On things nautical!

The only nautical analogy that I have carried through my days as a professional economist is the one that apparentely John F. Kennedy coined – A rising tide lifts all boats. It was used by famous American progressive economist Arthur Okun in the 1960s to motivate his research on upgrading benefits of what he called the high pressure economy. It was an aspirational term used to goad national governments into fiscal action to ensure that the economy was always as close to full employment (high pressure) as possible. Accordingly, when the economy is at high pressure, both the strong and the weak prosper. Labour participation is strong, unemployment is at the irreducible minimum, labour productivity is high, wages are high and a number of upgrading effects across social classes and generations occur. Children from disadvantaged families get a chance to transcend poverty and workers who are displaced by global economic changes are able to be re-absorbed into productive work. Direct public sector job creation is a significant part of the national government’s responsibilities in this regard. If the private sector is incapable of providing enough jobs then there is only one sector left, ladies and gentlemen. Today I read of a new nautical analogy and my how times have changed! Its time to debrief again!

The new nautical analogy is morose, defeatist and underpins a view of government that is neither credible from an economic theory perspective or aspirational from the perspective of what we should expect from our national government in terms of full employment. This new analogy “A tight ship can emerge safe from storm” was the title of an article by The Australian economics editor Michael Stutchbury in today’s newspaper. I don’t think this maritime analogy will stand the test of time however – and thanks be for that.

The thesis of the opinion piece is that if Australia resists the need for any further fiscal stimulus packages then we will keep our AAA credit rating intact. The claim is that we will be pulled up by China and avoid a “balance of payments blowout” (whatever that means in a flexible exchange rate system) if we just bunker down and cripple the power our national government has to invoke those upgrading effects that arise from high growth.

Further, the claim is if we continue to stimulate the economy to defend jobs and the livelihoods of the most disadvantaged workers – which is chacterised by the journalist as (can you believe it) panicking then:

Australia could become a bigger risk for the foreign investors that fund our chronic external deficit. If we lost our AAA credit rating, the federal Government would find it harder to raise offshore funds. So would the states and the banks, which rely on the feds’ AAA-rated balance sheet. The credit crunch would intensify, undercutting any recovery.

The journalist then recommends that the Australian government resist the OECD’s advice to further expand fiscal policy and that the central bank should only slowly ease interest rates.

There is so much wrong with this conception that it is hard to know where to start. First, foreign investors do not fund our trade deficit. Our desire to buy more off them in real terms than we sell them (that is, more imports of goods and services than exports) finances the foreign desire to accumulate financial assets in our currency. We finance them! And given exports are a cost (they represent real things that we do not use ourselves) then it is good that we can get the rest of the world to ship more real stuff to us than they want from us. This is possible because they want to have AUD financial assets in their portfolio. Sure enough, if they suddenly changed their mind about that then we would have to reduce our net exports. But while it lasts we should be happy to have more real things than we ship away. After all, standards of living will never be reflected in nominal (financial) wealth. It is the command over real goods and services that determines how well off a nation and a person is (in the narrow terms that economists think within!).

Second, I intend to write a blog on ratings (several people have asked me about them) so I will keep it short here. The ratings agencies are essentially corrupt (they admitted this to the US Congress hearings in 2008 – taking payments in return for ratings that they knew were incorrect); error-ridden (they admitted this to a UK enquiry) and use models that bear no resemblance to the way the modern monetary economy works. They rated Enron continuously at investment grade even though they knew long before that Enron would collapse.

To illustrate how stupid the ratings are, the ratings agencies reduced the rating on Japanese government sovereign debt to the same level of Botswana earlier in this decade. They considered the Japanese government was in danger of becoming insolvent! No sovereign government can be insolvent in terms of the debt they issue in their own currency. It is simply a nonsense of the highest order. Any sovereign government can simply credit a bank account to relinquish the bond and interest on maturity. There is no financial constraint and no possibility of default.

The ratings agencies, are just money-making enterprises that are similar to “mail-order degree shops” – you pay the shop, you get the paper you want. Pay them more you will get a higher degree. Even more – you can call yourself Dr with your new PhD.

Third, even if they lowered the ratings on Australian government sovereign debt what problem would that represent? The Australian government doesn’t have to borrow abroad to finance spending. In fact, no sovereign government should ever borrow in a foreign currency. That is a recipe for disaster. But more importantly, a sovereign government does not need finance its spending. Thus, it doesn’t even have to borrow locally if it is happy for monetary policy to become dependent on competition in the interbank market. But even then, the RBA could continue to target its preferred monetary policy rate by just paying the commercial banks the target rate on excess reserves. Then no debt issuance would be required and the spending would flow to lift employment in the economy and the monetary policy stance would be preserved.

There might be implications for state governments which could easily be overcome through Federal government financing – that is, avoiding the commercial markets altogether.

The private borrowers who may have to pay more for money (say the banks) should not be seen as more important than the need to get the economy out of the spending slump. The costs of persistently high unemployment (both economic and social) will always dwarf any residual costs that might be incurred if private finance is slightly more expensive.

Fourth, the credit crunch has nothing to do with a lack of funds. Loans create deposits after all. The reason banks are not lending has been covered in earlier blogs. Repeat: they are not lending because they do not think there are credit worthy customers knocking on their doors. This is because they fear that the goods and services which would be created by the capital loaned may not sell in today’s constrained economic environment. Solution: the Government needs to further stimulate the economy to get orders moving and keep employment and wages strong to ensure workers keep buying things. The last thing you want in this environment is for the Government to hold back on putting a nominal demand floor into the economy. To adocate otherwise is sheer idiocy and … wilful neglect!

With the OECD now estimating that the global contraction will be around 4.3 per cent this year (that is, in the OECD economies), and Australia precariously close to being declared officially in recession, there is a need for more spending to fill the gap. Given labour force growth in Australia is about 1.6 per cent per annum and labour productivity growth around 1 per cent, GDP growth would have to be around 2.6 per cent at the moment to keep the unemployment rate stable. So if the Australian economy slides further and, say, records a negative annual GDP growth rate of 1 per cent, then we would expect to see the unemployment rate climb up around 2.6 percentage points. That would take it close to 8 per cent. The accompanying rise in underemployment would push total labour underutilisation towards 15 or 16 percent. If GDP growth was minus 2 per cent this year … the situation gets worse and total labour underutilisation would head close to 20 per cent. That is 1/5 of our labour resources being wasted.

It is definitely not time to worry about what some ratings agencies might do as they try to restore there tattered images from their previous failures.

It is interesting to read the Full OECD report. They are inventing new neo-liberal terms. They have now introduced “room to manoeuvre” into the nomenclature which is taken to mean that “For countries with very weak initial fiscal positions, the room for further fiscal expansion is limited.” (p.10).

This is clearly incorrect. Any sovereign government has the same capacity to expand as the next irrespective of their starting positions. The fact that they may have run deficits previously or surpluses is somewhat irrelevant. Different countries will have differing need for fiscal expansion which will be dictated by the extent to which private spending in each has fallen and left the gap that must be filled. The ability of a sovereign government to spend is not dependent on what it spent last year or over the last 10 years. It is total nonsense to propound otherwise. Of-course our “maritime journalist” buys the erroneous OECD line “hook line and sinker” (just couldn’t resist continuing the nautical flavour) when he says

Australia has had room to produce two budget packages that add up to more than $50 billion because our zero net public debt is the lowest in the OECD. And the OECD now nominates Australia among the countries with the most room for further “fiscal manoeuvre”, along with Germany, Canada, the Netherlands, Switzerland, Korea and some of the Nordic nations — but not the United States.

Sorry, all those countries have the same capacity to stimulate their economies!

The article finishes with the claim that “While the the Australian recession will get worse, we will continue to suffer less than Europe and North America. But we need to keep a tight ship to ride out this storm.”

Sorry, we need to push the tide up as quickly as the capacity of economy will permit so that all the boats, even the smallest and most fragile, can proudly float again.

Bogan list, up one!

This Post Has 13 Comments

  1. “And given exports are a cost (they represent real things that we do not use ourselves) then it is good that we can get the rest of the world to ship more real stuff to us than they want from us”.

    I would be concerned about the volume and composition of our imports though Bill. This island floating in the Pacific has for many years been steadily divesting itself of our capacity to supply more and more of our own basic needs. Seems that before long, we won’t have the ability to clothe ourselves. We will be reliant on someone thousands of kilometres away to do it for us and ship it to us. Let’s hope nothing ever interrupts supply.

    Currency sovereignty is one thing but surrendering basic self-sufficiency capabilities seems as foolish to me as the countries who surrendered their currency sovereignty to the Euro-area. You can’t wear money.

  2. Dear Lefty

    You can make an argument for protection on the basis of national security. If you think clothing is at that level of concern then you can make that case. But I am not so worried that we don’t make clothes any more. What I am worried about is that the labour freed from that fairly dull work has not been fully employed in more useful pursuits that do add value to our communities and to the individuals and their families. I think if the supply from China ever dries up we would all have enough clothes in the cupboard to see us through while we worked out how to make them again! Highly unlikely event though.

    best wishes

  3. With all due respect Bill, I think that lack of concern for any eventual consequences arising from an inability to fulfill one’s basic needs at a domestic level is more than a little short sighted. Where would you draw the line? Or would you not draw the line if it ever became say, cheaper to cease most farming and import most of our food (not suggesting that this will occur).

  4. Dear Lefty

    I am for localised permaculture production because it achieves a better food quality. I consider myself an urban farmer growing a lot of our needs in the block I live on. And I repeat … there is a case to protect local industry if you think it is essential for national security. But in general a lot of the stuff we consume is not of that ilk and I don’t see the point of worrying. If foreigners are happy to send us boatloads of consumer items and take less from us then we gain and all because they want to save in $AUD. There are more important things to localise …. like environmental care, full employment, equity in distribution etc.

    best wishes

  5. We are not merely exporting Australian dollars to foreigners Bill, we seem bent on exporting entire industries and the (often skilled) jobs they provide and then buying the product back. I think that who actually gains in the long term here is a matter of perspective.

    I fully accept your explanation of the basic functioning of the modern economy but I am not convinced that the path we are on is either wise or all that reconcilable with full employment in the long run. As far as physical production goes, we appear to be headed towards increasing economic specialization. Is a highly specialized national economy sustainable in the long run?

    I too have an interest in permaculture. One of the key reasons for the success behing permaculture methods is diversity.

  6. And even where the goods and services are superfluous to any real need as such, we would still do well to keep some of the production here. In my kitchen cupboard I have an electric steamer, a roasting machine, an omlette maker and a variety of other electrical cookware that gathers dust and is seldom used (I did not purchase them myself) becuase they are only duplicating the functions that I can already achieve with my stove and a handfull of pots and pans and a bamboo steamer. But that is not the point.

    The point is that the production of these goods created EMPLOYMENT. That was their real value, not so much the Goeorge Foreman roasting machine and the other gadgets themselves. But that employment is no longer available here, we have exported it in return for stuff we can live without.

    I also don’t think we should necessarily regard any work as “fairly dull” as that is purely a matter of personal opinion. I do not regard my groundskeeper/janitor job as being dull, although I’ll bet most people would assume that it is. It is a little bit of everything all rolled into one. I do not see myself as being at the bottom of some social heirachy – schools cannot function without our services!! I am doing my part for the collective by ensuring that those who give our children their basic education have a safe and properly maintained environment in which do deliver that.


  7. Dear Lefty

    When we protected industries (under the so-called “infant industry” argument) we did not preserve employment. Employment fell in those industries progressively. There was a nice “tariff” sharing arrangement between bosses and workers but little real investment in state-of-art technology and the products produced were inferior to those that we started to import. Further, the composition of employment shifts as economic development occurs. Just because the production of a specific product (or line of products), such as your omelette maker, were important to providing jobs 20 years ago (or whenever) doesn’t mean they will always generate jobs. After all, in early stages of development we are all farmers! So as a country gets richer and its productivity levels rise, new employment opportunities become possible and we leave the old behind. This is saying nothing about the “status” of the jobs or passing any opinion on what you call the “social hierarchy”.

    We will also need to redefine what we think counts as “employment” as time goes by to ensure there are enough things that we can call work. I think there are hundreds and thousands of jobs out there to be done which provide meaningful input to our community and environment but which currently are not funded. I think they will be public sector jobs because the private sector won’t see profit in them. So the fact that a lot of jobs that were important in the past may be gone doesn’t worry me. It is the lack of commitment by the governments to take responsibility to fund these new jobs which is the worry.

    Further, we should be relaxed that as we grow richer as a nation, the jobs that helped us get that way are now being created in less well-off nations as part of their development process. As long as we insist of fair trade then we all benefit.

    best wishes

  8. I am not advocating a return to “Fortress Australia” Bill. Simply the recognition that it is not possible for a country with decent wages and industry costs such as workplace health and safety to ever have a hope of competing in an unfettered market with countries that have neither (unless perhaps they are an economic behemoth, which we are not). If we want fair trade, we cannot be completely unprotected.

    It seems clear that the new employment opportunities have not arisen fast enough to offset growing underemployment as local industrial production relocates somewhere cheaper. 300 jobs (many of them skilled) gone in Brisbane today as Fisher and Paykel relocates to Thailand. The Thai government has offered the company substantial tax breaks. I take it that you are of the opinion that the loss of these skilled jobs and the specialized plant, equipment and know how is irrelivent.

    As for Pacific brands, I do recall reading that Australia has signed (or will sign) a free trade agreement which abolishes all TCF tariffs (some I think were up to 25%) and other protections. If I was the mangement of Pacific brands, I would think “why bother keeping any production in Australia? We can’t compete in an unfettered market with super cheap rice bowl country production”.

    I’m not the least bit surprised at the high underemployment rate.

  9. Dear Lefty

    You are correct, it isn’t possible to compete if our working conditions are superior and our productivity doesn’t compensate for the difference. The problem is that protection did not actually protect jobs. It protected the profits of the firms (mostly multinationals) and the wages of the ever decreasing workforce working behind the tariff walls. Meanwhile, the consumers got relatively inferior products at significantly higher prices. Not a good deal all round I would conclude. As protection increased, employment fell in many of those industries. So it was actually counter productive.

    The other issue (which I discuss in today’s blog) is if the private sector does not generate enough jobs then the government has to fill the gap. I have never said I think that job losses are irrelevant as you conclude. Any job loss is a disaster. But I also think the private sector should do what it does and not receive handouts from the public purse. The private sector has had a very bad record in this country of abusing the massive corporate welfare that has been bestowed on it by misguided public policy. Conversely, there are many opportunities for skilled jobs in the public sector if we can reverse the trend away from public employment. I would be building manufacturing jobs in renewable energy if I was the government. I would be ramping up funding to researchers (again skilled jobs) to discover cures for cancer and innovative answers to climate change. There are countless possibilities right across the public spectrum which would be inclusive for all skill levels.

    So the fact that there is persistently high unemployment just tells me that public employment is too low.

    best wishes

  10. “The products we produced were inferior to those we started to import”

    Which products were those Bill? Some of them? All of them?

    I trust you will now prove to me that this is a fact – because my direct experience with a number of products from this era is that they are very much superior to cheap Chinese crap. I bought one of the last pairs (I believe) of steel blue workboots made in this country. They are EXCELLENT boots, extremely comfortable and last about the length of 5 pairs of Chinese cheapies. Nonetheless, they have packed up and moved (to Indonesia I believe).

    No, nothing inferior about Australian made – just much more lucrative to make them abroad and ship them here.

  11. Dear Lefty

    I agree with you. Some mass produced products in Australia were okay. I was thinking of cars!

    best wishes

  12. Yes, I have heard that cars were something we did not do so well – in fact many of them sucked badly.

    I think we might have gotten past that though – I drive a Nissan 4WD that my next door neigbour (also my mechanic) tells me is one of the last of it’s kind that was made in this country. I have owned it for 11 years and it has been halfway round Australia and back several times without so much as a single hiccup. It has had every service ever due to it, but the fact that it has travelled such huge distances (including off-road) without so much as even the most minor mechanical problem is testament to the excellence of it’s design and construction.

    I apologise if I misinterprated your outlook on job losses Bill, it seemed to me that you were advocating something akin to “tough love”. I do get quite passionate about this issue. I don’t want us completely hidden behind a 500ft high tariff wall but I do have deep misgivings about a nation divesting itself of most or all of it’s capacity for self-sufficiency in the name of completely free trade. It seems to me that if we reach a stage where we require most of our basic needs to be spoon fed to us by someone else, then we would not be so much a mature economy as a “geriatric” economy.

    I remember when I was a kid, Australia seemed to be on the cutting edge of so many things. Agricultural and biological sciences, in-vitro fertilization, breakthroughs in medicine and other areas. Where has it all gone? I realize that this is probably the fault of succesive governments as it became fashionable to force budgets into “fiscal discipline” and all the rest of it.

    I completely agree that government should use it’s extraordinary fiscal power to create the jobs the private sector will not or continue to shed. I take your point about a protected private sector bludging off government handouts but I also think that some that simply cannot compete in the unfettered market may be too valuable to lose. Automotive engineering and manufacture, with it’s highly skilled jobs, technologically advanced equipment and plant and numerous peripheral jobs seems a little too valuable for a nation to simply abandon. If we took it into public ownership, the howls about protectionism would be deafening. I do wish they would get their finger out though and roll out the smaller, more fuel efficient or maybe alternative energy cars that the public is demanding.

    cheers Bill

  13. There is another good nautical metaphor: “when the tide goes out, you see who isn’t wearing a bathing suit.” I think it’s Warren Buffet’s, and it is obvious who he is referring to.

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