{"id":12504,"date":"2010-11-25T17:24:58","date_gmt":"2010-11-25T06:24:58","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=12504"},"modified":"2010-11-25T17:24:58","modified_gmt":"2010-11-25T06:24:58","slug":"a-rising-public-share-in-output-is-indicated","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=12504","title":{"rendered":"A rising public share in output is indicated"},"content":{"rendered":"

\t\t\t\tI have been thinking about changing industrial\/sectoral shares today and how it bears on the way we construct macroeconomic policy (spending and taxation). At present, a major debate in Australia is how we are going to deal with the strong growth in the mining sector and the negative consequences this growth is having on other sectors that are not enjoying buoyant demand conditions. The mainstream response – to impose fiscal consolidation and tight monetary policy – is exactly the opposite response to what is required. But the discussion about sectoral change has further application in terms of the long-run movements in demography and shifting demand for health care and other age-related services. It generalises even further if we consider the growing need for environment care services. The upshot is that trends which will require a rising public share of total resource usage should not be seen as financial crises. Rather we should see them as part of the long process of structural transformation in our economies. Once we see it from that perspective, then the ideological nature of the ageing society debate is exposed. But first, Ireland …
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\nThe Irish Prime Minister yesterday unveiled the The National Recovery Plan 2011-2014<\/a> which is a sop to the unelected and largely incompetent IMF’s insistence that it make further cuts in public spending before any bailout funds will be provided.<\/p>\n

The Plan (which I used to think referred to some action designed to achieve objectives) is 140 pages long but has very little coherence at all. It also sells for \u20ac15.00 (although free to download) which I suppose covers printing costs. I would have actually not charged for printing so that the government spending (presuming they use privatised printing presses) could stay in this severely distressed, demand-constrained economy.<\/p>\n

On page 55, Section 3.2 the heading is “3.2 Why We Must Reduce Expenditure”. A Table (3.2) accompanies the text and shows that public spending in nominal terms has risen strongly between 2000 and 2008. The current price data shows total public expenditure rose by 141 per cent over that period. I did the calculation for Australia and the corresponding change in 106 per cent.<\/p>\n

But remember the 2008 data is contaminated by the recession for Ireland much more so than for Australia given the extent to which the Irish economy collapsed. The better comparison would have to been to use data at similar stages of the cycle to make the automatic stabiliser effect neutral. But whatever, the data presented provides zero justification for the heading “Why we must reduce expenditure”.<\/p>\n

The text accompanying the table says:<\/p>\n

\nThese significant increases in public expenditure were broadly in line with the strong nominal growth rate of the Irish economy with expenditure as a proportion of GNP remaining at around 28% for most of that period. However, with the sharp fall off in growth since 2008, that ratio has risen markedly to around 44% of GNP in 2010 … It is clearly not sustainable for public spending to remain at such a high level, and restoring overall expenditure back to an affordable level is now a key imperative of public policy.\n<\/p><\/blockquote>\n

Can you believe that a national government is so stupid that they think this sort of argument can justify expenditure cuts? I was amazed. There are many more examples of this sort of rhetoric in the paper. It is not worth reading really – just depressing.<\/p>\n

The point is that proportionally the Irish government spending merely kept pace with the nominal growth in the size of Irish economy until the growth collapsed. Of-course, the share of government spending increased as a consequence of the automatic stabilisers! But to then say that because the ratio<\/strong> has risen to 44 per cent in 2010 then public spending cannot remain as such a high level<\/strong> is to make one of the basis errors in statistical analysis.<\/p>\n

You cannot compare levels and ratios in this way. I would look at the same data and say that denominator rather than the numerator has to be restored to its previous acceptable levels. What sort of logic is it that the numerator of the ratio should collapse to the value of the (collapsed) denominator? Irish government (or should I rather say IMF and EU logic) it seems.<\/p>\n

That is the problem of the whole Eurozone – they realise they will lose face if they take the obvious action – increase growth via spending – remember spending equals income. Their ideology would also become transparent if they admitted that their “solution” was likely to be highly destructive of living standards, retirement security, public services, etc.<\/p>\n

So, to hide their ideological nakedness they try to tell us that by severely cutting public spending they will still<\/p>\n

The size of the Irish economy is currently about 130 billion euros down from 162 in 2007. The Plan proposes to take 15 billion euros out of the spending stream but also it proposes to cut 25,000 jobs. The multiplier effects of the lost income will be huge and it makes the growth prospects which they have put into their “macroeconomic models” look positively surreal.<\/p>\n

In Annex 2 they discuss growth prospects. The IMF forecasts are the most optimistic but overall it is difficult to see where the growth is going to come from. The Plan says that exports will be strong and then you see this gem in optimism – “It is also possible that the clarity provided by this plan could result in a more rapid restoration of domestic confidence than is currently anticipated” (the Ricardian effect!). But they conclude that “the domestic risks are tilted towards the downside”. In other words, exports are going to be the cavalry coming to the rescue.<\/p>\n

So with there major trading partner (the UK) about to go backwards courtesy of their austerity plan upon what basis will exports grow strongly enough to more than replace the spending cuts and tax hikes? They are just living in an ideological dream world.<\/p>\n

Even with exports rising a little at present, GDP growth was negative in the second quarter 2010. It will get worse!<\/p>\n

The Taoiseach tried to hype up the Plan by saying of Ireland:<\/p>\n

\n… that we are a people of sufficient ability and intelligence to see ourselves through these circumstances. We are a smart, resilient, proud people and we are going to come through this challenge\n<\/p><\/blockquote>\n

Sorry, the people who make up the government are stupid, rigid and inflexible, who have just surrendered all national pride by obsequiously bowing to the destructive demands of the IMF.<\/p>\n

The economy will “come through” but people will be poorer and the social fabric will be severely damaged. I wonder how many meals the Taoiseach will forgo in the coming few years and I wonder if his pension will be significantly cut.<\/p>\n

I wonder if the Taoiseach has stopped to think who holds the cards in this crisis. The reality is that the Irish government has all the power if they had the courage to use it. Default (on all euro debt), Exit (the EMU and reintroduce their own currency), Bailout (the economy with increasing public spending) and Takeover (the banks) – DEBT – is what they should be doing!<\/p>\n

Anyway, this was just an introduction to what I was thinking about today and on the plane last night.<\/p>\n

A big debate in the Australian policy arena at present is how we are going to handle an enduring mining boom driven by the growth of China and India.<\/p>\n

The Secretary of the Australian Treasury, Ken Henry gave an address in Hobart last Friday (November 19, 2010) – The Context and Drivers for State Tax Reform<\/a> – which has attracted a lot of attention.<\/p>\n

The specific context is the debate about tax reform and the growing call for a Resource Rent Tax to be applied to the mining sector and also a Carbon Tax as our response to the climate change agenda. I will write about each of those taxes at another time.<\/p>\n

But the debate also considers the changing nature of the Australian economy over the next few years. The Secretary outlined “a set of large-scale and long-term challenges facing Australia, including”:<\/p>\n

\n… (1) a population that is growing rapidly, becoming more culturally diverse, yet ageing; (2) the re-emergence of China and India as global economic powers in a world characterised by ever deepening international integration; (3) the technological transformation of government, business and personal lives, especially through advances in digital electronics and communications; (4) deepening stresses between human activities and wider ecosystems, globally and locally – of which climate change adaptation and mitigation strategies are especially challenging elements; and (5) powerful stresses on housing affordability and urban amenity.\n<\/p><\/blockquote>\n

I agree that these are all issues that we need to consider in framing current policy settings. But typically, the way in which the bureaucracy is thinking and advising governments is opposite to the way I would tackle these “challenges”.<\/p>\n

In terms of changing shares in total output (which is the theme of this blog) the Treasury Secretary noted that the “strong rise in Australia’s terms of trade over the past decade could well turn out to be the biggest external shock to our economy in history”:<\/p>\n

\nRising terms of trade mean increased aggregate purchasing power and higher aggregate incomes. But not everybody’s income, or purchasing power, gets a boost.<\/p>\n

The net outcome of the economic adjustments associated with an increase in the terms of trade is what we might call a ‘three speed economy’:<\/p>\n

* the mining and mining-related sectors grow strongly;
\n* other trade-exposed sectors (like many parts of manufacturing) grow more slowly; and
\n* non-traded sectors grow at a rate somewhere between those two.<\/p>\n

In order to balance demand and supply in the non-traded sector, there will be an appreciation of the real exchange rate. That is to say, there has to be an appreciation of the nominal exchange rate and\/or a period of time during which our costs of production inflate at a rate that is higher than the average inflation rate of our trading partners.<\/p>\n

Putting this another way, the economic adjustment required to balance demand and supply in the non-traded goods sectors necessarily has the effect of making all Australian businesses less internationally competitive. And that loss of competitiveness cannot be avoided unless the full income effect of the terms of trade boom is somehow sterilised.\n<\/p><\/blockquote>\n

The argument for the Resource Rent Tax was based on the idea that we needed to introduce a “secure complete sterilisation” from these external shocks. So the tax “can reduce the size of the real appreciation required to achieve macroeconomic balance”.<\/p>\n

I agree with this. It is an application of the capacity of fiscal policy as opposed to monetary policy to be targetted in its impact. An economy that is highly unbalanced and experiencing inflationary pressures coming in via the external income surge can be re-balanced by a specific tax. A Resource Rent Tax is one of the better means of taking “demand” out of the external sector.<\/p>\n

But note also, that the nominal appreciation in the exchange rate itself, provides an anti-inflationary buffer.<\/p>\n

The problem is that my profession is claiming that the mining boom requires a more widespread fiscal contraction and the Government is certainly building that into their strategy. But the problem is that an across-the-board cut in net public spending is not indicated at present for the following reasons:<\/p>\n