I read an article in the Financial Times earlier this week (September 23, 2023) -…
A good way to understand the origins of the current economic crisis in Australia is to examine the historical behaviour of key macroeconomic aggregates. The previous Federal Government claimed they were responsibly managing the fiscal and monetary parameters and creating a resilient competitive economy. This was a spurious claim they were in fact setting Australia up for crisis. The reality is that the previous government created an economy which was always going to crash badly.
The global nature of the crisis has arisen because over the last 2-3 decades most Western governments including the Australian government succumbed to the neo-liberal myth of budget austerity and introduced policies which allowed the destructive dynamics of the capitalist system to create an economic structure that was ultimately unsustainable. Once this instability began to manifest it was only a matter of time before the system imploded – as we are now seeing.
You can understand my take on this story by looking at the following graphs that I have put together (click on each graph for a larger version). This short blog is a summary of a major study I am conducting on this issue.
The first graph is the so-called “sectoral balances” which plots the Budget Deficit (-), the Current Account balance (- for deficit) and the private domestic balance (difference between Saving and Investment; – for deficit) as a per cent of GDP. The sectoral balances is another way of viewing the national accounts and provides empirical evidence for the influence of fiscal policy over private sector indebtedness. Consider the accounting identity drawn from the national accounts for the three sectoral balances:
(S – I) = (G – T) + (X – M)
The Equation says that total private savings (S) is equal to private investment (I) plus the public deficit (spending, G minus taxes, T) plus net exports (exports (X) minus imports (M)), where net exports represent the net savings of non-residents. Thus, when an external deficit (X – M < 0) and public surplus (G – T < 0) coincide, there must be a private deficit. While private spending can persist for a time under these conditions using the net savings of the external sector, the private sector becomes increasingly indebted in the process.
The graph shows the sectoral balances for Australia. While the current account deficit has fluctuated with the commodity price cycle, it has continued to deteriorate slightly over the longer term. Accordingly, the dramatic shift from budget deficits to surpluses from the mid-1990s onwards has been mirrored by a corresponding deterioration in private sector indebtedness.
The only way the Australian economy could keep growing in the period after 1996 was for the private sector to finance increased spending via increased leverage. As I have explained in other blogs, this is an unsustainable growth strategy. Ultimately the private deficits will become so unstable that bankruptcies and defaults will force a major downturn in aggregate demand. Then the fiscal drag compounds the problem.
The solution is simple. The government balance has to be in deficit for the private balance to be in surplus given a relatively stable external balance. In terms of the slightly worsening current account deficit, we can interpret that as signifying an increased desire by foreigners to place their savings in financial assets denominated in Australian dollars. This desire means that that the foreign sector will allow us to enjoy more real goods and services from them relative to the real goods and services we have to export. We note that exports are always a “cost” while imports are “benefits”. As long as there is a foreign desire for our financial assets, the real terms of trade will provide net benefits to Australian residents which manifests as the current account deficit. An external deficit presents no intrinsic problem despite views by the orthodoxy to the contrary.
In the second graph you can see that real wages have failed to track GDP per hour worked (in the market sector) – that is, labour productivity. Real wages fell under the Hawke Accord era which was a stunt to redistribute national income back to profits in the vein hope that the private sector would increase investment. It was based on flawed logic at the time and by its centralised nature only reinforced the bargaining position of firms by effectively undermining the traditional trade union movement skills – those practised by shop stewards at the coalface. Under the Howard years, some modest growth in real wages occurred overall but nothing like that which would have justified by the growth in productivity. In March 1996, the real wage index was 101.5 while the labour productivity index was 139.0 (Index = 100 at Sept-1978). By September 2008, the real wage index had climbed to 116.7 (that is, around 15 per cent growth in just over 12 years) but the labour productivity index was 179.1.
What happened to the gap between labour productivity and real wages? The gap represents profits and shows that during the neo-liberal years there was a dramatic redistribution of national income towards capital. The Federal government (aided and abetted by the state governments) helped this process in a number of ways: privatisation; outsourcing; pernicious welfare-to-work and industrial relations legislation; the National Competition Policy to name just a few of the ways. The next graph depicts the summary of this gap – the wage share – and shows how far it has fallen over the last two decades.
The question then arises: if the output per unit of labour input (labour productivity) is rising so strongly yet the capacity to purchase (the real wage) is lagging badly behind – how does economic growth which relies on growth in spending sustain itself? This is especially significant in the context of the increasing fiscal drag coming from the public surpluses which squeezed purchasing power in the private sector since around 1997.
In the past, the dilemma of capitalism was that the firms had to keep real wages growing in line with productivity to ensure that the consumptions goods produced were sold. But in the recent period, capital has found a new way to accomplish this which allowed them to suppress real wages growth and pocket increasing shares of the national income produced as profits. Along the way, this munificence also manifested as the ridiculous executive pay deals that we have read about constantly over the last decade or so.
The trick was found in the rise of “financial engineering” which pushed ever increasing debt onto the household sector. The capitalists found that they could sustain purchasing power and receive a bonus along the way in the form of interest payments. This seemed to be a much better strategy than paying higher real wages. The household sector, already squeezed for liquidity by the move to build increasing federal surpluses were enticed by the lower interest rates and the vehement marketing strategies of the financial engineers. The financial planning industry fell prey to the urgency of capital to push as much debt as possible to as many people as possible to ensure the “profit gap” grew and the output was sold. And greed got the better of the industry as they sought to broaden the debt base. Riskier loans were created and eventually the relationship between capacity to pay and the size of the loan was stretched beyond any reasonable limit. This is the origins of the sub-prime crisis.
The next graphs shows various perspectives on the increasing household indebtedness in Australia. The left hand chart shows the spiralling in the debt to disposable income ratio which stood at 69.1 per cent in March 1996 and by September 2008 had risen to a staggering 156.1 per cent. It was often argued by the Government, the RBA and so-called financial industry experts during the build up period that there was no call for alarm because wealth was growing along with the debt. Well the debt was increasingly purchasing volatile assets other than housing and a fair proportion of the wealth created during that period has gone but the debt remains. The right hand chart shows the servicing burden (interest payments as a percentage of disposable income). This ratio has risen from 5.7 per cent in March 1996 to 15 per cent in September 2008, further squeezing the living standards of the household sector.
The problem with this strategy is that is was unsustainable. Household savings went negative as the government budgets went further into surplus. The next graph shows this clearly.
The only thing maintaining growth was the increasing credit which, of-course, left the nasty overhang – the precarious debt levels. I said years ago that this would eventually unwind as households realised they had to restore some semblance of security to their balance sheets by resuming their saving. Further, this increased precariousness of the household sector meant that small changes in interest rates and labour force status would now plunge them into insolvency much more quickly than ever before. Once defaults started then the triggers for global recession would fire and the malaise would spread quickly throughout the world. I was often criticised by conservatives and neo-liberal types for “crying wolf”. They kept harping on the fact that wealth was rising. Well the wealth has been severely diminished in the crisis but the nominal debt and the servicing commitments remain.
The return to deficits is the first step in recovery. Budget deficits finance private savings and are required if the household balance sheets are to remain healthy. Real wages also have to grow in proportion to labour productivity for spending levels to be maintained with sustainable levels of household debt. The household sector cannot dis-save for extended periods.
In designing the policy framework that will sustain growth in employment and reduce labour underutilisation these tenets have to be central. It also means that the massive executive payouts both in the private and public sector (including universities) have to be stopped and more realistic distributional parameters (more widely sharing the income produced) have to be followed.
Further, the first thing the Federal government should purchase is all the labour that no-one wants. By introducing a Job Guarantee they could offer a minimum wage to all those who wanted work and therefore restore full employment at a fraction of the investment they are proposing to make by way of fiscal stimulus.