Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
It was a sort of relief being in Seoul for Monday and Tuesday immersed in discussions about development strategies for Kazakhstan and Korean experience. I could sort of kid myself that the Mid-Year Economic and Fiscal Outlook 2012-13, which usually doesn’t come out until December, didn’t really happen. Out of sight out of mind sort of logic. It did come out and I read all the news and the – Treasury Document – that the Treasurer delivered to the Australian public on Monday. The latter will be oblivious to the chicanery contained in that document and the sheer absurdity of the message that the Treasurer triumphantly presented. This is high farce, high deception, vandalism, and ultimately, shocking politics, despite politics being the motivation for the strategy that the Treasurer is pursuing. Anyway, for two days I abstracted from it, despite calls from the Australian media asking my views. It was much more interesting considering the way in which Korean created its growth miracle. But more on that another day. For now, I am back in Australia (Sydney this morning early, now Darwin) and have to confront the reality – Australia is being governed by a party that is intent on deliberately creating unemployment and pushing more Australians into hardship and despair at a time when we should all be prospering. Interestingly, by next year that unemployment will extend to their own tenure in office such will be the economic consequence of their cynical political strategy, which will backfire gloriously.
Now is not the time to be cutting net public spending
The facts are obvious although the Treasurer seems unwilling to acknowledge them.
The Australian economy is now slowing. If we extrapolate the June quarter real GDP growth rate over the next 12 months, then the rate would be 2.6 per cent. There is more recent evidence suggesting that the rate is slowing and will be below that on an annualised basis. It will certainly fall below the average of the last decade or so (3.4 per cent) and will struggle to reach the estimated MYEFO rate of 3 per cent (down from the Budget estimate in May of 3.25 per cent).
Employment growth is very slow (last 12 months = 0.52 per cent) and the last few months have yielded hardly any jobs growth. The housing market is slowing, which is giving pain to the Construction industry.
And the investment growth associated with the Mining sector is now waning and will not realise prior expectations.
The problem is that the Government has locked itself in to their promise to create a surplus in 2012-13 at all costs as a political imperative. As the economy slows, the task gets harder.
The latest estimates are that tax revenue is now likely to be $A4 billion less than was forecast 5 months ago when the May 2012-13 Budget was delivered by the Treasurer. A slowing economy delivers less tax revenue. Cutting public spending will make that worse.
By hanging onto the surplus obsession, the Government risks driving the economy into recession and forcing thousands more into unemployment. It will also lose office in the process because in my view (noting I am not a political scientist), they have welded themselves to this austerity promise so tightly that it will be seen as a major political failure when the automatic stabilisers thwart their aspiration.
So what will actually be a preferred outcome – the budget remaining in deficit – will be seen by the electorate as a failure and despite the Opposition claiming they will run bigger surpluses they will be seen as the preferred economic managers. That is how skewed all this has become.
There is no economic imperative to pursue a surplus at present. The Government has an inferiority complex when it comes to fiscal matters and wrongly thinks that surpluses constitute the hallmark of responsible fiscal management. They should never have made the promise in the first place. But now, in the light of a slowing economy, it would be reckless to undermine spending further.
The Government withdrew the fiscal stimulus too early which stifled the promising recovery. They believed the non-government spending would step in and more than offset any withdrawals in public spending.
In the process, the slowing economy is undermining its tax revenue. Instead of acknowledging that as a sign that stimulus is required, the Government’s inane response is that they are cutting spending even harder. Further austerity will make matters worse and further reduce tax revenue. The Government will most likely fail to achieve a surplus but will damage our prosperity in the pursuit.
There are two points to note. First, a national government cannot really deliver on a targetted budget outcome because that outcome is dependent on private spending and saving decisions, which are beyond the control of government. So targetting a particular outcome is poor policy. Policy targets should reflect outcomes that are within the control of the policy maker.
The government should target real outcomes – such as low unemployment – and let the budget deficit “float” in order to achieve that outcome.
Second, at times counter-cyclical fiscal policy changes need to be made to influence the composition and rate of aggregate demand growth. But by any assessment, the Australian government is pursuing a pro-cylical fiscal contraction, which will burn them politically, soon after it makes matters worse for the rest of us – although the negative consequences of the contractionary impulses, as usual, are disproportionately felt by those at the bottom of the wage and income distribution.
The Government’s stated economic logic is that:
Returning to surplus provides ongoing scope for monetary policy to respond to economic developments and underpins confidence in Australia’s public finances at a time of global economic uncertainty.
The Treasurer’s claims that the government’s surplus promise has allowed the RBA to cut rates is a strange argument. The Government’s strategy (combined with our excessively high interest rates) has been to deliberately create unemployment in the non-mining regions so that the idle resources could then service the mining boom.
Not only will the required migration patterns fail to occur but non-government spending is not strong enough to support trend growth – mining investment boom notwithstanding. Many large employing sectors are declining due to a combination of an appreciated currency (exacerbated by high interest rates) and the withdrawal of the fiscal stimulus.
The RBA is aware that its growth forecasts were wrong and is now trying to backfill the damage that the resulting high interest rates, combined with the Treasurer’s policy stance, are causing. That is a far cry from the way the Treasurer constructs the events.
The MYEFO also deliberately misleads Australians:
The European sovereign debt crisis has highlighted the importance of maintaining strong fiscal discipline and credibility to sustain confidence at a time of heightened instability in financial markets.
The European sovereign debt crisis has nothing to do with us in the context of what it means for the Australian government budget process. The Australian government does not use a foreign currency. It can always meet its financial obligations because it issue its own currency.
The Australian government rules bond markets because net spending is not dependent – when it comes down to the crunch – on what the bond markets might decide to do. The bond markets feed off the bond tenders not the other way round.
The scale of retreat is unprecedented – fudged data or not
As noted in my commentary on the May 2012-13 Budget – the planned fiscal retreat is unprecedented in our history.
At the time of the May 2012-13 Budget the planned budgetary shift was estimated to be at least $A38.5 billion. In the latest MYEFO the proposed fiscal shift is now $A44.1 billion or 3.1 per cent of GDP. That sort of shift towards surplus has never been achieved in known history.
The following graph shows annual fiscal shifts since 1972-73 in terms of proportions of GDP.
The shift into deficit in 2008-09 saved the economy from a major recession and growth was supported in the following year by a further shift to stimulus, although some of the shift in both years was the result of the automatic stabilisers reducing tax revenue and pushing out welfare payments (based on existing policy settings).
The Government’s take on this appears on Page 35 of the MYEFO:
Importantly, the economic impact of the fiscal consolidation in 2012-13 is much smaller than the 3.1 per cent of GDP turnaround in the underlying cash balance. This is because the surplus is being achieved through a combination of targeted and responsible savings and the natural increase in tax receipts associated with a growing economy, assisted by policy measures in this MYEFO to improve the operation and integrity of the tax and superannuation systems.
Of-course, one can ensure the growth assumptions and underlying tax elasticities (the response of tax revenue to growth for a given tax rate structure) are such that the budget outcome moves towards and/or into surplus. But a fiscal contraction has to undermine spending growth overall unless the non-government sector more than offsets the cuts (no matter what degree of contraction is finally endured). On the same page (35) of the MYEFO this is what the Government actually assumes.
But like all austerity-seeking governments who have assumed the private sector prefers smaller deficits or surpluses and will increase spending as a consequence of a government pursuing such a fiscal shift, the Australian government is in denial of not only the objective circumstances that exist at present (rising unemployment; outstanding and massive private debt overhang from the pre-crisis credit binge; declining terms of trade which is undermining $A export revenue but also discouraging further investment growth in the mining sector, etc), but also basic psychology.
The non-mining economy is in near recession at present with unemployment undermining income growth and non-mining investment very weak. Basic psychology tells us that in those situations private spending binges of the size required to “more than offset” the public cutbacks will not be forthcoming.
However, there is also some dishonesty in the way the government is presenting the data to us.
In the May 2012-13 Budget statement it was obvious that at least $A8.5 billion in spending that will flow this year was shifted to be recorded against the 2011-12 outcome. So the deficit in 2011-12 was artificially inflated, which just happened to allow them to record a paper surplus despite the degree of contraction associated with the 2012-13 fiscal position being less than would be forthcoming if there really had have been a 3.1 per cent of GDP withdrawal in one year.
In other words, the degree of contraction this fiscal year is actually less in 2012-13 than the nominal figures suggest. How much less is a guess but if we subtract the $A8.5 billion from last year and add it to this year then you are talking a $A27 billion fiscal shift, which is about 1.8 per cent of GDP.
More importantly, this means the underlying fiscal position in 2012-13 is not a surplus at all but a deficit of some $A7.4 billion (0.5 per cent of GDP).
Whatever the actual numbers are (and turn out to be) and the deviousness aside, the direction of fiscal policy is completely wrong. Even if it ends up being a 1.8 per cent of GDP contraction that scale of fiscal shift i one year is also unprecedented historically and is totally unsuitable at a time when non-government spending will not offset the loss of public net spending.
The question that has to be asked is under what circumstances would a Government be responsible in taking out net spending equivalent to 1.8 per cent of GDP in one year (when inflation is forecast to be constant or falling)?
You have to ask this question in the context of actual real GDP growth is running at around 2.5 per cent at present and trending downward and the main growth engine – private investment slowing as a result of the slump in commodity prices.
The answer to the question is that the economy would have to be pushing well above trend and straining the inflation barrier – with full employment and zero underemployment – and private growth would have to be very strong and becoming even stronger during the forecast period.
There have never been conditions like that in the last 40 years. Nor will there be in the next 12 months.
That is why this scale of fiscal withdrawal is an act of vandalism and driven by misguided (miscalculated) political machinations and is devoid of any economic rationale.
Misplaced trust in Monetary policy
On Page 35 of the MYEFO we read:
The Government’s fiscal consolidation should continue to provide scope for monetary policy to be eased, if appropriate, without generating price and wage pressures. Thisrecognises that in normal circumstances, monetary policy should play the primary role in managing demand to keep the economy growing at close to capacity, consistent with the medium-term inflation target. The impact of the fiscal consolidation in 2012-13 should be more than offset by growth in private demand, with the aggregate economy growing around trend.
The reliance on monetary policy as the principle counter-stabilising policy tool is a world-wide obsession, which stems from the now discredited mainstream view that fiscal multipliers are low if not negative and inflation-first policy approaches are best because any unemployment that results is temporary and incidental.
All these propositions are false and the enduring economic crisis has demonstrated that. Fiscal multipliers are likely to be well over 1 meaning the cuts to net public spending are not offset by greater gains in private spending.
Further, monetary policy changes have uncertain impacts on aggregate demand, which make them unreliable vehicles to influence spending growth. They cannot target regions, sectors or demographic cohorts, other than punishing (or rewarding) debtors and rewarding (punishing) creditors and fixed income recipients. These distributional impacts are unclear in net terms.
Labour Market considerations
The MYEFO revised employment growth for 2012-13 down from 1.25 per cent (as in the May 2012-13 Budget) to 1 per cent but held the unemployment rate estimate for the same period at 5.5 per cent. The participation rate was revised down from 65. 25 to 65 per cent.
So what do those numbers actually mean when applied to the current labour force aggregates?
Total employment in the June 2012 quarter was 11494.2 thousand. So the one percent employment growth assumption means that total employmentis estimated to grow by 9.6 thousand per month or 115 thousand over the year 2012-13.
We know the Working Age Population increases by about 20 thousand persons per month, which means that the Labour Force will increase by about 156 if the participation rate is assumed to be constant over 2012-13 at 65 per cent.
This means that unemployment is estimated to rise by 41 thousand from its June 2012 level of 640.5 thousand. When translated into a change in the unemployment rate we see that the estimate is for the rate to rise from 5.3 per cent at June 2012 to 5.5 per cent by June 2013.
So the internal MYEFO estimates are consistent but of-course, employment growth would have to get a kick on because over the last 12 months only 65 thousand jobs have been added and the growth trend is downward. So the Government is estimating this fiscal year will see a two-fold jump in the net employment change.
Over the last three months, only 17 thousand jobs (net) have been added. Given current signals I doubt that their estimates will come to fruition.
If employment growth continues to lag at around a 0.5 per cent growth rate (the rate achieved over the last 12 months) the total employment would only rise by 60 thousand over 2012-13 and, given the underlying population growth, unemployment would rise by 96 thousand. The result would be an unemployment rate of 6 per cent, which is more likely than the outcome being predicted.
Think about that in terms of the monetary policy logic. If the Government is giving room for the RBA to reduce interest rates, then according to the mainstream logic they must be assuming inflation rates are to decline which means that the current unemployment rate cannot be considered the steady-state unemployment rate (NAIRU in their parlance).
In their own logic that means there should be scope for the unemployment rate to fall. Yet their own projections means that unemployment will increase by 41 thousand over 2012-13 (from a rate of 5.3 per cent to 5.5. per cent).
With inflation forecast to decline, the Government is thus deliberately holding unemployment above the level which would be justified by their own perverted and empirically unsustainable logic.
It is clear that the government doesn’t consider this a major issue. The MYEFO review (page 28) says that the “unemployment rate is forecast to increase slightly” but in people terms that 41 thousand people without jobs, not to mention the 55 odd thousand workers who are assumed to exit the workforce into hidden unemployment as a result of the assumption that the participation rate will fall from 65.3 per cent to 65 per cent.
So around 100 thousand extra workers lost to productive employment because the government thinks it will win votes by running a surplus (which should be stated as “trying to run”, given it is unlikely to hit the target anyway). 100 thousand workers lost to production and income generation is what this Government calls a “slight” adjustment.
Nonsense from the Opposition (or their friends)
The former conservative Defence Minister also decided to demonstrate his absolute ignorance on these matters despite pretensions in the past to be treasurer.
Australian readers will remember him as the Minister who oversaw the scandalous lies associated the “children overboard” matter in 2001, such that the majority opinion of the Senate committee – <Select Committee on a Certain Maritime Incident – reported in 2002 that:
Despite direct media questioning on the issue, no correction, retraction or communication about the existence of doubts in connection with either the alleged incident itself or the photographs as evidence for it was made by any member of the Federal Government before the election on 10 November 2001.
Minister Reith made a number of misleading statements, implying that the published photographs and a video supported the original report that children had been thrown overboard well after he had received definitive advice to the contrary.
The Committee finds that Mr Reith deceived the Australian people during the 2001 Federal Election campaign concerning the state of the evidence for the claim that children had been thrown overboard from SIEV 4.
This was a major scandal where the government and its senior officials lied to the public about what had happened – purporting to claim that photos produced showed refugee parents throwing their children off a ship into a wild sea to score sympathy – just to gain political traction on the border defence issue at the time. It changed the result of the 2001 federal election campaign and has stymied the Labor party ever since.
The facts were the photos were not even of the incident and were altered using Photoshop by the Navy ((Source).
Anyway, Peter Reith is trying to reinvent himself as some sort of elder statesman of Australian politics, and had this to say about the MYEFO in his recent Op Ed (the Ed bit being a very liberal interpretation of the quality of the article) – Mr Swan, show us the money – (October 23, 2012):
In this context, although MYEFO is important, it is only one aspect of economic policy. Labor is right to keep pushing for a surplus. Australia has not fallen into recession and Labor’s accumulated deficits, from 2007 when they were first elected, are weakening our position. Australia can’t afford to risk future prosperity by not taking steps now to put our finances in better shape. Whilst Labor has not delivered a surplus at any time for over 20 years, it’s good for them to at least try.
The international situation is cause for concern. Treasury suggest in the MYEFO (PDF) that there are real concerns about the labour and housing markets in the US, the Europeans are not yet out of the woods and China should be OK, but time will tell. The Government itself says that unemployment will be higher (at 5.5 per cent) than they thought and GDP will be 3 per cent, which is less than the earlier forecast of 3.25 per cent.
In other words, the big sign posts on our economy are heading south and the international situation is not great. Under these circumstances, any effort to better manage the budget is sensible.
Which tells you that he knows nothing much about economics.
First, I know it was a word-limited article but his assertions that “accumulated deficits … are weakening our position” and “put our finances in better shape” need some explanation to an audience that doesn’t typically understand these things. But then Reith would be incapable of providing that explanation because he doesn’t understand it either.
Second, given all the concerns about the “international situation” and the fact that forecasts are for higher domestic unemployment and lower real GDP growth, the only sensible conclusion that can be drawn is that aggregate demand is likely to be lower than necessary.
How then could you conclude that when “the big sign posts on our economy are heading south” that we should be aiming for a bigger budget surplus?
No economist in their right mind would draw that conclusion. The austerity merchants have constructed pro-cyclical fiscal policy as if it was something that the textbooks would prescribe. Not even mainstream textbooks would advocate huge fiscal shifts into surplus when non-government spending is falling and the real activity indicators (unemployment and real GDP growth) are showing a slowdown is underway.
Overall, the MYEFO statement is very disappointing but totally predictable. The Australian government now runs fiscal policy as a political tool to garner short-run popularity in the lead-up to next year’s federal election rather than tailoring it to the economic needs of the nation.
In trying to implement pro-cyclical fiscal outcomes, the Government is not only damaging the prosperity of the nation but also undermining its own political capital because it is highly unlikely that it will achieve its surplus objective. The more it tries with these successive cuts in net public spending the harder it gets to reach the target.
The reason is that the target should never have been set in the first place. There was not urgency, no need and no justification for it.
That is enough for today!
(c) Copyright 2012 Bill Mitchell. All Rights Reserved.