Economic Strategy Matters
“It’s the economy, stupid!”
Long before James Carville immortalised these words into history, we all intuitively knew that this was and is a top political issue. With all the complexity and rhetoric flying around, it’s always helpful to have some principles to help you discern value from bluster.
Basically the economy can be broken down into 4 different categories of actors.
Domestic Consumers
Domestic consumers are the residents of a country – the individuals who demand and consume goods and services within an economy, as well as the source of labour.
International Sector
We can’t all produce everything we want in our home countries all the time so this is where goods and services flow across borders to fill the gaps. The international sector is where domestic corporations and consumers of different countries interact.
Domestic Corporations
These are the locally based producers. They take labour and raw materials and create goods and services. In free market systems, these assess what is produced, how much, how and at what price.
Government
The institutions in a country that wield the authority to regulate, mediate, and legislate over various aspects of life.
Balance Creates Structure
The balance and size of each of these components can be loosely referred to as the structure of that economy.
The relationship between these existing proportions of these sectors determines how each economic policy is going to impact the economy.
If the current economic structure has a small exposure to the domestic consumer sector, such as in the case of the Bahamas, then spending a lot of effort thinking about domestic income tax rates, is a waste of time of best. This is why one of the reasons that the country has scrapped them altogether.
Finally, each component of the economy has particular strengths and vulnerabilities. Countries with relatively dominant consumer segments may be less sensitive to international politics than those with more open economies. By understanding the relative balance of your home economy, you can make more informed judgments about how different trends are likely to impact you.
The Game Master and a Player
As the policy maker, enforcer of rules, and economic actor in its own right, the government has a unique ability to set the reward-punishment system of a country.
How the government chooses to orient its rewards and punishments relative to each economic component can be loosely referred to as its policy stance.
The overall combination of policy stances can be referred to as the policy strategy.
The interaction between economic stances can influence the effectiveness of the economic strategy as a whole.
For example, if a government increases general corporate tax rates, that tends to encourage internal investment, as business leaders seek to minimise the amount of money they hand over in taxes.
This effect could be enhanced by providing incentives, such as tax credits for internal investments – such as new machinery. This is because tax credits can be used to reduce future tax expenses, which increases future profitability. This combination of stick and carrot rewards the behaviour that the government is trying to encourage.
Couple this with the improvement of access to international markets – such as trade deals – and this can be a powerful driver to moving capital into productivity-enhancing measures.
However, simply lowering taxes, especially corporate taxes encourages corporate leaders and shareholders to line their own pockets by reducing the advantages of internal investing.
As the structure of the economy forms and economic actors form expectations about what the future policy strategy of the country will be, it becomes harder to adjust that strategy without causing major disruptions.
Policy strategy can have a significant influence on both:
1. The interactions in the wider economy today and
2. What future economic structure emerges.
Consequences of the Path of the Chinese Miracle
Consider China in the 1960s. The government did not have a lot of funding available to invest and neither did the general population or domestic corporations have the capacity to consume. What China did and still does have was a large population and massive natural resources. So they played to their strengths.
Between 1960 – 2010, China created a strong network of trading partnerships and incentives for international investors to make use of the abundance of natural resources and human capital there. The policy strategy we saw could be described as:
The numbers are completely made up of course – a precise measurement of the balance of policy measures is way beyond the scope of this article. It is the relative weightings that are important here.
This created the economic structure we see today, where China is a manufacturing powerhouse but has a relatively weak domestic consumer since low wages were key to attractive investment conditions.
The weak domestic consumer was a feature, not a bug, of their policy strategy over time.
However, the challenge now facing China is that as they appear to pivot to a more consumer-led economy, they are finding that structurally low wages and loose regulatory standards have left their domestic consumers too weak to carry the overall economy.
The Wrap Up
Of course, this is an oversimplified framework of how to think about economic strategy. Realities are complex and understanding how all the pieces fit together is a tricky business. One of the features of democracy generally is that we don’t choose economic policy – we choose politicians and the politicians choose the policy.
This disconnect means that most people don’t bother to think about how they think about economic policy but it affects almost every facet of our lives
Here are a few questions we should be asking when trying to make an informed decision.
- What are the specific policies being proposed by the candidate?
- Who do these policies tend to benefit? Consumers? Big companies?
- What is the aim of those policies?
- Do the parties that benefit make up a big enough part of the economy to make a difference for the public as a whole?
- How will any of those benefits align with my sense of where the country should go?
2024 is the year that the majority of the democratic world will go to the polls – and indeed over 300 million people already have. I hope this article will help you to provide some context for how you think about how to judge the substance of the economic policy asking for your support rather than descending into habit or tribalism.