{"id":9713,"date":"2010-05-16T20:15:40","date_gmt":"2010-05-16T09:15:40","guid":{"rendered":"https:\/\/billmitchell.org\/blog\/?p=9713"},"modified":"2010-05-16T20:15:40","modified_gmt":"2010-05-16T09:15:40","slug":"saturday-quiz-may-15-2010-answers-and-discussion","status":"publish","type":"post","link":"https:\/\/billmitchell.org\/blog\/?p=9713","title":{"rendered":"Saturday Quiz &#8211; May 15, 2010 &#8211; answers and discussion"},"content":{"rendered":"<p>\t\t\t\tHere are the answers with discussion for yesterday&#8217;s quiz. The information provided should help you work out why you missed a question or three! If you haven&#8217;t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary theory (MMT) and its application to macroeconomic thinking. Comments as usual welcome, especially if I have made an error.<br \/>\n<!--more--><br \/>\n<strong>Question 1:<\/strong><\/p>\n<blockquote><p>\nOnly one of the following propositions is possible (with all balances expressed as a per cent of GDP):<\/p>\n<ul>\n<li>A nation can run a current account deficit with an offsetting government sector surplus, while the private domestic sector is spending less than they are earning.<\/li>\n<li>A nation can run a current account deficit with an offsetting government sector surplus, while the private domestic sector is spending more than they are earning.<\/li>\n<li>A nation can run a current account deficit with a government sector surplus that is larger, while the private domestic sector is spending less than they are earning.<\/li>\n<li>None of the above are possible as they all defy the sectoral balances accounting identity.<\/li>\n<\/ul>\n<\/blockquote>\n<p>At the outset I accept Bruce&#8217;s point &#8211; the government surplus reinforces the demand drain coming from the current account deficit. I more correctly should have written &#8220;accompanied by a government sector surplus of equal proportion to GDP&#8221;. I don&#8217;t think it would have lead you astray though!<\/p>\n<p>This is a question about the sectoral balances &#8211; the government budget balance, the external balance and the private domestic balance &#8211; that have to always add to zero because they are derived as an accounting identity from the national accounts.<\/p>\n<p>To refresh your memory the balances are derived as follows. The basic income-expenditure model in macroeconomics can be viewed in (at least) two ways: (a) from the perspective of the <strong>sources<\/strong> of spending; and (b) from the perspective of the <strong>uses<\/strong> of the income produced. Bringing these two perspectives (of the same thing) together generates the sectoral balances.<\/p>\n<p>From the <strong>sources<\/strong> perspective we write:<\/p>\n<p>GDP = C + I + G + (X &#8211; M)<\/p>\n<p>which says that total national income (GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X &#8211; M).<\/p>\n<p>From the <strong>uses<\/strong> perspective, national income (GDP) can be used for:<\/p>\n<p>GDP = C + S + T<\/p>\n<p>which says that GDP (income) ultimately comes back to households who consume (C), save (S) or pay taxes (T) with it once all the distributions are made.<\/p>\n<p>Equating these two perspectives we get:<\/p>\n<p>C + S + T = GDP = C + I + G + (X &#8211; M)<\/p>\n<p>So after simplification (but obeying the equation) we get the sectoral balances view of the national accounts.<\/p>\n<p>(I &#8211; S) + (G &#8211; T) + (X &#8211; M) = 0<\/p>\n<p>That is the three balances have to sum to zero. The sectoral balances derived are:<\/p>\n<ul>\n<li>The private domestic balance (I &#8211; S) &#8211; positive if in deficit, negative if in surplus.<\/li>\n<li>The Budget Deficit (G &#8211; T) &#8211; negative if in surplus, positive if in deficit.<\/li>\n<li>The Current Account balance (X &#8211; M) &#8211; positive if in surplus, negative if in deficit.<\/li>\n<\/ul>\n<p>These balances are usually expressed as a per cent of GDP but that doesn&#8217;t alter the accounting rules that they sum to zero, it just means the balance to GDP ratios sum to zero.<\/p>\n<p>A simplification is to add (I &#8211; S) + (X &#8211; M) and call it the non-government sector. Then you get the basic result that the government balance equals exactly $-for-$ (absolutely or as a per cent of GDP) the non-government balance (the sum of the private domestic and external balances).<\/p>\n<p>This is also a basic rule derived from the national accounts and has to apply at all times.<\/p>\n<p>The following Table represents the three options in percent of GDP terms. To aid interpretation remember that (I-S) > 0 means that the private domestic sector is spending more than they are earning; that (G-T) < 0 means that the government is running a surplus because T > G; and (X-M) < 0 means the external position is in deficit because imports are greater than exports.\n\n<a href=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Sectoral_balances_comparison.jpg\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Sectoral_balances_comparison.jpg\" alt=\"\" title=\"Sectoral_balances_comparison\" width=\"394\" height=\"149\" class=\"alignleft size-full wp-image-9712\" \/><\/a><\/p>\n<div style=\"clear:both\"><\/div>\n<p>The first two possibilities we might call A and B:<\/p>\n<blockquote><p>\nA: A nation can run a current account deficit with an offsetting government sector surplus, while the private domestic sector is spending less than they are earn<\/p>\n<p>B: A nation can run a current account deficit with an offsetting government sector surplus, while the private domestic sector is spending more than they are earning.\n<\/p><\/blockquote>\n<p>So Option A says the private domestic sector is saving overall, whereas Option B say the private domestic sector is dis-saving (and going into increasing indebtedness). These options are captured in the first column of the Table. So the arithmetic example depicts an external sector deficit of 2 per cent of GDP and an offsetting budget surplus of 2 per cent of GDP.<\/p>\n<p>You can see that the private sector balance is positive (that is, the sector is spending more than they are earning &#8211; Investment is greater than Saving &#8211; and has to be equal to 4 per cent of GDP.<\/p>\n<p>Given that the only proposition that can be true is:<\/p>\n<blockquote><p>\nB: A nation can run a current account deficit with an offsetting government sector surplus, while the private domestic sector is spending more than they are earning.\n<\/p><\/blockquote>\n<p>Column 2 in the Table captures Option C:<\/p>\n<blockquote><p>\nC: A nation can run a current account deficit with a government sector surplus that is larger, while the private domestic sector is spending less than they are earning.\n<\/p><\/blockquote>\n<p>So the current account deficit is equal to 2 per cent of GDP while the surplus is now larger at 3 per cent of GDP. You can see that the private domestic deficit rises to 5 per cent of GDP to satisfy the accounting rule that the balances sum to zero.<\/p>\n<p>The final option available is:<\/p>\n<blockquote><p>\nD: None of the above are possible as they all defy the sectoral balances accounting identity.\n<\/p><\/blockquote>\n<p>It cannot be true because as the Table data shows the rule that the sectoral balances add to zero because they are an accounting identity is satisfied in both cases.<\/p>\n<p>So what is the economics of this result?<\/p>\n<p>If the nation is running an external deficit it means that the contribution to aggregate demand from the external sector is negative &#8211; that is  net drain of spending &#8211; dragging output down.<\/p>\n<p>The external deficit also means that foreigners are increasing financial claims denominated in the local currency. Given that exports represent a real costs and imports a real benefit, the motivation for a nation running a net exports surplus (the exporting nation in this case) must be to accumulate financial claims (assets) denominated in the currency of the nation running the external deficit.<\/p>\n<p>A fiscal surplus also means the government is spending less than it is &#8220;earning&#8221; and that puts a drag on aggregate demand and constrains the ability of the economy to grow.<\/p>\n<p>In these circumstances, for income to be stable, the private domestic sector has to spend more than they earn.<\/p>\n<p>You can see this by going back to the aggregate demand relations above. For those who like simple algebra we can manipulate the aggregate demand model to see this more clearly.<\/p>\n<p>Y = GDP = C + I + G + (X &#8211; M)<\/p>\n<p>which says that the total national income (Y or GDP) is the sum of total final consumption spending (C), total private investment (I), total government spending (G) and net exports (X &#8211; M).<\/p>\n<p>So if the G is spending less than it is &#8220;earning&#8221; and the external sector is adding less income (X) than it is absorbing spending (M), then the other spending components must be greater than total income<\/p>\n<p>The following blogs may be of further interest to you:<\/p>\n<ul>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=7864\">Barnaby, better to walk before we run<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=4870\">Stock-flow consistent macro models<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=2418\">Norway and sectoral balances<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=1801\">The OECD is at it again!<\/a><\/li>\n<\/ul>\n<p><strong>Question 2:<\/strong><\/p>\n<blockquote><p>\nIf the Greek government decided to leave the EMU and restore their own currency they would have no solvency problems and could avoid an austerity program.\n<\/p><\/blockquote>\n<p>The answer is <strong>False<\/strong>.<\/p>\n<p>The &#8220;could avoid an austerity program&#8221; dated the question as applying to the current situation rather than some period in the future when all the adjustments associated with a decision to leave the EMU had worked themselves out of the system.<\/p>\n<p>In that context, it is clear that all liabilities that the Greek government holds would immediately be denominated in a foreign currency if it left the Eurozone and introduced its own currency again. This is in a formal sense.<\/p>\n<p>In fact, the liabilities are currently in a &#8220;foreign currency&#8221; (Euros) in the sense that the Greek government does not issue that currency. But once it left the EMU then this alienation from the Euro would become formal.<\/p>\n<p>As a result, the decision to exit the EMU would have to be accompanied by a default on existing obligations, because the government would be insolvent (unable to meet its Euro liabilities).<\/p>\n<p>It will probably have to default anyway, given that the design of the EMU makes it impossible for a nation to manage a major aggregate demand failure such as the one that has occurred during the current crisis.<\/p>\n<p>So the question is: given that default (they will call it renegotiation or rescheduling) is inevitable, why not go the whole way and insulate your economy from this vulnerability forever.<\/p>\n<p>The general point is that a sovereign government (one that issues its own currency) can never face a solvency risk on liabilities denominated in its own currency. Once it issues debt in a foreign currency then it can face a solvency risk because the nation has to earn that currency via exports or other nations have to be willing to exchange it via currency swaps or whatever. For Greece, neither option is particularly plausible in the current circumstances.<\/p>\n<p>The following blogs may be of further interest to you:<\/p>\n<ul>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=5377\">Euro zone&#8217;s self-imposed meltdown<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=6545\">A Greek tragedy &#8230;<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=7208\">Espa\u00f1a se est\u00e1 muriendo<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=7362\">Exiting the Euro?<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=7909\">Doomed from the start<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8093\">Europe &#8211; bailout or exit?<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8581\">Not the EMF &#8230; anything but the EMF!<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8963\">EMU posturing provides no durable solution<\/a><\/li>\n<\/ul>\n<p><strong>Question 3:<\/strong><\/p>\n<blockquote><p>\nThe IMF claims that &#8220;Greece needs to rely on internal devaluation&#8221; and the austerity programs are designed to deflate nominal wages and prices which is claimed will make the economy more competitive as long as real unit labour costs fall faster than their trading partners. However, ignoring whether the logic is correct or not, which of the following propositions must also follow if the IMF logic is to follow:\n<\/p><\/blockquote>\n<p>The EMU countries cannot improve their international competitiveness by exchange rate depreciation, which is the option always available to a fully sovereign nation issuing its own currency and floating it in foreign exchange markets.<\/p>\n<p>Thus, to improve their international competitiveness, the EMU countries have to engage in &#8220;internal devaluation&#8221; which means they have to cut real unit labour costs &#8211; which are the real cost of producing goods and services. Governments setting out on this policy path have to engineer cuts in the wage and price levels (the latter following the former as unit costs fall).<\/p>\n<p>But the question demonstrates that it takes more than just a nominal deflation. The strategy hinges on whether you can also engineer productivity growth (typically).<\/p>\n<p>So given the assumption (wage and prices falling at the same rate), the correct answer is:<\/p>\n<blockquote><p>\nIf wages and prices fall at the same rate, then labour productivity has to rise and what happens to employment is irrelevant.\n<\/p><\/blockquote>\n<p>Some explanatory notes to accompany the analysis that follows:<\/p>\n<ul>\n<li>Employment is measured in persons (averaged over the period).<\/li>\n<li>Labour productivity is the units of output per person employment per period.<\/li>\n<li>The wage and price level are in nominal units; the real wage is the wage level divided by the price level and tells us the real purchasing power of that nominal wage level.<\/li>\n<li>The wage bill is employment times the wage level and is the total labour costs in production for each period.<\/li>\n<li>Real GDP is thus employment times labour productivity and represents a flow of actual output per period; Nominal GDP is Real GDP at market value &#8211; that is, multiplied by the price level. So real GDP can grow while nominal GDP can fall if the price level is deflating and productivity growth and\/or employment growth is positive.<\/li>\n<li>The wage share is the share of total wages in nominal GDP and is thus a guide to the distribution of national income between wages and profits.<\/li>\n<li>Unit labour costs are in nominal terms and are calculated as total labour costs divided by nominal GDP. So they tell you what each unit of output is costing in labour outlays; Real unit labour costs just divide this by the price level to give a real measure of what each unit of output is costing. RULC is also the ratio of the real wage to labour productivity and through algebra I would be able to show you (trust me) that it is equivalent to the Wage share measure (although I have expressed the latter in percentage terms and left the RULC measure in raw units).<\/li>\n<\/ul>\n<p>The following table models the constant and growing productivity cases but holds employment constant for five periods. We assume that the nominal wage and the price level deflate by 10 per cent per period over Period 2 to 5. In the productivity growth case, we assume it grows by 10 per cent per period over Period 2 to 5.<\/p>\n<p>It is quite clear that under the assumptions employed, RULC cannot fall without productivity growth. The only other way to accomplish this is to ensure that nominal wages fall faster than the price level falls. In the historical debate, this was a major contention between Keynes and Pigou (an economist in the neo-classical tradition who best represented the so-called &#8220;British Treasury View&#8221; in the 1930s. The Treasury View thought the cure to the Great Depression was to cut the real wage because according to their erroneous logic, unemployment could only occur if the real wage was too high.<\/p>\n<p>Keynes argued that if you tried to cut nominal wages as a way of cutting the real wage (given there is no such thing as a real wage that policy can directly manipulate), firms will be forced by competition to cut prices to because unit labour costs would be lower. He hypothesised that there is no reason not to believe that the rate of deflation in nominal wage and price level would be similar and so the real wage would be constant over the period of the deflation. So that is the operating assumption here.<\/p>\n<p><a href=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_Table_A.jpg\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_Table_A.jpg\" alt=\"\" title=\"Internal_devaluation_scenarios_Table_A\" width=\"780\" height=\"337\" class=\"alignleft size-full wp-image-9729\" \/><\/a><\/p>\n<div style=\"clear:both\"><\/div>\n<p>The following table models the constant and growing productivity cases as above but allows employment to grow by 10 per cent per period. All four scenarios in the Table are them modelled in the following graph with the Real Unit Labour Costs converted into index number form equal to 100 in Period 1. As you can see what happens to employment makes no difference at all.<\/p>\n<p>I could have also modelled employment falling with the same results.<\/p>\n<p><a href=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_Table_B.jpg\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_Table_B.jpg\" alt=\"\" title=\"Internal_devaluation_scenarios_Table_B\" width=\"778\" height=\"335\" class=\"alignleft size-full wp-image-9730\" \/><\/a><\/p>\n<div style=\"clear:both\"><\/div>\n<p>The following graph shows the four scenarios shown in the last two tables. I have dashed some scenarios to make the lines visible (given that Case A and Case C) are equivalent as are Case B and Case D. What you learn is that if wages and prices fall at the same rate and labour productivity does not rise there can be no reduction in unit or real unit labour costs.<\/p>\n<p>So the internal devaluation strategy relies heavily on productivity growth occurring. The literature on organisational psychology and industrial relations is replete of examples where worker morale is an important ingredient in accomplishing productivity growth. In a climate of austerity characteristic of an internal devaluation strategy it is highly likely that productivity will not grow and may even fall over time. Then the internal devaluation strategy is useless.<\/p>\n<p><a href=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_A.jpg\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_A.jpg\" alt=\"\" title=\"Internal_devaluation_scenarios_A\" width=\"482\" height=\"290\" class=\"alignleft size-full wp-image-9724\" \/><\/a><\/p>\n<div style=\"clear:both\"><\/div>\n<p>This graph compares the two scenarios in the first Table with the more realistic one that labour productivity actually falls as the government ravages the economy in pursuit of its internal devaluation. As you can see real unit labour costs rise as labour productivity falls and the economy&#8217;s competitiveness (given the exchange rate is fixed) falls.<\/p>\n<p><a href=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_B.jpg\"><img loading=\"lazy\" decoding=\"async\" src=\"https:\/\/billmitchell.org\/blog\/wp-content\/uploads\/2010\/05\/Internal_devaluation_scenarios_B.jpg\" alt=\"\" title=\"Internal_devaluation_scenarios_B\" width=\"482\" height=\"290\" class=\"alignleft size-full wp-image-9723\" \/><\/a><\/p>\n<div style=\"clear:both\"><\/div>\n<p>Of-course, this &#8220;supply-side&#8221; scenario does not take into account the overwhelming reality that for an economy to realise this level of output over an extended period aggregate demand would have to be supportive. The internal devaluation strategy relies heavily on the external sector providing the demand impetus.<\/p>\n<p>Given that Greece trade is mostly exposed to developments in the EMU itself, it seems far fetched to assume that the trade impact arising from any successful internal devaluation will be sufficient to overcome the devastating domestic contraction in demand that will almost certainly occur. This is why commentators are calling for a domestic expansion in Germany to boost aggregate demand throughout the EMU, given the dominance of the German economy in the overall European trade.<\/p>\n<p>That is clearly unlikely to happen given Germany has been engaged in a lengthy process of internal devaluation itself and the Government is resistant to any stimulus packages that might improve things within Germany and beyond via the trade impacts.<\/p>\n<p>Further, the recent evidence suggests that tourism, a prime export for Greece, is suffering as a result of the civil disturbances.<\/p>\n<p>The following blogs may be of further interest to you:<\/p>\n<ul>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=5377\">Euro zone&#8217;s self-imposed meltdown<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=6545\">A Greek tragedy &#8230;<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=7208\">Espa\u00f1a se est\u00e1 muriendo<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=7362\">Exiting the Euro?<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=7909\">Doomed from the start<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8093\">Europe &#8211; bailout or exit?<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8581\">Not the EMF &#8230; anything but the EMF!<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8963\">EMU posturing provides no durable solution<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8879\">Protect your workers for the sake of the nation<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=8893\">The bullies and the bullied<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=5402\">Modern monetary theory in an open economy<\/a><\/li>\n<\/ul>\n<p><strong>Question 4:<\/strong><\/p>\n<blockquote><p>\nOne possible problem with running continuous budget deficits is that the spending builds up over time and with inflation eventually becoming the risk that has to be managed.\n<\/p><\/blockquote>\n<p>The answer is <strong>False<\/strong>.<\/p>\n<p>This question tests whether you understand that budget deficits are just the outcome of two flows which have a finite lifespan. Flows typically feed into stocks (increase or decrease them) and in the case of deficits, under current institutional arrangements, they increase public debt holdings.<\/p>\n<p>So the expenditure impacts of deficit exhaust each period and underpin production and income generation and saving. Aggregate saving is also a flow but can add to stocks of financial assets when stored.<\/p>\n<p>Under current institutional arrangements (where governments unnecessarily issue debt to match its net spending $-for-$) the deficits will also lead to a rise in the stock of public debt outstanding. But of-course, the increase in debt is not a consequence of any &#8220;financing&#8221; imperative for the government. A sovereign government is never revenue constrained because it is the monopoly issuer of the currency.<\/p>\n<p>The following blogs may be of further interest to you:<\/p>\n<ul>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=332\">Deficit spending 101 &#8211; Part 1<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=352\">Deficit spending 101 &#8211; Part 2<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=381\">Deficit spending 101 &#8211; Part 3<\/a>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=2905\">Fiscal sustainability 101 &#8211; Part 1<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=2916\">Fiscal sustainability 101 &#8211; Part 2<\/a><\/li>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=2943\">Fiscal sustainability 101 &#8211; Part 3<\/a><\/li>\n<\/ul>\n<p><strong>Question 5:<\/strong><\/p>\n<blockquote><p>\nOne of the reasons, mainstream economists argue for lower taxes is that they believe they distort the allocation of resources by changing the rates of return on different uses of capital (and labour). In the 2010-11 Australian Federal Budget, the Australian government introduced a Resource Super Profits Tax on mining companies as a way of sharing the gains made from excess mining profits across all Australians. Leaving aside the arguments that the government does not need revenue to spend, a typical mainstream economist would conclude that this tax will reduce mining investment.\n<\/p><\/blockquote>\n<p>The answer is <strong>False<\/strong>.<\/p>\n<p>The question was a trick and doesn&#8217;t directly have much to do with Modern Monetary Theory (MMT) at all. It was intended to provide insight into the inconsistencies (doublethink) that mainstream economists get themselves caught up in when they blur their own &#8220;pure&#8221; theory with political and moral arguments.<\/p>\n<p>Even in mainstream economic theory there are many instances where government intervention is beneficial although you won&#8217;t find too many conservatives who continually invoke &#8220;competitive text book theory&#8221; to make their cases for cutting government intervention etc admitting that.<\/p>\n<p>In fact, most of the commentators who perpetuate &#8220;free market&#8221; economics do not fully understand it as a body of theory.<\/p>\n<p>The Resource Super Profits Tax proposed by the Australian government is in the class of taxes known as Resource Rent Taxes. What are they?<\/p>\n<p>The Australian government <a href=\"http:\/\/www.futuretax.gov.au\/documents\/attachments\/Announcement_document.pdf\">Information Paper<\/a> is of interest in this regard and the their <a href=\"http:\/\/www.futuretax.gov.au\/pages\/FAQs.aspx\">FAQ site<\/a> has more information.<\/p>\n<p>The papers available at the Australian Treasury&#8217;s <a href=\"http:\/\/taxreview.treasury.gov.au\/Content\/Content.aspx?doc=html\/home.htm\">Tax Review site<\/a> are of interest, particularly <a href=\"http:\/\/taxreview.treasury.gov.au\/content\/FinalReport.aspx?doc=html\/Publications\/Papers\/Final_Report_Part_2\/chapter_c1.htm\">Chapter C: Land and resource taxes<\/a> of the final Report.<\/p>\n<p>There you learn what economic rents are and how they arise:<\/p>\n<blockquote><p>\nThe finite supply of non-renewable resources allows their owners to earn above-normal profits (economic rents) from exploitation. Rents exist where the proceeds from the sale of resources exceed the cost of exploration and extraction, including a required rate of return to compensate factors of production (labour and capital). In most other sectors of the economy, the existence of economic rents would attract new firms, increasing supply and decreasing prices and reducing the value of the rent. However, economic rents can persist in the resource sector because of the finite supply of non-renewable resources. These rents are referred to as resource rent.\n<\/p><\/blockquote>\n<p>So an economic rent arises to a resource where it is in finite supply and demand drives its return above the minimum required for it to be used in the current use. For example, Madonna would probably work for much less than she does but enjoys rents because people seem to like her performances and records etc.<\/p>\n<p>The point about an economic rent is that if you eliminate it you will not alter the supply of resources.<\/p>\n<p>The Treasury Review Chapter tells us that in mainstream theory (derived from a 1931 article by Hotelling).<\/p>\n<blockquote><p>\nThe optimal rate for exploiting non-renewable resources is, in theory, determined by the required rate of return &#8230; The owner of the resource can maximise the value of their resource stock by extracting quantities at a rate such that the expected value of the remaining resources rises over time at the required rate of return.\n<\/p><\/blockquote>\n<p>So even in mainstream economic theory, a resource rent tax will be optimal if it fully taxes the super-normal profits accruing to the companies that have been given the rights to exploit the mineral deposits. In this respect the 40 per cent tax proposed by the Australian government is sub-optimal because it leaves some of the rents in the hands of the rights-owners.<\/p>\n<p>Theory then describes how leaving rents in the system will lead to sup-optimal outcomes. You can read the Treasury Report noted above for more information on that if you are interested.<\/p>\n<p>But the important point is that the <strong>tax on the rents will not lead to less investment in mining projects<\/strong>. Firms will still earn more than the competitive return on their capital available elsewhere &#8211; 60 per cent of the higher rate of return more!<\/p>\n<p>There are other arguments that can be used to support the tax which are more amenable to MMT. For example, the incidence of the tax (who bears the final burden of it) will most likely fall on high-income investors. In the case of mining this group also involves many foreign interests. Low-wage workers will not bear much if any of the incidence.<\/p>\n<p>The question also of who &#8220;owns the resources&#8221; is relevant. If the resources are &#8220;publicly-owned&#8221; by all of us then it appears inequitable to allow foreigners and high-income rights-owners to compile massive wealth arising from exploitation of the resources. These are complex arguments that I will leave alone at the present time.<\/p>\n<p>There are many more arguments that have been used.<\/p>\n<p>From the perspective of Modern Monetary Theory (MMT) the basic fiscal proposition underpinning the government&#8217;s justification for the tax, however, is flawed. They say that by raising funds in this way they will be able to improve infrastructure, pay better retirement benefits etc for Australians who do not directly benefit from the &#8220;mining boom&#8221;.<\/p>\n<p>Well, they can do that whenever they like given they are sovereign in the Australian dollar. The only MMT justification for the introducing the tax or increasing its rate would be if it helped drain demand at a time when the real capacity of the economy was being exhausted and inflation was threatening. The Australian government has suggested this is one of their motivations.<\/p>\n<p>The other point is to consider the overall tax drain on aggregate demand in terms of the composition of the taxes being used to achieve that drain. Of the available taxes, Resource Rent Taxes advance equity; do not have any disincentive effects (strictly speaking) and are relatively easy to administer.<\/p>\n<p>So shifting towards this type of tax as a vehicle to fight inflation would be sensible.<\/p>\n<p>The following blog may be of further interest to you:<\/p>\n<ul>\n<li><a href=\"https:\/\/billmitchell.org\/blog\/?p=5762\">Functional finance and modern monetary theory<\/a><\/li>\n<\/ul>\n","protected":false},"excerpt":{"rendered":"<p>Here are the answers with discussion for yesterday&#8217;s quiz. The information provided should help you work out why you missed a question or three! If you haven&#8217;t already done the Quiz from yesterday then have a go at it before you read the answers. I hope this helps you develop an understanding of modern monetary&hellip;<\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"open","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[58],"tags":[],"class_list":["post-9713","post","type-post","status-publish","format-standard","hentry","category-saturday-quiz","entry","no-media"],"jetpack_featured_media_url":"","jetpack_sharing_enabled":true,"_links":{"self":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/posts\/9713","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcomments&post=9713"}],"version-history":[{"count":0,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=\/wp\/v2\/posts\/9713\/revisions"}],"wp:attachment":[{"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fmedia&parent=9713"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Fcategories&post=9713"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/billmitchell.org\/blog\/index.php?rest_route=%2Fwp%2Fv2%2Ftags&post=9713"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}