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.
This article first appeared in The Canberra Times on 23 June 2012.