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.

Radicalism
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.