I have been travelling for most of today so I have to keep this post…
There is a popular segment (that is, I assume it to be popular) on the national ABC television news in Australia each night. the Finance Report presents one or more graphs which motivate the presenters so-called insights into what is going on in the Australian economy. I rarely see it and when I do I tend to ignore it because the presenter is infuriating to say the least. But last night, he presented to charts which were of interest although the conclusions he drew left the “elephant” that was standing in the room unnoticed. The conclusions he drew were facile and he ignored the most obvious conclusion – that the Australian economy could only maintain growth into the future if the budget deficit was larger and on-going. That would have been a bridge too far for him to cross but that is what his data and all the other related data that he didn’t present tells us. Us – in this context – being those who understand how the macroeconomy works. So today’s blog is a reprise of the graphs (or my versions of them) with the essential commentary that might have been presented last evening and would have helped the viewers appreciate the current economic situation more fully and understand why deficits are essential in these situations.
The first graph he presented was the Household saving ratio. The following graph is taken from the June-quarter National Accounts data. It shows the Household saving as a percentage of disposable income from the March-quarter 1960 to the June-quarter 2013 with the red horizontal lines being the relevant averages for the particular periods.
The point he made is one that I have made often. Prior to the credit-binge which started gathering pace in the mid-1980s as the neo-liberals began deregulating the financial system, the household saving ratio was averaging around 16 per cent (1959:3 to 1985:3).
Then it started plunging and was negative in the December-quarter 2005 and the March-quarter 2006 at the height of the borrowing frenzy.
With the onset of the crisis, households quickly started reverting back to prior behaviour and the saving ratio shot up to 10 per cent.
That seems to be the new attraction level, which is still well below the earlier behaviour. I speculate that the motivation to save is strong now but the capacity is reduced because of the interest servicing burdens resulting from the record levels of debt the household sector is now carrying as a hangover of the binge (see later).
It is important to understand this behaviour in the context of what the other sectors (external and government) and sub-sectors (capital formation by firms) have also been doing.
The next graph (also taken from National Accounts data) adds private business investment ratio (% of GDP) from first-quarter 1960 to the December-quarter 2012 to the household saving ratio for the same period.
The data is related to (but not an exact depiction of) the private domestic sector balance. Note the vertical axis is a percentage but the denominator in each case is different – being disposable income in the case of household saving and nominal GDP in the case of the investment ratio.
Obviously, if we expressed the saving ratio in terms of total nominal GDP it would be somewhat below the blue line. But we will come back to the sectoral balance (saving minus investment) later.
It is clear that up to the mid-1980s (and during the full employment era which ended in the late 1970s), there were no sharp deviations between the household savings ratio and the private business investment ratio other than during the 1974-75 recession.
The two series become divergent in the mid-1980s, as the then Labor government started pursuing its neo-liberal reforms of the financial system and squeezed the capacity of trade unions to ensure that real wages kept pace with productivity growth.
As a result, consumption spending became increasingly reliant on credit growth as the financial services industry started to grow quickly. Just before the crisis, Australian households have built up record levels of debt and realised their position was becoming precarious and unsustainable.
The onset of the crisis accelerated that sentiment and the household saving ratio started to rise and move back towards the investment ratio.
The point is that the neo-liberal period leading up to the crisis was atypical in behavioural terms.
The government was only able to run surpluses during this period because credit-fuelled consumption growth was able to maintain the tax revenue growth.
In addition, the investment ratio started to rise as a result of the record commodity prices (and terms of trade) which drove the mining boom investment as the consumption binge started to slow.
That abnormal divergence between the household saving ratio and the investment ratio was clearly unsustainable and with the current account behaving more or less as usual (deficit of around 3-4 per cent), the federal government had to move back into deficit to keep the economy growing on trend, irrespective of whether the global financial crisis occurred or not.
Another way of looking at these trends is to consider per capita consumption growth, which was the second graph that was produced on last night’s ABC Finance Report. The graph (you can view it HERE) was dated from 1988 to 2013 and was sourced to an investment bank.
It is unclear what data they were using but if we use the official ABS National Accounts data for household consumption and the ABS Resident population estimates then the following graph is produced.
I have used a longer dataset because it tells an even more interesting story to the one presented on the Finance Report (the extra elements would be inconvenient for the presenter’s usual message that deficits are too high). I have used resident population estimates from June 1971 to generate the annual per capita growth in household consumption.
While the behaviour of the series is similar to the TV graph over the same sample there is a noticeable different during the global financial crisis.
The TV presenter said “We’re Not Consuming Enough”. I would say that we have reduced our consumption growth relative to the growth in the population from the unsustainable levels prior to the crisis to adjust to the realities of too much debt, a widening gap between productivity growth and real wages growth, and rising unemployment.
The last point is important. My graph actually suggests four distinct periods. The first period up to late 1970s saw rapid annual growth in per capita household consumption.
The full employment era was still struggling to survive, real wages growth was in line with productivity growth which meant that robust consumption growth could be maintained without recourse to ever-increasing debt levels and household debt was low.
The attack on the trade unions began in earn in the early 1980s and throughout the 1980s the real wage was cut as productivity growth continued. The growth in per capita household consumption fell to a new level.
The 1991 recession – our deepest since the Great Depression – saw a new drop in the growth in per capita household consumption. The problem was that this period was marked by a continued divergence between real wages and productivity growth and the beginning of the escalation in household debt as all those friendly financial planners sought any means to ram debt down the throat of anyone who could sign a document – and others who couldn’t (no doc loans!)
After the latest crisis, the growth rate has fallen again (the point made by the TV presenter) and unless there is a dramatic shift in the distribution of national income back to wages (by allow real wages to grow in proportion to labour productivity – with a catchup for the redistributions that have been going on since the mid-1980s) and significant declines in unemployment and underemployment, what is happening now is the new norm.
The RBA dataset – Household Finances – Selected Ratios – B21 – tells us what has been happening with household debt burdens.
The following graphs provide further information as to why consumption growth is lower and why the household saving ratio has risen but is still below its pre-1980s levels.
The first graph shows total household debt as a percentage of disposable income since 1980 (to March-quarter 2013). The blue line is total and the red housing mortgage debt.
Conclusion: the balance sheets of the households holding this debt are now very precarious with rising unemployment and falling economic growth.
The next graph shows the related interest payment burden (as a percentage of disposable income) over the same period. You can see that even though the lower interest rates are bringing some relief at present, the nominal burden is still high due to the massive debt burdens.
The amount of discretionary income for households holding mortgages is, on average, now severely squeezed and that will work against any resumption in strong consumption spending growth.
You can see that as the crisis hit the RBA dropped interest rates quickly fearing a financial collapse. But then the inflation bogey entered – the fear not the actuality – and they prematurely started to tighten again at the same time as the government was beginning its obsessive (failed) pursuit of a budget surplus.
The combination of policy changes stifled economic growth well before it had recovered to trend and drove up the debt burden for households again.
The following Table breaks down the sectoral balances into five-year periods from the March-quarter 1960 to the June-quarter 2013 (the last period being from 2010-13).
Please read my blog – Answer to Question 1 – for the derivation and meaning of these balances if you are unsure. Remember they are derived from the National Accounts and (S – I) – (G – T) – (X – M) = 0.
In the full employment era spanning 1960 to the mid-1970s the budget deficit was continuous and stable and this provided the aggregate demand stimulus to offset the small drain in spending arising from the small external deficits.
The private domestic sector balance (saving minus investment) was in a small deficit as nation building continued but there was strong saving (as a result of strong real GDP growth) supporting strong investment (and building of productive capacity).
The situation started changing in the 1980s with deficits declining (and occasional surpluses recorded) as the neo-liberal anti-deficit mantra gathered pace. The external deficit rose on average and the private sector balance went into higher deficits as the saving ratio fell.
With the external deficit stable between 1985 and 2005 the shift to budget surplus was only possible because the private sector went further into debt.
Since the crisis, the private sector has radically altered its behaviour returning more to the behaviour of the 19060s (but constrained by higher debt levels) and growth is being supported by the return to budget deficits.
The fact that the growth rate is well below trend and unemployment is rising again tells me that with this private sector behaviour the deficit has to be higher.
That is the major message of all these graphs.
The point is that the period before the neo-liberal era was characterised by several features.
1. Relatively continuous use of fiscal deficits.
2. Stable household saving ratio of around 16 per cent of disposable income.
3. Real wages growing in line with labour productivity – so that consumption could be driven by real wages growth rather than credit.
The neo-liberal period is in fact the outlier – an atypical period. Which makes the claims by those who hold out that governments should return to surplus as a demonstration of fiscal responsibility rather difficult to understand.
In many cases, where actual budget surpluses were recorded, the economies went into recession soon after. The important point though is that the surpluses were made possible by the unsustainable growth in private credit which drove private spending and boosted tax revenue.
It is clear that we have returned to a more normal environment now where the private sector are attempting to save more out of disposable income and reduce its reliance on credit.
Two implications arise if that if the private consumption growth is returning to more normal (lower) levels then two things follow:
1. The government will more likely have to run budget deficits of some magnitude indefinitely – as in the past.
2. Real wages growth will have to be more closely aligned with productivity growth to break the reliance on credit growth.
And when the nature of the balance sheet adjustments that are going on at present are included in the assessment these two points become amplified.
This also makes the quest for fiscal austerity to be mindless and very destructive. Where will growth ever come from if consumers are returning to higher saving ratios, firms are very cautious, all countries are eroding each other’s export markets, and governments are adding tot he malaise?
That message was missing from the TV presentation. It was the most obvious conclusion to be drawn from the data presented.
I outlined the conceptual material to support the conclusion of this blog in these earlier blogs – Government deficits are the norm and Budget deficits are part of “new” normal private sector behaviour.
That is enough for today!
(c) Copyright 2013 Bill Mitchell. All Rights Reserved.