Two wrong commentary streams on Oz economy

WE SEEM to have a two-stream commentary interpreting our two-speed economy. One expresses puzzlement that Australia’s comparatively stellar economic performance is yielding nothing but whingeing from the voters and undeserved poor marks for a good government. The other asserts the Government is bungling and if only it would move out of the way the private sector would bring prosperity to all.

Both views allow political viewpoints to colour their interpretations and they both ignore some fundamental economic principles.

In the past week, Prime Minister Gillard lauded the Australian Way to overseas audiences, with a great emphasis on government spending as a vehicle to economic growth and prosperity in hard times.

Her message was: you lot should do what we are doing. But the message was flawed. Most countries could not have done what the Rudd-Gillard Governments did, because they were coming off different bases.

It is a myth that greater government spending always stimulates economies through the multiplier effect. The multiplier effect is the great gift to economics of the neo-Keynesians. They argue that if you give someone a dollar and they spend most of it, and the next recipient spends most of it and so on, the dollar has a multiplier effect. One dollar of government spending boosts the economy by $2, the theory goes.

So when things are bad just add government money.

Well, more recent economic thinking suggests this is far too simplistic. Government spending will stimulate the economy only in certain conditions. They are: that the public sector has little debt because it has been prudent in the good years; that the stimulus is modest and not continuous; and that people retain confidence in the currency and banking systems.

If a government already has high debt; if it has already pushed a lot of public money into the economy and if people are concerned about the currency, inflation and the banking system, then more government spending merely crowds out the private sector and there is no multiplier effect.

A good explanation of this is in Jim Rickard’s new book, Currency Wars.

The Australian Way (Australia’s successful navigation through the global financial crisis) comprises more than government spending as a means of stimulating the economy and avoiding high unemployment. But neither side of politics wants to admit it. Each side wants to cherry pick its own contributions as the cause and ignore the rest.

The other legs to the Australian Way are: a competent Reserve Bank which has kept interest rates fairly high; an almost ideal level of regulation in the banking system; a decade of public debt reduction and government surpluses; and tax reform (especially the GST) – though not enough of it.

These things inspire confidence. High interest rates inspire savings, enabling banks to lend. A good tax system ensures more equality and efficiency. It also enables government to perform better. The Howard Government’s surpluses permitted the Rudd-Gillard stimulus.

Compare that to what happened in Europe and the US.

The US Fed under Alan Greenspan and Ben Bernanke in the past decade worked on a policy of ultra-low interest rates and printing money to devalue the dollar. It failed to regulate the banks enough. The Bush Administration let the banks do what they liked. It also lowered tax on the wealthy and madly increased public spending, mainly on the military, thereby destroying the Clinton Administration’s efforts to get into surplus. The US tax system has been corrupted because of the ease with which the wealthy can convert their income to low-tax capital gains.

When the banks got into trouble, the Fed and US Administration should have let them go broke and wipe all the toxic debt off their books, so new banks could restart the investment cycle. Instead, they were propped up and still carry a lot of toxic debt so are not in a position to lend. Moreover, people do not have much confidence in them anyway.

In Europe, most countries in the south have suffered chronic public deficits and many of them have laughable tax systems. This was made worse by the Euro. If Greece, Spain and Ireland had never joined the Euro they could have devalued their currencies and wiped a lot of their internal debt. But now the debt is denominated in Euros.

For the Australian Way to continue working in Australia, though, the Government and the Reserve have to keep their nerve. Deficits and stimulus packages will not work from our present base. They worked once, but that does not mean they will work again.

Lowering interest rates works up to a point. After that you shatter the incentive of people moving to or in retirement to save or leave money in safe bank deposits. That means less money for banks to lend to investors.

And if the Coalition wins the next election it must resist the temptation to deregulate. The regulations that prevented takeovers and required banks to keep a certain percentage of their assets liquid and safe and imposed prudential requirements on their lending meant Australian banks did not go the way of US banks. The Government’s deposit guarantee also helped.

The mining boom has helped a bit, but much less than popularly imagined. Mining is not a big employer, taxpayer or payer of dividends to Australians. Moreover, it tends to suck in capital that would otherwise go to other parts of the economy and be more geographically spread.

So if unemployment is down and growth is good, why are we whingeing? The stream of commentary that is puzzled by this do not understand that a lot a people are quite right to complain by what they rightly see is lowering of service provision in education, health, public transport, other infrastructure and the natural environment.

A report last week from the Gillard government’s infrastructure finance working group to the economic forum warned of an infrastructure deficit. It was not keeping up with present demand and would not keep up with projected demand.

Its solution, of course, ignored the blindingly obvious: high population growth. Instead, it talked about more user-pays solutions. Those just add to inequality and put more burden on the wider public, so they rightly complain and vote governments out of office.

An ACT Assembly committee report into the ecological carrying capacity of the ACT and region typified the mentality at the state level. It called for steps to “prevent and mitigate the adverse environmental impacts of population growth”.

Governments should stop trying to deal with the adverse impact of population growth and deal with population growth directly – by lowering it.

We have managed our economy fairly well by world standards, but that is now threatened by unnecessarily imposing on ourselves the impossible burden of delivering the infrastructure and protecting the environment for a population growing (exponentially) at nearly 2 per cent.

A 2 per cent population increase doubles the infrastructure requirement – 2 per cent a year to replace major infrastructure that wears out at an average of 50 years and 2 per cent more to cater for the extra population.

People complaining may say they are complaining about government failure to deliver services – but the underlying cause should be more obvious.
CRISPIN HULL
This article first appeared in The Canberra Times on 23 June 2012.

3 thoughts on “Two wrong commentary streams on Oz economy”

  1. The infrastructure in Australia is broken. Take a look at Sydney, the roads are packed and the only solution the gov’ts have is user paid slow ways. The freeway from campbelltown to liverpool is 20-30 kmh. The railways are slower today than when the first train travelled from Central to Parramatta nearly one hundred years ago. Increasing population density in inner cities has resulted in no sports grounds for children to play on. The ACT gov’t cannot see the writing on the wall and buries light rail.

    I have Unnoccupied Canberra and now live in rural NSW. There is no traffic, i drive past creeks, cows and forests to go shopping. I get free parking ALL day in town, I am no longer woken up by helipcopters and sirens. I also bought a 3 bed house for less than $100K.

    Federal and State governments know that Sydney, Melbourne and Brisbane are broken. Just to bring current Infrastructure up to standard would take over a decade IF the money was available. With further population (immigrants and breeding) as you have pointed out the cost will double, in fact we all know it is never going to happen.

    Governments should act urgently on decentralisation. The NBN was hailed as a “saviour” to our economy, yet no government department has moved staff out of the big cities to rural Australia. Rural towns offer much cheaper office space, better lifestyle and with NBN (even current WAN) it doesn’t matter where most of the staff is. Most Rural towns could handle the 2% increase in population with their current infrastructure, in fact they could probably handle 10%, and there are a lot of rural towns.

    hooroo

  2. Nicely balanced article – though to be fair you must acknowledge that John Howard built much of his surplus on very low public works spending and a brutal budget on funding both the education and healths sectors. Add to that a commodities boom and its no great fiscal virtue to generate such a surplus.
    But the principle that a surplus is neccessary to precede massive public spending, without critical deficits being built up, is sound. Its also a common dilemma for many nations who are not in a postion to build up such surplus’s, IE Greece, Spain, Portugal etc.
    The population is is tanglier’ than you suggest though. With a rapidly aging population and a current skills crisis soon to be massively increased by the loss of retirees Australia has little choice but to have increased is migration and birth rates to fill the shoes of the unporecedented numbers leaving the economy.
    When added to the huge increase in demand for services only set to increase overt he next two decades by those same retirees and the drifting ratio of tax payers supporting non tax payers/retirees and we have a serious economic conundrum. Admittedly structural unemployment driven by technological innovation will take care of some of this nasty equation, but its no magic bullet. But niether is state structured overpopulation over burdening our ecological and economic bases.
    The only long term viable solution I can see is a technological one. We need people to live much longer, stay healthier and work longer to offset the simple maths involved in the tax payer to retiree ration and soften the loss of skills. A working life of 80 or more years as opposed to 40 or less removes the numerical and skills lag between those entering the economy and those leaving it.

  3. Great article Crispin – its like you read my mind and put it into words, particularly your analysis on population.

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