Fiscal austerity obsession – that’s a dud policy!

I have been reading the latest report from the International Labour Organization (ILO) – World of Work Report 2012 – which documents the disastrous trends in employment that are expected as fiscal austerity grinds economies into the ground. The ILOs Social Unrest Index has risen in 57 out of 106 nations and negatively related to employment fortunes. The ILO also found that “deregulation policies … fail to boost growth and employment” and “there is no clear link between labour market reforms and employment levels”. They conclude that the “austerity trap” is destroying jobs and that concerted effort is needed to ensure that “wages grow in line with productivity” and that there should be a “coordinated increase in the minimum wage”. I will analyse this report in more detail another day because it is schizophrenic in approach reflecting the struggle within the ILO between the neo-liberal influences that have grown over the last few decades and the more balanced labour market understandings that come from a thorough understanding of the importance of labour market institutions and government oversight and a keen appreciation of the empirical dimensions. But today I am going to briefly reflect on an extraordinary interview – Former Reserve Bank Governor bemoans state of politics and inequity – on the ABC current affairs program – 7.30 – last night, where the former RBA governor let fly at budget surplus obsessions and demanded more expansionary fiscal and monetary policy interventions at a time when demand is faltering and growth falling. And some other snippets appear afterwards.

The interview was remarkable because rarely does former RBA governor speak so publicly about current fiscal and monetary policy settings. In this case, the former RBA governor (1989 to 1996), Bernie Fraser was also the head of the Treasury for a time in the 1980s (being appointed by a previous Labor government).

Bernie Fraser opened the interview by saying that:

For a long time I’ve thought Australia could become something of a special country, a demonstration of a country that was competitive, fair and compassionate. And I’m afraid those hopes have been dashed a bit over the years.

We’ve had 20 years of uninterrupted growth, solid, sustained growth for 20 years, and yet we’ve got more homelessness, distribution of income and wealth is more unequal now than it was 20 years ago, we’ve got infrastructure, social and economic, that is breaking down and creaking.

He might have also said that over the same period we have had persistently high labour underutilisation rates, increasing trend to casualisation and job insecurity (30 per cent of Australia’s workforce is now casual mostly without normal entitlements), and currently we have around 38.8 per cent of our active teenagers idle in one way or another.

He said that both sides of politics have “failed, and they’re both failing still, and the more distressing thing is I don’t see a way out from either side”.

The common element is that both sides of politics have followed the world trend and embraced neo-liberalism as their economic approach. While Labour and the Conservatives differ on social policy (even those differences are narrowing) they share almost lock-step the same economic mantra – run surpluses at all costs.

Next week, the Federal government will deliver the 2012-13 Budget and it will announce that it plans to deliver a surplus despite the economy now slowing dramatically. The fiscal consolidation proposed if successful would be the largest one-year shift in net spending in our history.

The former RBA government was asked whether the Government had “lost its way?”.

Yes … [in relation to the pursuit of the budget surplus] … This is another attempt to try to rationalise what is really a pretty poor political commitment to deliver a budget surplus next year irrespective of the economic circumstances. I think that’s a dud policy.

For overseas readers, the Labor Party (now in government) began as the political arm of the trade union movement and used to have socialism as a key national policy platform. It has traditionally been accused by the conservatives (Liberals aided in coalition by the National Party (rural lobby)) of being poor economic managers – spendthrifts with no fiscal discipline.

It has reacted to those criticisms by becoming more neo-liberal in intent that the conservatives. Two years ago it promised to deliver a budget surplus this year – because it considered that would allow them to wear the “badge of fiscal responsibility”. As their political fortunes have waned (no pun intended – Wayne Swan is the Treasurer) they have become more obsessive that they will deliver the surplus at all costs.

The Federal government is caught up in the fiscal austerity narrative that the neo-liberals had imposed on failing economies everywhere.

It thinks that if it maintains its pursuit of a budget surplus the electorate will reward it for being a responsible fiscal manager. However, the electorate is more concerned about real income growth and employment opportunities and the government’s current strategy is undermining both.

What the Government also fails to grasp is that in trying to achieve a budget surplus at a time when the economy is slowing that the automatic stabilisers (that is, the plunging tax revenue growth) will likely see the budget in deficit anyway and nothing positive to show for it.

Pro-cyclical fiscal policy at a time when private spending is weak overall is very irresponsible fiscal management.

The Government claims that the mining sector is growing so strongly that it needs to create room for this growth to occur. What this means is that it intends to deliberately starve the sectors that employ the most Australians of demand (via high interest rates and fiscal drag) in the hope that the unemployment workers will move to remote regions in the North West to take up mining jobs.

The fact is that worker mobility will never be high enough to achieve that purpose and in the meantime the major population areas are in recession or nearly so. Remember that the mining industry is a very small employer and a lot of the income generated and investment that is associated with mining growth goes abroad – out the current account!

There is some presumption that the mining sector should grow as far as the demand for resources will take it, even though it is clear that the majority of Australians are not enjoying the benefits of that growth.

If the overall economy was growing strongly we would have no hesitation in putting on the policy brakes to avoid an inflationary spiral of emerging. The solution would seem obvious – the Australian government, if it really believes that labour shortages in the mining sector are going to drive widespread wage inflation in Australia then it can simply introduce policy initiatives that will reduce the growth of mining.

I do not believe the inflation threat claim and last week’s inflation data shows it to be false – see this blog – Australian inflation plummets as the fiscal vandals undermine the economy.

With the rest of the economy in recession or near-recession, the Federal government should be maintaining its stimulus to support sectors, which not only employs the overwhelming majority of workers but also produces the overwhelming majority of our national income.

The beauty of fiscal policy (as opposed to monetary policy) is that specific sectors can be targetted for stimulus or contraction while maintain the opposite overall policy stance. If there are inflationary bubbles emerging in one sector – for example, real estate – then targetted taxation initiatives are appropriate and very effective.

Using a broad (blunt) instrument like the overall interest rate to target specific sectors is poor policy and largely ineffective (given the vagaries about the direction of monetary policy impact and its timing).

Please read my recent blogs – Inflexible governments undermine our standards of living and A seriously reckless act – for more pre-Budget discussion.

In this context – “With large parts of the economy in the doldrums, sub par growth and hardly any expansion of employment over the past year” (the words of the interviewer Stephen Long) – the former RBA Governor was asked about the Government’s budget surplus obsession. He replied:

It just doesn’t make sense because on 1st May the Reserve Bank could well reduce interest rates by 25, maybe even 50 points. On 8th May we’ve got the prospect of the Treasurer introducing a policy that’s going to tighten fiscal policy quite significantly.

Of interest were his commments about the fiscal stimulus which the Government introduced in 2008-09, which clearly added enough aggregate demand to allow the Australian economy to avoid a formal recession.

The interviewer concludes that these comments suggest the stimulus intervention “has given government spending a bad name”. Bernie Fraser said;

The education building program, the insulation programs, unfortunately they were pretty disastrous and the implications of those sort of failures have rebounded adversely on all government spending. It’s really given the Coalition some free kicks, that here’s a government spending money and wasting money and therefore governments shouldn’t spend, they shouldn’t run deficits, they shouldn’t have debt.

The myth propogated by the conservatives is that Australia might have been better off without the package because the government footprint distorted prices and was an adminstrative disaster.

I have consistently said that some parts of the stimulus intervention (a relatively minor proportion of total funds spent) were problematic in terms of adminstrative issues. The home insulation program was poorly conceived and highly problematic in its implementation.

But large-scale stimulus interventions of the type taken by the Australian Government in 2008-09 are very complicated and you can expect some administrative inefficiencies. Imagine if the private sector had to ramp up investment spending to the scale that the Australian government did in 2009 – within a quarter or so – What do you think would be the outcome of those projects?

The other point that is not well understood in this debate is that the neo-liberal era has been marked by a major reduction in Departmental capacity to design and implement fiscal policy – given the obsession with monetary policy and the major outsourcing of “fiscal-type” government services to the private sector.

Many of the major Federal government policy departments are now just contract managers for outsourced service delivery. So with the voluntary reduction in “fiscal space”within the federal government over the last 20 years or more it is no surprise that the overall capacity of the government machine to implement efficiently and speedily complicated nation-wide infrastructure programs has been diminished.

This is a lesson for the future in my opinion. We can no longer deny that fiscal policy is required to address serious swings in private spending. Monetary policy has been proven – categorically – to be ineffective in dealing with aggregate demand failures of the sort we have witnessed in the current crisis. In that context, governments must develop forward-looking capacity to ensure that it has project implementation skills when they are required.

Having said that, I also pointed out in the interview that while complex interventions will not be perfect in design or execution you have to consider what would have been the case if we had have followed the Chicago school (or the Harvard school) line – and left it to the private market to sort the mess out. It is clear to me that we were facing a repeat of the Great Depression such was the damage to the financial system and the plunge in real output in the major economies.

The major point is that at the time the stimulus packages were designed and announced, the Government believed the nation was on the precipice of another Great Depression. The international events demonstrate that the crisis has been very severe and on-going. The government rightly assumed that there would be major idle labour skills available to be brought back into productive work. That was a reasonable assumption and the fact that the downturn wasn’t as bad as that demonstrates that the fiscal stimulus was very effective.

The Government should have concentrated the stimulus on efforts to provide public sector jobs to the most disadvantaged workers who bear the brunt of unemployment and underemployment. They are still idle and without sufficient income and that situation is worsening as the fiscal austerity sets in.

But Bernie Fraser’s point is valid – the conservatives have been able to cast all government spending as wasteful and bad and has led to his fear (in Stephen Long’s words) that “Labor’s failings could pave the way for a long era dominated by an extreme ideology of small government”. Bernie Fraser said:

To listen to the Coalition spokespeople, I hear echoes of the Republicans and the more extreme Tea Party Republicans. All this folksy nonsense about governments have to live within their means, governments have to behave like households and like businesses, that government spending is bad, deficits are bad, debt’s bad – all this to me is nonsense really because governments are not like households, they’re not like businesses, they have responsibilities that go beyond.

But more importantly, the Federal government as the issuer of the currency has capacities that go beyond those possesed by any currency-using entity in the non-government sector.

The rest of the interview was about the conduct of the RBA and today’s (impending) interest rate decision.

Don’t forget Greece …

While the focus of the Eurocrisis is firmly on Spain at present – given its impending demise – don’t forget about Greece. The latest data from the Hellenic Statistical Authority (April 30, 2012) – Turnover Index in Retail Trade, February 2012 – reports that:

The retail trade volume index, including automotive fuel, decreased by 13.0% in February 2012 compared with February 2011.

13 per cent!

The following graph shows the evolution of retail sales growth (volume) in Greece – in annual terms – from January 2010 to February 2012. I have superimposed the annual growth in real GDP (red line) to show you the correspondence between real spending and output growth – one of the most basic facts of macroeconomics. The real GDP line is quarterly data extrapolated in a linear fashion over the monthly retail sales data.

The sustained decline in both tells us that the claims that fiscal austerity would lead to a spurt in private spending as a result of private households and firms shedding their fears that they would be subject to higher future taxes to pay the deficits back – is plainly false.

This Bloomberg Editorial (May 1, 2012) – Spain’s Slump Means Europe Must Rethink Tough-Love Policy – is one a growing number that challenges the Eurozone obsession with fiscal austerity.

It says that “Spain is the crucial front in Europe’s battle to contain its economic crisis, and the fight is going badly” – totally failing would be a better description.

They note that the Spanish government has followed the EU bosses demands for austerity to the letter and faces a labour market and banking sector meltdown. In addition, it is under increasing attack from the bond markets.

The Editorial says that austerty “can’t provide short-term relief” and that relief:

… can only come from the EU as a whole … any feasible solution will require some pooling of Europe-wide fiscal policy, with the European Central Bank acting as lender of last resort for distressed sovereigns … it’s absurd to assert — as Germany has — that Spain and other struggling economies can claw their way back to economic stability through fiscal austerity, despite slow or no growth. If Europe’s leaders are betting they’ll have time to act if the situation deteriorates, they’re wrong. The pressure on Spain is no longer productive. It’s undermining a government that is doing all it can. If the gamble fails, things will unravel quickly — too quickly, maybe, for Plan B to take effect.

The time for Plan B is now.

Plan B should be the total dissolution of the Eurozone and the restoration of sovereign currencies. The sooner the member states agree to that and proceed to dismantle the monstrosity in an orderly manner the better the individual nations will be.

I will be talking about this tonight in Melbourne – at an event – Can the Eurozone survive its Crisis? – which is hosted by the Monash University European Union Centre.

The event is open to the public and will be held at the Monash Conference Centre, Level 7, 30 Collins Street, Melbourne (that is, in the CBD) from 18:00 to 19:30.

Joining the debate is the Ambassador and Head of Delegation of the European Union to Australia and New Zealand who is pro-Euro and pro-austerity. We should have some interesting converstations.

Another laboratory opening up

It is May Day today and the Malaysian Government appears to celebrate Workers’ Day.

The News Straits Times article (May 1, 2012) – Minimum wage cheer for workers – reported that the Malaysian Prime Minister announced last night that a minimum wage would be introduced in Malaysia for all private sector workers (except for domestic services, involving maids and gardeners).

The PM said that “this was in preparation for Malaysia morphing into a high-income nation. He was quoted as saying:

The introduction of the minimum wage is a historic moment for Malaysia. The lowest paid will now be guaranteed an income that lifts them out of poverty and helps ensure that they can meet the rising cost of living … The proposed rates take into account the needs of businesses, while ensuring that no Malaysian is left behind in the country’s economic progress.

He also “wished Malaysians a Happy Workers Day 2012” and said that “the success achieved and enjoyed by the country in the past, present and future would not be possible without the contributions and sacrifices made by Malaysian workers”.

In an earlier article (April 29, 2012) – Najib to announce minimum wage for private sector workers on Worker’s Day – we read that the minimum wage would be “the perfect gift for employees and trade unions”.

So we have another laboratory opening up. The Eurozone and the UK is providing us with priceless data to demonstrate that a vast body of mainstream macroeconomics is total bunk – even though logically we already knew that.

The introduction of the minimum wage in Malaysia will also provide us with time series data – before and after – to assess all the mainstream flim-flam that minimum wages cause unemployment.

I remind readers that even the most vehement proponents of that idea have had to moderate their views in recent years in the face of overwhelming evidence to the contrary.

In the face of the mounting criticism and empirical argument, the OECD began to back away from its hard-line 1994 Jobs Study position (which demanded widespread deregulation as the solution to unemployment).

In the 2004 Employment Outlook, OECD (2004: 81, 165) admitted that “the evidence of the role played by employment protection legislation on aggregate employment and unemployment remains mixed” and that the evidence supporting their Jobs Study view that high real wages cause unemployment “is somewhat fragile.”

Then in 2006, the OECD Employment Outlook entitled Boosting Jobs and Incomes, which claimed to be a comprehensive econometric analysis of employment outcomes across 20 OECD countries between 1983 and 2003 went further. The study sample for the econometric modelling included those who adopted the Jobs Study as a policy template and those who resisted labour market deregulation. The Report revealed a significant shift in the OECD position. OECD (2006) finds that:

• There is no significant correlation between unemployment and employment protection legislation;
• The level of the minimum wage has no significant direct impact on unemployment; and
• Highly centralised wage bargaining significantly reduces unemployment.

The only robust finding that the OECD (2006) demonstrated was that employment protections do not impact on the level of unemployment but merely redistribute it towards the most disadvantaged – including the youth who have not yet developed skills and have little work experience.

That point is obvious. In a job-rationed economy, supply-side characteristics will always serve to only shuffle the unemployment queue. The problem is a shortage of jobs. Unemployment dances very closely to labour demand not labour supply.

But I don’t expect that to be a problem in Malaysia given the willingness of the national government to use its policy mandate responsibly.

For example, in a related article (May 1, 2012) – Govt projects will offset lower private sector demand for cement – we read that;

… the fourth largest cement company in the country, sees lower cement demand from private sector jobs this year but expects the decline to be compensated by government projects.

The company spokesperson said that “mega projects from the government will definitely help the company and the industry, to compensate the decline from the private sector … Overall, we expect the industry to be generally stable this year”.

Compare that approach to the West!

Anyway, in a few years we will be able to analyse the time series labour market data coming out of Malaysia and we should be able to determine whether the introduction of the minimum wage generated higher unemployment.

My prediction – there will only be benefits – lower poverty, higher productivity, higher skills and a more bouyant labour market.

Can anyone please E-mail this lot and tell them that they issue the currency?

Sometimes I have to look up the date when I read an article just to make sure it isn’t April 1st. Take this Bloomberg news story (April 27, 2012) – Riksbank Says Considering Establishing Krona Bond Portfolio

The Swedish Riksbank issued its latest – Economic Commentary: The operational framework for the implementation of monetary policy and experience of the financial crisis – on April 27, 2012.

The first part of the document describes the way in which the central bank (Riksbank) maintains its policy rate – “the overnight rate as its operational target”. It says that the;

Riksbank can determine the terms and conditions for overnight deposits and lending for the banks that participate in the Riksbank’s central payment system, RIX.

They outline a totally standard set of operations whereby the “banking system is balanced at the end of every day” and, initially “the banks do this between themselves on the overnight market by means of overnight loans”. But the banks can also:

… deposit money overnight with the Riksbank or borrow against collateral using the so-called standing facilities where the lending rate is equal to the repo rate plus 0.75 percentage points and the deposit rate is equal to the repo rate minus 0.75 percentage points.3 These interest rates conditions create an incentive for the banks to come to an agreement with each other on an overnight rate that lies within the corridor formed by the Riksbank’s deposit and lending rates. The Riksbank thus in practice sets the conditions governing the overnight market.

As I said totally standard.

They then describe how the Riksbank drains (or adds) liquidity to the overnight market to ensure the overnight rate is stable and consistent with its policy target. We read that:

… when the banking system has a liquidity surplus in relation to the Riksbank, the Riksbank needs to draw in this surplus using various market operations so that the balance of the banks’ accounts at the end of the day is as close to zero as possible.

The liquidity surplus (that is, excess reserves) would induce banks to lend at decreasing rates to each other – even though such lending can only shuffle the excess not eliminate it (all these transactions net to zero) – and would compromise the central bank’s policy target.

The central bank says that the “total sum in these draining operations is limited to the banking systems total liquidity surplus”.

When there is a deficit in the banking system, the central bank will add liquidity via repos (repurchase agreements) and overnight loans.

The document then describes how the Riksbank reacted to the financial crisis which included “lending banks large sums” with the “aim of managing the negative effects of the crisis on the liquidity of the banking system”. There were other measures taken – all of which are fairly standard.

Interestingly, they say in relation to some of the measures they took in the crisis, that:

It was necessary, for example, to revise both legal agreements with external counterparties and the Riksbank’s internal regulations.

I have often said that the artificial restrictions that governments (treasury) and central banks place on themselves to give a pretence of financial restriction bend as quickly as is needed. It is clear that in the Swedish case, they had created neo-liberal structures – for example, the transfer of the market-maintaining repo facility to the Swedish National Debt Office in 2001 – to make it harder for the government to spend and the central bank to fund that spending.

But in the crisis – they revised “legal agreements” and their “internal regulations” in a flash.

The document then says that to meet a future emergency the “Riksbank needs to add to its toolkit: to have “an infrastructure in place that enabled them at very short notice to take extraordinary measures in a situation where this was deemed necessary”.

They claim that the Riksbank is unusual because it doesn’t “have a portfolio of assets in its own currency” and so to it needs to acquire:

… a bond portfolio in Swedish kronor once again could ensure that the Riksbank has the systems, routines and knowledge needed to be able to take extraordinary measures at short notice in the future. Under normal conditions, however, the holding and management of such a bond portfolio by the Riksbank should not be seen as signs that the Riksbank intends to intervene in the market for monetary policy purposes. To avoid the portfolio affecting interest rate formation or sending undesired monetary policy signals it should therefore be limited in size and managed transparently.

So they want to hold some assets in the currency it issues, even though it can lend in that currency unlimited amounts. At the same time, it doesn’t want to manipulate yields in the bond markets or give the impression it might be funding government spending.

What a joke!

The world will be much more simple when these neo-liberal idiots leave the stage.

Conclusion

There is clearly a growing number of voices that are realising that the obsession with fiscal austerity is not only damaging the real economies but is also self-defeating (the budget deficit and public debt ratios do not move in the direction intended).

With social unrest rising – many countries are reaching a critical point where the economic burdens imposed by their leaders will lead to more governments topplings and more riots.

The current trajectory is unsustainable and I hope that the combination of increased social strife and the increased awareness among commentators etc as to the real heart of the problem will see the neo-liberals being run out of town for good.

I have to think about my talk for tonight now.

That is enough for today!