A rising public share in output is indicated

I have been thinking about changing industrial/sectoral shares today and how it bears on the way we construct macroeconomic policy (spending and taxation). At present, a major debate in Australia is how we are going to deal with the strong growth in the mining sector and the negative consequences this growth is having on other sectors that are not enjoying buoyant demand conditions. The mainstream response – to impose fiscal consolidation and tight monetary policy – is exactly the opposite response to what is required. But the discussion about sectoral change has further application in terms of the long-run movements in demography and shifting demand for health care and other age-related services. It generalises even further if we consider the growing need for environment care services. The upshot is that trends which will require a rising public share of total resource usage should not be seen as financial crises. Rather we should see them as part of the long process of structural transformation in our economies. Once we see it from that perspective, then the ideological nature of the ageing society debate is exposed. But first, Ireland …

The Irish Prime Minister yesterday unveiled the The National Recovery Plan 2011-2014 which is a sop to the unelected and largely incompetent IMF’s insistence that it make further cuts in public spending before any bailout funds will be provided.

The Plan (which I used to think referred to some action designed to achieve objectives) is 140 pages long but has very little coherence at all. It also sells for €15.00 (although free to download) which I suppose covers printing costs. I would have actually not charged for printing so that the government spending (presuming they use privatised printing presses) could stay in this severely distressed, demand-constrained economy.

On page 55, Section 3.2 the heading is “3.2 Why We Must Reduce Expenditure”. A Table (3.2) accompanies the text and shows that public spending in nominal terms has risen strongly between 2000 and 2008. The current price data shows total public expenditure rose by 141 per cent over that period. I did the calculation for Australia and the corresponding change in 106 per cent.

But remember the 2008 data is contaminated by the recession for Ireland much more so than for Australia given the extent to which the Irish economy collapsed. The better comparison would have to been to use data at similar stages of the cycle to make the automatic stabiliser effect neutral. But whatever, the data presented provides zero justification for the heading “Why we must reduce expenditure”.

The text accompanying the table says:

These significant increases in public expenditure were broadly in line with the strong nominal growth rate of the Irish economy with expenditure as a proportion of GNP remaining at around 28% for most of that period. However, with the sharp fall off in growth since 2008, that ratio has risen markedly to around 44% of GNP in 2010 … It is clearly not sustainable for public spending to remain at such a high level, and restoring overall expenditure back to an affordable level is now a key imperative of public policy.

Can you believe that a national government is so stupid that they think this sort of argument can justify expenditure cuts? I was amazed. There are many more examples of this sort of rhetoric in the paper. It is not worth reading really – just depressing.

The point is that proportionally the Irish government spending merely kept pace with the nominal growth in the size of Irish economy until the growth collapsed. Of-course, the share of government spending increased as a consequence of the automatic stabilisers! But to then say that because the ratio has risen to 44 per cent in 2010 then public spending cannot remain as such a high level is to make one of the basis errors in statistical analysis.

You cannot compare levels and ratios in this way. I would look at the same data and say that denominator rather than the numerator has to be restored to its previous acceptable levels. What sort of logic is it that the numerator of the ratio should collapse to the value of the (collapsed) denominator? Irish government (or should I rather say IMF and EU logic) it seems.

That is the problem of the whole Eurozone – they realise they will lose face if they take the obvious action – increase growth via spending – remember spending equals income. Their ideology would also become transparent if they admitted that their “solution” was likely to be highly destructive of living standards, retirement security, public services, etc.

So, to hide their ideological nakedness they try to tell us that by severely cutting public spending they will still

The size of the Irish economy is currently about 130 billion euros down from 162 in 2007. The Plan proposes to take 15 billion euros out of the spending stream but also it proposes to cut 25,000 jobs. The multiplier effects of the lost income will be huge and it makes the growth prospects which they have put into their “macroeconomic models” look positively surreal.

In Annex 2 they discuss growth prospects. The IMF forecasts are the most optimistic but overall it is difficult to see where the growth is going to come from. The Plan says that exports will be strong and then you see this gem in optimism – “It is also possible that the clarity provided by this plan could result in a more rapid restoration of domestic confidence than is currently anticipated” (the Ricardian effect!). But they conclude that “the domestic risks are tilted towards the downside”. In other words, exports are going to be the cavalry coming to the rescue.

So with there major trading partner (the UK) about to go backwards courtesy of their austerity plan upon what basis will exports grow strongly enough to more than replace the spending cuts and tax hikes? They are just living in an ideological dream world.

Even with exports rising a little at present, GDP growth was negative in the second quarter 2010. It will get worse!

The Taoiseach tried to hype up the Plan by saying of Ireland:

… that we are a people of sufficient ability and intelligence to see ourselves through these circumstances. We are a smart, resilient, proud people and we are going to come through this challenge

Sorry, the people who make up the government are stupid, rigid and inflexible, who have just surrendered all national pride by obsequiously bowing to the destructive demands of the IMF.

The economy will “come through” but people will be poorer and the social fabric will be severely damaged. I wonder how many meals the Taoiseach will forgo in the coming few years and I wonder if his pension will be significantly cut.

I wonder if the Taoiseach has stopped to think who holds the cards in this crisis. The reality is that the Irish government has all the power if they had the courage to use it. Default (on all euro debt), Exit (the EMU and reintroduce their own currency), Bailout (the economy with increasing public spending) and Takeover (the banks) – DEBT – is what they should be doing!

Anyway, this was just an introduction to what I was thinking about today and on the plane last night.

A big debate in the Australian policy arena at present is how we are going to handle an enduring mining boom driven by the growth of China and India.

The Secretary of the Australian Treasury, Ken Henry gave an address in Hobart last Friday (November 19, 2010) – The Context and Drivers for State Tax Reform – which has attracted a lot of attention.

The specific context is the debate about tax reform and the growing call for a Resource Rent Tax to be applied to the mining sector and also a Carbon Tax as our response to the climate change agenda. I will write about each of those taxes at another time.

But the debate also considers the changing nature of the Australian economy over the next few years. The Secretary outlined “a set of large-scale and long-term challenges facing Australia, including”:

… (1) a population that is growing rapidly, becoming more culturally diverse, yet ageing; (2) the re-emergence of China and India as global economic powers in a world characterised by ever deepening international integration; (3) the technological transformation of government, business and personal lives, especially through advances in digital electronics and communications; (4) deepening stresses between human activities and wider ecosystems, globally and locally – of which climate change adaptation and mitigation strategies are especially challenging elements; and (5) powerful stresses on housing affordability and urban amenity.

I agree that these are all issues that we need to consider in framing current policy settings. But typically, the way in which the bureaucracy is thinking and advising governments is opposite to the way I would tackle these “challenges”.

In terms of changing shares in total output (which is the theme of this blog) the Treasury Secretary noted that the “strong rise in Australia’s terms of trade over the past decade could well turn out to be the biggest external shock to our economy in history”:

Rising terms of trade mean increased aggregate purchasing power and higher aggregate incomes. But not everybody’s income, or purchasing power, gets a boost.

The net outcome of the economic adjustments associated with an increase in the terms of trade is what we might call a ‘three speed economy’:

* the mining and mining-related sectors grow strongly;
* other trade-exposed sectors (like many parts of manufacturing) grow more slowly; and
* non-traded sectors grow at a rate somewhere between those two.

In order to balance demand and supply in the non-traded sector, there will be an appreciation of the real exchange rate. That is to say, there has to be an appreciation of the nominal exchange rate and/or a period of time during which our costs of production inflate at a rate that is higher than the average inflation rate of our trading partners.

Putting this another way, the economic adjustment required to balance demand and supply in the non-traded goods sectors necessarily has the effect of making all Australian businesses less internationally competitive. And that loss of competitiveness cannot be avoided unless the full income effect of the terms of trade boom is somehow sterilised.

The argument for the Resource Rent Tax was based on the idea that we needed to introduce a “secure complete sterilisation” from these external shocks. So the tax “can reduce the size of the real appreciation required to achieve macroeconomic balance”.

I agree with this. It is an application of the capacity of fiscal policy as opposed to monetary policy to be targetted in its impact. An economy that is highly unbalanced and experiencing inflationary pressures coming in via the external income surge can be re-balanced by a specific tax. A Resource Rent Tax is one of the better means of taking “demand” out of the external sector.

But note also, that the nominal appreciation in the exchange rate itself, provides an anti-inflationary buffer.

The problem is that my profession is claiming that the mining boom requires a more widespread fiscal contraction and the Government is certainly building that into their strategy. But the problem is that an across-the-board cut in net public spending is not indicated at present for the following reasons:

• Only one sector is really growing strongly and it happens to be a small employer – the rest of the economy is fairly flat.
• Inflation is benign and (recently) falling.
• Households continue to suffer the burden of record debt levels as an artefact of the credit-binge in the previous boom.
• At least 12.5 per cent of available productive labour resources are idle (through unemployment or underemployment).
• Some regions are stagnant and facing major declines in services and population as a result.

The other problem is that we are obsessed with the mainstream view that the major counter-stabilisation has to come via monetary policy (interest rate hikes). Referring back to the previous list – that is, a very poor policy choice in those circumstances. It is blunt – that is, it cannot discriminate by region or sector. Its overall impact is uncertain (because of the distributional complexities – creditors gain, borrowers hurt) and it certainly is “indirect” (that is, take some unknown time to “work”).

I thought the Treasury Secretary’s response to cutting net public spending as a solution was interesting:

But consider the orders of magnitude here. Over the past decade, world prices of our non-rural commodity exports have increased, on average, by about 300 per cent. Exports of these products represent about 10 per cent of GDP. Clearly, offsetting the full income boost from higher non-rural commodity prices on aggregate demand through a fiscal contraction would require an implausibly large reduction in government spending, possibly equal to, or even greater than, the total current level of government spending in Australia. That is, to completely sterilise the terms of trade boom through fiscal policy, we may have to abolish all government spending. Note that we would, however, have to keep raising the same level of taxes as presently.

The point is that when people call for cuts in public spending they rarely know what they are really proposing in terms of magnitudes and ultimate impacts. The Irish government is living a dream if they think their “ratios” are going to improve by following their National Plan which really is an incompetent statement of ideologically-motivated vandalism on a national scale.

But the interesting part of the Treasury Secretary’s talk came next. He was talking about the how the “prospects … look good for mining” and are, equally, “demanding” for “those parts of the traded sector of the economy that are not benefitting directly from the strong demand for our minerals”. The Dutch disease playing out before our eyes. As a primary commodity trading nation we are familiar with these sectoral pressures.

When growth becomes unbalanced like this there are (in the Secretary’s words) “strong incentives for capital and labour to move to mining enterprises and the other enterprises on which mining depends for various inputs”.

The Treasury Secretary noted that there are “costs associated with structural change; including human costs” and that the Government should avoid falling into providing specific assistance to the damaged sector which might impede the flow of resources between sectors. In general I agree with that government policy should not be providing “rents” to private firms who are unable to cut it in the private market place.

However, I also do not consider the “economic settlement” (where the private economy creates jobs) should dominate the “social settlement” (where people live). Communities are paramount in family-life and social well-being and should be nurtured. We should not place the social settlement at the behest of the private market which is not the ultimate judge or mediator of social well-being.

In general, I value jobs and require that all people have access to decent work wherever they choose to live. If there are no private job opportunities in some areas then the public sector has to stand ready to provide the vital employment.

So there is a role for government policy to help communities make painful sectoral transitions. In this blog – The Budget (what else) and a parrot or two – I outlined a concept called a Just Transition – which was part of a major report I was a co-author on that examined the likely regional consequences of closing the coal fired powered industry in Australia and encouraging transitions to renewables.

We recognised that economic restructuring at a regional level is painful. In the Commissioned Report we noted that a just transition policy recognises that people and ecology are both important.

A just transition ensures that the costs of economic restructuring and the shift to sustainability do not fall on workers in targeted industries and their communities. A just transition in any threatened region requires government intervention and community partnerships to create the regulatory framework, infrastructure and market incentives for the creation of well-paid, secure, healthy, satisfying environmentally-friendly jobs with particular attention to appropriately meeting the needs of affected workers and their communities.

A just transition requires the governments to play a critical role in fostering the adjustment such that it protects local communities and environments during change. Government support must include:

• Assistance for both displaced workers and for contractors;
• Adequate notice of workplace change and closures;
• Consultation and full engagement of relevant unions;
• Support for innovation and partnerships for new local industries, research and development and infrastructure investments;
• Training and alternative employment tailored to local and individual needs and opportunities;
• Special targeted support for older, disabled and less educated workers;
• Relocation assistance for displaced workers;
• Income maintenance, redundancy entitlements and retraining allowances;
• Cheap loans and subsidies for new industries and employers;
• Compensation and equipment buy-outs for contractors;
• Assistance programs extended to workers employed by contractors;
• A just transition requires investment in training programs and apprenticeships to create a highly trained ‘green’ workforce;
• The introduction of a Job Guarantee to provide continuous employment for all those without work.

I will come back to this in a moment because it bears on how we handle changing needs over time.

The rest of the Treasury Secretary’s address was about tax reform and if you are interested in that I invite you to read the rest of the transcript.

But I was thinking about all of this in terms of the other “challenges” facing our nations over the next fifty years. Cutting across this thinking were the “ideas” (not sure I would dignify in this way) presented by Thomas Friedman in his latest New York Times article (November 23, 2010) – U.S.G. and P.T.A..

Friedman claims that the US “unemployment today is not only because of the financial crisis. There are some deeper problems”. He offers the following explanation for the entrenched unemployment in the US (which generalises to all advanced nations):

Global competition is stiffer … it is only going to get more competitive for American men and women at every school.

Then, just as the world was getting flattened by globalization, technology went on a rampage – destroying more low-end jobs and creating more high-end jobs faster than ever. What computers, hand-held devices, wireless technology and robots do in aggregate is empower better-educated and higher-skilled workers to be more productive – so they can raise their incomes – while eliminating many lower-skilled service and factory jobs altogether …

Finally, just when globalization and technology were making the value of higher education greater than ever, and the price for lacking it more punishing than ever, America started slipping behind its peers in high school graduation rates, college graduation and global test scores in math and critical thinking.

This is the standard human capital or supply-side explanation of unemployment. The problem is that these trends move slowly and cannot possibly explain the sharp rise in unemployed that accompanied the sudden collapse of aggregate demand in the US and other economies. These sorts of “structural” dodges are just examples of denial.

Friedman notes that the sectoral/technological changes have denied many high school drop-outs the chance of employment. That is true but is only a problem if assume that the overall sectoral response that has accompanied these private market changes are appropriate.

What does that mean? Why doesn’t Friedman note that the US public sector could easily also evolve and redress the stark disparities in regional employment growth in the US? Answer: a blind ideological disposition against public employment creation.

The public sector could easily provide “good jobs” for “high school drop-outs” with structured skill development opportunities. There are millions of productive jobs that could be designed, for example, to advance personal care service and environmental care service in the US (and elsewhere).

Jobs come and go. Think about the decline of agriculture, the rise and subsequent decline of manufacturing, and the rise of service employment. These transitions are on-going. It doesn’t mean that you have to have unemployment.

In December 2008, we released a major report – Creating effective local labour markets: a new framework for regional employment policyCreating effective local labour markets: a new framework for regional employment – that was the result of a 3-year national study.

The research that underpinned the Report conducted a national survey of local governments in Australia. We identified hundreds of thousands of jobs that would be suitable for low-skill workers in areas such as community development and environmental care services. There is enormous unmet need for public works across regional Australia. For larger economies, the estimates would run into millions of jobs.

Further, we outlined an effective role for the state in direct skill formation through a National Skills Development (NSD) framework which we consider could be integrated into the Job Guarantee.

Why don’t these commentators think of policy responses in the context of unemployment? Answer: blind ideology (against public employment).

Part of any policy framework should include the introduction of a Job Guarantee.

Full employment can be maintained by the introduction of an open-ended (infinitely elastic) public employment program that offers a job to anyone who is ready, willing and able to work and cannot find alternative employment.

These jobs ‘hire of the bottom’ in the sense that the minimum wages paid which are not in competition with the market sector wage structure. By avoiding competing with the private market, the Job Guarantee anchors the nominal value of money and the economy avoids the inflationary tendencies of old-fashioned ‘military Keynesianism’, which attempts to maintain full capacity utilisation by ‘hiring off the top’ (making purchases at market prices and competing for resources with all other demand elements).

Further, in this blog – Norway … colder than us but … – I discussed the way that “enlightened” nation addressed the evolving sectoral changes that all of the advanced world has faced – increasing proportion of women in the labour force; growth of services and decline of manufacturing etc.

The public sector in Norway is a major contributor of employment in their economy. It has often been stated by neo-liberals that the reason our unemployment rate rose over the last three decades was because of the increased participation of women and the rise of the service sector. There were many spurious arguments used to justify these claims which I won’t rehearse here (I have written many words in academic papers about this in the past). But Norway had one of the highest rises in female participation rates since the mid-1970s and also faced the decline in manufacturing and related industries as their service sector grew.

The big difference is that while the growth of the service sector in Australia, the US, the UK and elsewhere has been characterised by the growth in “burger flipping” employment – casualised, low-skill, low-pay and going nowhere, in Norway, the public sector has been a major source of service sector employment growth. These jobs are in personal care services, health, education and the like. They are typically secure, well-paid skilled jobs that allowed that country to absorb these structural changes without the significant increases in unemployment or inequality that have marked Australia’s industrial shifts since the 1970s.

Further, by increasing the share of public employment in total employment, the Norwegian government has been able to use the public sector as a means to keep unemployment low and absorb the structural and cyclical shocks much better than us.

Another factor is that in Norway, long-term unemployment is defined as being unemployed for more than 26 weeks whereas in Australia we consider spells of unemployment greater than one year to represent long-term unemployment. This means that more intensive assistance is given to the long-term unemployed worker in Norway much sooner.

Additionally, Norway, like most Scandinavian countries considers its youth to be the future. In Australia and the US, we allow our youth to wallow in high states of unemployment accompanied by no formal schooling/training requirements. In Norway, they targetted youth specifically with their Youth Guarantee which ensures that all youth between 20 and 24 years of age will be either employed; participating in formal education or receiving trade training.

Further, the Norwegian Government guarantees all youth below 20 years of age support for 3 years of upper secondary education. All those who leave upper secondary school and who are unemployed are immediately subsumed by the Youth Guarantee into a paid job (typically public sector) or a skills development program (which could be in the context of paid employment).

Finally, in the neo-liberal English-speaking world labour market services tend to be privatised and provided through a perverse system of “profit incentives” that guarantee poor outcomes. Norway retained these functions within the public sector. They do not seek to make profit or create an industry from the unemployment as has been the case in Australia, for example.

Recent reforms in Norway established the Norwegian Labour and Welfare Administration (NAV) in 2006 by integrating the Public Employment Services, the National Insurance Services and the municipal social assistance services into one public body. It is a decentralised public sector organisation accessible to all Norwegians (by 2010 it will be available to all at their local level). The NAV is responsible for providing services to the unemployed; it runs labour market programmes (training etc); it conducts job placements and administers the unemployment benefits system.

It is truly a public sector “one stop shop” covering employment, welfare and skill development. The NAV also offers services to sick leave and disability recipients and other pensioners.

Compare this to what we currently have in Australia and the reforms currently being proposed by the Federal government and you just shake your head in disbelief.

I could also go into differences in their regional development and education policies and more but I think you get the message. The Norwegian government actually acts to improve standards of living for its citizens. A case can be made that in Australia successive federal governments since the mid-1970s have actually undermined broad standards of living by running budget surpluses and refusing to deal with the unemployment problem.

Commentators like Friedman do not help in this regard.

Finally, the notion of shifting sectoral composition also has another application to the long-term “challenges” facing the advanced world.

Regular readers will note that I sometimes comment on the myths surrounding the ageing population. The allegations from the deficit terrorists are that governments will face unsustainable “fiscal blow-outs” as a result of rising demand for health care and pension support as the dependency ratio rises.

In this blog – Another intergenerational report – another waste of time – I discuss dependency ratios. Further, please read my blogs – The US should have universal public health care – Another intergenerational report – another waste of time – The myths of the ageing society debate – for more discussion on this point.

Modern Monetary Theory (MMT) highlights that the rising dependency ratios that are occurring in advanced nations are exacerbated by government policy which deliberately leaves millions unemployed and cuts spending to public education and research in the name of fiscal austerity. These actions all undermine the capacity of the economy to enjoy productivity growth in the future which is the key to ensuring there will be sufficient output to meet demand.

The point is that there is no “financial crisis” ahead for any sovereign government. A sovereign government is never revenue constrained because it is the monopoly issuer of the currency. There may be a real crisis (inadequate provision of real goods and services) ahead and the way our governments have embraced the neo-liberal ideology and are obsessed with fiscal austerity/consolidation will certainly increase the likelihood that a real crisis will occur.

I also note that the idea that it is necessary for a sovereign government to stockpile financial resources now to ensure it can provide services required for an ageing population in the years to come has no application. It is not only invalid to construct the problem as one being the subject of a financial constraint but even if such a stockpile was successfully stored away in a vault somewhere there would be still no guarantee that there would be available real resources in the future.

The best thing to do now is to maximise incomes in the economy by ensuring there is full employment and every citizen can maximise their productive potential. This requires a vastly different approach to fiscal and monetary policy than is currently being practised and a vastly different approach to education policy.

Long-run economic growth that is also environmentally sustainable will be the single most important determinant of sustaining real goods and services for the population in the future. Principal determinants of long-term growth include the quality and quantity of capital (which increases productivity and allows for higher incomes to be paid) that workers operate with.

Strong investment underpins capital formation and depends on the amount of real GDP that is privately saved and ploughed back into infrastructure and capital equipment. Public investment is very significant in establishing complementary infrastructure upon which private investment can deliver returns. A policy environment that stimulates high levels of real capital formation in both the public and private sectors will engender strong economic growth.

If we adequately fund education and create highly productive individuals and publicly fund research this will help reduce the real resource costs of health care in the future and further improve labour productivity of the workforce. Then the real burden on the economy will not be anything like the scenarios being outlined in the “doomsday” reports. But then these reports are really just smokescreens to justify the neo-liberal pursuit of budget surpluses.

That is my usual response to the ageing society “challenge”.

But you can also think about it in another way which also exposes the ideological nature of the debate. The sectoral composition of output undergoes change in response to variations in patterns of final demand and the jobs distribution then reflects this pattern and the changing productivity patterns (which later input demand in relation to output demand).

We worry about that – in a Luddite sort of way – as in Friedman above. Australia is certainly undergoing such a change at present with the rise of mining and the squeeze this is putting on other sectors.

But these changes in industrial compositional also have implications for the public/private mix. The neo-liberals have tried to thwart the changes in the public/private mix by attacking all public provision. So we have witnessed inefficient privatisations that have just transferred public resources into the hands of selective private lobby groups.

We have also witnessed outsourcing, contracting-out, public-private partnerships etc as part of the general attack on the public sector. The justification for the transfer of resources to the private sector has been drawn out of microeconomic textbooks which purport to argue that private provision is always more efficient than public provision. At least that is what the ill-informed viewpoint concludes when they only read the research selectively.

Once you read the chapter on social benefits and costs and market failure you quickly realise that even the standard mainstream textbook solution is highly questionable.

There are times when private provision is suitable and times when public provision is suitable. There are no blanket findings that public provision is always detrimental and vice versa for private provision. The current crisis tells us categorically that the idea that private markets self regulate and deliver optimal outcomes is a myth.

So if you distance yourself from these myths then the ageing society issue just becomes one of structural change. As we demand more health care services and pensions etc and less early childhood and primary schools the allocation of resources to different activities will change. That sort of allocative response has been going on forever.

Given the dominance of the public sector in providing social safety nets and the demonstrated capacity of the public sector to provide first-class health care (for example, Australia!) then as the demand for these areas of allocation rise we should be comfortable with a growing public presence (in levels and ratios).

The Treasury Secretary would then – to be consistent – argue that we should not impede that sort of allocative transition. Just as the mining sector is going to absorb more resources proportionally in the coming years, by 2030 the public sector should be also more important.

In that sense we should ensure that taxation policy allows such transfers to occur so that the public sector can provide these services and outputs without generating inflation.

It might be argued that in some countries the private sector might also provide these services. Fine! But the public sector will be their major clients given that health care, for example, should be considered a basic right (subject to some conditionality). The point is that the health sector will grow and policy has to be designed to allow resources to flow towards that area of growth.

Trying to construct this sort of compositional change as a financial crisis misses the point entirely.

My laugh for today!

Please see – We Gotta Stand With Our North Korean Allies. Maybe Friedman’s claims about the US education system have some traction although the author of those words is not languishing among the unemployed.

Conclusion

That is enough for today!