Fool me once, fool me twice

Dr David Law
Insights Newsletter
8 May, 2020

As the Government looks ahead to the end of the Covid-19 public health emergency it should first look to the past for examples of how good policy intentions in a recovery can go horribly wrong.

For instance, a paper by US-based macroeconomists David and Christina Romer shows that fiscal headroom is crucial because it means countries with low-debt will experience much milder downturns after a crisis than highly leveraged countries.

Another paper by Danish economist Christian Bjørnskov looked at 212 crises in 175 countries to see what role economic freedom plays in a recovery. He assessed the quality of institutions, trust in the rule of law and relative ease of doing business and found those freedoms resulted in less pain and faster recovery times. 

We can take heart from these findings. New Zealand was fortunate to have relatively low levels of public debt before the Covid-19 crisis and in 2020 ranked third out of 180 countries in the Heritage Foundation’s index of economic freedom. 

This does not mean, however, the Government has room to introduce new regulations to survive the Covid-19 crisis. On the contrary, it should find ways to improve its institutions and cut away regulations. Likewise, while New Zealand has the fiscal headroom now to stimulate the economy, hasty implementation of expensive investment and policy initiatives risks failure – or at least unintended consequences.

History provides plenty of examples encouraging caution here.

Consider the notorious “Cash for Clunkers” scheme in the US, introduced to stimulate consumer activity after 2008. Under the programme, the US Federal Government offered incentives of between $US2500 and $US4500 to anyone trading in a gas-guzzling, older vehicle to buy a new, more fuel-efficient car. 

Unfortunately, about 60% of the funds went to folk who would have bought a new car anyway and since many environmentally-friendly cars already had subsidies to encourage people to buy them (making them cheaper) the overall consumer spending actually dropped as a result of the scheme.

Back in New Zealand, it is already concerning to see Cabinet’s recent decision to suspend the Regulatory Impact Analysis (RIA) framework due to Covid-19. That kind of decision only undermines proper cost/benefit evaluation of some of the Government’s largest looming decisions. 

Budget 2020 is coming up next week, and the Government will likely increase spending to counter the crisis. It is crucial that New Zealand’s long-term economic health is not jeopardised by the allure of quick, potentially dubious, wins.

More details are available in the New Zealand Initiative's recent report “Policy Point: For better or for worse: How governments respond to crises

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