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Keith Rankin: The Business of Government

Keith Rankin's Thursday Column
The Business of Government

8 June 2000

Business interests in New Zealand have been lobbying hard to make the Labour-led government more "business friendly". The Parliamentary Labour Party seems to be acquiescing to this pressure.

The impressions being given are that business interests believe that it is the role of government to alleviate business costs in the name of international competitiveness, and that many people in government have bought that argument.

That's not the role of government. It is the role of business to minimise business costs. It is the role of government to make sure that businesses pay the costs they incur. Government is an enforcer, not a fairy-godmother to business.

Stage One students of economics learn that, in an economy in equilibrium, businesses maximise their profits at ZERO. Further, they learn that businesses which are allowed to pass off some of their costs to parties other than themselves or their customers create an inefficient economy. Costs dumped onto third parties are known as external costs. The remedy is for the government to internalise business costs; ie to levy such businesses as a means of making them pay for costs they have passed onto the public at large. (Employer funded parental leave provision is an example of an attempt by Labour's coalition partner to internalise business costs that are at present borne by parents, or by people who would like to be parents but cannot afford to make that choice.)

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When economists talk of zero profits, they mean something different from what accountants mean. Both agree that profits are a firm's surplus; revenue less costs. They disagree about what constitutes costs. Both economists and accountants impute a market salary payable to a working proprietor or a managing director as a business cost rather than a part of the surplus. Likewise depreciation. Economists however also treat dividends, imputed at the prevailing market rate, as business costs. Accountants, on the other hand, treat such dividends as profit. Economic profits are net of owners' salaries, depreciation, and market returns on capital invested.

When interest rates (or any other costs) go up, market dividends are forced up. So, to economists if not to accountants, business costs rise, supply falls and prices go up. (Our government has been conned into believing that rising interest rates are counter-inflationary, in contravention of microeconomic orthodoxy.)

Business interests - the owners of capital - want to be able to make their employees and the public bear some of their costs so that they can make above-zero profits. The public however expects to see the government resist pressures by business to manipulate the economy. When businesses act to distort the national economy to their advantage, the process is called "rent-seeking" by those economists who haven't been bought by business or by governments that have succumbed to business.

When rent-seeking is successful, the economic cake becomes smaller than it would otherwise be, but the rent-seekers get more. That is, successful rent-seekers get absolutely more 'cake' and not just a bigger share of a smaller cake.

The system through which business interests successfully lobby government at the expense of the public interest and other interests (eg labour) was called by Adam Smith "the Commercial or Mercantile System". Indeed, Smith's famous book, that launched economics as a philosophical discipline (The Wealth of Nations), was an extended and passionate argument against the corruption and inefficiency inherent in the Commercial System he so despised. Business lobbyists today, many of whom have the gall to claim Smith as one of their own, are no different to business lobbyists in Smith's time. Then as now, they want the referee to favour them.

Economic theory is simple and unequivocal on these matters. The problem that muddies the waters is that governments are not only expected to act as referees; as cost internalisers. Governments are also expected to advocate for national economic interests in the international economy. Hence governments are under pressure to connive with national business interests; to facilitate cost externalisation by business in the name of each nation's international competitiveness.

This becomes the "race to the bottom" (otherwise known as the 'prisoners dilemma') that the Seattle protestors rightly condemned last year. Governments in each country are encouraged to burden their populations and environments with the costs that their businesses say they cannot afford if they are to compete with businesses in other countries.

The problem can be solved either by a cost-internalising international authority (which the World Trade Organisation is not), by the spontaneous cooperation of all of the world's trading peoples (which would happen if we had global full employment), or by the introduction of some forms of protection.

While waiting for the former two options (a bit like 'Waiting for Godot'), import protection is a viable second best option. If New Zealand's government acts to internalise domestic business costs, and other governments do not do so, then New Zealand as a nation bears the costs passed on by those other governments which grant cost-concessions to the businesses that employ their workforces. If we grant some offsetting protection to our economy, we would be granting our businesses the equivalent of an international level playing field, while making them fully pay their domestic costs. (That is the kind of social contract most developed countries signed up to in the middle third of the 20th century.)

That's how we all got out of the Great Depression in the 1930s. The world economy in the 1920s was a classic race to the bottom. There was no general worldwide recovery until most countries adopted protective measures so that they could reverse that race by inducing recoveries in their domestic economies.

It is disquieting that Labour is revealing itself to be an easy prey to the web of the modern commercial system. Finance Minister Michael Cullen needs to do two things: read up on the basic theory of cost externalisation as a form of market failure; and read about how governments in the late 1920s tried to spite other nations. Businesses were subsidised, public spending was retrenched, wages were held down.

It is the business of businesses to minimise their costs. It is the business of governments to make sure that businesses pay their costs. The two roles are quite distinct.

© 2000 Keith Rankin

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