{"id":39578,"date":"2018-06-21T08:20:20","date_gmt":"2018-06-20T22:20:20","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=39578"},"modified":"2018-06-21T08:20:20","modified_gmt":"2018-06-20T22:20:20","slug":"real-resource-constraints-and-fiscal-policy-design","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=39578","title":{"rendered":"Real resource constraints and fiscal policy design"},"content":{"rendered":"

\t\t\t\tThere is an interesting dilemma currently emerging in Australia, which provides an excellent case study on how governments can use fiscal policy effectively and the problems that are likely to arise in that application. At present, the Australian states are engaging in an infrastructure building boom with several large (mostly public sector) projects underway involving improvements to road, ports, water supply, railways, airports and more. I travel a lot and in each of the major cities you see major areas sectioned off as tunnels are being dug and buildings erected. Not all of the projects are desirable (for example, the West Connex freeway project in Sydney has trampled on peoples’ rights) and several prioritise the motor car over public transport. But many of the projects will deliver much better public transport options in the future. On a national accounts level, these projects have helped GDP growth continue as household consumption has moderated and private investment has been consistently weak to negative. But, and this is the point, there have been sporadic reports recounting how Australia is running out of cement, hard rock and concrete and other building materials, which is pushing up costs. This is the real resource constraint that Modern Monetary Theory (MMT) emphasises as the limits to government spending, rather than any concocted financial constraints. If there are indeed shortages of real resources that are essential to infrastructure development then that places a limit on how fast governments can build these public goods. The other point is that as these shortages are emerging, there is still over 15 per cent of our available labour resources that are being unused in one way or another – 714,600 are unemployed, 1,123.9 thousand are underemployed, and participation rates are down so hidden unemployment has risen. So that indicates there is a need for higher deficits while the infrastructure bottlenecks suggest spending constraints are emerging. That is the challenge. Come in policies like the Job Guarantee.
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Infrastructure boom yet idle labour<\/h2>\n

Australia is currently enjoying a major infrastructure spending boom via several large-scale projects in the States and Territories, but also at the Federal level (for example, the National Broadband Network construction).<\/p>\n

There is no doubt that one of the major reasons Australia’s GDP growth has been relatively robust in recent years is due to this large public spending commitment.<\/p>\n

The first graph shows movements in State Final Demand indexes from the March-quarter 2008 to the March-quarter 2018 (most recent data). The March-quarter 2008 was the peak of the last cycle before the GFC slowdown.<\/p>\n

The humps in WA and Northern Territory between 2012 and 2015 relate to the Mining boom (mostly private investment) which is now well and truly over.<\/p>\n

But you can also see that in the last few years, there has been an acceleration of State Final Demand nearly across the board, which is mostly down to public spending.<\/p>\n

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The next graph breaks down the aggregate Final Demand measure into its components and show the overall growth in each expenditure component over the decade from the March-quarter 2008.<\/p>\n

You can see the strong growth in public investment over that time (biased to recent years), which has been an important driver of growth in the Australian economy.<\/p>\n

Over the same period, household consumption expenditure growth has been moderate and private investment expenditure weak to negative in many states.<\/p>\n

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But as I have indicated in my labour force briefings – see latest (June 14, 2018) – Australian labour market – weaker in May with tepid employment growth<\/a> – Australia is still a long way from being ‘fully employed’.<\/p>\n

The May 2018 data confirms that:<\/p>\n

1. There are 714,600 persons unemployed with an official unemployment rate of 5.4 per cent (1.4 percentage points higher than the pre-GFC low).<\/p>\n

2. There are 1,123.9 thousand persons underemployed (working less hours than they desire) which is 8.5 per cent of the labour force.<\/p>\n

3. The total labour underutilisation rate (unemployment plus underemployment) is thus 13.9 per cent or 1,838.6 thousand workers.<\/p>\n

4. At 65.5 per cent, the labour force participation rate is still below its previous peak (December 2010) of 65.8 per cent. This means that hidden unemployment has risen over that period and if we adjusted the official unemployment rate to include that effect it would be 5.9 per cent rather than 5.4 per cent. Unemployment would be 780.4 thousand rather than 714.6 thousand.<\/p>\n

5. Many of those who are unemployed or underemployed are typically low-paid workers, many classified as low-skill.<\/p>\n

What this means is that the fiscal deficit is to low relative to the non-government spending and saving behaviour.<\/p>\n

There is a need to stimulate labour demand (generate jobs). That is unambiguous. The question is where that increased labour demand should be stimulated.<\/p>\n

Resource constraints increasing in Australia’s construction sector<\/h2>\n

There have been sporadic reports over the last year or so, in response to this infrastructure construction boom, recounting how Australia is running out of cement, hard rock and concrete and other building materials, which is pushing up costs.<\/p>\n

Other reports generalise this and suggest that there is a growing shortage of many other productive resources.<\/p>\n

For example, on March 19, 2018, there was a report – Growing demand pushing up construction costs<\/a> – which suggested that:<\/p>\n

\n… the growing demand from the infrastructure sector is creating pressures within the construction industry with personnel, plant and equipment as well as base materials such as cement, steel and aggregates showing a significant increase in cost.\n<\/p><\/blockquote>\n

Most of these media flurries were based on the interesting report released in January 2018 by the international construction cost analysis firm, WT Partnership – Construction Market Conditions 2018<\/a>.<\/p>\n

There are large-scale projects, mostly public spread across Australian states at present.<\/p>\n

New South Wales and Victoria are leading the charge.<\/p>\n

In New South Wales there is “record levels of investment in infrastructure and strong demand for residential, commercial and retail”.<\/p>\n

There is on-going “Government investment in projects such as CityLink and Tullamarine freeways, Melbourne Metro Rail, West Gate Tunnel and North East Link in Melbourne” (Victoria), which is transforming the state’s urban transport systems.<\/p>\n

In Queensland, the Government is embarking on several major projects (“Cross River Rail, social and affordable housing, and schools”).<\/p>\n

Similarly in Western Australia (“significant road, rail, and port projects”), South Australia (“numerous cranes in the city skyline and forecasts growth in various sectors including aged care, student accommodation, defence and education”), Australian Capital Territory (“construction of commercial, retail, housing and aged care”), “Major LNG development and defence projects continue to underpin activity in the Northern Territory” and so on.<\/p>\n

This significant level of (mostly public) infrastructure development is:<\/p>\n

\n… pushing up costs of personnel, plant and equipment, and base materials such as aggregates, cement and steel. As resources become more stretched, these pressures create an industry wide challenge.\n<\/p><\/blockquote>\n

These trends raise significant issues for the conduct of fiscal policy – its design and implementation.<\/p>\n

In this blog post – I wonder what the hell I have been writing all these years<\/a> (February 12, 2013) – I discussed, in part, the Modern Monetary Theory (MMT) approach to inflation theory.<\/p>\n

In our introductory textbook – Modern Monetary Theory and Practice: An Introductory Text<\/a> – we introduced a simple first blush model of the aggregate supply function (which tells us at what prices firms will supply output).<\/p>\n

It looks like this:<\/p>\n

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If we assume that the price mark-up that firms use to price their goods and services and money wage rates and labour productivity (and all other unit resource costs) then it reasonable to assume that firms would supply output at a constant price – quoted in their catalogues and honour those prices for some time.<\/p>\n

There is a cost to a firm of changing prices regularly and also a possible loss of customer loyalty.<\/p>\n

On the horizontal portion of the supply curve, firms in aggregate will supply as much real output (goods and services) as is demanded at the current price level set according to the mark-up rule described above.<\/p>\n

The vertical portion of the curve after full employment (Y*<\/sup>) is explained by the fact that the economy exhausts its capacity to expand short-run output due to shortages of labour and capital equipment.<\/p>\n

At that point, firms will be trying to outbid each other for the already fully employed labour resources and in doing so would drive money wages up.<\/p>\n

Under normal circumstances, economy rarely approach the output level (Y*<\/sup>, which means that for normally encountered utilisation rates the economy typically faces constant costs.<\/p>\n

The description of the model in the textbook acknowledged that:<\/p>\n