Scottish-born economist - Angus Deaton - recently published his new book - An Immigrant Economist…
Senior journalists often do more harm than good when they write about technical issues that they clearly do not understand. In many cases, they rely on the technical knowledge of their favourite economist or the flavour of the month economist and they are not skilled enough to know when their “economist” is also talking rubbish.
I have noted something interesting going on recently. In this current economic turmoil, the neo-liberal conservatives who created the problem are not all taking cover to avoid our disdain. Slowly but surely, some notable neo-liberal economists are being wheeled out by the media (for example, ABC television, Fairfax and Murdoch newspapers) to tell us how bad it is that governments are moving into deficit. Their prophets of doom testimonies are being used to attack the notion that governments should stimulate the ailing economy – something which the conservative lobby hates with a passion unless it is feathering their own nests. There is not a lot being said about the government handouts to business to keep them afloat. The conservatives haven’t much to say about the bank guarantees, for example. But the essential point is that the grasp that these so-called experts have on how the economy actually operates is rather thin indeed.
This morning in the Sydney Morning Herald, senior writer Paul Sheehan wrote about Comrade Rudd’s great con game. Unfortunately, the writer clearly does not understand how the modern monetary macroeconomy works and until he does he should desist from prosletysing. He might be better reassigned to covering the “Best rose award at the local agricultural show”. Less damage would probably be done.
The Australian Prime Minister made the following comment on national television last night:
Any person’s job loss through no fault of their own is a lost job too many when it comes to me. I’m the Prime Minister of the country, the buck stops with me.
Okay, I read that as saying that the Federal government should immediately introduce a Job Guarantee and ensure that everyone who is without sufficient work can contribute to the community through a government guaranteed job at minimum wages. That would ensure he took full responsibility. My main criticism of the current strategy being employed by the Federal government is that it is not focused on direct job creation and is relying on the “market” to convert the spending stimulus into jobs. Given the participants in the private market have to start saving more (and the National Accounts data shows this is happening) then it means tha the government net spending has to be that much higher and focused more on direct job creation.
However, Sheehan has another view. He writes:
Was Rudd able to save a single one of the 2000 manufacturing jobs lost at Pacific Brands last week? No, the buck stopped with the workers. This is the man who increased the immigration program to the largest annual intake in Australia’s history, and it is now swelling the ranks of job seekers. This is the man whose Government will, tomorrow, introduce workplace legislation which will increase the power of unions, and give pause to job creators. This is the man who has offered no structural relief to the great job-creating engine of the economy – small business. And this is the man who panicked at the first sign of danger and sprayed the entire $20 billion budget surplus he inherited up against a wall.
Swelling labour force argument
First, what is the official ABS Labour Force data say on the “swelling ranks of job seekers”. The following table summarises labour force trends over the recent past. The statement that the current government has created a labour force surge is patently false.
|Period||Labour Force growth %pa|
|Howard years (Jan 1996-Jan 2008)||2.00|
|Jan 2007-Jan 2008||2.39|
|Rudd year (Jan 2008-Jan 2009)||1.67|
Small business and industrial relations argument
Second, the Federal government has an overwhelming political mandate to pass legislation which will reverse some of the worst aspects of Work Choices. In my view, their proposed Fair Work bill is weak and doesn’t offer enough protection to vulnerable workers. But Sheehan says that the legislation will “increase the power of unions, and give pause to job creators. This is the man who has offered no structural relief to the great job-creating engine of the economy – small business.”
Are small businesses the job engines in the economy? This is a very disputed area in the research literature. There is a solid body of evidence that shows that the finding that small- and medium-sized enterprises (SMEs) dominate job creation is a fallacy (see articles by Davis, Haltiwanger & Schuh, 1996a; 1996b – all references are noted in full below) who show the finding to be based on methodological errors in the way the job flows are measured against size; see also Harrison (1994a, 1994b). The OECD suggests that while small and medium-sized enterprises are important in OECD countries “less than one-half of start-ups survive for more than five years and only a fraction develop into the high-growth firms which make important contributions to job creation. High job turnover poses problems for employment security; and small establishments are often exempt from giving notice to their employees. Small firms also tend to invest less in training and rely relatively more on external recruitment for raising competence.”
The OECD among others also find that small firms on average create jobs that are of lower quality and that small firms do not create more jobs because they are small but because there are more of them starting up at all times. Small firms do not grow more than large firms. It is newness rather than smallness that is the key.
My own research is one of the few studies of this phenomena in Australia and the most recent that I am aware of. You can download the Working Paper, which was subsequently published in a conference proceedings later that year. I have several other subsequent academic publications in the area of job dynamics.
Some Australian work concludes that small firms have disproportionately higher job creation rates (Borland and Home, 1994) and net employment growth is lower in large workplaces (Mumford and Smith, 2004). However, the validity of these studies has been questioned. A major issue is in differentiating the statistical facts of employment generation from what has caused that generation. Davis, Haltiwanger and Schuh (1996a) found that smaller plants have both high job creation and high job destruction rates. It is also unclear whether smallness per se matters or whether it is correlated with the underlying job generation factors. Our study is the only to date that analysed whether there are industrial or regulative constraints on the employment dynamics of small businesses
In addressing the question of whether SMEs ‘punch above their weight’ it is worthwhile to consider why employment in large corporations is more pro-cyclical in nature. First, through their supply chains, large corporations operate as smoothers of demand shocks, with SMEs more dependent on the income and wealth generated within their local region. Second, SMEs are less dependent on long term credit and equity-raising, the latter of which is characterised by cyclical ebbs and flows. Third, SMEs are more dependent on public R&D and subsidies, which are themselves more stable than their private sector counterparts over the business cycle. Nevertheless, our findings suggest that … larger firms had higher rates of job creation and lower rates of job destruction.
In relation to the claim that industrial relations legislation which aims to protect workers (award wage determinations, unfair dismissal etc) impedes net jobs growth in small businesses we found the opposite. No significant impact could be found on job creation rates apart from a tiny negative impact arising from union coverage in the workplace. However, in terms of job destruction rates we found that all the ‘industrial’ variables (union coverage, workers’ compensation, width of awards coverage etc) were significant and negative. That is:
… job destruction rates were lower in firms with higher wage rates, wider awards coverage, more unions in the workplace and higher workers compensation and employers’ contribution to superannuation expenses as a percentage of total expenses.
We also concluded that
… the notion that greater resource ‘flexibility’ (including the removal of unfair dismissal procedures) and an easing of the ‘regulatory burden’ will assist SME job creation is not supported by our empirical findings.
So unless Sheehan has done more recent research or can show the faults in our research his conclusions are not evidence-based but reflect his ideological free market view. That is, he is making religious statements which you might like to believe or not depending on your orientation to his particular (non-evidence based) faith.
Budget surpluses …
Now what are we to make of his claim that the Federal government has “panicked at the first sign of danger and sprayed the entire $20 billion budget surplus he inherited up against a wall.” He repeats this nonsensical “inheritance” claim several times in his article.
First, all governments are attempting to pursue stimulus packages because the scale of the problem is huge and the indications are that major net spending injections are needed. We can argue about the composition but not the need for spending. Employment growth is driven by spending. That is one of the facts of life that the neo-liberals cannot seem to grasp, elementary though it is.
Second, the current Federal government did not inherit anything by way of a storage shed of surpluses from the previous government. As I have been at pains to point out for many years – when the Federal government runs a surplus the purchasing power it rips out of the private economy goes nowhere. It is destroyed and provides no capacity for future spending. Sovereign government’s do not have a financial constraint so their spending is not determined by what they spent in net terms yesterday. This is not to say that their fiscal decisions yesterday will condition what they might do today. If they have been injecting net spending into the economy and have achieved full employment then there is no need today to increase that injection. But they could if they wanted to. Further, running surpluses yesterday gives then no extra funds today.
Sheehan criticises the idea of using stimulus to moderate the private contraction by appealing to the writings of one Professor Niall Ferguson, who the ABC has wheeled out recently. He quotes Ferguson as follows:
There is something desperate about the way people are clinging to their dog-eared copies of John Maynard Keynes’s General Theory. Uneasily aware that their discipline almost entirely failed to anticipate the current crisis, economists seemed to be regressing to macroeconomic childhood, clutching the multiplier like an old teddy bear.
… The harsh reality that is being repressed is this: the Western world is suffering a crisis of excessive indebtedness. Many governments are too highly leveraged, as are many corporations. More importantly, households are groaning under unprecedented debt burdens. Worst of all are the banks. Some of the best-known names in American and European finance have balance sheets 40, 60 or even 100 times the size of their capital …
The delusion is that a crisis of excess debt can be solved by creating more debt. Yet that is precisely what most governments currently propose to do.” Space precludes listing Ferguson’s prescriptions but they can be found on his website, and summed up with this sentence: “The solution to the debt crisis is not more debt but less debt.
First, there is a fundamental difference between debt held by the government and debt held in the non-government sector. Debt is not debt. Private debt has to be serviced using the currency that the state issues. So the non-government sector has to engage in economic activity which will earn it that currency and this involves exchanges between the non-government and government sector. Ultimately, if there is a shortage of government spending (say when the sovereign government runs a budget surplus) then the likelihood of private insolvency increases. Public debt in the currency of issue can always be serviced by the government.
Second, there is a fundamental difference between public debt held in the currency of the sovereign government holding the debt and public debt held in a foreign currency. A government can never go insolvent in its own currency. If it is insolvent as a consequence of holdings of foreign debt then it should default and renegotiate the debt in its own currency. In those cases, the debtor has the power not the creditor.
Bad debts in the private sector should be allowed to default and undergo their normal contractual processes. Where the public purpose is likely to be seriously impinged by this process – for example, widespread bank defaults then public intervention is required. One of the reasons the private sector is now so indebted is because its ability to save was squeezed so severely by the federal surpluses. See more on this below.
The intergenerational debate … again!
Ferguson claims that part of the problem facing the US government are the “unfunded liabilities of the Medicare and Social Security systems, the net present value of which is estimated at around $60-70 trillion … [which will put us on the] … on the eve of a public debt explosion …” So he is trying to entwine the intergenerational debate (IGR) into this crisis. I have written extensively about the fallacy in the claim that these unfunded liabilities threaten public insolvency. They don’t. It is a nonsensical neo-liberal scare claim that was used by the conservatives to justify the obscene and destructive surpluses being run by sovereign governments.
For example, Warren Mosler and I concluded that
… the basic monetary assumptions of the IGR are without any application once there is a complete understanding of the dynamics of a floating exchange rate policy in regard to the government of issue … Federal spending is not inherently financially constrained and does not have to be facilitated via prior taxation or debt-issuance … budget deficits … [do not] … cause higher interest rates, lower levels of capital formation and diminished rates of economic growth. These misconceptions together lead to the nonsensical claim that by running surpluses now the Government will be better able (because it has ‘more funds stored away’) to cope with future spending demands.
… in fact, the pursuit of budget surpluses as a means of accumulating ‘future public spending capacity’ is not only without standing but also likely to undermine the capacity of the economy to provide the resources that may be necessary in the future to provide real goods and services of a particular composition desirable to an ageing population … by achieving and maintaining full employment via appropriate levels of net spending (deficits) the Government would be providing the best basis for growth in real goods and services in the future … in a fully employed economy, the intergenerational spending decisions come down to political choices sometimes constrained by real resource availability, but in no case constrained by monetary issues, either now or in the future.
… the social security privatisation debate in the US and the intergenerational debate in Australia are being driven by the same macroeconomic misunderstandings and dissipate into (interesting) political debates once the so-called economic issues are shown to be erroneous. We thus challenge the validity of these public debates at their most elemental level and conclude that the mainstream position is misguided at best.
Closed and open economy myths …
The born-again Keynesians seem to have forgotten that their prescription stood the best chance of working in a more or less closed economy. But this is a globalized world, where uncoordinated profligacy by national governments is more likely to generate bond market and currency market volatility than a return to growth.
This is an important point that most economists do not grasp – including it seems Ferguson. The traditional Keynesian approach was developed for a fixed exchange rate economy. Under a fixed exchange rate system, fiscal policy was cramped by the requirements that monetary policy (specifically, foreign exchange sales and purchases) had to be used to defend the fixed (agreed) parity. So you had the phenomena of “stop-go” growth where fiscal policy would push economic growth along which then increased imports and put downward pressure on the exchange rate. The monetary authorities (central bank) had to then contract the economy to reign in the imports and maintain the parity.
Today, we live largely in a flexible exchange rate world where fiscal policy is freed from those shackles and becomes a powerful tool for maintaining full employment. The sovereign government can buy anything that is available in its own currency including all the unemployed labour without much concern for what is happening in other countries. So Ferguson is wrong to claim that fiscal policy is now more dangerous than ever.
More or less debt?
As Sheehan notes, Ferguson concludes that
The solution to the debt crisis is not more debt but less debt. Two things must happen. First, banks that are de facto insolvent need to be restructured – a word that is preferable to the old-fashioned “nationalization”. Existing shareholders will have face that they have lost their money. Too bad; they should have kept a more vigilant eye on the people running their banks. Government will take control in return for a substantial recapitalization after losses have meaningfully been written down.
It humours me that the conservatives cannot come to terms with the reality that the free market system has failed badly and that major state intervention is the only thing that will keep it from collapsing altogether. Whether state ownership is called “restructuring” or “nationalisation” doesn’t change the reality. Governments around the world are using their sovereign currency issuing capacity to provide some solvency to the failed capitalist system.
But I agree that governments should be using their fiscal capacity to restore equanamity into the failed system and “finance” a return to private saving. That is a fundamental responsibility of the government. But it has nothing at all to do with whether the central bank issue public debt in its own currency to support interest rates that are placed under downward pressure by fiscal policy expansion.
Further, what Ferguson and Sheehan don’t understand is that the only way that the capitalist system which uses sovereign currencies can grow in a sustainable way without increasing levels of debt being held by the non-government sector is if the government (which maintains a monopoly in the currency issue in their country) maintains budget deficits. The non-government saving are $-for-$ a mirror of the government deficit. Whether the government chooses to offer the private sector an interest-bearing government bond to provide a return on those savings is another matter – I wouldn’t do it but then I would allow the short end of the yield curve to drop to zero (which would minimise the long end investment rates). In saying that I am of-course saying that I would express monetary policy in terms of a zero target rate of interest.
The general point is that the net spending (budget deficits) and the debt issuance are two separate processes (the former being fiscal policy and the latter being an aspect of monetary policy) that are not intrinsically linked despite what Sheehan and others claim.
So the major take-home point is that governments better get used to running deficits in perpetuity if stability is really going to be achieved.
I also have differences with Ferguson on how to handle the housing debacle. While Ferguson wants “a generalized conversion of American mortgages to lower-interest rates and longer maturities” but this interupts the contract process and creates moral hazard – the unwise investor is rewarded. The best approach to housing is that the government allow all legal foreclosures to proceed but purchases the property at a fair market value (or the net mortgate outstanding) and then rents the house back to the owner at fair rent. After employment has recovered, the government then gives the former owner the first right of refusal to buy it at fair market prices. My friend Warren Mosler points out that this: (a) keeps people in their own homes via affordable rents; (b) does not interfere with existing contract law; (c) minimises government disruption of outcomes for mortgage-backed security holders; and (d) minimises moral hazard – the rent is not a subsidy; the repurchase option is not a subsidy and foreclosure occurs normally.
Sorry for the long blog … but it covers a lot of important issues that need to be on the public record.
Borland, J. and Home, R. (1994) ‘Establishment-level Employment in Manufacturing Industry: Is Small Really Beautiful?’, Australian Bulletin of Labour, 20 (2), 110-128.
Davis, S.J., Haltiwanger, J. and Schuh, S. (1996a) ‘Small Business and Job Creation: Dissecting the Myth and Reassessing the Facts’, Small Business Economics, 8, 297-315.
Davis, S.J., Haltiwanger, J. and Schuh, S. (1996b) Job Creation and Destruction, Boston, MA., The MIT Press.
Harrison, B. (1994a) ‘The Small Firms Myth’, California Management Review, Spring, 142-158.
Harrison, B. (1994b) Lean and Mean: the Changing Landscape of Corporate Power in the Age of Flexibility, New York, Basic Books.
Mumford, K. and Smith, P. (2004) ‘Job Reallocation, Employment Change and Average Tenure: Theory and Workplace Evidence from Australia’, Scottish Journal of Political Economy, 51(3), 402-421.