You cannot have more jobs by cutting spending

Its all weather today with severe winter storms giving grief to people (and some friends) in the US at present. Closer to home Northern Queensland, fresh from being flooded, will be hit later tonight by Tropical Cyclone Yasi which is now classified as a Category 5 and will have winds up to 300 kms per hour. My friends up in Townsville are staying calm though. Down here in Newcastle it has been around 40 degrees Celsius for the third day now with no real change coming. So weather extremes – and yes I think they are becoming more pronounced but I am an economist so that is just my uninformed (non climate change sceptic) opinion. But today I am writing about a speech the Australian Prime Minister gave to CEDA yesterday (February 1, 2011) that exposed her lack of understanding of how the macroeconomy works. The problem is that I suspect no-one else in the room who listened would have thought that her message was fundamentally inconsistent. The lesson is that cannot have more jobs by cutting spending despite what the Prime Minister thinks.

Here is a graphic of Yasi (at 11:00 January 2, 2011) bearing down on the Australian coast (click for full size). I posted this photo to let our overseas readers see how big the cyclone is relative to the continental mass of Australia (white line). Amazing! It is travelling towards the land at 30 kms per hour and is about to hit the coast. Fingers crossed for everyone in its face.

But back to the Prime Minister’s speech to CEDA. By the way, CEDA is the Committee for Economic Development of Australia and is a mainstream economics organisation which continually pressures the government to run surpluses. So not much credibility.

The PM was talking about the need to maintain “continuous reform” to ensure that “continued economic success” will “take us beyond the resources boom”.

She said that it will “take national leadership and decision-making” to nurture “the boom” and share “the growth”.

I agree that national policy leadership is always required. One thing that is not often understood is that irrespective of one’s views about the role of government (its scope, size etc) the fortunes of the non-government sector are still heavily dependent on the conduct of fiscal policy.

One might take the view that they want to pursue budget surpluses as an expression of their ideological preference for small government but you have to understand the consequences of that choice and what it means for the private domestic sector. Whether we like it or not in a modern monetary system the fortunes of government and the non-government are intrinsically related.

As an aside I have always wondered why those who desire small government want budget surpluses which are the ultimate expression of the state ripping off our purchasing power.

Too often we hear a raft of desired outcomes and related policy suggestions that are inconsistent in the sense that they cannot all be fulfilled – for example, in a nation running an external deficit it is impossible for the government and private domestic sector to be in surplus (that is, running down their overall debt levels).

Unless, of-course the public sector breaks with its gold standard throwback habit of issuing debt to match its net spending. But the proponents of the reduce debt everywhere lobby clearly don’t want the government to take that sensible path of action.

So these inconsistencies arise because of a incomplete or erroneous understanding of how the monetary system functions and the choices that a fiat system offers to the government and the non-government sector. The Australian Prime Minister certainly highlighted that yesterday.

Much of the speech is warm and friendly stuff about how ambitious we are as a nation and how hard working and innovative. I will write next week about a report that has just come out (today) about our productivity performance over the last 20 years which tells you that we are not innovative at all – and going backwards rapidly. But that story is for another time.

There was a lot of stuff about being lucky to have had a resources boom but that we have to ensure the future is with a “high tech, high skill, clean energy economy that is self-sustaining beyond our reliance on mineral exports”. I agree with that.

At one point she used a domestic analogy to drive home the beneficial movements in our real terms of trade in recent years as a result of the primary commodities boom. She said:

Five years ago, the money earned from exporting 10,000 tons of iron ore would buy about 280 dishwashers.

Today it would buy you around 1,400 dishwashers, a 500 per cent increase.

While the figures are probably accurate the imagery is misleading because the growth has been accompanied by rising income and wealth inequality; stark disparities in regional outcomes; persistently high unemployment and rising underemployment and overall suppressed real wages growth.

Yes, our real terms of trade should be sufficient to spread the fortune but government policy over the last 30 years has been creating conditions that have delivered exactly the opposite – government deregulation and labour laws have made it more difficult for workers to participate in the growth unless you are employed directly in the mining sector and have reduced the capacity of unions to defend the interests of their members.

But moreover the mindless pursuit of budget surpluses eroded our public infrastructure which delivers services to all and ensured the labour underutilisation rates remained very high throughout the growth boom (prior to the crisis).

So “we are living though a boom” but the we is a selective subset of the national population.

She more or less acknowledges that the boom does not benefit everyone by referring to the “‘patchwork pressures’ where some parts of the economy are strained by growth while others risk being left behind”.

But that didn’t last long and instead she returned to the mantra that Australia is being beset by a “shortage of skills” which has supplanted unemployment as “our major problem” and is “a problem unmatched anywhere in the industrialised world”.

The PM also claimed that:

Since November 2007, we have created more than 715,000 jobs.

Never have so many Australians enjoyed the benefits and dignity of work.

But we need more workers – for today and tomorrow.

First, the 715 thousand figure is not accurate. The Australian economy has created many times that number of jobs but has also destroyed many more times that number. The 715,000 are the net result.

Second, and more importantly, this is a tactic the previous (conservative) government used to engage in – how many thousand jobs had appeared during their period of tenure. It is true that there is a record number of Australians working now – but that is mostly population driven. There are also a “record number of Australians” and that record is surpassed each hour! It has nothing much to do with governments.

The first question is whether a rising proportion of that population is enjoying employment. Thinking about it in terms of employment-population rates, the November 2007 figure was 62.7 per cent while in December 2010 the corresponding figure was 62.5 per cent. So less people are working as a proportion of the population now than when this government came to office.

Why doesn’t the PM admit to that?

Further, in simple employment rate terms (employment as a percent of the labour force) the November 2007 rate was 94.5 per cent while in December 2010 it was 95 per cent. Again, nothing to be proud of.

Third, what about the quality of the net employment created? Since November 2007, there have been a net addition of 715 thousand jobs to the Australian economy – 365 thousand have been full-time and 351 thousand have been part-time. So 49 per cent of the net new jobs have been part-time. If you combine that with the knowledge that there has been a significant increase in the number of part-time workers who want more hours (on average 15.1 hours per week) but are unable to find them – that is, they are underemployed.

I assembled the following Table to help sort out what has actually happened in the labour market. Note it is for the period November 2007 to November 2010 because the broad labour underutilisation (underemployment data) only comes out on a quarterly basis.

You can see that underemployment has surged in the period of the current government’s tenure – by 169.2 thousand pushing the underemployment rate up to 7.1 per cent from 6.2 per cent. So of the 350.3 net part-time jobs created 48.3 per cent of them were unsatisfactory in terms of the hours on offer.

Over their tenure, not only has the unemployment rate risen (by 0.8 points) but total labour underutilisation is now 1.7 per cent higher. When they came to office total labour underutilisation (the sum of unemployment and underemployment) was 10.7 per cent, so despite the rhetoric at the time – the economy was not close to full employment.

Now the rate of labour wastage is higher – how can the Prime Minister think we are close to full capacity? Answer: the Treasury has a flawed measure of the NAIRU which they assert is the full employment unemployment rate and the PM (that is, her advisors) are not talented enough to see through that ideological lie.

Given that is the current state of affairs I fail to see what she is proud of in relation to the performance of the Australian labour market over their period of tenure.

More and more Australians are being forced by aggregate demand deficiency to remain unemployed or underemployed – hardly, despite her claim, to be enjoying the “dignity of work”.

In terms of the alleged skill shortage, the Prime Minister say that:

… the ageing of the population will create even greater pressure over the next 40 years because it will create a yawning demographic deficit.

By 2050 almost one-quarter of this country’s population will be over 64; almost double the figure today.

She could have also said that at present the Australian government has a policy set that is seeing around 25 per cent of 15-24 year olds either unemployed or underemployed.

In either case, they are not gaining the experience and skill development necessary to render them high productivity workers in the future. This cohort could be employed within a very short time if the Federal government chose to return to its former role (during the true full employment period from 1945 to 1975) of being a major employer of our youth. In that period, the jobs invariably provided apprenticeships which ensured that we had requisite skills development.

After the government bailed out of this role in the second half of the 1970s as the neo-liberal hold on policy makers strengthened youth unemployment has never been low.

If we are worried about the rising dependency ratio as a result of the ageing population then the best thing to do now is to reduce all non-ageing components of that dependency ratio by ensuring their is true full employment. The current government has just continued the policy failure of successive (neo-liberal) governments of the last 35 years – Labor and conservative.
She continued to talk about unlocking “all the potential of our labour market” by creating “the best education system in the world” despite continuing to under-fund primary, secondary and higher education and maintaining the conservatives funding policy which favours the rich schools and starves the poor schools of resources.

She self-praised the Government’s supply-side focus for labour market programs – training without creating jobs; making it harder for people to receive income support when jobless – etc. None of these programs create jobs. They assume that the reason people are not participating or are unemployed relates to the ascriptive characteristics of the individuals involved.

It is a denial that mass unemployment arises from a lack of aggregate demand of which net government spending is one component.

Please read my blog – What causes mass unemployment? – for more discussion on this point.

And then … some reality entered the speech. The Prime Minister said:

Friends,we look with particular care and concern on the large number of working-age Australians, possibly as many as two million, who stand outside the full-time labour force, above and beyond those registered as unemployed. Around 800,000 are in part-time jobs but want to work more. Another 800,000 are outside the labour market, including discouraged job seekers. And there are many thousands of individuals on the Disability Support Pension who may have some capacity to work.

We know that not all of them can work right away. Many will need re-skilling. The right mix of incentives. Help to overcome ill-health or meet family responsibilities. But we do want them to re-engage with the workforce and gain the benefits that come from having a job: increased income; social engagement and friendship; self-esteem and well-being.

That is why this year I will continue to take steps to improve the incentives for such potential workers to rejoin the labour market, while also investing in the intensive support needed to lift their skills and job readiness.

She didn’t say – that is why this year I will ensure there are enough jobs created for such potential workers to rejoin the labour market – and if the private sector cannot create those jobs I guarantee that the public sector will. We will introduce a Job Guarantee to ensure there are paid employment opportunities for all workers who want some or extra work.

She didn’t say – we recognise that extensive research evidence indicates that job-specific training is only effective when provided in the context of paid employment. We realise the supply-side emphasis on full employability which pretends that training can be effective without any accompanying paid employment is a poor use of our funds and is particularly harsh on the most disadvantaged workers who are forced by conservative welfare-to-work policies to undergo such training. We will not subject our citizens to that form of cruelty which amounts to state terrorism.

She didn’t say – we will use our fiscal capacity as the monopoly issuer of the Australian currency to ensure there are enough jobs and hours of work available. We have identified hundreds of thousands of jobs that can be funded to provide services in areas of current unmet need right across regional Australia in the form of personal care services; community development services and environmental care services.

She did claim that:

The policy changes are formidable, and we will not lose sight of the need for compassion and understanding of individual circumstances.

But to the maximum extent possible, I want to ensure that every Australian who can work, does work.

I want to ensure that the incentives of work always outweigh the attractions of staying on welfare.

Sorry, the policy changes are very simple. The politics might be formidable given that the Government has painted itself so far into the neo-liberal corner that it will find it hard to rescind the stupidity of its “budget surplus at any cost” promise. But if they really were honest about ensuring that “that every Australian who can work, does work” then they have the capacity to do it.

It is not about incentives being perverse – that is the classic neo-liberal lie. It is about a lack of jobs. A lack of jobs is the result of a lack of spending. The Government has the capacity to provide that extra aggregate demand and could do so easily by directly creating the necessary work.

But for her government it appears that it is all about needing “flexible markets with the right incentives and price signals to maximise the value of our people and capital resources”. That nonsense was categorically exposed 80 odd years ago during the Great Depression. If there are not enough jobs then all the flexibility will not help.

Employment is driven by spending. People or governments have to spend in sufficient volumes to create the demand for labour that employs people.

The Prime Minister then raved about the types of transformations that the Australian economy has undergone over the last 30 odd years and her commitment to prepare the “the nation’s journey through the 21st century” via broadband, carbon pricing etc.

But then she exposed the inconsistency in her position. She said:

To complement an increase in private savings, we also need to increase public savings and strengthen our budget position. The truth is that although our economy is strong, our budget position remains compromised by the recklessness of the Howard years … Returning the budget to surplus is thus not a political goal but an economic imperative.

Running a budget surplus does lead to the government saving. It is nonsensical to believe that a national government that issues its own currency is saving when it takes more revenue off the non-government sector than it spends back into that sector. All it is doing is undermining the capacity of the economy to grow and reducing the non-government saving.

Please read these blogs – Budget surpluses are not national saving and Deficits are our saving – for more clarification of this point.

Further, there is no sense that can be attached to the term – “our budget position remains compromised” independent of a context. If the “economy is strong” then the budget position is likely to be sound irrespective of whether it is in surplus or deficit. The actual budget outcome would depend on external and private domestic spending and income aggregates.

I dispute that the economy is strong but that is another point and suggests that the budget position is too tight.

In terms of this economic imperative, the Prime Minister claimed the urgency was to “rebuild the structural integrity of our nation’s finances” whatever that means.

Given the use of the term “rebuild” she is clearly not happy with the current fiscal stance. Does she mean that the current budget deficit is too high? Clearly – but in relation to what? Answer: to her misguided obsession with achieving a “budget surplus no matter”. That benchmark has no economic meaning or credibility. It is a purely ideological position divorced from any sense of responsibility for the well-being of the nation.

Once all the political decisions have been taken about the “size” of government – that is, what composition of final output should be public and private, then there is only one rule that ensures the “nation’s finances” have “structural integrity” – that is, to ensure there is sufficient growth in nominal aggregate demand consistent with the real capacity of the economy to respond and consistent with full employment.

That is a simple fiscal rule – which means the budget outcome will be whatever it takes to achieve that state of well-being.

The Prime Minister’s version of this involves ensuring:

… that the footprint of government does not add to aggregate demand when the economy is running close to full capacity as expected in 2012-13. In circumstances of strong demand, it is economically prudent to reduce inefficient spending and offset all new outlays.

Exactly. If we are full employment by 2012-13 then the government should be running a budget stance that will maintain that. But why should we assume that will be consistent with a budget surplus? Answer: it is highly likely that a budget surplus will withdraw demand below the full employment level. In that case, a budget deficit would be “economically prudent”.

A budget surplus is only sensible if net exports are so strong that they support economic growth and private domestic net saving overall and still maintain full capacity.

But if net exports are not strong enough (which is likely), then the strategy to tighten fiscal policy will either reduce economic growth and prevent us from absorbing the idle workers or it will squeeze the private domestic sector for liquidity and force that sector to maintain private spending growth by increasing indebtedness. Neither option is desirable or sustainable.

Further the concept of “inefficient spending” in this context is misleading. Modern Monetary Theory (MMT) does not advocate wasteful public spending – like building statues of dictators! While it is desirable to cut wasteful spending to ensure that resources are being used in meaningful ways, if the overall net spending position of the government is too low then these cuts have to be replaced by increased spending in other areas.

Conclusion

So you see the contradictions. The Prime Minister cares about the unemployed and underemployed and wants them to have work and be part of the active economy.

But then she also wants to create budget surpluses no matter what and thinks the current deficits are not structurally sound.

The reality is that the huge pool of idle workers is a signal that the budget deficit is too low. The desirable direction of fiscal policy at present is exactly the opposite of the expressed aspirations of the Government.

You cannot have it both ways – you cannot create jobs by stifling aggregate demand. Living on the hope that private demand will somehow increase to fill the current aggregate spending gap is an irresponsible policy stance.

It would demonstrate sophisticated leadership if the Prime Minister introduced a large-scale job creation program and allowed the buffer stock of jobs thus created to fluctuate with private spending. That is, make the employment creation spending an automatic stabiliser in the budget. Then when (if) this supposed private investment boom occurs – the budget outlays will fall automatically – the Job Guarantee pool will shrink – and the budget outcome will automatically adjust to its desirable level.

Eyes are now turning north to see how the storm turns out.

That is enough for today!