SECULAR STAGNATION COMES TO AUSTRALIA

Talk to Comview conference, Melbourne, Tuesday, December 3, 2019

You’ve probably seen me writing a lot lately about “secular stagnation”, how it applies to all the advanced economies – the US, Europe, Britain and Japan – and how, particularly since the marked slowing in our economy since the September quarter of 2018, it’s now clearer that Australia, too, has long been caught in the same long-lasting period of stagnation. This is true even though none of our political leaders or econocrats have used the term, and they persist in forecasting that, within the next year or two, the economy will return to trend growth or better. It’s true, however, that Reserve Bank governor Philip Lowe has on several occasions acknowledged the phenomenon of a savings glut which is at the heart of secular stagnation, and is evident from the fall in world interest rates to unprecedented lows.

What I’ll do today is give you a bit more of the context and background to the secular stagnation hypothesis – more than it’s possible to include in a newspaper column and, probably, more than you’ll feel needs to be passed on to your students. I’ve always believed that teachers need to be equipped with more understanding of a concept than they see fit to pass on to their students. I often write that the world’s economists are still debating the causes of secular stagnation and, hence, the main things governments should be doing to get our economies moving again. Today I’ll outline some of the main issues they are debating - without, let me warn you, offering any resolution of that debate.

Meaning and origins of the term

Secular stagnation means a prolonged period of weak economic growth caused by change in the underlying structure of the economy. “Secular” is the old word for “structural” – as opposed to short-term weakness caused by the business cycle. “Stagnation” could mean no growth at all, but usually refers to growth persistently weaker than an economy’s “potential” growth rate, as estimated in the conventional way.

The term was first re-introduced to the debate in 2013 by the leading American economist, Laurence Summers, of Harvard, a former US Treasury Secretary in the Obama Administration. Summers was reviving a term first used by the famous American economist, Alvin Hansen, who argued in 1938, after the end of the Great Depression, that the US economy had entered a period of protracted weak growth. Since the advanced economies grew strongly in the 1940s and the post-war period, most economists believe Hansen’s theory was wrong. Summers’ retort is that, since it took another world war to lift the US economy out of the doldrums, that just shows Hansen was right. A point worth remembering is that, once the war was over, many economists feared the economy would lapse back into weak growth. Instead, it enjoyed a 30-year-long post-war “golden age” of technological advance, strong growth, full employment and rapidly rising material living standards. So accepting the reality of secular stagnation at present doesn’t necessarily imply accepting that nothing could occur that returns us to more healthy rates of growth.

In a recent speech to the IMF, the former governor of the Bank of England, Mervyn King, essentially accepted the reality of secular stagnation, but preferred to say that, since the Great Recession of 2008-09, we’ve entered the Great Stagnation and are "stuck in a low-growth trap".

This looks like another macro paradigm shift

The fact that we’re in a period of confusion and furious debate between economists about the causes of the “low-growth trap” we’re caught in, and what we need to do to escape it, may be disturbing to you, but I feel like I’ve seen this movie before – and know it will end satisfactorily . . .  eventually. Why? Because I became an economic journalist in 1974, immediately after the first OPEC oil shock and just before the world recession it precipitated, which saw the advanced economies caught in “stagflation” – the combination of high unemployment and high inflation that Keynesian economics and the Phillips curve said couldn’t happen. The world’s economists fell into furious debate between Keynesians and monetarists, which took about a decade to be resolved into the new macro management policy orthodoxy that today we find under challenge: the main instrument used to manage demand should be monetary policy, not fiscal policy. The conventional wisdom among the economic managers abandoned Keynesian demand management and reverted to a neo-classical macro-economics which gave primacy to the supply (production) side of the economy.

Which side is the bigger problem: demand or supply?

This is where I advance my own theory. The concept of a macro economy that needs to be managed by the authorities goes back only as far as the Great Depression of the 1930s and the utter confusion among economists about why it had happened and what should be done about it. At the time, neo-classical economics, which was preoccupied with micro, used Say’s Law – supply creates its own demand – to assume the overall economy was always at full employment and so needed no meddling by governments. That is, it said depressions couldn’t happen. Keynes wrote the General Theory to explain why it had happened – deficient demand – and, since what today we call monetary policy was caught in a liquidity trap, why the answer was for government to create demand by its own spending. Hence the post-war orthodoxy that the big problem in achieving full employment was recurring deficiency of demand – growth in the economy’s supply side, potential production capacity, could be left to its own devices – and the best instrument to use to ensure adequate demand was the budget.

After the arrival of stagflation in the mid-1970s, economists eventually decided that, with so much inflation, demand could hardly be said to be deficient, and the big problem was on the supply side: getting productive capacity to grow faster and keep up with demand. The reversion to a form of neo-classical macro-economics fitted with this analysis. Over the medium term, the rate at which the economy could grow was determined by the supply side – the growth in potential output – which, in turn, was determined by the growth in the three Ps: population, participation and productivity. If we wanted faster growth in supply, the answer was micro-economic reform to reduce the government interventions that were inhibiting growth in participation and productivity. Macro management of demand could do nothing to hasten supply-determined growth over the medium term. Over the short term, however, monetary policy was the best instrument to use to dampen the impact of either inadequate or excessive demand which can cause fluctuations around the growth path as determined by supply. Otherwise these fluctuations would result in the new problem of excessive inflation (which was assumed to be purely “demand-pull” inflation) or, alternatively, a temporary rise in unemployment.

Which brings us to the present era of secular stagnation. Inflation is almost non-existent and interest rates are hovering above the “zero lower bound” but, though employment growth is strong and unemployment isn’t particularly high, economic growth is weak, real wage growth is weak and living standards have stopped improving. Advocates of the secular stagnation hypothesis say the problem is deficient demand and that the answer is for governments to generate some demand, particularly via government spending on such things as infrastructure. This is especially so since monetary policy now has no room to move. It’s comparative advantage relative to fiscal policy is controlling inflation, not stimulating demand when the economy is again caught in a liquidity trap.

Are you starting to detect a pattern here? In the 30-odd years after World War II, the problem was perceived to be deficient demand not deficient supply, and the right macro instrument was seen to be fiscal policy. In the 30-odd years following the emergence of high inflation, however, the problem was perceived to be deficient supply not deficient demand, and the right macro instrument was seen to be monetary policy. Since the global financial crisis and Great Recession roughly 30 years later, however, the economy has fallen into a “low-growth trap” and the leading thinkers are defining the problem as deficient demand not deficient supply, with the right instrument being fiscal policy. If so, we’re seeing unfold before us the emergence of another paradigm shift in macro management.

Symptoms of secular stagnation

In the decade or more since the Great Recession, the advanced economies’ performance has been characterised by weak growth in consumption and business investment, plus unusually low rates of productivity improvement, adding up to persistently weak economic growth overall. Inflation has been consistently below-target everywhere – itself a sign of weak demand. It’s thus not surprising that nominal wage growth has been low, but real wage growth has also been unusually low. The US economy has been stronger than most other economies, but it’s had a temporary benefit from the “sugar hit” delivered by Donald Trump’s pro-cyclical cuts in corporate and personal income tax.

The bit that doesn’t fit this story of universal weakness is surprisingly strong growth in employment and, in consequence, falling unemployment. We know that’s happened in Australia, but it’s also happened in most other economies. The strong growth in employment at a time of continuing weakness in real wage growth has prompted many of the advanced economies to revise downward their estimates of their NAIRU – non-accelerating-inflation rate of unemployment – that is, full employment. The Reserve has cut ours from “about 5 per cent” to “about 4.5 per cent”, but it’s probably lower and, in truth, no one can be sure how low.

With the sharp slowdown in Australia’s economic growth in the quarters following the June quarter of 2018, it’s become much easier to see that we, too, have been caught up in the stagnation affecting the other advanced economies. Using the three Ps, Treasury and the Reserve Bank estimate the economy’s forward-looking “trend” or potential rate of growth to be 2.75 per cent. Over the seven financial years to June 2019, that figure has been touched just twice, the economy achieving a simple average growth rate of 2.5 per cent. It’s important to note that this below-trend growth has happened despite unusually strong growth in the population – much higher population growth than in the other advanced economies. So whereas over the seven years to June 2019 real GDP grew by 19 per cent, real GDP per person grew by a pathetic 6.4 per cent. This doesn’t mean the economy is on the edge of recession. Rather it means that mere population growth accounted for two-thirds of the overall growth, leaving the other two Ps – participation and productivity – accounting for just a third.

Treasury and the Reserve have gone year after year forecasting an early return to above-trend growth, only to fall short of their forecasts, particularly for nominal wage growth. By now, it’s hard not to believe that they are merely cracking hardy, refusing to accept that something fundamental in the economy has changed.

But at the heart of the secular stagnation hypothesis is the remarkable decline in world interest rates. It’s not surprising that, with the advanced-economy-wide fall in inflation rates, nominal interest rates have also fallen. But Summers and others have demonstrated that the world real interest rate – on long-term government bonds – has been falling since long before the GFC and now is at record lows. As Phil Lowe has noted several times, this fall in interest rates can be explained only by the supply of “loanable funds” made available by savers exceeding the demand for funds from real and financial investors. Obviously, the interest rate is the price that equilibrates the supply of funds with the demand for funds. Note that this process happens on the financial side of the economy, not the real side.

Rival explanations of secular stagnation

Globalisation and the digital revolution. We know that the digital revolution is working its way through the economy, industry by industry – the entertainment and news media, retailing, accommodation, taxis, motor vehicles and many others – destroying traditional business models and leading to much uncertainty. This usually benefits consumers, bringing lower prices and new or improved services, but doing so at the expense of industry incumbents and their workers. In Australia, our retailers in particular are being put through the wringer, and it may be that this is a big factor in holding down inflation and making firms reluctant to invest. If so, this would be more in the nature of a once-only adjustment spread over a number of years, rather than permanent source of weak demand.

Mismeasurement. Many economists find it hard to believe that productivity growth, as measured, could be so weak at a time when the digital revolution is indeed revolutionising our lives and delivering so many benefits to producers and consumers. It’s probable that many of these benefits occur in our private lives and so aren’t measured by the national accounts. But Professor John Quiggin makes the broader point that the national accounting framework, which was developed about 80 years ago, was designed to measure an economy very different to the one we have today. It was designed to measure an economy dominated by the production of goods – farming, mining and manufacturing – whereas today’s economy is dominated by services, which are much harder to measure. If so, this suggest the economy is doing better in reality than the figures are telling us.

Demographic change. It’s widely believed that the ageing of the population – and, specifically, the greater proportion of workers getting close to retirement – helps explain why households are saving a higher proportion of their incomes (and thus devoting a lower proportion to consumer spending), on one hand, while the slow growing or even declining populations of most advanced economies have reduced the incentive for firms to invest in expansion. The retirement of the baby-boomer bulge has been expected to reduce the participation rate and thus make a negative contribution to the growth in potential production, though many older workers, particularly women, are staying in the workforce longer than expected. Just because people stop working doesn’t stop them consuming, of course.

Inequality. There is much evidence that globalisation and, more particularly, technological change, are “skill-biased”, favouring the growth of high-skilled occupations (eg managers and professionals), leaving some scope for growth in unskilled service occupations, but greatly reducing the demand for semi-skilled, routine jobs that are easily done by machines. Thus the middle of the workforce has been “hollowed out”. This implies that a much higher proportion of the growth in total wages is going to highly skilled and already highly paid workers. If so, a much higher proportion to wage growth is being saved rather than spent on consumption. It’s a demonstration of how increased income inequality is inhibiting economic growth. This is the reason former top econocrat Dr Mike Keating believes the best medium-term response to secular stagnation is a much great effort to ensure every level of our education and training system is helping our workforce adapt to employers’ changing demand for skills.

Debt. Phil Lowe argues that much of the weak growth in investment spending by households, companies and governments is explained by, variously, those sectors’ high levels of existing debt. In Australia, the inhibitor is much more housing debt than company debt or even government debt.

Market concentration. Some American economists believe weak growth in real wages, consumer spending, business investment and productivity can be explained partly by increasing “market concentration” as a few firms account for an ever-greater share of particular markets. The pricing power they acquire allows them to keep consumer prices higher than otherwise, limit wage increases, buy up new competitors and even limit productivity-enhancing investment. In other words, economic growth has been slowed by decades of successful rent-seeking by a small number of dominant firms – where rent-seeking means not just seeking favours from governments but also seeking out market situations when firms are able to charge prices that greatly exceed production costs (including “normal” profit). The big tech firms – Microsoft, Google, Facebook, Amazon and Apple – are classic examples of firms dominating their markets by early innovation, then buying out start-ups.

Arguments about real wages. Economists offer rival explanations for weak growth in real wages. Neo-classically inclined economists argue that real wage growth is weak purely because improvement in the productivity of labour is weak. Their solution is more micro-economic reform. But it’s by no means clear that the reforms they favour – eg lower company tax rates and further weakening of union bargaining power – would lead to higher labour productivity. Nor, at this point, is it as sure as we used to assume it was that the market economy contains some property which pretty much ensures all improvement in labour productivity is reflected in real wage growth. What if the mechanism through which that occurred was the industrial relations law’s previous balance of bargaining power between employers and unions, which IR “reform” – with its efforts to reduce collective bargaining and increase individual bargaining - has now shifted in favour of employers? Certainly, this is the union movement’s explanation for weak real wage growth. An alternative explanation is that technological change has most affected those jobs that been most unionised.

Arguments about business investment. There are various explanations for the weakness in business investment spending (or, in our case, non-mining business investment). Remember that business investment spending adds to demand in the short term and to supply – production capacity – in the medium term. One explanation is that the digital revolution has lowered the cost of capital equipment. If so, the weakness in spending isn’t as bad as it looks. Linked to this is the argument that the digital revolution has changed the nature of things firms want to invest in from expensive machinery and structures to less-expensive computer hardware and software. And linked to that is the argument that with services share of the economy ever-expanding at the expense of the goods share, meaning a shift from capital-intensive to labour-intensive production, the typical firm’s investment needs have been reduced. All these arguments imply that the weakness in business investment spending isn’t as bad as it seems, and thus not as damaging to continued expansion of potential production.

Conclusion: Although some of these explanations are mutually exclusive, it’s possible than many of them explain part of the slowdown. I’ll meet you back here in five or 10 years and tell you what economists have finally decided are the main causes, and the new conventional wisdom on how we should respond to secular stagnation. I’m pretty sure it will involve a return to worrying most about deficient demand and relying mainly on fiscal policy.

 

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QE: not certain, not soon, no great help, no let-out for govt

The big economic development this week was Reserve Bank governor Dr Philip Lowe giving the financial markets’ expectations about QE – “quantitative easing” - and other unconventional monetary policy an almighty hosing down.

In his speech on Tuesday he disabused the financial markets of the notion that, as soon as the Reserve had cut the official interest rate to zero, it would be on with QE and business as unusual.

Equally, he disabused our surplus-fixated government of any notion that his resort to unconventional monetary policy (manipulation of interest rates) would relieve it of the need to use conventional fiscal policy (budget measures) to get the economy moving again.

Lowe’s first act was to pooh-pooh most of the unconventional policies the letters QE conjure up in the minds of excitable market players. He identified four possible tools and rejected two and a half of them.

Let’s start with “forward guidance” – the notion of the central bank seeking to improve the confidence of consumers and firms by making its intentions on interest rates unmistakably clear. Great idea, he said, which is why he’d be doing it for ages and would keep doing it. Interest rates, he said, “will remain low for an extended period”.

Second is “extended liquidity operations”. During the global financial crisis in 2008, many central banks made significant changes to their usual ways of dealing with banks.

This was when financial markets were so disrupted that banks were too worried about their own finances to want to keep lending to ordinary businesses, threatening to crunch the economy.

Central banks dramatically increased their lending to banks, lent against the security of assets other than government bonds, lent for longer periods and lent at discounted rates of interest.

That is, they did what anyone with any sense would do to calm a crisis. Most of these extraordinary arrangements were soon unwound after calm had been restored. The Reserve itself had done some of them.

Would it do the same again should another crisis occur? Of course. At present, however, everything was working normally and our banks were able borrow as much as they needed – here or from abroad - at reasonable interest rates. So forget that one.

The third unconventional measure Lowe listed was “negative interest rates”. We used to assume that interest rates couldn’t go below zero, but things have become so desperate in Japan and then Europe – but nowhere else – that central banks have started paying banks negative interest rates. Governments have issued bonds at negative yields. That is, the borrower doesn’t pay the lender, the lender pays the borrower.

“Unconventional” doesn’t do justice to such a topsy-turvy world. It was long assumed that if banks started charging people to deposit their money, most of them would keep their money in cash under the bed. Lowe says there’s been a bit of that, but not much.

Why not? Partly because the negative rates are tiny – minus 0.5 per cent in the euro area, minus 0.1 per cent in Japan. But mainly because the negative rates have been restricted to charging banks and bond holders. No one’s been mad enough to try it on ordinary businesses or households.

So what are the chances we’d see negative rates here? It’s “extraordinary unlikely”, according to Lowe.

Which brings us finally to “asset purchases”. This is the only one of the four unconventional tools that can be called QE – quantitative easing. The central bank buys financial assets – securities – from the banks, paying for them merely by crediting the banks’ deposit accounts with the central bank.

This adds to the central bank’s liabilities, and to its holdings of financial assets, thus expanding its balance sheet and increasing the supply of money. Many central banks have purchased huge amounts of securities since the financial crisis, the vast majority of them being government bonds.

So, what’s Lowe’s attitude to QE? Well, for openers, he has “no appetite” for buying private sector securities (that’s the half I mentioned). But “if – and it is important to emphasise the word if – the Reserve Bank were to undertake a program of quantitative easing, we would purchase government bonds, and we would do so in the secondary [second-hand] market”. That is, it wouldn’t buy bonds newly issued by the government.

It would do QE because government bonds are assumed to be risk-free, and adding to the demand for bonds would lower the risk-free interest rate – not just for bonds but for all borrowing, from short-term to long-term. This should encourage borrowing and spending, as well as making our industries more price-competitive internationally by further lowering our dollar.

Whoopee-do. The financial markets ride again and monetary policy rolls on, allowing the government to continue putting the state of the budget ahead of the state of the economy.

Not so fast. Lowe said he wouldn’t even start to wonder about QE until we reached the point where the official interest rate had been lowered to 0.25 per cent (which would be as low as it’s possible to go).

And get this: “the threshold for undertaking QE in Australia has not been reached, and I don’t expect it to be reached in the near future.”

But his “threshold” isn’t the official rate down to 0.25 per cent. It’s trickier. “There is not a smooth continuum running from interest rate reductions to quantitative easing. It is a bigger step to engage in money-financed asset purchases by the central bank than it is to cut interest rates.

“In considering the case for QE, we would need to balance [the] positive effects with possible [adverse] side-effects.” Oh, didn’t think of those. He implied that he wouldn’t move to QE unless he was convinced we’d begun moving away from the inflation target and full employment.

Finally, having said the official interest rate couldn’t be cut below 0.25 per cent, he then estimated the scope for using QE to lower interest rates was no more than 0.2 percentage points. Sound like a magic wand to you?

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High immigration is changing the Aussie way of life

The nation’s economic elite – politicians of all colours, businesspeople and economists – long ago decided we need to grow our population as fast as we can. To them, their reasons for believing this are so blindingly obvious they don’t need to be discussed.

Unfortunately, however, it’s doubtful most ordinary Australians agree. A survey last year by researchers at the Australian National University found that more than 69 per cent of respondents felt we didn’t need more people, well up on a similar poll in 2010.

This may explain why Scott Morrison announced before this year’s election a big cut in our permanent migrant intake – while failing to mention that our booming temporary migrant intake wouldn’t be constrained.

He also foreshadowed measures to encourage more migrants to settle in regional cities. What he didn’t say is what he’d be doing differently this time, given the many times such efforts had failed in the past.

In between scandalising over the invading hordes of boat people, John Howard greatly increased the immigration intake after the turn of the century, and this has been continued by the later Labor and Coalition governments. “Net overseas migration” accounts for about 60 per cent of our population growth.

In 2000, the Australian Bureau of Statistics projected that our population wouldn’t reach 25.4 million until 2051. We got there this year. Our population is growing much faster than other developed countries’ are.

The growth in our economy has been so weak over the past year that they’ve had to stop saying it, but for years our politicians boasted about how much faster our economy was growing than the other economies.

What they invariably failed to mention was that most of our faster growth was explained by our faster-growing population, not our increasing prosperity. Over the year to June, for instance, real gross domestic product grew by (a pathetic) 1.4 per cent, whereas GDP per person actually fell by 0.2 per cent.

That’s telling us that, despite the growth in the economy, on average our material standard of living is stagnant. All that immigration isn’t making the rest of us any better off in monetary terms.

Of course, that’s just a crude average. You can be sure some people are better off as a result of all the migration. Our business people have always demanded high migration because of their confidence that a bigger market allows them to make bigger profits.

Economists, on the other hand, are supposed to believe in economic growth because it makes all of us better off. They’re not supposed to believe in growth for its own sake.

This week one of the few interest groups devoted to opposing high migration, Sustainable Population Australia, issued a discussion paper that’s worth discussing. It reminds us that many of the problems we complain about are symptoms of migration.

The biggest issue is infrastructure. We need additional public infrastructure – and private business equipment and structures, and housing – to accommodate the needs of every extra person (locally born as well as immigrant) if average living standards aren’t to fall.

Taking just public infrastructure – covering roads, public transport, hospitals, schools, electricity, water and sewage, policing, law and justice, parks and open space and much more – the discussion paper estimates that every extra person requires well over $100,000 of infrastructure spending.

When governments fail to keep up with this need – as they have been, despite a surge in spending lately – congestion on roads and public transport is just the most obvious disruption we suffer.

The International Monetary Fund’s latest report on our economy says we have “a notable infrastructure gap compared to other advanced economies”. Spending is “not keeping up with population and economic growth”. We have a forecast annual gap averaging about 0.35 per cent of GDP for basic infrastructure (roads, rail, water, ports) plus a smaller gap for social infrastructure (schools, hospitals, prisons).

One factor increasing the cost of infrastructure is that about two-thirds of migrants settle in the already crowded cities of Sydney and Melbourne – each of whose populations is projected to reach 10 million in the next 50 years, with Melbourne overtaking Sydney.

According to a Productivity Commission report, “growing populations will place pressure on already strained transport systems. Yet available choices for new investments are constrained by the increasingly limited availability of unutilised land”.

New developments such as Sydney’s WestConnex have required land reclamation, costly compensation arrangements, or otherwise more expensive alternatives such as tunnels. It’s reported to cost $515 million a kilometre, with Melbourne’s West Gate Tunnel costing $1.34 billion a kilometre.

Who pays for all this? We do – one way or another. “Funding will inevitably be borne by the Australian community either through user-pays fees or general taxation,” the commission says.

Combine our growing population with lower rainfall and increased evaporation from climate change and water will become a perennial problem and an ever-rising expense to householders and farmers alike.

The housing industry’s frequent failure to keep up with the demand for new homes adds to the price of housing. And the only way we’ll double the populations of Melbourne and Sydney is by moving to a lot more high-rise living.

High immigration is changing the Aussie way of life. Before long, only the rich will be able to afford a detached house with a backyard.

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Confessions of a pet shop galah: much reform was stuffed up

As someone who, back in the day, did his share of being one of Paul Keating’s pet shop galahs – screeching "more micro reform!" every time they saw a pollie – I don’t cease to be embarrassed by the many supposed reforms that turned into stuff-ups.

My defence is that at least I’ve learnt from those mistakes. One thing I’ve learnt is that too many economists are heavily into confirmation bias – they memorise all the happenings that affirm the wisdom of their theory, but quickly cast from their minds the events that cast doubt on that wisdom.

Well, let me remind them of a few things they’d prefer to forget.

Of course, it’s not the case that everything done in the name of "micro-economic reform" was wrong-headed. The floating of the dollar was an unavoidable recognition that the era of fixed exchange rates was over. And the dollar’s ups and downs have almost always helped to stabilise the economy.

The old regulated banking system wasn’t working well and had to be junked. With the rise of China in a globalising world, persisting with a highly protected manufacturing sector would have been a recipe for getting poorer. Nor could we have persisted with a centralised wage-fixing system or a tax system that failed to tax capital gains, fringe benefits and services – to name just a few worthwhile reforms.

Many privatisations were justified – the government-owned banks, insurance companies and airlines – but the sale of geographic monopolies (ports and airports) and natural monopolies (electricity and telephone networks) was a step backwards, mainly because governments couldn’t resist the temptation to maximise the sale price by preserving the businesses’ pricing power at the expense of consumers.

The conversion of five state monopolies into the national electricity market proved a monumental stuff-up at all three levels: generation, transmission and retail. It quickly devolved into an oligopoly with three big vertically integrated firms happily overcharging consumers at every level, with collateral damage to the use of carbon pricing in reducing greenhouse gas emissions.

We’ve learnt that “markets” artificially created by governments and managed by bureaucrats are – you wouldn’t guess – hugely bureaucratic, with the managers susceptible to “capture” by market players. The gas market has also been an enormous stuff-up, threatening the survival of what remains of Australian manufacturing.

The ill-considered attempt to treat schools and TAFEs and universities as being in some kind of market, where fostering competition between them and paying teachers performance bonuses would spur them to lift their performance, proved an utter dud.

Had the harebrained plan to deregulate uni fees not been stopped, it would have made even worse the chronic disorientation of the nation’s vice chancellors on what universities are meant to do and why they’re doing it. Lesson: trying to turn non-market parts of society into markets, while blithely ignoring all the obvious reasons such "markets" would fail, is a fool’s errand.

Which brings us to the half-baked idea of trying improve the provision of taxpayer-funded services by making their delivery “contestable” by for-profit providers. It's been an expensive failure pretty much everywhere it’s been tried: childcare, employment services, vocational education and training, and aged care (see present royal commission), not to mention privately run prisons and offshore detention centres. How long will it be before we’re having a royal commission into the abuses of the largely outsourced national disability insurance scheme?

Why have so many reform programs ended so badly? Partly because of the naivety of econocrats and other proponents of "economic rationalism". They had no notion of how far the grossly oversimplified neo-classical model of markets they carry in their heads misrepresented the big bad real world.

And many of them, having spent their working lives solely in the public sector, had no idea of how wasteful or bureaucratic the supposedly rational private sector could be. Actually break the law if they thought they wouldn’t get caught because corporate law-breaking wasn’t being policed? Sure. Rip off the government because the bureaucrats wouldn’t notice? Love to.

But there’s another reason so many reforms blew up. Because naive econocrats failed to foresee the way reforms intended to leave consumers or taxpayers better off could be hijacked by Finance Department accountants looking to cut government spending and produce "smaller government" by whatever expediency possible (see uni fee deregulation) and politicians looking to win the approval of big business or to move money and influence from the public sector column (them) to the private sector column (us).

Lesson: if a venal politician can find a way to sabotage micro-economic reform to their own advantage, they will.

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Weak wages the symptom of our stagnant economy, but why?

If you don’t like the term "secular stagnation" you can follow former Bank of England governor Mervyn King and say that, since the Great Recession of 2008-09, we’ve entered the Great Stagnation and are "stuck in a low-growth trap".

On Friday we saw the latest instalment of our politicians’ and econocrats’ reluctant admission that we’re in the same boat as the other becalmed advanced economies, with publication of the Reserve Bank’s latest downward revisions of its forecasts for economic growth.

This time last year, the Reserve was expecting real growth in gross domestic product of a ripping 3.25 per cent over the present financial year. Now it’s expecting 2.25 per cent. Even that may prove on the high side.

What their eternal optimism implies is our authorities’ belief that the economy’s weakness is largely "cyclical" – temporary. What the past eight years of downward revisions imply, however, is that the problem is mainly "structural" or, as they used to say a century ago, "secular" – long-lasting.

If the weakness is structural, waiting a bit longer won’t see the problem go away. The world’s economists will need to do a lot more researching and thinking to determine the main causes of the change in the structure of the economy and the way it works, and what we should be doing about it.

Apart from dividing problems between cyclical and structural, economists analyse them by viewing them from the perspective of demand and then the perspective of supply.

Obviously, what you’d like is demand and supply pretty much in balance, meaning low inflation and unemployment, with economies growing at a good pace and lifting our material standard of living. In practice, however, it’s not that simple and demand and supply don’t always align the way we’d like.

For about the first 30 years after World War II, the dominant view among economists was that the big problem was keeping demand strong enough to take up the economy’s ever-growing potential supply – its capacity to produce goods and services – and keep workers and factories in "full employment". Keynesian economics was developed to use the budget ("fiscal policy") to ensure demand was always up to the mark.

From about the mid-1970s, however, the advanced economies developed a big problem with inflation. After years of uncertainty and debate, the dominant view emerged that the main problem wasn’t "deficient" demand, it was excessive demand, always threatening to run ahead of the economy’s capacity to produce and thus cause inflation.

The answer was to get supply – potential production – growing faster. Most economists abandoned Keynesian economics and reverted to the former, "neo-classical" macro-economics, in which the central contention was that, over the medium-term, the rate at which an economy grew was determined on the supply side, by the three key determinants of production capacity, "the three Ps" – population, participation (by people in the labour force), and productivity – the rate at which investment in more and better machines and structures allowed workers to produce more per hour than they did before.

If so, the managers of the macro economy could do nothing to change the rate at which the economy grew over the medium term. Their role was simply to ensure that, in the short term, demand neither grew faster than the growth in the economy’s production potential (thus casing inflation) nor slower than potential (thus causing unemployment).

And the best instrument to use to achieve this balancing act was, as Treasury secretary Dr Steven Kennedy explained recently, monetary policy (moving interest rates up and down).

Everyone agrees that the problem with the advanced economies at present – including ours – is weak demand. The question is whether that weakness is mainly cyclical or mainly structural. If it's cyclical, all we have to do is be patient, and the old conventional wisdom - that, fundamentally, growth is supply-determined - doesn’t need changing.

But the conclusion that fits our circumstances better is that the demand problem has structural causes. Consider this: we’ve had plenty of episodes of weak demand in the past, but never has demand been so weak that inflation is negligible. Nominal interest rates are way down in consequence, but even real global interest rates have been falling since even before the financial crisis.

That’s why monetary policy has almost done its dash. It doesn’t do well at a time of negligible inflation, and fiscal policy is back to being the more effective instrument. But if the demand problem is mainly structural, then a burst of stimulus from the budget may help a bit, but won’t get to the heart of the problem.

As former top econocrat Dr Mike Keating has argued consistently, weak growth in real wages seems the main cause of weak growth in consumer spending and, hence, business investment, productivity improvement and overall growth – both in Australia and the other advanced economies.

Reserve Bank governor Dr Philip Lowe would agree. But he tends to see the wage problem as mainly cyclical: wait until we get more growth in employment, then the labour market will tighten, skill shortages will emerge and real wages will be pushed up.

Other economists stick to the supply-side, neo-classical approach: if real wages aren’t growing fast enough it can only be because the productivity of labour isn’t improving fast enough, so the answer is more micro-economic reform. Not a big help, guys.

The unions say the root cause is that deregulation has robbed organised labour of its bargaining power – and there may be something in that. But Keating’s argument has been that skill-biased technological change has hollowed out the semi-skilled middle of the workforce, with wage increases going disproportionately to the high-skilled, who save more of their income than lower-paid workers.

So Keating wants any budget stimulus to be directed towards the lower-paid, and a lot more spending on all levels of education and training, to help workers adopt and adapt to the digital workplace.

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