A dummy’s guide to the role of government
Fri 22 Jun 2012 by Benje Patterson in Government

I am irked by society’s tendency to mistakenly identify unemployment as a variable which the Government directly controls. Unfortunately, this idiotic misattribution is so endemic that finding a solution is beyond me.

The Government plays an important role in setting the institutional framework under which firms operate, but it is employers who bear the risk. As a result, hiring and firing decisions, and in turn, the level of unemployment in the economy, ultimately rest with the private sector.

New Zealand’s currently elevated level of unemployment is the by-product of a prolonged trough in the economic cycle – which has left firms reluctant to hire. This trough was sparked by drought and tighter credit conditions, while it has lingered due to a combination of economic disarray abroad, a private sector keen on paying down debt, and the destruction of capital following natural disasters.

Although none of these factors are directly controlled by the Government, I am sick of the opposition and some members of the journalistic fraternity blaming the Government for New Zealand’s current level of joblessness. And, I am fed up with the Government helping to propagate the myth that they determine unemployment by every so often proudly announcing how many zillion jobs they will create.

Frankly, I can’t bear listening to people talk as if the economy is a puppet on a string any longer. To help dispel this myth, I am going to give you a stylised account of the role of Government.

In broad terms, there are two main economic objectives of Government: to provide a sound institutional framework and, if necessary, to then correct for any unwanted market outcomes. The Government could attempt to target additional objectives, but lessons learnt in the 1970s showed us that these are the only two objectives the Government can sustainable achieve. I will discuss each of these objectives in turn.

Ensuring the soundness of institutions is the most fundamental economic role of Government, as it is these institutions that regulate the framework within which people interact to do business.

At their most basic level, institutions must enforce property rights so that individuals can conduct productive activities with the knowledge that their personal safety and rights to any investment returns will be protected. In addition to regulating these economic interactions, institutions also have an important role in providing goods which benefit broader society, but would be provided in inadequate quantities by the private sector. Such goods include: public infrastructure, national security, education, and basic public health.

To fund these institutions, the Government must collect taxes. This taxation in itself is merely a funding mechanism, but as you will soon see it can also have other goals.

With these basic roles in place, people are free to engage in mutually beneficial economic exchange, which from a theoretical perspective should maximise the aggregate level of activity in the economy.

However, our society’s goal is not only to maximise economic activity, it is also to ensure that we correct for perceived inequalities. The Government addresses the issue of inequality via the way it designs the taxation system and who it directs spending towards. All political parties in New Zealand have policies which deal with inequality – it is just that the weight placed on this issue and methods of solving it differ between parties.

The underlying design of New Zealand’s income taxation system appeals to equality ideals. Our taxation system is progressive, meaning that those on larger incomes, with a greater ability to pay, are taxed at a higher marginal tax rate than those on lower incomes. Money is then redistributed further towards lower income earners and the vulnerable – such as by way of social welfare benefits, superannuation, and additional healthcare subsidies.

We also expect our Government to ease the pain of unexpected shocks to the economy in the short run. For example, benefits are paid to those out of work and the Government can borrow to bring forward investment plans in the hope that the temporary boost to economic demand gives firms the confidence to increase hiring. However, there are limits to this stimulus. The Government can only attempt to fill the void in domestic demand for a limited time because, although the government enjoys better credit lines than individuals, they are still limited by global perspectives on New Zealand’s credit worthiness.

So there you have it in a nut shell – contrary to popular belief, the Government is not a puppeteer who can perfectly steer our economy. The Government’s key roles are providing us with well-functioning institutions and some kind of system which eases inequality. It is wrong to believe that the Government can do much more than this. Instead of blaming the Government for unemployment, we should focus on burning issues that it actually can control – such as the sustainability of superannuation.

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