly by the creation of new and additional money. But for the rest, they are financed by selling government securities to the citizens, who pay for the securities with money that already exists and which is part of their savings. If the government had not been running at a deficit and had not needed to sell these securities, the citizens would have used most of the savings with which they buy the government securities to buy corporate securities and in other ways to make their funds available to business firms.

Those savings, in the hands of business firms would have been used to purchase capital goods and to pay wages. These wages, however, never come into existence if the savings out of which they would have been paid are diverted to the government to finance its deficit. Thus, wage payments in the economic system are smaller because of government deficits.

Yes, it is true that the government itself pays wages to some extent. But it is unlikely to do so to the same extent as do business firms. And to whatever extent the additional wage payments it makes out of the proceeds of its securities sales are less than the wage payments that business firms cannot make because of the diversion of part of what would have been their capital funds to the government, total wage payments in the economic system are reduced.

And that's not all. Because of the large welfare-state component of government spending, most of this borrowing is not used on production, but on consumption.

A part of the output of the economic system that would have gone into the production of future output is instead diverted to the government’s consumption and to the consumption of those to whom the government gives money.

The effect of this cannot fail to be that the productivity of labor in the economic system will be less than it otherwise would have been and that real wages in the future will consequently suffer from production being less than it otherwise would have been and thus from prices being higher than they otherwise would have been.

By taking the private capital that is needed to produce future capital and future output, both deficits and high government spending reduce capital investment, making labour less productive and the country produce less than would have been produced otherwise. The result is (amongst other theings) a loss in real wages, which continues to make the country the low-wage, fifth-of-an-acre pavlova paradise it has become.

LINKS: How Government Budget Deficits Reduce Wages and Raise Profits - George Reisman

RELATED: Economics, Politics-NZ, Politics-National