Economics New and Old

Because resources are limited, we can't have everything we want and therefore we have to make choices about how we use what we have.

---------------------------------

Speech notes for Christ's College Guest Speaker series, Christ's College, Rolleston Avenue, Christchurch

Introduction
As an economic historian I have a special interest in this area, 'Economics New and Old'.
I specialise in looking at the reason economies developed the way they did.
And that is valuable in approaching the way we manage the economy today.

Fundamentals of economics
Economics is the science of allocating scarce resources
It's a given that we have a limited number of resources: natural resources such as land, water and minerals, a limited number of hours in the day and limited amount of capital to develop the things we have.
Because resources are limited, we can't have everything we want and therefore we have to make choices about how we use what we have.

Old economics - a short history of western economics
If we go back far enough, decisions about how to allocate resources were made by might. The person with the greatest army got the most gold.
As the world developed mercantilists believed capital was represented by the sum of valuable commodities like gold and silver. The total of capital was fixed and governments tried to protect against imports and encourage exports
In 1776 Adam Smith published the Wealth of Nations, changing the orthodox view of economics.
He argued markets where people could trade, allocate capital efficiently and allow people to specialise.
Specialisation increased productivity. For example, one worker making pins could produce about one a day. But if ten people divided up the eighteen steps in making a pin they could produce nearly fifty thousand a day.
Smith's ideas were picked up by economists like David Ricardo - who used a similar principle to show that nations could specialise to mutual advantage if they trade.
Classical economics emphasised the efficiency of the market but at the same time real people noticed the market had other consequences
Working people who sold only their labour didn't share in the great riches the market helped create. As Europe industrialised they lived in poverty.
A century ago, then socialist parties began to be elected to governments that saw government as a way to redress the inequalities the market produced.
We saw the rise of the welfare state, that provided for care and protection, in New Zealand 'from the cradle to the grave', in the words of the first Labour government.
The state also took an active role in the economy - it owned many of our largest businesses and heavily regulated others.
This was the model for much of the twentieth century.
Our economy was narrowly based on the export of unprocessed meat and wool, mainly to Britain.
The market was secure, the returns were high and for a while we enjoyed one of the highest living standards in the world
But because our market was narrow it was also vulnerable. When Britain joined the European community we had to find new markets and sell new products
Unfortunately, our economy was poorly equipped to adapt. Producers didn't get very good price signals, because the government regulated so much of it.
In the eighties the fourth Labour government changed all that and introduced far more market signals into the economy. Subsequently some parts of the welfare state were dismantled.

What old economics taught us
The old ways of doing economics have taught us fundamentally that both markets and governments have limits. Neither will deliver utopian outcomes.
The consequences affect who gets what, and they affect our productivity (the amount we can produce).
In a very complex economy it is not always possible to know what the effects will be!
But we should also recognise that policy consequences will shape our policy direction.
For example, if the fruits of economic growth are not shared equitably, then there will be a demand for change.
Likewise, policy that impoverishes everyone equally is going to be short-lived in a democracy. (That's one reason poverty and dictatorships go hand in hand - when everyone is happy governments welcome elections).
But there is nothing inevitable about policies that improve economic growth or about the fruits of growth being shared equitably.
'New' economics - that is, the way we approach the economy today, is really the way we go about trying to create a strong economy and fair society.

Fairness
We are all born equal and we should all have an equal chance to participate in society and life in our country.
I've been lucky, both in the genetic lottery and in my parents encouraging me and getting me a decent education. Getting a scholarship to Christ's College was quite a bonus!
I took advantage of that luck, but fairness demands that everyone has the opportunity to participate in society, regardless of the hand they are dealt.
The founding fathers of America were on the right track with "the pursuit of happiness". Fairness means everyone being able to pursue happiness how they wish.
Research about happiness shows that the things that actually matter to people are time with family and friends, a sense of contribution through work, being part of the community, the ability to trust each other, and having good health, just as much as financial situation.
Old economics told us these things happen by themselves. But in fact the very strong natural tendency in modern societies is for only a very modest level of trickle down. Inequalities tend to increase and concentrate on the individual rather than the broader social concerns. So we need to intervene to make outcomes fairer.
So - old economics: Ignore fairness and concentrate on maximising wealth to the economy overall.
New economics - Fairness does not happen by itself. We need to think about the things that actually matter to people. We need to ensure that a rising tide lifts all boats, and not merely the 'average' of the economy.

Limits of power
Governments do not have limitless power to influence fairness and happiness in the economy
We need to adopt smart interventions to change outcomes
Our approach to social welfare is one example
The old way was to attempt to provide universal family support for example, to ensure every family had the means to look after the kids. That required taxing everyone at a high level and then returning the cash through the benefit system. High taxes in turn create avoidance and disincentives to high performance.
Now, we target assistance more carefully towards those who need it most. So, for example, a married couple with two kids with a single income earning the average wage pays tax of just 2.6 per cent, once we count Family Support.
A single earner on the average wage with no kids pays 20.9 per cent tax by comparison - (still one of the lowest rates in the developed world).

Working with the real world
The old way the government tried to influence behaviour was by regulation.
For example, in 1979 when world oil prices leapt, the government of the day made it compulsory for everyone to choose a day when they wouldn't use their car.
Today we recognise that the rise in the price of fuel should have that effect. People will choose how much to use their car on the basis of the cost. If you spend money on petrol, you can't spend it on something else.
There is a very popular economics book around now called 'Freakonomics' It's a book about how people respond to incentives.
But there are limits to how people respond. For example, when we designed KiwiSaver, the theory said there is no economic difference between opt-in and opt-out.
In fact we know that if we make a scheme 'opt-out', a lot of people will just do nothing. Momentum will do a significant amount of work. So with KiwiSaver, we made the scheme 'opt-out' for new employees.
The old way of doing economics was to regulate to make people do things whether they want to or not.
The new way is to use smart tools that reflect people's behaviour in the real world, whether incentives or otherwise.

Globalisation
The government's ability to influence outcomes is also constrained by increasing globalisation.
Capital can be quickly moved around the world.
Financial instruments are massively more complex than they were even ten years ago.

Globalisation means global production chains are changing.
Twenty years ago, it was common for a sophisticated manufactured product to be designed, manufactured and assembled in the same plant. Today, consider a product like an iPod. Designers in California conceive the product. Engineers in the UK, India and Korea design the software on the chip. The chip might be manufactured in Taiwan and Korea and then shipped to China to be assembled into the rest of the device. It is then marketed and sold all over the world.
This process is accelerating. It has both risks and opportunities for New Zealand.

It means we can no longer expect to have all the processes of creating sophisticated products located here in New Zealand. We have seen businesses like Icebreaker relocate their manufacturing to China, while keeping high value activities such as design and marketing here.

It also opens up new niches for New Zealand. This may actually suit our small manufacturers. We don't have a large car manufacturer - designing, fabricating, assembling and exporting cars. But we do have in the Hutt Valley near Wellington a firm that makes a very specific 'race style' car seat for high performance cars that are exported to Detroit.

The old economics was about trying to do as much as we could for ourselves, here.
The new economics emphasises the opportunities of the global economy. That is, we are trying to be better, not just cheaper.

Knowledge
Competing in the global economy requires skills and knowledge so that we can innovate. Innovation is the only way to increase productivity, and therefore economic growth.
If we look back a fifty years ago, New Zealand has exactly the same amount of natural resources as we did then.

Our population has increased substantially - it's doubled in the last fifty years
Yet we are many times wealthier, even on a per capita basis.
Where did all the extra wealth come from?
What has changed is that we have added knowledge to the resources
Knowledge has enabled us to increase our productivity - that is, to extract more returns from our inputs of labour and capital.

The old economic approach was to assume innovation and knowledge happen on their own. But we found that didn't happen. Our levels of research and development in the private sector are some of the lowest in the developed world.
The new approach is for the government to work in a smart partnership with the private sector. For example the government invests heavily in science through Crown Research Institutes and universities. It also helps fund industry research through funds like Tech NZ and the Foundation for Research, Science and Technology.
The government is also working to improve our workplace skills through our tertiary reforms and Modern Apprentices

Adapting to new challenges
It's not only globalisation that is changing the world economy.
There are also emerging issues, such as climate change.

Economists have long talked about 'externalities' from the market. When an oil company sells you petrol and you put it in your care and motor away, you and the oil company are both happy with the transaction. But not represented in the transaction are the people who breathe the fumes and the environment being wrecked by the carbon produced.

Climate change is a critical issue for New Zealand in two ways.
First, we are more dependent on agriculture than any developed country. Climate change produces more adverse weather events that threaten our agricultural production.

Second, rising concern about climate change is producing a regulatory reaction. In Europe, there is talk about levying taxes on 'food miles' - the distance goods travel to market. Since we are the most remote developed country in the world, we are more threatened by this than anyone.

'Food miles' are spurious. The real issue is the total amount of carbon used in production and we stack up very well on that score.

But the issue also highlights that climate change and concerns about sustainable production are not only a threat, they are also an opportunity.
It means there is rising demand for sustainably produced products.
Therefore the government has a vision to make New Zealand the first sustainable nation in the world.

The old economics largely ignored externalities. The new economics recognises we have these risks ahead and we adapt to them in a way that turns the issue into an opportunity.

What doesn't change between old and new
For all the talk about new and old economics, there are some fundamental values that are enduring. These are the values behind our economics, regardless of the policy tools we use.
We try to maximise fairness and people's ability to participate in their society and maximise their potential.
We try to maximise people's freedom to enjoy the opportunities available.
What ever tools we use we try to focus on preparing for the future and the risks we know are ahead as well a the goals we want to achieve.
The real long-term challenge is to keep adapting smart policies. It is a continual process.
It's not enough just to put a set of policies in place and pronounce the job finished.
What will always be enduring is that we should all be able to enjoy the benefits of a higher standard of living. That means we also need to position our economy for the future, so that the next generation will be able to enjoy that higher standard of living too.
There will never be a time when we can pronounce the job 'finished'. But we can always learn from what we have done before.

Ends

© Scoop Media