Category Archives: Australian economy

Doing its level worst

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A government is supposed to do its level best, as best it knows how, to improve economic conditions and make the world a better place. It’s not supposed to do this. From The Age front page today:

Labor ‘booby trap’ set to enrage Coalition

Lock in unaffordable increases whose costs G&S will never have to find the money for and then leave the next guys to drown in the debt and deficits they have left behind. The worse the economy inherited will be, the sooner the ALP believes it can return to continue its wrecking program.

The worst government in our history. Since they know a surplus is what needs to be achieved, since they continually promised to deliver one until it became impossible, that they are doing the reverse only demonstrates an inability to rise about politics and think about the national interest.

“Adhering to the outdated ideas of thinkers such as Mises, Hayek and Friedman”

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Having looked at Ben Eltham’s uninformed analysis of my article which was published in the Australian Financial Review in 2010, in which he had stated that I was “adhering to the outdated ideas of thinkers such as Mises, Hayek and Friedman”, I thought I might also put up the article I wrote then. I still think the RBA is far and away the best central bank in the world and I say this even though they have brought official interest rates to their lowest level since 1959 (or so I think I read). It is a reflection of their judgment on how dead in the water the Australian economy is. My AFR article was however published in November 2010, a more hopeful time for the economy when government plundering was at its height. And for you Keynesians out there, the analysis I use in this article is the same Wicksellian analysis Keynes used in his Treatise on Money.

It was pleasing to see the RBA raise interest rates, and the economy will be all the better for it as well.

The trouble with all that free stuff governments like to give out is that it isn’t really free after all. The true cost of government spending comes out of our collective wealth in a process almost invisible to the naked eye, with the frequent aim of governments to keep it as invisible as possible.

Australia is amongst the few economies where official interest rates have been rising. Nor is it a coincidence that the Australian economy has been amongst the better performing economies of the world. Raising rates has been an essential part of the reason why the economy has performed as well as it has. It is a cause as well as a consequence of our relative economic success.

The rate of interest is the price paid for resources made available for investment. When people save, they may think what they are saving is money but this is in many ways an illusion. They have produced goods and services, received an income for their efforts but chose not to buy everything their income would have allowed them to buy. Unspent income is saving, and to the individual saver these savings come in the form of money.

But that is to look at things from the perspective of the individual saver. From the economy’s perspective what savers do is leave for others the goods and services they had produced but did not themselves consume.

They have transferred to others, for a price, the right to use the output that has been made available by their decisions not to immediately buy as much as their incomes would have enabled them to.

They have postponed their own purchases until a later date but in doing so have provided an opportunity for others to make use of those unused resources to build productive assets through investment programs of their own.

Without saving there can be no investment. All investment is the product of saving and however much or little there is, you cannot invest more than what you have saved.

But it is not just private firms who seek access to these savings. Governments, too, absorb huge amounts, taking these in as tax revenues and then borrowing more to finance projects of their own.

Rising rates are a reflection of the supply and demand conditions for private savings. What’s left after the government has taken what resources it has decided to use up is what’s left for the private sector to divide amongst itself.

The advantage the government has in getting its hands on the savings of a nation is that when it borrows lenders know they will get their money back, governments get to print money when they cannot borrow all they want, and they can run deficits without immediate concerns about where the money to repay their debts will be coming from.

But here is the trick. Borrowing almost invariably comes in the form of money. A nation’s real savings, on the other hand, come in the form of actual resources which can be applied in building investment projects.

Of money there is an almost endless supply. There is as much as a government is prepared to create.

As to the availability of underlying real resources, the supply is finite and strictly limited. The core task for a central bank is to make sure the flow of dollars entering an economy is matched by an available flow of real resources the money can be used to buy.

Too much money relative to the resource base of an economy and we have inflation. It is this the RBA is determined to stop.

Interest rates are rising because the government is using resources even before they reach the private sector. The government may be able to provide school halls, install insulation and now the NBN. But if you think you are getting all this for free, you should think again.

The RBA is continuing to raise rates because the government is taking up domestic savings more rapidly than we are able to generate those savings through productive activity.

In this economy at this time it is the government that is the single most important cause of rising rates. The RBA is only doing what it can to ensure the resources available for investment are properly priced.

The pressure on rates therefore remains upwards and will continue to remain upwards so long as the government continues its relentless take up of our productive resources.

But if you don’t like higher interest rates, there is no point in blaming the RBA or for that matter the private banks. It is the government that is absorbing our national savings and raising the cost of capital. So long as it continues to do so, the pressure on rates will remain.

As a side note, The Age this morning ran a front page splash on how the banks are gouging their customers based on the economically illiterate notion that the central bank sets the rates for everyone else.

Why you should study economics at RMIT

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As it happens, I teach one of the finest introductory economics courses you will find anywhere in the world. Not standard by any means, it is based around my text, Free Market Economics: an Introduction for the General Reader. If you would truly like to understand how an economy works, you could not do better, in my view, than to read my book and if you can, to take my course. The reality is that you could not do better than to study economics at RMIT.

For all that there is a wildly absurd blog post by Ben Eltham, a self-confessed Keynesian and economic know-nothing, that comes first up if you google my name that goes under the heading, “Don’t Study Economics at RMIT”. Mr Eltham, it seems, wrote this in 2010. Must have been expecting a wondrous recovery although I must say he was a very optimistic soul to have still harboured such confident beliefs as late as the 6th November that year.

The kind of certainty found in Skidelsky (and Eltham) has drifted out to sea in the last few years. There are a few diehards of the Krugman variety but with economic matters getting worse just about everywhere, it will be a while before we again hear about the return of the master in relation to Keynes. I am told my students do read this post but interestingly they have never brought it up with me. What I describe to them in theoretical terms is exactly what they can see for themselves everywhere they look.

The notion that Keynesian policies have worked anywhere at all since the stimulus programs at the end of the GFC can not be sustained for a moment. They have been a disaster everywhere they were tried with the American economy amongst the most disastrous. The likelihood of any kind of serious recovery even now is remote. And it’s not because of some financial crisis years ago but because of the stimulus and the deficits and the debt that are a direct result of Keynesian theory. Mr Eltham, a self-confessed non-economist, totally without formal training in economics, is in absolutely no position to comment on any economic matter other than as a matter of wishing things were true that are not. You would think that by now he would have the decency to apologise but the possibility is as remote as his ever understanding the first thing about how an economy works.

Which is better?

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Listening to the unctious and ignorant comments by Swan and Gillard talking about the economy is an actual health hazard for someone such as myself. But here is the question: Which would be better, today’s level of spending and our present deficit or public sector spending cut in half with a deficit twice as large? I don’t know your answer but I do know mine. It’s the growth you want, which will only come about if we manage to cut the dead weight cost of this useless politically driven public spending.

Everyone thinks of the Great Depression having been brought to an end by the start of World War II. Sure, sure. Most of the men in their 20s and many of the women were drafted into the armed forces so disappeared from the labour market. And while this may have ended the unemployment, it hardly created an economic boom since the war was characterised by shortages and rationing as well as massive deficts and a rise in the level of debt.

World War II ends with the soldiers mustered out of service and only some of the women who replaced them in the workforce returning to the home. This is 1945 and in the United States only four years before there had been 14% unemployment. And what does the American President do? He cuts spending and balances the budget. The result: the beginning of the fastest growth in world history which continues from 1945 through until the 1970s.

Make your economy productive and it will create the growth that eliminates your debt. Continue with public spending and extenstions of various forms of non-value-adding welfare expenditures one upon the other and our economies will continue to struggle. But the public spending addictions, shared by both the politican class and their constituencies will continue to edge us towards the cliff unless some kind of economic sanity can return.

Austerity and Keynesian economics

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Oddly, could the real beginning of the Keynesian counter-revolution begin here in Australia? It’s one thing to stop spending because you have run out of other people’s money. It’s quite another to understand the problem of valueless public spending which will lead to a very focused attack on public waste.

Adam Creighton has a wonderful article in today’s Australian, Nothing austere about Europe’s fiscal policies which truly goes to the heart of the problem. He begins:

IN 1946 George Orwell famously pointed out how politics degraded and abused the English language for the sake of political ends. The same is true in economics. The word austerity, used to describe European and even US fiscal policy, has been a clever ruse by opponents of measures that may cause any reduction in the size of government.

No objective, sane person could describe, in a relative or absolute sense, fiscal policy in Europe or the US as austere, a word stemming from the Greek meaning harsh or severe.

‘The word austerity entered into the conversation once it became clear what a disaster the debt-financed stimulus was going to be,’ says Steven Kates, an economics lecturer at RMIT University, referring to the failure of repeated and colossal budget deficits to resurrect economic growth across advanced countries, almost five years after the end of the global financial crisis.

‘Those who support public spending and deficits prefer to characterise those who oppose them as wearing a hair shirt, rather than wanting to reduce public waste and have governments live within their means,’ he adds.

Government budget deficits in Europe are still up to twice as large as they were before the GFC – when no one described them as austere – and are contributing to already vast public debt burdens. Far from the ‘savage cuts’ of Wayne Swan’s imagination, European governments have reduced only the rate of growth of public spending. Even in Greece, a country with little population or economic growth in recent years, spending is still greater than it was five years ago.

Yet ‘mindless austerity’ has become a favourite phrase of the Treasurer since he dumped his promise to restore the budget to surplus this financial year. With a tsunami of costly spending promises on the horizon across disability, health, the environment and parental leave, it appears unlikely the budget will return to surplus soon – and without a change in attitude, ever.

OK, obviously I was one of the people he spoke to when he put this article together. But I speak to lots of people who never seem to get it. This is different. He sees the point and explains it exactly right which I don’t think you can do unless you understand it. And while it has felt somewhat strange to discover what I have discovered ploughing this furrow since the 1980s, I would still make the statement that there is no other way to find our way out of the economic problems we are in without a return to pre-Keynesian economic theory. First let me get back to the article and then let me continue:

Adam Smith’s dictum that what is prudent for households is never folly for governments infuriates economists who remain deeply wedded to the theory of John Maynard Keynes, who said public borrowing and spending, however wasteful, could revive moribund economies.

The giants of economic history before then – Jean Baptiste Say, John Stuart Mill and Alfred Marshall, for instance – all railed against the idea, which for Mill was an absurdity: ‘The usual effects of the attempts of government to encourage consumption is merely to prevent saving; that is, to promote unproductive consumption at the expense of the reproductive (investment).’

You won’t find the problem explained in any modern text based on the idea that aggregate demand drives an economy forward, which as it happens constitutes virtually all modern texts at the macro level. You certainly cannot make sense of the economic problems we have in the absence of a focus on value adding activity (i.e. the supply side of the economy) as the actual driver of economic growth. These concepts were, however, the foundational principles of the economics of Smith, Mill and Marshall, and indeed for all economists of the classical school prior to Keynes. But with the publication of The General Theory, which argued that public spending on anything at all will prime the pump and get an economy moving again, the notion that spending to create growth and jobs had to be value adding evaporated from the curriculum.

For me, schooled in the classics as I am, it was as obvious as a cloudless day that the stimulus could never achieve its ends. For virtually the rest of the profession it was not. Why the difference? I base my understanding on the classical theory of the cycle; they base their understanding on Keynes. That’s it. Nothing else. Anyone can do it. So why don’t they? Because the grip of Keynesian demand management has since the 1930s had the profession locked into the most destructive form of economic analysis, a form of analysis every classical economist understood as fallacious to its very roots. So all I can do is direct you to the pre-Keynesians. Here is a primer on the classics.

After that read either the first edition of Haberler’s 1937 Prosperity and Depression or if that doesn’t appeal to you, you can try my own Free Market Economics. But unless we can get out of this Keynesian death grip, our economies may never fully recover. We’ll just get used to slow rates of growth and limited improvements in our standard of living, in just the same sort of way the Japanese have done since their own Keynesian stimulus of the 1990s wrecked the world’s fastest most vibrant economy of the time.

What’s missing here?

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The Australian Conference of Economists has listed a number of areas of interest for special examination at this year’s meeting in Perth. Notice anything missing?

Researchers are invited to submit original papers that examine factors that influence ‘Beyond the Frontiers: New Directions in Economics’. We welcome the submission of papers that further develop this theme. We believe the theme offers considerable flexibility and could be used to report research findings or discuss issues related to areas such as:

  • GFC / Euro / Banking Crisis
  • Resources Boom (Energy Crisis)
  • Federal / State Financial Relations
  • Chinese Economy and Impact on WA / Australia
  • Experimental and Behavioural Economics
  • Climate Change / Environment
  • Monetary Policy / World Bank

Of interest to me, but to few others apparently, is the dismal policy failure of Keynesian economic theory. And as long as the belief remains that the world’s economies are suffering from the after effects of the financial crisis rather than the Keynesian stimulus that followed, the longer it will be before we start dealing with the actual nature of the problems we have.

The media prepares for a change of government

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Of all the worries about Australia’s political future, near the bottom of my list of concerns is Peter van Onselen’s Tony Abbott in danger of being a do-nothing PM. I fear such an opportunity will not be his lot in life but the leftist notion that pervades the article, that a good government is an activist government, is one I do not share.

But even with the issues that Abbott is accused of of buying into, this is really no more than refusing to fix parts of Gillard’s mess. He cites

Supporting a national disability insurance scheme levy via an increase in the Medicare levy blows the top marginal tax rate out to 47 cents in the dollar. That, quite simply, is not internationally competitive.

and

the market challenges Australia faces after years of the unrestricted Fair Work Act require a swifter correction.

That these decisions are Gillard’s is noted but the responsibility and need for a solution in his view belongs to the Coaltion, and more particularly to Tony Abbott.

And what is the only actual policy recommendation he can come up with:

Increased consumption taxes, via a broadening out of the Goods and Services Tax or an increase in its rate.

Some policy, but more money for the government to spend is typically all these people can think of. You can already see the media preparing for an Abbott government, building its list of failings based on not fixing immediately and in its entirety the mess that Labor will leave behind. Cynical, sure, but standard operting procedure as well.

On the train this morning

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On the train this morning our driver told a story while we were delayed and waiting to find a berth at Flinders Street.

He said he had been told that the Australian navy is so broke that to raise money it is having to grow and sell oranges. He had thought this was nonsense until this morning but now he sees it’s true since he had just eaten a piece of fruit with a sticker that said “naval orange”.

Not great, although it did make me smile. But what really charmed me was that the incompetence of this Labor Government is now so universally understood – even by those who are going to vote for them – that this is the kind of joke that train drivers tell their passengers. It must be common knowledge which does give me hope. That Labor is utterly bereft of talent, ability and ideas this I knew but my worry was would anyone else notice and even if they did, would they vote to throw them out. My worry always is can the country be bought off. Can there be one more set of fairy tales that will get these people back over the line.

Anyway, Andrew Bolt has the latest poll results:

Essential Media poll yesterday: Labor 45, Coalition 55

Roy Morgan poll today: Labor 42, Coalition 58

I’m a pessimist from way back. That these people won in 2007 and won again in 2010 only reinforced my sense that competence doesn’t matter or at least not as much as it should, and with 80% of the media behind them that maybe they will make it back again or only lose by a small margin. But if train drivers know the ALP is ruining our national defence, they must know a lot more as well about the harm the ALP have done. And if they know it, I can only hope it will influence their vote.

My reply to Russ Roberts on the minimum wage

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Here’s my reply to Russ Robert’s query about the Australian minimum wage.

Dear Russ

You may recall that I visited with you about a year ago at George Mason where we discussed, amongst other things, Say’s Law and Keynesian economics. But why I am writing now is because yesterday, when I opened Cafe Hayek as I regularly do, I found your query about the Australian minimum wage which is less of a puzzle to us here than it seems to be elsewhere. I will go into this a bit, but before I do I should just mention that I was the Chief Economist of the Australian Chamber of Commerce and Industry (ACCI) for a quarter of a century which drew me right into the very heart of the Australian industrial relations system. Although this won’t mean much in America, I wrote something like a hundred economic submissions in various test cases on industrial relations issues over the years, about a third of which dealt with the National Wage Case, which is the name given the process of minimum wage adjustment here in Australia. We have a quite unique industrial relations system and while it never appeals to anyone else – it hardly appeals to anyone here – it is a piece of institutional genius which has lasted for more than a century. It’s not perfect but then again nothing is.

Now when I saw your post the first thing I did was post it on our own blog here asking for comments. You can see the posting and the comments here.

What seems to surprise many others about Australia is how well we have fared during the period following the GFC. But there were three aspects of the post-2009 period that made the all important difference. The first was the economic policies of the previous Liberal Government from 1996 through to 2004 in which not only did Australia almost continuously run a surplus but we were the only country in the world that had zero debt. By sometime around 2001, the surplus could not even be used to pay off debt since there was none. So money was placed in a “future fund” which left the finances here in Australia extraordinarily robust when the GFC finally came.

There is then, secondly, our incredibly well managed financial system. Our banks held virtually none of the toxic assets that had weighed down the economies of other developed economies. But beyond that, we have a central bank that was the first to raise interest rates after the GFC and has kept them high every since. There is no easy money rolling around inside Australia. Artificially low interest rates are recognised by our central bank as part of the problem and not part of any sound solution.

Then, thirdly, the Chinese stimulus, whatever it may have done for China, caused a mining boom in Australia that continues. Rather than a disastrous downturn, our downturn was generally mild. Unemployment did shoot up from the low of 3.9% when the GFC began to reach 5.8% at its highest point. Sounds good to others but we did experience the two percentage points rise in the unemployment rate and avoided the official definition of two consecutive quarters of contraction by something like 0.2 percentage points. We had a recession but it did not last very long mostly because of the Chinese demand for resources which allowed Australia to pull forward almost immediately.

We naturally had a Keynesian stimulus which has been a cause of major havoc ever since. Billions entirely wasted. The debt and deficits that have accrued since 2009 have completely overturned the incredible position our Labor Government inherited. Having started with zero debt and no deficit, both are now high and uncontrolled. Our situation only looks good to others because no one appreciates the benchmarks which these outcomes have originated from.

Turning to the minimum wage, it is high on an exchange rate basis but in purchasing power parity terms is not as good as you might think. What $15 will buy you in Australia is about what $8-9 might buy you America. There is also an inflation ripping through the basic elements in our cost of living due to a number of factors, not least of which is the introduction of a carbon tax.

Australia has always had just about the highest minimum wage in the OECD (only France may be higher but it’s been a long time since I looked). The minimum wage is also a lot closer to the median wage than just about anyone else, or at least it was when I was last doing these Wage Case submissions. And while the official unemployment rate may seem low by American standards, the effect of the minimum wage has been detrimental on employment outcomes with the labour market visibly deteriorating for a large number of reasons beyond the minimum wage. Were we to have the same participation rate today as we did in the middle of 2010, the unemployment rate would be something like 6.5%. If one bears in mind that the average unemployment rate from 1945 till around 1970 was 1% (yes, one percent), you can see just how high our present unemployment rate is when looked at in our own terms.

Meanwhile, I have been looking at our latest ACCI economic survey and the trends in every important category are downwards, most notably in regard to employment. We have done rather better than most because where our current government has been unable to influence all aspects of policy – such as with our central bank and with the Chinese demand for minerals – we have done rather better than most. But where they have been able to intrude their policies, such as with fiscal policy, tax, wage outcomes and industrial relations, they have been poison to the economic system with these problems about to come to a head over the next twelve months. We could quite easily be looking at an unemployment rate no different from yours a year from today.

With kind regards

Steve

A query from Café Hayek about the Australian labour market

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Russ Roberts at Café Hayek has put up this post about the Australian labour market. I will write to him myself but I am curious if there are any other thoughts he might find of interest.

But the legacy from the years of surplus inherited by these absolutely hopeless economic managers, plus the quite extraordinarily good monetary policy in Australia, plus the mining windfalls that have now been dissipated have all contributed to the labour market outcome. And of course the unemployment rate started at 3.9% when the GFC began which rose to 5.8%, so 5.4% is quite an increase since then and there has been hardly any genuine improvement and is now getting worse. Not to mention the fall in the participation rate which has helped keep the number under six percent. Anyway, this is from Russ Roberts.

A number of people have asked me (Russ) about Australia’s minimum wage. It’s $15.96 an hour. Yet the unemployment rate in Australia is only 5.4%. The implication is that maybe the minimum wage doesn’t have the effects it is alleged to have.

Could be–maybe the laws of economics don’t apply to Australia. Or maybe the laws of economics don’t apply in countries that start with an “A.” Or maybe the world is a complicated place and you have to think carefully about how it works.

My first thought is to wonder how the minimum wage is enforced. Does it apply to all jobs? I know it doesn’t apply to all ages at the same rate–younger workers confront a lower minimum wage:

For junior employees, the minimum rates are:
Under 16 years of age $5.87
At 16 years of age $7.55
At 17 years of age $9.22
At 18 years of age $10.90
At 19 years of age $13.17
At 20 years of age $15.59.

But still, every one over 20 years of age earns at least $15.59 per hour? Shouldn’t that lead to more unemployment than 5.4%?

I would think so, given my understanding of Australian standards of living. And if the law applies to everyone and is enforced. Is it? I don’t know. Here’s what the government web page for the Australian minimum wage say:

The national minimum wage acts as a safety net for employees in the national workplace relations system to provide minimum rates of pay for employees not covered by awards or agreements. National minimum wage orders are made by the Minimum Wage Panel of the Fair Work Commission.

Hmm. What is an award? Here’s some help:

How to find an award

Which modern award (or other arrangement) am I covered by?

The 122 modern awards replace thousands of federal and state based awards, so finding your modern award can be complex. It will depend on factors including the relevant job type and duties, any exclusions that apply in the modern award and what your previous federal or state award (pre-modern award) was.

You’ll need to know which award covers you to use many of the tools on this website.

To work out your pay rates, you will most likely need to know both your modern award and your pre-modern award. There are a number of ways you can locate your modern award:

use our online tool Award Finder
browse our A-Z of modern awards
use the Fair Work Commission (the Commission) Draft Awards audit spreadsheet

One thing I’ve learned. I don’t know enough about Australia’s labor market regulations but it doesn’t appear to be anything remotely like what we call a market here in the US.

And it turns out that unpaid work is on the rise among young people in Australia–what we call an internship here in the US–a way of avoiding the minimum wage–somehow the minimum wage applies unless you pay ZERO. In which case it’s OK.

Here’s a charming excerpt from a recent government study of unpaid work:

The report extrapolates that, if the trend in unpaid internships is left unchecked, it is likely to gather pace as it has done in other countries like the United States, where employers are forced by their competitors into a ‘race to the bottom’. However, the report also notes that concern about unpaid work arrangements, especially as they impact on young people, has become a focus in other developed economies in recent years, especially since the Global Financial Crisis. In the United Kingdom, for instance, the present government has made a concerted effort in recent years to end any exploitation and to ensure fair access by all to the labour market.

Do we have some Australian readers who can tell us more about the Australian labor market?

…

A Free Market Defence of Industrial Tribunals: I just might mention my Quadrant article on our industrial relations system. A partial sense of what it argues.

I spent a quarter of a century in the middle of Australia’s industrial relations system working on behalf of national employers and can tell you from close observation that we in Australia have developed quite possibly the best industrial relations system in the world. I need hardly point out that very few others see it that way, but having the best system and some of the worst unions is quite a combination. The example I used to give to demonstrate the relative virtues of our system in comparison with others was that at the same time Rupert Murdoch was setting up his Fortress Wapping in the UK to allow him to bring new technology into the newspaper industry, he made the same transformation in Australia without, so far as I am aware, as much as a minute of lost time.