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Two's company, three's a crazy

The most famous theory in political science is the median voter model.

Developed in 1929 by Stanford economics professor Harold Hotelling, it provides strategic guidance to politicians, anticipates their policy positions and predicts election results.

Broadly, it suggests that, in any two-candidate election, both are best to adopt policy to please the median, middle-of-the-road voter, and that the candidate closest to the median will win.

This is the same economic theory that says, with two fast-food vendors at a beach, both will operate next to one another behind the median sunbather – and that a duopoly, like the old Vodafone/Telecom rort, will tend to offer undifferentiated products and prices.

In politics, the model’s predictive power is proven not just by vast screeds of algebra by microeconomists, game theorists and political scientists, but – unlike much social-science theory – by real-world observation.

Even with apparent exceptions, like Baroness Thatcher’s three election wins, she was indeed closer to the median than failed prime minister Lord Callaghan in 1979, Soviet appeaser Michael Foot in 1983, and even Lord Kinnock in 1987.

In New Zealand, governments have sometimes implemented more radical policy once in office, but the party positioned closest to the centre in its political rhetoric usually wins.

Academics have spent over 80 years discussing potential flaws in the model, with the most serious being that some politicians want to implement deeply held political beliefs rather than simply please the median voter – but that obviously doesn’t apply to anyone important in New Zealand’s parliament.

Consequently, the model helps explain why New Zealand has had a mostly two-party system, how to game it, and why – with some famous exceptions – our governments have tended to trundle along, trying not to upset “ordinary kiwis”.

Holy trinity
There is another important feature of the model.

Do the maths again, but assume three major players, and you get a different result.  Suddenly, there is an incentive to differentiate and diverge.

Hence, if a third fast-food vendor shows up at the beach, the three will separate along it.  Similarly, when 2degrees entered the market, a wider range of mobile plans became available.

It is not just that the new entrant offers more choice, but that the incumbents have to offer more choice too, making the consumer much better off.  This is why the Commerce Commission will almost always prefer three-player markets than duopolies. 

Similarly, in politics, the model suggests that, in three-party systems, parties will no longer all cuddle up to the median voter but some will offer more radical policy choices.  It’s argued, as with consumer markets, that this leads to a more lively democracy.

The release of the Labour/Green electricity policy suggests something like this is happening in New Zealand.

The Greens are now clearly established as a permanent third party, with the other small parties melting away.  Professor Hotelling and his academic heirs could have told us this would likely lead to something like the electricity policy, which has already wiped hundreds of millions from the Crown balance sheet, including the SOE portfolio and the ACC and Superannuation funds, and from KiwiSaver accounts.

It is no good Labour/Green saying the policy is not radical by arguing that something like it has been implemented elsewhere.  That would be like National saying a 15% flat tax is not radical in a New Zealand context by pointing to Hong Kong.

The very fact the mere announcement of the policy destroyed so much wealth and dominated the political news proves that its radicalism was beyond the expectations of both the finance and political communities.

With three parties, the model suggests more such radicalism should be expected, offering voters broader choices, so that the 2014 election may well be the first for many years to be more about policy than personality.

Again, observation supports the model’s prediction.

Already, and extraordinarily in a country with a high rate of home ownership, Labour has promised to reduce the value of the family home by flooding the market with cheap new houses under KiwiBuild.

Talk of trying to get the Reserve Bank of New Zealand to take on the Reserve Bank of Australia, the People’s Bank of China, the US Federal Reserve and the European Central Bank to drive down the kiwi dollar is also stunningly radical after so many years of bipartisan consensus.

Stand by for more.  If, as seems increasingly likely, a Labour/Green government is elected in 18 months, the question will be: Will it implement its radical programme or decide the wealth destruction associated with it would jeopardise it winning a second term?

Or, will the wealth destruction already have happened in anticipation of a change of government, so that the defeated Key administration will unfairly get the blame?

Disclosure: Matthew Hooton’s firm, Exceltium, worked with 2degrees on telecommunications regulatory issues.

Comments and questions

It is really interesting that the Greens have moved away from their environmental roots towards policy that is aimed toward shifting more of the wealth from those earning to the poor.

Their power policy is one clear example. I gripe as much as the next person at the ever-increasing cost of electricity in this country. However, it is clear that lower power prices will lead to an increase in the use of electricity and lessen the incentive for the country to become more energy efficient... Individuals and families will be less willing to pay the large upfront costs associated with more efficient heating, insulation and other energy saving measures. As businesses consume more, cheaper, power we will be effectively subsidising the goods we produce that foreigners buy.

Unfortunately, this power will need to come from somewhere. However, all forms of electricity generation are inherently bad from a Green perspective. Dams provide cheap power, but flood pristine valleys and thermal generation warms the planet. Two of the most expensive forms of energy, wind farms and geothermal, either ruin sleep and kill birds, or probably have a negative effect on the water table. Solar panels, while good for the soul, require minerals that have to be dug out of the earth from somewhere and don't provide power when New Zealand needs it (winter evenings).

New Zealand's environment will be the loser, because the true cost of electricity generation encourage energy efficiency. Although maybe the environment will not be the loser, if that generation is not developed. After all, private power generators will look to reduce their overall costs and reduce their investment in their plants. State generators, will therefore need to be directed to provide additional, now uneconomic, generation capacity. That will be paid for by the state, or the taxpayers of New Zealand, and if as demand increases (or does not decline as fast as present) this cost will grow.

I'm a firm believer that if New Zealand wants to be a wealthy country, we need to act like a wealthy country. That means New Zealanders need to increasingly act like wealthy individuals. I won't be purchasing any partially privatised state companies, because I do not currently have the financial means to do so. I am not wealthy.
However, I firmly believe that in order for this country to act like a wealthy country there needs to be wider range of companies available for the private investor. Infrastructure companies like the power companies, up until this policy, fills out a niche that is rather lacking in the New Zealand stock market and allows New Zealanders to invest their capital into areas other than housing, thereby providing additional investment in the productive sector of society.

Perhaps then this country will be less reliant on foreign capital for our growth. Most individuals are exposed to the sharemarket only through their KiwiSaver accounts, which are skewed towards the wealthier investors, and KiwiSaver alone will not provide the capital that this country needs so badly.

Too bad Labour and the Greens have just ensured that the poor investment levels of New Zealanders in the share market will drop even further and private money will stay in the property sector where it always has been. Ask any Contact investor what they now think about investing in the NZ sharemarket.

There is a whole lot of talk about wealth in Hooton's article and in the above comment. How do you define wealth? Who do we compare ourselves against when deciding if we are wealthy or not? Who actually cares provided we are all content?

I feel wealthy when I share a meal with friends and family. I feel wealth when I find a clean river to fish and swim in. I feel wealth when I go for a surf. I feel wealth when I take my my $6000 motorbike for a run through our beautiful landscape with a friend on the back. I feel wealth when I can buy someone a gift or contribute to a cause I believe in. Wealth and happines are states of mind. No one can feel truly wealthy if they have a mean, stunted, greedy, grasping, soul always comparing themselves to someone else to justify their existance. It doesn't matter how much money you've got.

Wealth in this context is referring to assets. What you are talking about is utility, which can vary widely between different people. You value landscapes and rivers, yet don't consider others who do not. You are just as greedy, wanting a pristine landscape for your leisure time, as the entrepreneur wanting to build a factory that will ruin your landscape.

And which is better for the public good? Which delivers the most morally and ethically justifiable outcome?

Great analysis, Matthew.

National now need to begin pushing some of the success stories of their two terms in power and continue to differentiate themselves from the radical socialist Labour-Green-Mana opposition rather than constantly being put under the cosh by GCSB allegations.

"Labour has promised to reduce the value of the family home by flooding the market with cheap new houses under KiwiBuild". Is this a bad thing? It will be a good thing for the many people who can't afford a house at present prices, won't it? That sounds fair and just to me. If you disagree, are you saying it is good to have a rental housed underclass living in NZ who are denied the NZ dream of owning their own home?

Actually I don't think the current situation quite fits the model.

Labour is the natural partner for the Greens. So a vote for the Greens is a vote for Labour but the voters feel they are voting for someone else (which matters for voter participation). Since the Greens are the far left, Labour is guaranteed those votes and can campaign for other voters. The result should be Labour moving to the right. Their ideal position may actually be to the right of national, far enough to take votes, not too far to damage the Greens. But instead they are moving further left, trying to take votes off the Greens. They should save the move left until after they have won the election and are negotiating a coalition deal.

Having two parties compete for the far left may increase voter participation in that part of the spectrum, shifting the median voter slightly toward the left, but they have seemingly given up trying to sway the current median.

I disagree. Many people vote for the Greens for the environment policies. I am one of them and didn't considered that it is a vote for the left (which it clearly is). I would never vote Labour but will vote Greens most of the time. Therefore Labour isn't taking voters away from the Green Party. l will be surprised if Greens don't get 10%-15% of all votes in NZ from now onwards.

A vote for the Greens is a vote for Labour, in as much as it helps put Labour/Green in with presumably Labour as the major party. You can't vote Green and claim you are not supporting Labour.

If this government believes that the market model and selling off our power companies are the best models to get a lower electricity prices for the NZ consumers, then why has the electricity prices skyrocketed under both Labour and National governments in the past 15 years after the Max Bradford reform in the late 1990s?
Do they really believe that most NZers will take notice of their scaremongering comments when their minds are now fixed on getting a cheaper power bills?

"why has the electricity prices skyrocketed under both Labour and National governments in the past 15 years after the Max Bradford reform in the late 1990s?"

They didn't. They fell after the Bradford reforms until Labour got their hands on power and the market again.

Absolutely, there's a graph doing the rounds that shows this very clearly. Prices fell dramatically after Bradford's reforms, then when Labour got back in and started fiddling the prices skyrocketed.
I don't know why National isn't really pushing this fact.