Analysis by Keith Rankin.
Changing Income-Relaxation Balance as a sequence of Pie Charts
On June 30 (Chart Analysis on Evening Report) I promised to elaborate on the economic policies that would underpin the new optimisation of work-life balance. I argued that economic optimisation means a balance between income and leisure, and that the Covid19 pandemic – and especially the experience of level four lockdown – involved a household reassessment of that balance in favour of more leisure and less work; more relaxation and less income.
The first (pre-pandemic) chart did not necessarily reflect the pre-pandemic optimal balance; it reflected the reality of 2019. There is every reason to believe that the economically optimum balance in 2019 would have favoured more relaxation then. (The optimum balance for each household is determined by its preference at the margin. Some households – if free to choose – would favour a bit more relaxation and a bit less income; other households would favour less relaxation and more income. Involuntary unemployment does not count as relaxation. The optimum balance for society exists when each household is able to achieve its optimum.)
The central argument of that analysis was that our experiences in March and April 2020 caused a change in the optimal balance. However, for this change to be reflected in actual post-pandemic outcomes, some policy accommodation will be required.
Phase One Policy Accommodation – The Recession
There can be little question that the world as a whole – and just about every country – has entered a state of recession, of negative economic growth.
(A rule of thumb definition of recession is the experience of two successive quarters of negative seasonally adjusted economic growth, where ‘economic growth’ means the percentage change of price-adjusted gross domestic product [GDP]. This definition is inadequate; under Covid19 lockdowns, while most countries have experienced a dramatic single quarter decline in GDP many will experience small increases in subsequent quarters. It is appropriate to assert that a recession is a period of GDP decline of at least six months that ends when GDP returns to its pre-recession level; some recovery growth does not necessarily mean the recession is over.)
Traditional policies to address a recession have the goal of ending the recession, and restoring economies to their normal growth paths. While that approach remains valid, it needs to be sensitive to the possibility of a new normal where optimum GDP – the income part of ‘income-relaxation balance’ – needs to be less than it would have been prior to the recession.
A standard cyclical recession requires a mechanism to ensure that interest rates quickly come down, to encourage more borrowing and spending by solvent businesses and households, and by governments.
A more intransigent recession – a ‘balance sheet recession’ – requires aggressive fiscal stimulus (more government spending and more government mandated payments to households) because too few businesses and households are in a position to take advantage of low interest rates. An example here is the global recession following the 2008 global financial crisis [GFC]. The historically most important recent example of a balance-sheet recession is Japan’s prolonged 1990s’ recession; an experience the rest of the world still needs to learn from. The present recession is a variation of the balance-sheet type, but with overlaid supply chain disruptions and induced changing work-life household preferences.
Government debt must increase – and sharply – during a balance sheet recession. For the most part, this new debt is newly created money owed by the people of a country to the people of that country. This is essentially an accounting process that – if managed properly – self-unravels over time. (Premature forced unravelling – as occurred in the United Kingdom after the GFC – creates much unnecessary economic hardship and loss of happiness.)
At today’s early stage of the recession, so long as the economy remains in recession (evidenced by high levels of available labour) the central government needs to pursue a policy of aggressive fiscal stimulus; a policy which has the additional benefit of forestalling a requirement for negative interest rates. (An important part of this stimulus should be that the central government makes substantial transfers to local governments.) Further, the government should proactively shut down – through reasoned reassurance and explanation – all the reckless chatter about how this new technical debt does not set households up for a biblical reckoning in the future. Rather, the process of expanded recession finance self-resolves.
The most basic part of the resolution process is the restoration of business and household balance sheets, more economic activity, more taxes paid, more private sector debt, slightly higher interest rates (ie low rather than very low), and less requirement for new government debt as the economy enters a new expansionary phase.
However, if there has been a structural change in household demand – a change in favour of less consumption and more relaxation – then the process will resolve with the central government holding a permanently larger amount of debt on its books. In Japan this technical debt – money owed, through the government’s balance sheet, by the people to the people – has settled at about 250 percent of its GDP. By 2025 – if sensible policies are followed in the European Union and North America – similar debt can be expected to settle at around 200 percent of GDP. (If foolish policies are followed, government debt in these countries will still be about 200 percent in 2025, but all of those countries will be going through an experience similar to the economic depression that was imposed on Greece.) In New Zealand, with good policies, our comparable level of government debt in 2025 should be between 50 and 100 percent of GDP.
Phase Two Policy – A New Post-Pandemic Balance
In the new situation – characterised by Chart 4 in my chart analysis – we no longer require aggressive fiscal stimulus. Rather, we need to establish a new lower-growth equilibrium – with government debt permanently sitting at over 50 percent of GDP – and with regular government outlays funded by taxes. In this situation, we need equilibrium levels of revenue and spending, not the aggressive deficit spending required to achieve Phase One recovery.
To maintain a low-growth equilibrium with a higher relaxation component – reflecting a 2020s’ shift in favour of more relaxation and less income – we will need public equity dividends set higher than the sensible initial setting of $175 per week – and a flat income tax rate set higher than the sensible initial rate of 33 percent.
Once a country has a mechanism of flat income tax and universal incomes – UIFT – in place, the simple rules to maintain an appropriate income distribution are:
- as productivity arising from public inputs increases, then both public equity dividends (universal incomes) and the income tax rate should increase.
- as households increasingly favour more sustainable work-life balances – more sustainable in terms of either the wider environment or the internal household relaxation-income balance – then both public equity dividends (universal incomes) and the income tax rate should increase.
If a country enters the Phase Two post-pandemic post-recession phase with this necessary mechanism already in place, then ongoing financial management becomes an easy governmental task; a process that can reflect both changing household work-life preferences and humanity’s need for a sustainable natural environment.
If such a mechanism is not in place, the solutions to the problems of work-life balance and environmental sustainability will remain as intransigent as they have been over previous decades.
Phase One Policy – 2021
Looking back to 2021 from 2025, the ongoing economic recession – the emergency phase – represents a wonderful opportunity to implement universal incomes and flat income taxes at the appropriate introductory level; this is the time to transition to explicit public equity dividends. By adopting the 33 percent tax rate and the $175 per week public dividend, there would be no change to the incomes of higher earners and beneficiaries, though both would gain a degree of protection from changed circumstances.
The new New Zealand government – the government chosen after the September 2020 election – will easily gain another term in 2023 if it takes advantage of these uncertain times to implement the policy change that we have to have; the policy breakthrough that can give ourselves a prosperous and relaxed economic future.