Friday, February 8, 2008

Economic Mistakes of Politicians

Politicians are very rarely economists. Economists very rarely become politicians. Our elected officials often make serious economic mistakes due to political pressures which often work against sound economic sense. These are some of the most common economic mistakes.

Boom and Bust Cycle.

Generally, politicians do better when growth is high and unemployment is falling. Therefore, in the lead upto elections, there is a clear incentive to stimulate the economy through expansionary fiscal and monetary policy. E.g. cutting taxes and cutting interest rates. However, the problem is that politicians can easily go too far; they allow demand to increase too much and this causes inflationary pressures to increase. This leads to a boom and bust economic cycle. See Lawson Boom of the 1980s. It is mainly for this reason that monetary policy is now operated by independent Central Banks, - taking away the temptation of politicians to meddle in the economy.

2. Increasing National Debt.

There is a clear political incentive to cut taxes and increase spending. The result is that government's invariably create budget deficit's. This needs to be financed by borrowing from the private sector. The long term consequence of higher borrowing levels are unnecessarily high levels of interest payments. In the UK, £30billion a year goes on interest payments servicing the national debt. If the government had not built up debt in the past. Taxes could be cut quite significantly.

The problem is who is going to vote for the candidate who promises to cut spending and raise taxes?

3. Increasing Complexity

Politicians often want to do something which creates positive headlines, so they introduce a new tax and benefit which sounds good. The consequence is that the tax system becomes very complicated with many loopholes and different levels to deal with.

4. Affect on Incentives.

Politicians often look for short term fixes without thinking of the long term consequences. A good example is in the UK, the government were criticized for only increasing old age pensions by 75p a week. Therefore, they introduce a Minimum Income Guarantee for pensioners. This could be used to say they were reducing pensioner poverty and increasing their incomes.

However, the long term consequences of this policy are not good. Basically, it rewards people who do not save for a private pension. If you save for a private pension then you could end up with the same take home income as someone who didn't bother saving but then benefited from the governments minimum income top up. A better solution would be to increase the basic rate of pension or provide additional benefits to those who get a small private pension.

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