Saturday, July 18, 2020

We won't achieve economic reform until we start co-operating

If you wonder why the push for economic reform has ground to a halt, I’ve discovered the reason. It’s because the foundational assumption of conventional economics – that individuals competing in pursuit of their self-interest make us all better off – is only half the truth.

If the mention of economic reform made you think of tax reform, then you’re making my point. Those who want a higher GST because they’d benefit if the proceeds were used to lower income or company tax are stymied by the many punters convinced they’d be worse off if this “reform” came to pass.

Many other cases for reform suffer the same fate. Your pursuit of your self-interest is neutered by my pursuit of my mine.

What the conventional economic model misses with its emphasis on individuals, competition and self-interest is that much of the success of the human animal – including its success economically – is owed to people co-operating to achieve changes of benefit to the whole community.

Often, norms of socially acceptable behaviour – entrenched views about what behaviour is ethical and what isn’t - are used to encourage people to put the interests of the group ahead of their own immediate interests. Markets work much better, for instance, if it’s realistic to assume that almost all the people you deal with can be trusted to act honestly.

All this applies in spades to our failure to make progress in the area of reform that’s more important to our economic future even than conquering the coronavirus: stopping emissions of greenhouse gases from wrecking the climate.

Here, the owners and miners of our huge remaining deposits of coal and gas are fighting tooth and nail to delay the day when those deposits become worthless, while the rest of us are encouraged to put the frightening thought of having to pay a bit more for electricity and petrol ahead of the future environmental and economic wellbeing of our children and grandchildren.

It’s okay for the oldies – who, until this year’s bushfire conflagration, fondly imagined they wouldn’t live long enough to suffer the consequences of their selfish short-sightedness. And those who will suffer the consequences have either yet to be born or are only just realising what a mess their loving parents are leaving for them.

But the deterrent to action isn’t just that the (modest) adjustment costs are upfront, whereas the (much greater) costs of inaction are off in the uncertain future. It’s also that the greenhouse effect is global, not local.

As the climate-change deniers love reminding us, no amount of effort to reduce emissions on our part will make much difference until people in other parts of the world are doing the same. In which case, why don’t you and I do nothing and leave it to all the others? (Economists call this the “free-rider” problem.)

All this may explain why a recent discussion paper from the Academy of the Social Sciences in Australia, Efficient, Effective and Fair, included a chapter on the moral case for action on climate change, written by Professor Garrett Cullity, a philosopher from the University of Adelaide.

Cullity argues there are five reasons why climate change is a moral issue, each of which is independent of the others. The first is that it involves many causes of harm including extreme weather events, tropical diseases, and malnutrition.

“These harms are primarily borne by the most vulnerable members of the global community,” he says. “We should be morally concerned to reduce the amount of harm we do to them.”

The second argument holds if we believe there’s a risk of serious harm in the future but can't be sure it will come to pass. “Action that imposes serious risks on others can be morally wrong because it is negligent and reckless, independent of the harm that actually eventuates,” Cullity says.

These first two arguments give us moral duties of both “mitigation” (reducing the further damage our emissions are doing) and “adaptation” (helping vulnerable people to adapt to the damage already done).

“They apply not just to national governments, but to any agent whose actions contribute to increasing atmospheric greenhouse gas concentrations – including state and local governments, cities, corporations, non-government associations and individuals.

“And they apply to each of these agents unilaterally. The moral duty not to engage in actions that harm or endanger others is not a duty that we are exempted from when someone else is not complying with it.

“The strength of the duty is proportional to the harm or risk imposed if the duty is not followed, and it may be related also to the capacity to influence others to comply with their duty.”

The third argument concerns “contributional fairness”. When a group needs to achieve something important by acting together and is doing so by sharing the overall burden among its members, failure to contribute an equitable share of that burden amounts to free-riding. Duties of fair contribution apply to groups of any size.

In the case of a wealthy country such as Australia, the size of our contribution to the solution should reflect the size of our contribution to causing the problem, the benefit we have derived from past emissions-producing economic activity, and our relatively great “ability to pay”, as tax economists put it.

The remaining two moral arguments concern the responsibility of national governments. If you accept that they have a duty to protect future citizens, not just present ones, it follows that they must contribute to global mitigation, not just local adaptation. And, since the economic costs of responding to the problem get higher the longer you delay, they have a moral duty to begin now.

Conventional economics doesn’t take much interest in morality. But economies where everyone sticks out for Number One stop working very well. And self-interest isn’t enough to solve a “wicked” problem like climate change.
Read more >>

Wednesday, July 15, 2020

Don't forget those the pandemic leaves out in the cold

After a fortnight's patriotic duty swanning round the backblocks of the state dispensing modest monetary good cheer – and discovering we were far from the only cityslickers doing it – it's back to a city plunged into renewed foreboding. The greatest concern is the pandemic's returning risk to our lives but, for me, this worsens rather than detracts attention from the great economic cost: protracted unemployment. A second wave of the virus would bring a double-dip recession.

When Treasurer Josh Frydenberg – a man so committed to looking on the bright side he's positively Pythonesque – feels it his duty to advise that the official unemployment rate of 7.1 per cent is actually an effective rate of 13.3 per cent once you allow for the peculiarities of the lockdown, you know we must be in deep trouble.

He wouldn't be issuing such a warning if he didn't need to prepare us for next week's mini-budget, which the setbacks in Melbourne and Sydney will have caused to be a lot less penny-pinching than earlier planned.

Where before Scott Morrison might have told himself the worst was over and it was time to start limiting the damage to his precious budget, now he must keep the money flowing so as to limit the damage to the livelihoods of many workers and their families.

Back in March, many of the government's initial measures to limit the economic damage caused by his harsh but unavoidable efforts to stop the spread of the virus – including the innovative JobKeeper wage subsidy scheme and JobSeeker's doubling of the rate of unemployment benefits – were timed to last six months and so end in late September.

The mini-budget's main purpose is to announce what will happen after that. A point to remember is that these measures don't just directly relieve the financial pressure on people who've lost their jobs, they benefit all of us indirectly by injecting additional money into the economy, which then flows through many hands – shopkeepers and workers alike – keeping the economy moving and thus limiting the further rise in joblessness.

A further thing to remember is that the unemployed don't only need money to help them keep body and soul together and feed their families (not to mention money to keep their mobile working, travel to job interviews and be appropriately dressed), they also need help finding another job.

The terrible thing about recessions is that they throw the economy up in the air, so to speak, and what eventually comes down is different to what went up. Recessions accelerate the changing structure of the economy. The industries and occupations change, with some contracting and others expanding.

So the jobs move, and employers' demand for particular occupations changes. Even with assistance from the wonders of the internet, many workers need help to locate a new job, need guidance to give up on industry A and try industry B, or even help to retrain for a job in another occupation where demand is greater.

After a severe recession, it can take a year or more before the quantity of goods and services produced each quarter has returned to where it was before it started falling, and several years before it gets back to where it would have been had the recession not happened.

But it takes longer for employment to return to where it was and far longer for unemployment to fall. After the last recession, the number of people on unemployment benefits fell by almost half, from a peak of 890,000 in 1993 to 464,000. But get this: it took 14 years.

If that wasn't bad enough, in that time, the number of recipients who'd been on the dole for more than a year fell by only 20 per cent to 276,000.

One lesson from this is that it's the unemployed who'll bear most of the economic cost of this pandemic, however long it lasts. It will take longer than you may think for people who lose their jobs to find another. While they're out in the cold, we who've kept our jobs have a moral obligation to ensure they're given a reasonable sum to live on, as well as a lot of help finding a new berth.

Many will find a job within a month or two, but some will take much longer. And the longer it takes, the less likely it becomes. These are people who deserve extra help to avoid getting stuck in the mud at the bottom of the unemployment pool, and we should give it.

Last week the Australian Council of Social Service called for JobKeeper to be phased down only gradually, and for the JobSeeker payment to be increased permanently by at least $185 a week, which would lift it to the rate of the age and other pensions.

The focus of Centrelink and the Job Network should be switched from penalising the jobless for concocted infringements to actually helping them find jobs and retrain. It's the least we should do.
Read more >>

Monday, June 29, 2020

Morrison is taking the recovery too cheaply

In theory, recovery from the coronacession will be easier than recoveries usually are. In practice, however, it’s likely to be much harder than usual – something Scott Morrison’s evident reluctance to provide sufficient budgetary stimulus suggests he’s still to realise.

The reasons for hope arise from this recession’s unique cause: it was brought about not by a bust in assets markets (as was the global financial crisis and our recession of the early 1990s) nor by the more usual real-wage explosion and sky-high interest rates (our recessions of the early 1980s and mid-1970s), but by government decree in response to a pandemic.

This makes it an artificial recession, one that happened almost overnight with a non-economic cause. Get the virus under control, dismantle the lockdown and maybe everything soon returns almost to normal.

It was the temporary nature of the lockdown that justified the $70 billion cost of the unprecedented JobKeeper wage subsidy scheme. Preserve the link between employers and their workers for the few months of the lockdown, and maybe most of them eventually return to work as normal.

Note that, even if this doesn’t work out as well as hoped, the money spent still helps to prop up demand. Had we not experimented with JobKeeper, we’d have needed to spend a similar amount on other things.

Because this recession has been so short and (not) sweet, it’s reasonable to expect an early and significant bounce-back in the September quarter. Just how big it is, we shall see. But, in any case, there’s more to a recovery than the size of the bounce-back in the first quarter after the end of the contraction.

And there are at least five reasons why this recovery will face stronger headwinds than most. The first is the absence of further help from the Reserve Bank cutting rates. People forget that our avoidance of the Great Recession in 2009 involved cutting the official interest rate by 4.25
percentage points.

Second, Australia, much more than other advanced economies, has been reliant for much of its economic growth on population growth. But, thanks to the travel bans, Morrison is expecting net overseas migration to fall by a third in the financial year just ending, and by 85 per cent in 2020-21.

Now, unlike most economists, I’m yet to be convinced immigration does anything much to lift our standard of living. And I’m not a believer in growth for growth’s sake. It remains true, however, that our housing industry remains heavily reliant on building new houses to accommodate our growing population. And if Morrison’s HomeBuilder package is supposed to be the answer to the industry’s problem, it’s been dudded.

Third, we’re used to our floating exchange rate acting as an effective shock absorber, floating down when our stressed industries could use more international price competitiveness, and floating up when we need help constraining inflation pressures – as happened during most of the resources boom.

But this time, not so much. With the disruption to our rival Brazilian iron ore producer’s output, world prices are a lot higher than you’d expect at a time of global recession. And with world foreign exchange markets thinking of the Aussie dollar as very much a commodity currency, our exchange rate looks like being higher than otherwise – and higher than would do most to boost our industries’ price competitiveness.

Fourth, the long boom in house prices has left our households heavily indebted, and in no mood to take advantage of record-low interest rates by lashing out with borrowing and spending. The “precautionary motive” always leaves households more inclined to save rather than spend during recessions, but the knowledge of their towering housing debt will probably make them even more cautious than usual.

The idea that bringing forward the government’s remaining two legislated tax cuts could do wonders for demand is delusional. If you wanted the cuts spent rather than saved, you’d aim them at the bottom, not the top.

Finally, although our politicians and econocrats refuse to admit it, our economy – like all the advanced economies – has for most of the past decade been caught in a structural low-growth trap. We can’t get strong growth in consumer spending until we get strong growth in real wages. We can’t get strong growth in business investment until we get strong consumer spending. And we can’t get a strong improvement in the productivity of labour until we get strong business investment.

Meanwhile, the nation’s employers – including even public sector employers - will do what they always do and use the recession, and the fear it engenders in workers, to engineer a fall in real wages. Which will get us even deeper in the low-growth trap.

I fear, however, that Morrison and his loyal lieutenant, Josh Frydenberg, will learn all this the hard way.
Read more >>

Saturday, June 27, 2020

We should get a fair share of foreign investors' profits

Australia has been a recipient of foreign investment in almost every year since the arrival of the First Fleet in 1788. Yet for much of that time the idea of foreigners being allowed to own so much of our businesses, mines, farms and land is one many ordinary Australians have found hard to accept.

For older Australians, the thought of “selling off the farm” to foreigners makes them distinctly uncomfortable. Why can’t we do it ourselves and own it ourselves?

The short answer is, we could. But had we chosen that path we wouldn’t be nearly as prosperous today as we are. As the Productivity Commission reminds us in a paper published this week, you need money to set up a business, let alone a whole industry.

That money has to be saved by spending less than all your income on consumption. And had we been relying solely on our own saving, we’d have been able to develop much less of this vast continent than we have done. So, from the days when we were a British colony and had no say in the matter, we’ve invited foreigners to bring their savings to Australia and join us in exploiting the golden soil and other of nature’s gifts with which our land abounds.

Total foreign direct investment – that is, where the foreigner owns enough of the shares in a company to have some control over its management – is now worth about $1 trillion. The largest sources of direct investment are, in order, the United States, Japan and Britain. In recent years, of course, most of the action – and the angst – comes from China.

The less poetic way to put it is that Australia has been a “net importer of capital” for more than two centuries. It’s thus not so surprising that, despite whatever reservations ordinary Australians may have, the dominant view among our politicians, business people and economists has been that we must keep doing whatever it takes to attract the foreign investment we need to keep the economy expanding strongly.

For many years it was felt that we always run a deficit on our balance of trade in goods and services with the rest of the world, so we always need to attract sufficient net inflow of foreign capital to be sure of financing that trade deficit – as well as covering all the regular payments of dividends and interest we need to make to the foreigners who have invested in local businesses or have lent us money.

This mentality made sense in the days when we had a “fixed exchange rate” – when the government, via the Reserve Bank, set the value of our country’s currency relative to other countries’ currencies – particularly the British pound and, later, the US dollar – and changed that value only very rarely in situations where it couldn’t be maintained.

The point is that when you choose to fix the price of your currency, you do have to worry about getting sufficient net inflow of foreign capital to cover the deficit on the “current account” of the “balance of payments”. Should you fail to attract sufficient inflow, you’re forced into the ignominy of cutting the price you’ve fixed.

Now, this problem went away a long time ago. In 1983, after we’d been having a lot of trouble keeping our exchange rate fixed and our balance of payments in balance, we decided to join most of the other advanced economies in allowing the value (or price) of our currency to float up and down according to the strength of the rest of the world’s demand for the Australian dollar (the Aussie, as it’s called in the foreign exchange market) relative to the supply of it.

From that day, the two sides of our balance of payments – the current account and the capital account – were in balance, the deficit on one matched exactly by the surplus on the other, at all times. How? Because the price of the Aussie adjusted continuously to ensure they were.

The “balance of payments constraint”, which had worried the managers of our economy for so long, just evaporated. But here’s the point: the attitude that we must always be doing as much as we can to attract as much foreign investment as possible continued unabated.

There’s this notion that, in the now highly competitive, globalised financial markets, if poor little Australia doesn’t try really, really hard, we’ll miss out.

This, of course, is the reasoning behind the unending push by big business for us to cut the rate of our company tax. Our system of “dividend imputation” means Australian shareholders have nothing to gain from a lower company tax rate. The only beneficiaries would be foreign shareholders because they aren’t eligible for “franking credits”.

We’re asked to believe that how well the level of the nominal rate of our company tax compares with other countries’ rates is the main factor determining whether we get all the foreign investment we need. Not even how the tax breaks we offer compare matters much, apparently.

I don’t believe it. It’s a try-on. As the Productivity Commission’s paper reminds us: “Foreigners invest in Australia because of our fast-growing and well-educated population, rich natural resource base, and stable cultural and legal environment.”

Just so. Mining companies flock to Australia because we have the high-quality, easily-won minerals and energy they need. The idea that global companies such as Google or Amazon would give Australia a miss because our company tax rate’s too high is laughable. Especially when they’re so adept at minimising the tax they pay in advanced countries.

We should take a more hard-nosed, business-like attitude towards foreign investors such as the miners, which make huge profits but employ very few workers. When state governments fall over themselves building infrastructure for them and offering royalty holidays and other inducements, it matters greatly how much company tax they pay before they ship their profits back home.
Read more >>

Wednesday, June 24, 2020

Morrison moves the deck chairs on the hulk of our universities

A new rule of politics seems to be that no matter how badly the pollies have stuffed up some area of government responsibility, they can always make it worse. Enter the hapless federal Education Minister Dan Tehan who, doubtless acting under instructions from the boss, has just announced another set of passive-aggressive changes to university funding.

If, like a good Quiet Australian, you haven't been paying close attention, you may have gained the impression that the government is acting to help our unis to take in more local students – helping fill the vacuum left by the disappearance of overseas students – and changing the structure of tuition fees to encourage students into more occupationally oriented courses, which will make them "job-ready graduates" going into fields where the need for graduates is expected to be greatest.

You probably haven't noticed that, according to Tehan, the package includes "an additional $400 million over four years" for regional unis, and "a further $900 million" for the National Priorities and Industry Linkage Fund.

Except that the whole package is "budget neutral" – a bureaucrat's way of saying it will cost the government not an extra cent. Since the government's expecting extra demand for uni places over the next three years, this is tantamount to its first major cost-cutting exercise after taking fright at the blowout in the budget deficit caused by the lockdown of the economy. So the "extra" and "further" funding will be coming not from the government's pockets but those of the universities and their students.

The government will fund an extra 39,000 places by 2023 – an increase of about 6 per cent – as the recession prompts more school leavers to stay on in education (and avoid taking a gap year), but will compensate for this by cutting the amount of its funding per student.

According to calculations by Professor David Peetz, of Griffith University (whose former job as a senior federal bureaucrat helps him find where the bodies are buried), the government will cut its funding by an annual $1883 per student, with the average increase in tuition fees of $675 per student reducing the net loss to universities to $1208 per student. (The fee changes won't apply to existing students, however.)

That is, the unis are being asked to do more with less. It's a safe bet their main response will be to further increase their ratio of students to staff. Unis will become even more of a sausage factory – which will be really great for the nation's investment in "human capital".

My guess is that the changes to the structure of tuition fees – with a hodgepodge of big cuts, small cuts, small increases, big increases and no changes – are intended to give the appearance of doing something to increase employment, to gratify the parliamentary Liberal Party's antipathy towards the universities (hotbeds of leftie activists who think Black Lives Matter and have kids who wag school because the silly-billies are worried about climate change) and to divert attention from the way the unis have been short-changed.

With the fee for humanities degrees up by a mere 113 per cent, it's quite a diversion. I'll be diverted only to the extent of quoting from a speech by a Business Council official in 2016: business needed the skills of "critical thinking, synthesis, judgment and an understanding of ethical constructs". The humanities produced people who can "ask the right questions, think for themselves, explain what they think, and turn those ideas into actions".

Ah, maybe that's what the backbench doesn't fancy.

Professor Andrew Norton, of the Australian National University, a recognised expert, doubts that the fee changes will do much to change students' preferences away from courses they think they'd like. And Peetz points out that it's the unis, not the government, that will be bearing the cost of the fee reductions for those courses the government prefers.

Which brings us to Professor Ian Jacobs, boss of UNSW, who points to the perverse incentives the changes will create (assuming the Senate is mad enough to pass them). Unis will be tempted to offer most places in those courses with the widest gap between the high government-set tuition fee and the cost of running the course. They'll be pushing BAs harder than ever.

This, of course, is exactly the way you'd expect the vice-chancellors to behave when you've taken government-owned and regulated agencies, spent 30 years pursuing a bipartisan policy of cutting their federal funding (from 86 per cent to 28 per cent of total receipts, in the case of Sydney University) and pretending they've been privatised.

Then, after they've turned to getting about a quarter of their funding from overseas students, but the coronavirus obliges you to ban foreign travellers, you hang them out to dry, refusing them access to the JobKeeper wage subsidy scheme because they should never have allowed themselves to become so dependent on a single source of revenue.

For a while I thought the crisis had got Scott Morrison governing for all Australians. It hasn't taken him long to revert to playing friends and enemies.
Read more >>

Monday, June 22, 2020

Wage tribunal saves employers (and us) from their own folly

Sometimes if you really want to help somebody, you do them a favour and don’t do what they ask you to. The employer groups begged the Fair Work Commission not to increase minimum award wages during the recession, but it broke with convention and decided on a rise intended to preserve the real value of award wages.

The unions wanted a 4 per cent rise, the employers wanted none, and the Morrison government didn’t have the courage to say what it wanted (that is, it wanted whatever the employers wanted, but didn’t want to lose workers’ votes by saying so).

So the spin-doctor-renamed industrial relations commission did what came naturally and split the difference at 1.75 per cent (which will amount to a lot more than $13 a week for many of the 2.2 million workers on award wages).

In recessions past, the commission has almost always “deferred” the annual increase – without any catch-up the following year. That is, an unspoken cut in real wages. This time the quarter of award workers in (mainly public-sector) industries whose job numbers have been least affected by the lockdown will get their rise as usual on July 1.

The 40 per cent of award workers in only moderately affected industries (including construction and manufacturing) will have to wait four months until November 1, with award workers in badly affected service industries (accommodation, arts and recreation, aviation, retail and tourism) waiting seven months until February 1.

In other words, a carefully calibrated compromise that – despite the anguished posturing with which industrial relations abounds – won’t annoy any of the parties. Both the unions and the employer groups will assure their members they’ve had a qualified win.

Even so, any kind of pay rise during what will be the deepest contraction since the 1930s is something for the history books. It’s happened partly because of the unique circumstances surrounding this recession and partly because the economics profession is in the middle of slowly turning its conventional wisdom on minimum wage rates on its head.

You can see that in the results of the Economic Society of Australia’s recent poll of 42 academic and business economists, asking whether they agreed that “a freeze in the minimum wage will support Australia’s economic recovery”.

On past performance, you could have expected overwhelming support for that statement of economic orthodoxy. Instead, two respondents were undecided and, of the rest, only 21 agreed while 19 disagreed.

This question has a long history in economics. After the severe recession of the mid-1970s and the steady rise in unemployment that followed, there was a long debate between economists over the rival theories of the causes of – and thus cures for – unemployment.

Neo-classical economists argued that real wage increases far in excess of the improvement in the productivity of labour had raised the price of labour to the point where employers preferred to invest in labour-saving machines rather than hire all the people wishing to work.

By contrast, Keynesian economists argued that high unemployment was explained by “deficient demand” – employers weren’t hiring enough workers because consumers weren’t buying enough of their products to make it necessary.

It wasn’t until 1988 that two Reserve Bank economists, Bill Russell and Warren Tease, published a seminal article resolving the debate: the rise in unemployment could be explained by both theories, in roughly equal measure.

But that was when we were still working to overcome the extraordinary rises in real wages under the Whitlam government. Even by the end of 1985, the Australian Bureau of Statistics’ index of real labour costs per unit of output – a measure of how real wages are growing relative to labour productivity - stood at 116. That is, real wages were running 16 per cent ahead of productivity.

Nowadays, the index has been a bit below 100 since the end of 2017. There’s no way wage rates can be said to be excessive. More to the point, there’s no visible evidence that moderate increases in minimum award wages have discouraged growth in employment.

No, the real problem is that employers and their Canberra lobbyists are caught in a “fallacy of composition” that does much to make recessions worse: it may make sense for individual employers to keep wage rises to a minimum, but when all employers do it, all employers suffer. Why? Because what’s a cost to one employer is income to another employer’s customers.

Our economic growth was weak even before the coronacession, primarily because real wage growth was weak. Using the recession as an excuse to actually cut real wages just gets us in deeper, making demand even more deficient. Most employers and half our economists don’t understand that. Fortunately for them, the Fair Work Commission does.
Read more >>

Saturday, June 20, 2020

A recovery won’t get us out of the low-growth trap

The most useful insights in economics are deceptively simple. The most widely relevant is the idea of “opportunity cost” – whatever you choose to do costs you the opportunity to do something else – but the most useful after that is probably the notion of supply and demand. This can tell us much about why we’re in recession and how we recover from it.

The discipline of “micro-economics” tells us that a market consists of firms willing to supply a particular good or service and customers interested in buying (demanding) that good or service. If the two sides can agree on the price of the item, a sale is made. It’s the relative willingness of the supplier and the demander that determines the price.

The discipline of “macro-economics” takes all the markets that make up a market economy like ours and studies the relative strengths of “aggregate” (total) supply and “aggregate” demand. When aggregate demand is growing more strongly than aggregate supply, this puts upward pressure on prices, causing inflation.

When the growth in aggregate demand is weaker than the growth in aggregate supply, this means firms have idle capacity to produce goods and services and some of the workers who want to help in the production process will be unemployed.

Your typical recession involves a boom in which demand outstrips supply and the rate of inflation is high, but unemployment is low. The managers of the economy use higher interest rates and cuts in government spending or tax increases to try to slow the growth of demand and thus reduce inflation. But they end up overdoing it and the boom turns to bust. Demand falls back, so the inflation rate falls, but unemployment shoots up.

But that doesn’t describe this recession. There was no preceding boom. The growth in demand hadn’t been strong enough to take up all the growth in firms’ “potential” to supply goods and services – which the econocrats estimate was growing by 2.75 per cent a year - meaning the inflation rate’s been lower than their target of 2 to 3 per cent a year, while the rate of unemployment’s been higher than their target of about 4.5 per cent.

So, with no boom and no jamming on of the brakes, why are we in recession? Because the sudden arrival of the coronavirus and the need to stop it spreading and killing many people obliged the government to do something that would normally be unthinkable: order the closure of non-essential industries and order all of us to stay in our homes and leave them as little as possible.

The management of the macro economy is intended to be “counter-cyclical” – to smooth the economy’s path through the ups and downs of the business cycle by slowing demand when it’s too strong and boosting it when it’s too weak.

So, obviously, the task now the virus has been suppressed and we can end most of the lockdown (but not yet open our borders to foreign travellers) is to “stimulate” the economy to get demand growing more strongly than supply is growing and start reducing unemployment. (Supply increases because of growth in the population, more people participating in production, and business investment to improve the productivity of the production process.)

The authorities usually stimulate demand with big cuts in interest rates (known as monetary policy) and by increasing government spending or cutting taxes (fiscal policy). Trouble is, this time interest rates are already as low as they can go, meaning virtually all the stimulus will have to come from fiscal policy – the budget.

This standard approach assumes the imbalance between demand and supply is essentially “cyclical” – caused by short-term factors. But we shouldn’t forget that, before the virus arrived out of the blue, we were struggling to explain why, at least since the global financial crisis more than a decade ago, economic growth had been much weaker than we’d been used to.

This was true in Australia where, except for a year or two, the growth in real gross domestic product – our production of goods and services - had fallen well short of our potential growth rate of 2.75 per cent a year. But it was just as true of most other advanced economies.

The fact that this weak growth had gone on for most of a decade, and applied to so many countries, was a pretty clear sign the imbalance between supply and demand wasn’t just cyclical – short-term – but was “structural”: long-lasting.

The symptoms of weakness included weak growth in wages, consumer spending and business investment, without much improvement in the productivity (efficiency) of our production process. Because the old word for structural was “secular”, economists called this phenomenon “secular stagnation”. But Mervyn King, a former governor of the Bank of England, prefers to say we’re caught in a “low-growth trap”.

Why are we caught in a protracted period of weak growth? Because aggregate demand has gone for a decade failing to keep up with the growth in aggregate supply – our potential (but not our reality) to produce goods and services.

The evidence that demand isn’t keeping up with supply is unusually low inflation and low growth in real wages. Also the weak rate of improvement productivity – although this also means supply isn’t growing as strongly as it used to, either.

But the ultimate evidence of secular stagnation is that interest rates have been so close to zero for so long. Interest rates are just another price. Why are they so low? Because the supply of money savers are making available to be borrowed exceeds the demand for those funds by people wanting to invest.

The debate over the possible reasons why aggregate demand is chronically falling short of aggregate supply is a fascinating subject for another day. What’s clear is that recovering from this cyclical recession won’t eliminate our pre-existing structural weakness.

It’s equally clear, however, that if the Morrison government isn’t prepared to use its budget to stimulate demand sufficiently, we won’t even achieve much of a recovery from the recession.
Read more >>

Wednesday, June 17, 2020

Economy's need may run second to Morrison's spending hang-ups

Looking back, Scott Morrison's response to the coronavirus has been masterful on the medical side and, on the economic side, his willingness to spend money cushioning the job-threatening consequences of the lockdown was unstinting. But (and there had to be a but) with the economy's recovery far from assured I fear his nerve may be cracking.

The plain truth is that the only way out of deep recessions is for governments to spend their way out. But for a government as far to the right as Morrison's, spending money with enthusiasm is an unnatural act. It has an ideological objection to government spending which, it believes, is a necessary evil at best, and so should be kept to a minimum.

It claims to be motivated by the pursuit of Jobs and Growth but its "revealed preference", as economists say – not what it says, but what it does – is to prioritise the elimination of debt and deficit.

So great is its aversion to debt that the government is impervious to reason. Interest rates have been so low for so long that governments can borrow for 1 per cent or less. When you allow for an inflation rate of about 2 per cent, this means financial institutions (including your super fund) are willing to pay the government for the privilege of lending to it.

In which case, why not borrow as much as you need? Because that word "debt" just sounds so bad. And that debt will have to be repaid by our children. Actually, it won't be. Governments rarely repay debt. What they mainly do is roll it over while they wait for the economy to outgrow it, with help from inflation.

And ask yourself this: what do you think your kids would prefer to inherit? A bit more public debt or an economy that's been deeply recessed for a decade, with stagnant living standards, little opportunity to get ahead and stories about how much better things were in their parents' day.

Recessions always involve the private sector – businesses and households – contracting and the public sector expanding to take up the slack and get things moving again. In our particular circumstances, six years of weak wage growth and record household housing debt mean consumers have little scope to start spending big.

For their part, businesses won't spend on expansion until they see a reason to. Morrison's notion of incentivising business with investment tax breaks, changes to wage fixing and cuts in red tape is magical thinking.

That leaves it up to the government to keep spending until the private sector has the wherewithal to spend. Without a government-laid foundation, believing in a "business-led recovery" is believing the economy runs on spontaneous combustion.

I suspect Morrison has looked at our prospective budget deficits and taken fright. Paradoxically, although he readily agreed to the JobKeeper wage subsidy scheme when told it would cost $130 billion, when Treasury realised it wouldn't take nearly as much to "flatten the curve" as the epidemiologists had led it to expect and so cut the cost to $70 billion, Morrison saw this as a miraculous escape from the sin of profligacy.

The ideologically pure end of his own party started urging him to spend no more. And this week he started talking about the need to find budgetary savings.

This would be completely contrary to the advice he received only last week from the Organisation for Economic Co-operation and Development that "there is ample fiscal space to support the economic recovery as needed". This is the OECD's way of saying "if you Aussies think you have a frightening level of debt, you're kidding yourselves". The International Monetary Fund says the same.

The OECD continues: "The scarring effects of unemployment – especially for young workers – should be alleviated through education and training, as well as enhancing job search programs. Firms should continue to be supported ... The authorities should be considering further stimulus that may be needed once existing measures expire ... Such support should focus on improving resilience and social and physical infrastructure, including strengthening the social safety net and investing in energy efficiency and social housing."

To be fair, should Morrison turn from spending to cutting before the economy has fully recovered, he'd be no more disastrously wrong-headed than Britain's David Cameron and other European leaders after the global financial crisis, when they started tightening their budgets too soon and condemned their countries to a decade of weak growth.

You can see Morrison's change of tack in his poorly received HomeBuilder package. Reviving the housing industry is a standard part of the response to every recession, but this is the package you have when you're only pretending to have a package.

It's too small to make much difference and the deadlines for its $25,000 grants are so tight few people are likely to qualify. Glaring by its absence was any mention of spending on social housing.

But this raises another of the Libs' hang-ups. They oppose government spending in general, but spending that helps the needy in particular.
Read more >>

Monday, June 15, 2020

Morrision's report: high marks so far, but now the hard part

There are more ways than one for Scott Morrison still to stuff up the virus crisis. And in seeking to avoid such a calamity he’d do well to remember a rule followed by all successful leaders: don’t believe your own bulldust.

It’s become increasingly clear that Morrison’s handling of the corona crisis has benefited greatly from his disastrous handling of the bushfires. Obviously, he resolved not to make the same mistakes twice – and he hasn’t.

He was too slow to appreciate the magnitude of the political, environmental and human consequences of the fires. And by the time he did, it was too late. But when the medicos gave him the classic Treasury advice to "go early, go hard", he took it.

When you’re dealing with "exponential" growth, starting a week or two earlier than you might have can make all the difference. And it has. Morrison’s entitled to be terribly proud of our success in suppressing the virus, which compares well against all the big advanced economies.

With the bushfires, Morrison was wrong to see them as primarily a state responsibility. What the constitution says and what voters think aren’t always aligned. A good rule for prime ministers is that any problem that affects more than one state is a problem the electorate will hold the feds responsible for. Which is fair enough when you remember it’s the feds who control the purse strings.

In our federation, most problems involve shared federal and state responsibilities. Health and education are key examples. In which case, Mr Moneybags should always take the lead. Morrison’s masterstroke solution in the case of the virus was the national cabinet – though I share the scepticism of the former premier who doubted that the unity would last once we’d all stopped singing Kumbaya.

Another reaction to the fires failure, I reckon, was Morrison’s decision to under-promise and over-deliver. This fitted with the epidemiologists who, having to predict the consequences of a new virus about whose characteristics they knew little, seem to have decided to err on the high side.

For his part, Morrison left us with the impression the lockdown would last six months, and didn’t discourage the econocrats from predicting that gross domestic product would fall by 10 per cent and the rate of unemployment would double to 10 per cent.

It now seems clear it won’t be as bad as that. We’ll learn this week whether the fall in employment in the four weeks to mid-May was anything like as bad as in the four weeks to mid-April. We may well have seen the worst of it – at least until the JobKeeper wage subsidy scheme winds up in late September.

But having to wait until mid-June to know where we were a month earlier is frustratingly slow in this uniquely fast-moving recession. The "weekly activity tracker" – based on high frequency data such as restaurant bookings, confidence, retail foot traffic, hotel bookings, credit card usage, etcetera – used by Dr Shane Oliver, of AMP Capital, suggests the economy hit bottom in mid-April and has now risen for eight weeks in a row.

The medicos hate it when I say this, but my guess is that suppressing the virus will prove to be the easy half of the problem. Getting the economy back to being anything like where it was in December is a much harder ask, demanding first-rate judgment from Morrison’s econocrat advisers and Morrison having the humility to take that advice and suppress his instinct to play political favourites.

This is where he must resist the temptation to believe his own political bulldust. Exhibit A: the claim that we entered the crisis from a "position of strength". This is the very opposite of the truth, which is why restoring the economy to healthy growth will be exceptionally hard. The key problem is six years of weak wage growth, which the recession is making even weaker.

Exhibit B: Morrison’s belief that, come the election in early 2022, voters won’t blame him for still-high unemployment and weak growth because they’ll remember with gratitude his sterling performance in averting their own deaths. If only.

Exhibit C: Morrison’s belief that supply-side economic reform aimed at raising the economy’s "potential" growth rate in the medium to longer term is an adequate substitute for demand-side budgetary stimulus in the short term.

That yet more tinkering with the tax system and the wage-fixing system is what will give us "business-led growth" out of recession. That’s not economics, it’s rent-seeking propaganda you mouth while swinging one for your big-business donors. Jobs and growth – yay!

Actually believe such tosh and you’re dead meat.
Read more >>

Saturday, June 13, 2020

The tables have turned in our economic dealings with the world

If you know your economic onions, you know that our economy has long run a deficit in trade with the rest of the world which, when you add our net payments of interest and dividends to foreigners, means we’ve long run a deficit on the current account of our balance of payments and, as a consequence, have a huge and growing foreign debt.

Except that this familiar story has been falling apart for the past five years, and is no longer true. In that time, our economic dealings with the rest of the world have been turned on their head.

Last week the Australian Bureau of Statistics announced that we’d actually run a surplus on the current account of $8.4 billion in March quarter. Does that surprise you? It shouldn’t because it was the fourth quarterly surplus in a row.

But that should surprise you because the first of those surpluses, for the June quarter last year, was the first surplus in 44 years. And now we’ve clocked up four in a row, that’s the first 12-month surplus we’ve run since 1973.

Of course, when the balance on a country’s current account turns from deficit to surplus, its net foreign liabilities to the rest of the world stop going up and start going down.

What’s brought about this remarkable transformation? Various factors, the greatest of which is our decade-long resources boom, which occurred because the rapid development of China’s economy led to hugely increased demand for our coal, natural gas and iron ore.

A massive rise in the world prices of those commodities, which began in 2004 and continued until 2011, prompted a boom in the construction of new mines and gas facilities which peaked in 2013. From then on, the volume of our exports of minerals and energy grew strongly as new mines came online.

But while our mining exports expanded greatly, the completion of the new mines and gas facilities meant a fall in our extensive imports of expensive mining equipment. As a consequence, our balance of trade in goods and services – which between 1980 and 2015 averaged a deficit equivalent to 1.25 per cent of gross domestic product – has been in surplus ever since.

The rise of China’s middle class gets much of the credit for another development that’s helped our trade balance: strong growth in our exports of services, particularly inbound tourism and the sale of education to overseas students.

When our country has gone since white settlement as a net importer of foreign financial capital – which has been necessary because our own savings haven’t been sufficient to fund all the physical investment needed to take full advantage of our country’s huge potential for economy development – it’s not surprising we have a lot of foreign investment in Australian businesses and have borrowed a lot of money from foreigners.

In which case, it’s not surprising that every quarter we have to pay foreigners a lot more in interest and dividends on their investments in our economy than they have to pay us on our investments in their economies.

This “net income deficit” – which is the other main component of the current account - has grown enormously since the breakdown of the post-World War II “Bretton Woods” system of fixed exchange rates prompted us to float our dollar in 1983 and started a revolution in banks and businesses in one country lending and investing in other countries, including the rise of multinational corporations.

That was when Australia’s net foreign debt started rising rapidly and the net income deficit began to dominate our current account. The net income deficit has averaged a massive 3.4 per cent of GDP since the late 1980s.

It hasn’t changed much since the tables started turning five years ago. Except for one thing. The rapid growth in our superannuation funds since the introduction of compulsory employee super in the early 1990s has seen so much Australian investment in the shares of foreign companies that, since 2013, the value of our “equity” investment in other countries’ companies has exceeded the value of more than two centuries of other countries’ investment in our companies.

At March 31, Australia had net foreign equity assets worth $338 billion. You’d expect this to have significantly reduced our quarterly net income deficit, but it hasn’t. Why not? Because the dividends we earn on our investments in foreign companies aren’t as great as the dividends foreigners earn on their ownership of our companies. Why not? Because our hugely profitable mining industry is three-quarters foreign-owned.

If you add our net foreign equity assets and our net foreign debt to get our net foreign liabilities, they’ve been falling as a percentage of GDP for the past decade. If you look at the absolute dollar amount, just since December 2018 it’s fallen by more than 20 per cent.

If all this sounds too good to be true, it’s certainly not as good as it looks. The final major factor helping to explain the improvement in our external position is the weakness in the economy over the 18 months before the arrival of the virus shock.

The alternative way to see what’s happening in our dealings with the rest of the world is to focus on what’s happening to national saving relative to national (physical) investment. That’s because the difference between how much the nation saves and how much it invests equals the balance on the current account.

Turns out that national investment has fallen in recent times (business investment is weak, home building has collapsed and government investment in infrastructure is falling back) while national saving has increased (households have been saving more, mining companies have been retaining much of their high profits, and governments have been increasing their operating surpluses).

So much so that the nation is now saving more than it’s investing, giving us a current account surplus. But this is a recipe for weaker not faster “jobs and growth”.
Read more >>