A seriously reckless act

I read this morning that there were riots in Spain overnight – Arrests, clashes amid general strike in Spain. I thought that, ultimately, this may be the only way that the neo-liberal economic madness that has beset the world, amidst the worst economic crisis in 80 odd years, will be curtailed. By people power. It is a pity that we have allowed the political class to move so far beyond what is required to introduce policies that enhance the well-being of the citizens. How that happened is a separate question which I hope the political scientists and other experts shed some light on soon. It seems totally bizarre that popular support is given to political parties that introduce policies which undermine the prosperity of the supporters. In Australia, the Treasurer delivered a speech yesterday that confirms that even though we are a long way from the European maelstrom, our intellectual underpinnings are the same. Our Government is currently about to walk the plank because it is engaging in a “seriously reckless” act – trying to cut public spending by around 2.6 per cent of GDP when the economy is already in decline.

There was actually an interesting ABC news article this morning – LNP driving ‘jobs-for-the-boys gravy train’ – which, while parochial (about Queensland politics) has general relevance to all democracies.

It was reporting a speech made by former “Queensland corruption inquiry chief Tony Fitzgerald” who described the “current political culture in Australia” as being “toxic” and that the “Westminster system is a flawed and outdated model of representative democracy and political parties have learnt to exploit its weaknesses”.

Tony Fitzgerald said:

The current toxic political culture can be radically altered by an infusion of public-spirited talent to counteract the mediocrity and venality of those power brokers and professional politicians, whose life experience is limited to learning and practising the dark arts of misinformation, secrecy and character assassination … Self-interest makes it unlikely that political parties and politicians who benefit from the current system will initiate real change – their likely mind set is that it’s their turn … “Political reform is a task for the community …”

Which I hope is what is going on in Spain at present although I suspect the events are just the manifestations of still relatively unorganised anger.

The ABC News Report quoted the Spanish government as saying that the austerity:

… is necessary for the country’s economy to improve and to meet strict debt targets set by the European Union.

The two goals are incommensurate. A seriously depressed economy with 23 per cent unemployment (and 50 per cent youth unemployment) cannot improve if policy is geared to meeting the EU fiscal rules. The latter will drive the economy further into depression.

It is also likely that in trying to pursue the fiscal rules, the worsening economic state that will result will undermine the capacity of the government to meet the rules anyway.

It would be far better to ignore the rules and go for growth (under the support of the ECB given the flawed design of the EMU) and let the budget outcome take care of itself.

Talking about the blind pursuit of fiscal rules, yesterday (March 29, 2012), the Australian Treasurer made a speech in Sydney – The revenue base and the 2012 Budget – which was aiming to set the scene for the upcoming May federal budget.

The Treasurer began by saying that he was going to get into some:

… complex and really rigorous economic analysis …

His speech basically attempted to outline “three very important and related points”:

One, that getting the Budget back into surplus is economically imperative in a turbulent new global economic era.

Two, this surplus will be much harder to achieve because of substantial revenue write-downs and historically low tax levels, coming from global turbulence and longer term structural changes to the revenue base.

Then three, that this all forces us to make substantial savings in the Budget, consistent with the strict discipline that has seen our fiscal position applauded right around the developed world.

At which point, if you appreciate what is happening in the Australian economy at present, you will wonder whether the Treasurer is on the same planet with the rest of us.

Basically the three points are this:

1. They are obsessed with getting a surplus because they think it is the hallmark of responsible fiscal management and, besides, they promised it and have to face an election next year and don’t want to be accused of breaking a promise. They should never have made the promise but then they are a government that is prone to error.

2. The pursuit of the surplus meant they withdrew the fiscal stimulus far too early and long before the non-government sector could drive growth (private spending growth is subdued). The result is that after a promising recovery from the downturn, the Australian economy is now slowing and the automatic stabilisers are undermining their taxation revenue. Structural issues relating to the growth of mining (too many tax concessions) are exacerbating the cyclical impact.

3. Their previous surplus target is in tatters as a result. So instead of realising that they need to back off from their obsession they are instead planning on cutting spending harder than previously estimated to chase the declining tax revenue – down the drain of recession!

The Treasurer claims the cyclical downturn “forces us” to make “substantial” spending cuts which is a lie and demonstrates that the Australian government has fallen foul of the neo-liberal obsession with pro-cyclical fiscal policy management. There is no decent economist who would suggest that pro-cyclical policy adjustments at a time of declining growth is responsible.

So it seems that the “complex and rigorous economic analysis” didn’t survive the Treasurer’s opening remark.

The Treasurer’s “economic case for surplus” went like this. He was trying to hose down the claims made by most commentators (including myself) that the Government’s “determination to reach surplus is a political strategy, and not an economic imperative”.

He said of this claim:

This is rubbish – there are compelling reasons why the economics of surplus in 2012-13 make so much sense.

I have been a macroeconomist for some time and there are no economic reasons – compelling or otherwise – why the government would try to pursue a surplus at this present time.

But here are his reasons.

1. The Government’s fiscal stimulus helped “support demand” and “ensured our economy did not go into recession”.

I agree with this. It was a very sound intervention from a macroeconomic perspective even though the design of the programs did not yield enough jobs per dollar spent.

2, “But just as it was right to step in and support demand when it is needed, it is right to step back and provide space for the private sector to grow – and that is what we have been doing”.

Except that the economy is slowing as private spending growth is not strong enough to fill the gap left by the public sector spending withdrawal. Further, a government should only withdraw fiscal support to “let the private sector grow” if there the economy is running up against the full employment barrier.

Fiscal contraction would be reasonable in those circumstances would be a reasonable strategy for government take, as long as the public-private mix in final output was considered appropriate. In fact, it would be an essential anti-inflationary policy change.

However, the Australian economy is nowhere near full capacity. The ABS estimates that around 12 .5 per cent of workers are either unemployed or underemployed. This, in fact, underestimates the true state of labour underutilisation because it ignores the hidden unemployed and other marginal workers who may offer some services should the economy be growing more quickly.

The Treasurer then said that “you can’t be a Keynesian on the way down, but not on the way back up”, which is fine, apart from the fact that the Government’s strategy is anti-Keynesian. They are engaging in pro-cyclical fiscal policy changes.

3. The Treasurer said “in an economy moving back towards trend growth … it is appropriate for the Government to be returning the budget to surplus”.

Several points can be made about this.

First, trend growth is not the relevant benchmark if the economy has been operating at levels of activity for many years, which are patently well below full employment. Over the last three decades, government policy has deliberately maintained a state of the entrenched labour underutilisation.

So using the trend rate of growth associated with this historical period as the policy goal is to adopt a somewhat diminished aspiration.

Second, the Treasurer is not being accurate when he says the economy is moving back towards trend growth.

The following graph is taken from ABS National Accounts data (latest available December quarter 2011) and shows the annual rate of real GDP growth since the March quarter 2000 to the December quarter 2011 (blue bars). The red line is the average growth rate (3.5 per cent) for the 20-quarters before the recent crisis impacted (September 2003 to September 2007).

The Australian economy started slowing in the March 2008 quarter and has not gone close to achieving the growth rate that was enjoyed in the 5 year period before the crisis. The pace of growth was gathering on the back of the fiscal stimulus in the December 2009 to June 2010 quarters but then fell away as the fiscal stimulus was withdrawn.

Private domestic spending growth remains subdued and the pursuit of the fiscal surplus is now introducing serious drag on the growth rate.

The point is that the economy is nowhere near is past trend. The Treasury has a current trend estimate of 3 per cent which is the average growth of the period from March quarter 2000. Even with this more subdued growth trend forecast (a period which included two major downturns as you can see from the graph), the Australian economy is nowhere near trend performance and is now moving away from that benchmark.

The Treasurer then ambled through all the usual myths – the primacy of a AAA rating even though the government doesn’t intend borrowing anymore (so on their own logic the claim is odd); the need to take pressure of the inflation rate (even though inflation is falling and well within the RBA’s upper bound for policy); the praise the IMF has bestowed on the Government (even though the IMF is deeply implicated in advocating policies that created and have extended the crisis).

The next part of the speech focused on the plunging tax revenue. The analysis was fine.

His final point related to what the Government planned to do about the declining revenue given that it refuses to see it as a sign that their budget surplus plans are now (and always were) inappropriate.

He said:

… because revenues are being written down, we need to find even more substantial savings in the Budget than we had earlier anticipated. I’m not talking about slash-and-burn …

Well it looks like slash-and-burn to me. In accounting terms, ignoring the fact that the cyclical impacts of the cuts will most likely thwart the Government’s ambitions anyway, the scale of the fiscal retreat is unprecedented in our history – it is that big.

In one fiscal year, the Government is planning a shift in the budget outcome of at least $A38.5 billion. In the Mid-Year Economic and Fiscal Outlook (published last December) the government revised their budget estimate for this financial year upwards from $A22.6 billion (1.5 per cent of GDP) to $A37.1 billion (2.5 per cent of GDP), in light of the collapsing revenue.

The MYEFO also revised the surplus projection for 2012-13 down from $A3.5 billion (0.2 per cent of GDP) to $A1.5 billion (0.1 per cent of GDP).

It is likely that the budget deficit will be higher for this financial year than the December projection, which means the scale of the fiscal retreat is even larger than it appears on paper.

A retrenchment of net public spending of $A38.5 billion in one year is equivalent to 2.6 per cent GDP (currently). That is a massive contraction, especially considering the current state of private demand.

Does the Government really believe that private spending will not be negatively influenced by that sort of liquidity squeeze on final demand?

By way of press reaction, Tim Colebatch (the economics editor of the Melbourne Age) wrote an article (March 30, 2012) – Swan’s foolish surplus fetish – which provided a good assessment of the state of play in Australia at present with respect to macroeconomic policy setting.

Tim Colebatch wrote:

Wayne Swan’s determination to deliver a budget surplus, regardless of the state of the economy, is seriously reckless. Labor has chosen to risk sending most of Australia into recession in order to keep a promise it should never have made.

Thanks to Tim for the title of today’s blog!

Tim Colebatch notes that the scale of fiscal retreat being planned is “equivalent to shutting down the entire electricity industry, all arts and entertainment venues and all airline travel for a year”.

His reaction is:

Why on earth would you do this in an economy that has added just 10,000 jobs in the past year, where the growth rate is just 2.5 per cent, and most of that is in mining and related industries, and with Victoria and south-eastern Australia on the verge of recession?

The Australian economy effectively is producing no net employment and hasn’t done so for more than a year – with the trend worsening. We haven’t been in this situation since 1992 when we were just starting to see recovery after the worst recession since the 1930s.

Tim Colebatch says the planned budget cuts are “two to three times as large as those landmarks of fiscal austerity – at a time when most sectors of the economy are already going backwards or sideways under pressure from the high dollar and low demand”.

He likens the Treasurer’s claims to those made by the current British government when it “slashed public spending and forecast that the economy would bounce higher”. We know now that the British economy “hasn’t grown for 15 months” and unemployment is rising.

Tim Colebatch prompts us to some simple arithmetic:

Just do the sums. Suppose Treasury forecasts trend growth of, let’s say, 3 per cent in an economy when it’s already taken out 2.6 per cent of activity. That would imply that it thinks growth would have been 5 to 6 per cent had the budget bottom line remained unchanged. In the position we’re in now, that is ludicrous.

Amazingly, ludicrous.

The Treasurer’s speech made no mention of the downside risks of this sort of planned spending withdrawal.

Tim Colebatch also says this of the Treasurer’s claims:

Swan’s economic case for this hara-kiri is, first, that the economy is ”on the way back up”; second, that it will create room for the Reserve Bank to cut interest rates; and third, that it will ”send a strong message of confidence to investors around the world”.

The first claim is clearly wrong. The second is misplaced: the Reserve already has plenty of room to cut interest rates, given low inflation and low growth. It doesn’t need an excuse; it just needs the honesty to admit it was wrong.

And the third case is counter-productive. It is because investors are so confident in Australia that they have driven our dollar to levels that have made Australian producers uncompetitive. That’s why Victoria has lost 42,000 full-time jobs since last April.

I also agree with him that the “focus of this budget should be on targeting a stimulus to recharge the south-east, including south-east Queensland”. The reality is that the electorate will not be awarding the Government at the next election if it somehow records a budget surplus but unemployment rises.

The scale of contraction being planned will almost certainly push the economy towards recession. The electorate will then, almost certainly give the Government its marching orders.

Tim Colebatch says that the Government’s strategy will likely “end up with most of Australia in recession, the budget still in deficit and Labor losing power in a landslide”.

The Treasurer concluded in this way:

Maintaining fiscal discipline is not for the faint-hearted …

The only qualification you need to have to be Australian Treasurer it seems is blind ambition.

For a different view of what fiscal discipline actually means please read the following blogs – Fiscal sustainability 101 – Part 1 – Fiscal sustainability 101 – Part 2 – Fiscal sustainability 101 – Part 3.

Conclusion

Seriously Reckless indeed. Blind and ignorant. Dangerous. Irresponsible … and all the rest.

The Australian government does not deserve to hold office. The problem for us is that the Opposition claims it would cut public spending harder.

As Tony Fitzgerald said (in my opening) – we desperately need to:

… counteract the mediocrity and venality of those power brokers and professional politicians, whose life experience is limited to learning and practising the dark arts of misinformation, secrecy and character assassination …

That is a world-wide problem but it won’t happen unless we – the people – do something about it. Proposals to storm and occupy various government offices etc will be happily received.

Saturday Quiz

The Saturday Quiz will be back sometime tomorrow (actually at 04:00 EAST – pre-programmed)! I hope it provides some amusement over the weekend or whenever you get around to dealing with it.

That is enough for today!