Big P Political Economy

Debt, Inequality and Financial Crises

2012-02-07T16:30:00.002+10:00

Paul Krugman is a figure of hate for the right in American politics. He is a liberal in the American sense of the word. But he is also an intelligent economic liberal, which means that he realises the benefits of markets and the necessity of government intervention.

In a recent blog post he counters views that he only talks about the Bush property bubble, while ignoring the Clinton stock bubble.

Except I did. Actually, back then the WSJ editorial page was flogging Dow 36,000 and telling readers that anyone who had doubts about the level of stock prices must hate capitalism.

Beyond that, there are some real differences between the Bush and Clinton bubbles.

One is that Bush presided over only four years of job growth, 2003-2007 — and those were all bubble-driven years. Clinton presided over eight years of job growth, with job growth at roughly equal rates in the first and second halves of that eight-year period, and the Internet bubble inflated only in the second half.

Another difference, which is really crucial, involves the debt implications. Here’s non financial debt, public plus private, as a percentage of GDP.

Have a look at those years of debt growth and which Presidencies they are associated with.

One of the arguments that I find most interesting about the growth of debt, beyond the significance of financial liberalisation, is the clear association of increasing debt with income stagnation.

During a period of income stagnation households increase their level of debt to maintain their living standards or to keep up with new consumption norms (often based on the consumption patterns of those on upper income levels).

Another interesting argument is that higher inequality might, therefore, be an important factor in creating the conditions for financial crises.

Michael Kumhof and Romain Rancière in Finance and Development argue that

Long periods of unequal incomes spur borrowing from the rich, increasing the risk of major economic crises.

The United States experienced two major economic crises over the past 100 years—the Great Depression of 1929 and the Great Recession of 2007. Income inequality may have played a role in the origins of both. We say this because there are two remarkable similarities between the eras preceding these crises: a sharp increase in income inequality and a sharp increase in household debt–to-income ratios.

Kumhof and Rancière argue that there are two major policy options for governments to deal with high levels of household indebtedness.

There are two ways to reduce ratios of household debt to income.

The first is orderly debt reduction. What we have in mind here is a situation in which a crisis and large-scale defaults have become unavoidable, but policy is used to limit the collateral damage to the real economy, thereby leading to a smaller contraction in real economic activity. Because this implies a much smaller reduction in incomes for any given default on loans, it reduces debt-to-income ratios much more powerfully than a disorderly default. Still, a long-lasting trend toward higher debt-to-income ratios resumes immediately after the debt reduction, because workers continue to have a reduced share of the economy’s income.

The second possibility, illustrated in Chart 4, is a restoration of workers’ earnings—for example, by strengthening collective bargaining rights—which allows them to work their way out of debt over time. This is assumed to head off a crisis event. In this case, debt-to-income ratios drop immediately because of higher incomes rather than less debt. More important, the risk of leverage and ensuing crisis immediately starts to decrease.

Any success in reducing income inequality could therefore be very useful in reducing the likelihood of future crises. But prospective policies to achieve this are fraught with difficulties. For example, downward pressure on wages is driven by powerful international forces such as competition from China, and a switch from labor to capital income taxes might drive investment to other jurisdictions. But a switch from labor income taxes to taxes on economic rents, including on land, natural resources, and financial sector rents, is not subject to the same problem. As for strengthening the bargaining power of workers, the difficulties of doing so must be weighed against the potentially disastrous consequences of further deep financial and real crises if current trends continue.

Restoring equality by redistributing income from the rich to the poor would not only please the Robin Hoods of the world, but could also help save the global economy from another major crisis.

It certainly makes intuitive sense, irrespective of the economic modelling. Mix easier access to credit with stagnating incomes and a culture of conspicuous consumption and you have a major factor in why the developed world is in crisis at the moment.

It also returns to my long-standing point that Australia's greatest generally unremarked vulnerability is our vulnerability to rising inequality.

Inequality, not just poverty, does matter, and research like that above makes clear that it presents real dangers to economies as well as societies.

China and the Australian Dollar

2012-02-05T19:41:00.000+10:00

The high Australian dollar is a source of joy for many Australians, especially those travelling overseas or buying goods overseas via the Internet. To be honest, I dig it in a big way. I get that lovely feeling of schadenfreude every time some British person complains about how expensive everything is here in Australia and I love buying books from the UK's Book Depository at reduced rates with no shipping costs and an inflated exchange rate.

(Nevertheless try as I might I couldn't buy the running shoes I wanted from the US either because the stores didn't ship to Australia or they did, but didn't have the size or style I wanted. I eventually found an Australian online store that sold shoes much cheaper [for Asic Kayano 18s about $70 cheaper than the retail outlets like Rebel and Super Amart]. For an analysis of the Internet and bricks and mortar retail see here)

But these pleasures just serve to highlight that a high dollar is a major problem for Australian (non-resource) exporting and import-competing businesses. Resource exporters aren't suffering yet, because demand remains high for the things that they export, especially coal, iron ore and gas.

As most educated Australians will understand, a high Australian dollar makes imports cheaper and exports dearer, which eventually causes many businesses, especially those with options to make things in other countries to reassess whether it is worthwhile continuing production in Australia. This is what has been happening in recent weeks with Toyota and Holden announcing job cuts and before that Bluescope Steel announcing that it was abandoning exports and cutting jobs.

Expect these announcements to become more frequent in coming months, especially given the fact that economic policy-makers in Australia seem to think that nothing can or should be done about the high dollar.

The exchange rate is a key enforcer of structural change in a resources boom. This phenomenon has been called variously 'Dutch disease", the two-, three- or multi-speed economy, and of course the patchwork economy.

Current concerns go beyond the banal fact that economies are always multi-speed. But right now the higher prices for Australian resources and the inflow of capital to fund investment and to take advantage of interest rate differentials between Australia and most countries with very low, zero, or effectively negative, interest rates is bolstering the Aussie. Borrowing at low interest rates and then investing in Australia with relatively high interest rates is rather attractive at the moment. Also a factor is growing foreign purchases of Australian bonds, especially by central banks and sovereign wealth funds.

According to another report in the FT, foreign ownership of Australian government securities has reached 80%.

While this makes some bond traders nervous, the real problem for Australian government bonds at the moment is a lack of supply. Still one trader argues:

this is worrying as heavy foreign ownership of government bonds can be very dangerous, particularly when this is combined with a country running a current account deficit (i.e. the country is reliant on capital inflows from abroad).

These concerns seem to be overdone - Australia's CAD is as low as it has been for some time, but I suppose things could change if China fell in a hole.

Right now, the worry is the high exchange rate's negative impact on key sectors of the economy, particularly those that employ large numbers of people and help to create a more diverse economic structure for Australia.

As I have noted many times before on this blog and elsewhere, exchange rate-induced structural economic change has a lot to do with whether the high Australian dollar is sustained over the medium term or whether it falls against our major trading partners and, especially, the US Dollar.

According to Hume in the FT, most economists expect a fall in the Aussie, but not back to its long term post float average of around 75 US cents. Instead the consensus view is that it will be supported at about the mid 90s. But at the moment Australians going overseas are doing pretty well compared to the early 2000s:

Australians planning to visit London for this summer’s Olympic Games will get bang for their buck. The Aussie, which recently hit a 27-year high of 67.96p against sterling, has appreciated by more than 80 per cent since Sydney hosted the Olympics in 2000.

Given that he is a long-term bear about China's medium-term economic prospects (increasingly becoming more short-term) Michael Pettis questions whether the Aussie should be currently so strong:

I am actually much more pessimistic about Chinese growth prospects, commodity prices, and the pace of European recovery ... but even so we would have expected that the obvious prospective problems in Europe and China should have made themselves felt in the Australian dollar. So why has it remained so strong?

The answer he suggest might have something to do with the amount of capital flowing out of China as cashed up Chinese worry about the potential for wealth destruction in China in coming years.

I just had coffee earlier in the week with one of my PKU students. He told me that he and his business-owning father are trying to take money out of the country as quickly as possible. He says it has become harder recently (I don't know why) but everyone they know is setting up businesses abroad and trying to do the same, in part, he said, so that they can get foreign passports if they ever need it. On that topic there was an interesting article last week in the New York Times:

A recent survey of 980 Chinese millionaires found that 46 percent of them were considering leaving China and another 14 percent had already emigrated or were completing the paperwork for relocating. The survey by the Bank of China and the Hurun Report said 40 percent of the would-be émigrés — they’re known as “migratory birds” in China — would aim for the United States, followed by Canada (37 percent), Singapore (14 percent), Europe (11 percent), Hong Kong (5 percent) and Britain (2 percent).
The leading reasons for taking flight: better educational opportunities for their children, advanced medical treatment, worsening pollution back home (especially urban air quality) and food safety concerns. But many potential émigrés, not surprisingly, are working on a Plan B in case China’s economic growth begins to slow, widespread social unrest takes hold or the political winds begin to blow against them.

We are seeing this process most vividly in Hong Kong. In spite of a recent video showing a fight between Hong Kongers and mainlanders in the Hong Kong subway, which went viral and inspired real anger and mutual recriminations among even some of my most laidback Beijing and Hong Kong friends, mainlanders are scooping up apartments in Hong Kong. This is from an article in Saturday’s South China Morning Post:

Data compiled by Midland Realty shows individual mainlanders spent HK$62.3 billion on residential properties in Hong Kong last year, or about 20 per cent of the value of all sales excluding those involving corporate buyers. That was almost double the 10.8 per cent in 2010. The agency expects the figure to jump to about 25 per cent this year.
Rich mainlanders are clearly eager to take money out of the country. And what is just as clear, the debate on the limits of state capitalism we have been hearing and reading about a lot recently is not just of academic interest to them. According to my student, it is becoming harder and harder for non-SOEs [state-owned enterprises] to do business in China, and more necessary than ever to have friends in high places.

As an aside, for those watching the real estate market, my student also mentioned that two very large real estate projects that his father runs are having trouble selling units. He said his father has decided to sell as quickly as he can, even at very low prices, rather than wait for prices to recover.

One of the places that Chinese capital could go is, of course, Australia. which may account for the continuing strength of the Aussie:

a lot of Chinese capital is flowing into Australia. He, for example, has traveled to Australia nine times in the past year, mainly looking after business for his father, who has also been to Australia many times. The family has large investments in food, real estate and construction, and my student tells me he often arranges to meet in Sydney or Melbourne school friends of his who also happen to be in Australia for similar purposes. My guess is that at least part of the reason for a strong dollar, in spite of weakening growth expectations, may be that a lot of Chinese capital is flowing into Australia.

What would happen if growth in China slows significantly? This would probably result in a sharp drop in non-food commodity prices, which should cause much slower growth in Australia. But if a Chinese slowdown coincided with an increase in private Chinese capital outflows, it might be difficult for the Australian dollar to adjust downward sufficiently to help absorb some of the cost of the slowdown. In that case Australia might suffer low growth and an expensive currency – not a very good combination.

Let's hope that this doesn't eventuate!

Let me finish this already long post by noting that this is not an argument against the floating exchange rate, which has been overwhelmingly beneficial for Australia since the early 1980s and has helped Australia to adjust to international shocks and keep inflation in check during the boom. But let's not pretend that it doesn't have some costs that the government and the RBA will need to manage.

Long-term Employment Trends in Queensland

2012-02-02T14:46:00.000+10:00

My post from the other day on employment and industry structure in Queensland contains data up to 2009-10. The following graph provides an outline of long-term employment trends by industry as a percentage of total employment, up to November 2011 (thanks to Mick Peel for pointing this out).

The percentage data and the graphics are quite revealing of the changes in Australia since 1984.

I tried putting all of the sectors on the one graph, but it looked like something Barry Jones or Kim Beazley might have designed, so I decided to separate them out for your viewing pleasure.

Remember that these graphs don't represent absolute levels of employment in the economy, just their relative importance as a percentage of total Queensland employment. Note too that scales are different for different charts. Raw data file available on request.

Agriculture and manufacturing are big losers over this time period and remember that they had already been losing employees from well before 1984. Mining has virtually doubled in size, but still accounts for less than 4% of total employment. Construction has also grown, perhaps matching increased investment in housing and more recently in construction associated with mining and other infrastructure. That downturn in construction from 2007 to late 2011 could have been a lot worse without government assistance to the construction sector.

Wholesale and retail trade have not had the continuous decline of agriculture and manufacturing, but have done poorly in recent times, apart from an upturn for Accommodation and Food 2008-09.

It's important to remember that changes in employment may represent the decline of an industry or improvements in productivity. Those of you who grew up in the 1970s and 1980s (or before) will well remember how much more service was provided in certain retail sectors for example. Petrol stations are an obvious example, but "self serve" is a late 20th century phenomenon generally.

Professional, scientific and Technical services employment has grown rapidly since the early 1980s, while sadly education and training has remained fairly static as a percentage of the whole. I must admit that I thought that Financial and Insurance Services might have garnered a larger percentage, but this might represent the fact that Queensland jobs in finance etc might have shifted to Sydney or Melbourne.

Unsurprisingly Health Care and Social Assistance has increased significantly in recent years as have Arts and Recreation Services. Expect both of them to keep increasing their stake over coming years as the population ages and as young people increasingly "service" the recreation and health needs of cashed-up baby boomers.

Putting all the lines together reminded me of the start of that Barracudas song from the 1980s "Summer Fun". "ba ba ra ra cu cu da da"

Australia Lags World's Best Practice in Alcohol Consumption

2012-02-02T10:54:00.005+10:00

Australians like to think of themselves as world class drinkers. Talking about getting drunk on the weekend must dominate a good percentage of workplace conversations on Monday morning (and perhaps for other mornings of the week).

I always remember my manager at the drive-in bottle-o I worked in from the time I was 18 rolling his eyes at one customer's story about how much he'd drunk the night before, before turning to me and saying "anyone would think it was hard work getting drunk, the way that guy goes on about it". Quite. Mind you he was a big drinker himself, he just didn't think it was worth going on about, probably because it was such a regular occurrence.

But I digress. It seems we are not quite as good as those former Eastern European and Soviet Communist countries. Perhaps it's all those steroids Communist bloc athletes took in the 1970s and 1980s that has given them the advantage.

The Economist has just put out a neat little graphic based on a report from the World Health Organisation, which says that we (i.e. the world) apparently drank 6.1 litres of pure alcohol per person over 15 in 2005. (That's not 6.1 litres of drinks with alcohol in them, but 6.1 litres of "pure" alcohol - the stuff you can run cars on!).

A little maths can put this in perspective. If an average stubby of beer contains 375ml and is roughly 4.5% alcohol then each beer contains 16.8 ml of alcohol or 0.0168 litres. If we then divide 6.1 by that figure we get an average global consumption of alcohol that is equivalent to 363 stubbies of beer per person per year. Using the same logic, that's 56 bottles of wine (14.5% alcohol, 750ml bottles). But this is for all adults (over 15). Given that abstaining rates are around 15%, then those who actually do drink, down a case load more.

Moldovans score the gold medal, drinking 18.2 litres each. But a closer look at the figures for Moldovans reveals that Moldovan men who do imbibe, drink over 32 litres of pure alcohol per year - close to 2000 stubbies/300 bottles of wine).

The Czechs get the silver medal with about 16 litres each.

More than half of Moldovan drinking is moonshine, which you'll know, if you've ever drunken some, ain't particularly good for your health. Illegal alcohol production supposedly accounts for almost 30% of the world alcohol consumption.

At said pub I worked at in Adelaide ("The Shandon", now "the Links" I think), it seemed to be the southern Europeans most keen to make their own alcohol. I remember having a tiny little swig of some concoction of grappa, which made me gasp for air and immediately a little unsteady on my feet, a bit like a bucket bong (at least that's what I've been told by people who've had such things).

The WHO conveniently provide country fact sheets, which are quite revealing, even if they are from 2005. Data on these things obviously takes time to collate. Perhaps it's all that drinking going on.

(For a list of country fact sheets see here)

Generally Australians are fairly happy with their consumption because it is "stable". Like in the soccer, we kick ass in the Western Pacific, beating our neighbours by almost 4 litres of pure alcohol a year per person.

But when we get rid of the "abstainers", we do even better (worse?), with males drinking 16.26 litres of pure alcohol a year (that's almost 1000 stubbies or 150 bottles of wine or some drunken combination of the two, with a few bottles of spirits thrown in).

The Australian Bureau of Statistics also collates statistics on alcohol consumption, which it calls "Apparent Consumption of Alcohol, Australia". The latest figures are from 2009-10 and reveal that:

There were 184.0 million litres of pure alcohol available for consumption from alcoholic beverages in Australia in 2009–10. This was 0.7% more than the amount available for consumption in 2008–09 (182.7 million litres).

The increase was comprised of increases from wine (up 4.3%) and spirits (up 0.7%), and decreases from beer (down 1.7%) and Ready to Drink (pre-mixed) beverages (down 1.9%).

Of all pure alcohol available for consumption in 2009–10, beer contributed 43.3%, wine 37.2%, spirits 12.5% and RTDs 7.0%.

On a per capita basis, there were 10.3 litres of pure alcohol available for consumption per person in 2009–10, which is less than in 2008–09. As a standard drink consists of 12.5 mls of pure alcohol, this is equivalent to an average of 2.2 standard drinks per day per person aged 15 years and over.

Over the past 5 years, beer is down and wine is up.

Over the longer-term this trend is even more marked.

Those guys swilling beers at 6pm in the 1960s would be deeply disappointed by all these new fangled blokes (like myself) who've almost fully switched to wine. I used to drink beer when it was really hot, now I just drink cold pinots!

My old man recalls him and his mates buying five drinks each, just before six so that they could keep drinking a little longer beyond the legislated 6pm pub closing time. The six o'clock swill indeed.

Legislation does make a difference to consumption, but not always in the ways intended. Wine is favoured in taxation terms, partly as a spur to the wine industry, but this means a higher consumption of cheap wine. And although there is some evidence that the government's increased taxation on ready-to-drink alcopops reduced young adults from 'binge' drinking, others argue that it has led to greater drinking of spirits, which are then post-mixed, rather than pre-mixed. Anecdotally, this does seem to be the case, at least amongst the small sample of young adults I know.

But while many of us like a drink, we often do tend to minimise its harmful effects.

According to "The WHO":

The harmful use of alcohol results in 2.5 million deaths each year.

320,000 young people between the age of 15 and 29 die from alcohol-related causes, resulting in 9% of all deaths in that age group.

Alcohol is the world’s third largest risk factor for disease burden; it is the leading risk factor in the Western Pacific and the Americas and the second largest in Europe.

Alcohol is associated with many serious social and developmental issues, including violence, child neglect and abuse, and absenteeism in the workplace.

But even more importantly as The WHO notes:

It also causes harm far beyond the physical and psychological health of the drinker. It harms the well-being and health of people around the drinker. An intoxicated person can harm others or put them at risk of traffic accidents or violent behaviour, or negatively affect co-workers, relatives, friends or strangers. Thus, the impact of the harmful use of alcohol reaches deep into society.

Harmful drinking is a major determinant for neuropsychiatric disorders, such as alcohol use disorders and epilepsy and other noncommunicable diseases such as cardiovascular diseases, cirrhosis of the liver and various cancers. The harmful use of alcohol is also associated with several infectious diseases like HIV/AIDS, tuberculosis and sexually transmitted infections (STIs). This is because alcohol consumption weakens the immune system and has a negative effect on patients’ adherence to antiretroviral treatment.

A significant proportion of the disease burden attributable to harmful drinking arises from unintentional and intentional injuries, including those due to road traffic accidents, violence, and suicides. Fatal injuries attributable to alcohol consumption tend to occur in relatively younger age groups.

I often wonder, given these obvious pathologies, why alcohol is legal and marijuana is illegal. Alcohol seems to be a much bigger problem and many of the problems associated with marijuana are caused more by its illegality, rather than its consumption.

For those interested in an analysis of the possible benefits of legalising marijuana, see an article by Professor Jan van Ours "The Long and Winding Road to Marijuana Legalisation" at Vox.

Rock, Paper, Scissors in Queensland: Manufacturing Beats Mining

2012-01-31T15:33:00.004+10:00

The ABS has recently put out 1312.3 Queensland at a Glance, which provides a wealth of information on Queensland for the year ending 2009-10. While there are many newer stats on the various topics available this publication brings them all together.

What interested me, apart from the fact that the significant migration to Queensland that occurred for most of the 2000s has significantly slowed, is the percentage contributions of industry sectors to employment and total sales and service income. See here.

What might be an interesting exercise before you look at the figures is to imagine what you think they might be roughly. Most Queenslanders, I imagine, would think agriculture would be bigger than it is; most would assume that mining would be bigger than manufacturing and retail trade. Contrary to these perceptions, agriculture is now a small sector of the economy and manufacturing is still larger than mining, especially when it comes to employment. Both mining and agriculture are of course more important when it comes to exports.

The ABS doesn't provide percentages so I added the data to excel, converted to percentages and sorted by size to provide a more meaningful assessment of relative contributions.

See here for some data on relative contributions of various industry sectors for Australia as a whole.

As you can see below, retail trade is the biggest employer, followed by construction, accommodation and manufacturing at 9%. Compare this to mining, which employs 1.9%. Now obviously some of the construction sector and retail jobs are dependent on mining, but so are these service sectors dependent on manufacturing, albeit not to the same degree at the moment because of the colossal amount of investment in infrastructure going on in the mining sector.

For a long-term and more up-to-date account of Queensland employment see here.

When it comes to contributions to sales and service income, mining is vastly more important, but still only the fifth largest industry contributor. Wholesale and retail trade account for 31% of income, with manufacturing contributing almost double mining's share.

As with the Australian economy as a whole, the real structural change that has been going on for the past half century is the shift to services. But let's not forget that manufacturing is still vastly important to the Queensland and Australian economies, not just in terms of employment, but in terms of contributing to a more diverse economy.

While we should avoid protectionism, governments at all levels, local, state and federal, need to think of ways to assist industry sectors without feather-bedding them. Assisting innovation, cutting red-tape, facilitating industry linkages (between industries and between industry and research institutions) and providing support for education, training and research would seem to be a good start. At a human level working on ways to keep employment high and long-term unemployment low is also vital.

Economic Austerity is Not Good for You: Forgetting the Lessons of History

2012-01-31T12:58:00.001+10:00

Who would have thought cutting government spending in the middle of a slump would lead to lower growth? Anyone with half a brain that's who. I'm not talking about Australia here, but Britain. However, Britain provides an example of what could have happened in Australia if simple-minded austerity politics had operated as per the Coalition's critique of Labor's fiscal expansion during 2008-09. Certainly the fact that the Chinese didn't believe in austerity helped our cause as well.

While China certainly came to the rescue after the slump, according to Treasury (see this also), it is the fiscal expansion that kept Australia out of recession during 2009. Despite revisionist views that it was all about China, it was fiscal expansion that helped Australia to avoid a downturn in business and consumer confidence during 2008 and 2009, which may have led to a negative spiral of increasing unemployment and declining consumption.

Here as a reminder is how bad things were late last decade on a global scale

As Steve Morling and Tony McDonald point out:

As stark as these annual growth figures are, they disguise the speed and extent of the decline in the second half of 2008. In through-the-year terms, world growth fell from 3.8 per cent in the June quarter 2008 to -2.8per cent in the March quarter 2009, a 6.6 percentage point turnaround. The extent of the slowdown over this period was quite similar in the advanced and emerging economies.

A couple of other charts from their paper make interesting viewing.

The first chart shows that the fiscal expansion, hit when it was needed most, during the second half of 2008 and first half of 2009.

If the global economy goes pear shaped in 2012-13, then the government should and probably will make the government contribution to growth help us avoid the severe downturn that will occur elsewhere. Still, what happens in China matters more and more, not just the direct impacts of Chinese demand on Australia but the indirect effects of Chinese demand for the goods and services of other Asian countries, which also helps us to keep growing. Even if Asia has decoupled from the rest of the world (which in the medium term I don't think it has), the countries of Asia have not decoupled from each other.

This second chart shows that the downturn badly affected China as well and our major trading partners in general. During this period of time, Australia was not being saved by China or the rest of Asia.

On a per capita basis Australia's growth performance was not as exemplary. Remember that GDP per capita is a much better measure of progress than aggregate GDP, which can be bolstered, as it has been throughout Australian history, by population increases.

Another interesting chart shows the differences between Australia's economic structure and the OECD average. In the 1980s these differences were seen as likely to lead to Australia falling down the rankings of of advanced economies. Now they are seen as a fundamental factor in our economic success. It is possible, if Australian policy-makers don't work to diversify the economy, that in 20 years time we might be making the same arguments about the Australian economy that were made in the 1980s.

Labor's determination, therefore, to produce a surplus sooner rather than later is not the same thing because of Australia's better and sustained recovery (so far) from the downturn on the back of Asian demand (remember the Asia story is much more than just China). The government was right to get the budget balance in order, while the sun's been shining. Indeed, they might have had a better shot at this if they'd raised taxes on mining profits sooner rather than later.

Wayne Swan and Treasury realise that if global growth falls off a cliff then they have room to manoeuvre to again support the economy through fiscal expansion (i.e. government spending).

While there may be too much focus on Europe's possible negative effects on Australia at the moment, it's important to remember that Europe as a whole accounts for about 40 per cent of global GDP. (The European Union itself is a larger economy than the United States).

The difficulty in the face of a return to a renewed global recession might be in ignoring those who believe that governments should be more like virtuous households - with a keen saving and protestant work ethic.

Instead they will have to make a case that increasing government spending will be a necessary move to avoid a downward economic spiral that could be caused by stupidly believing that austerity is a suitable policy during a slump. Expect the Coalition to go on about unsustainable public debt. Just make sure you realise that this is rubbish. The aim of government fiscal and monetary policy during a downturn should be to maintain aggregate demand. The Rudd government and the Reserve Bank did a good job during the last global recession, let's hope that they do an equally fine job during the coming downturn.

The major example of stupid austerity has been Britain, which has gone from bad to worse as far as growth is concerned. Paul Krugman nicely captures the perverse reasoning in the UK of so-called "expansionary austerity", wherein advocates argued that cuts in government spending would encourage confidence in the business sector and lead to investment, jobs and finally consumption. Krugman begins by quoting UK PM, David Cameron:

“Those who argue that dealing with our deficit and promoting growth are somehow alternatives are wrong,” declared David Cameron, Britain’s prime minister. “You cannot put off the first in order to promote the second.”

But this is faith of the highest order, based on the same sort of logic as the Laffer Curve.

How could the economy thrive when unemployment was already high, and government policies were directly reducing employment even further? Confidence! “I firmly believe,” declared Jean-Claude Trichet — at the time the president of the European Central Bank, and a strong advocate of the doctrine of expansionary austerity — “that in the current circumstances confidence-inspiring policies will foster and not hamper economic recovery, because confidence is the key factor today.”

Such invocations of the confidence fairy were never plausible; researchers at the International Monetary Fund and elsewhere quickly debunked the supposed evidence that spending cuts create jobs. Yet influential people on both sides of the Atlantic heaped praise on the prophets of austerity, Mr. Cameron in particular, because the doctrine of expansionary austerity dovetailed with their ideological agendas.

Instead what has happened has been - surprise, surprise - lower growth. According to a recent National Institute of Economic and Social Research press release:

output [in Britain] grew by 0.1 per cent in the three months ending in December after growth of 0.3 per cent in the three months ending in November. This implies the economy expanded by 1 per cent in 2011, half the rate of growth experienced in 2010 (2.1 per cent).

Krugman highlights an interesting graph from the NIESR (but doesn't show it) that reveals that in terms of growth Britain is doing worse than during the Great Depression.

Last week the National Institute of Economic and Social Research, a British think tank, released a startling chart comparing the current slump with past recessions and recoveries. It turns out that by one important measure — changes in real G.D.P. since the recession began — Britain is doing worse this time than it did during the Great Depression. Four years into the Depression, British G.D.P. had regained its previous peak; four years after the Great Recession began, Britain is nowhere close to regaining its lost ground.

Here's the graph:

Given the rhetoric of the Conservatives one would think that Britain's public debt situation is unparalleled. In terms of British history it is not even close to the high debt levels of the past.

The problem for the present and near-term is that low growth is not confined to Britain, which is still an important economy in the global scheme of things despite its long term relative economic decline. Other still important economies are also doing poorly.

Italy is also doing worse than it did in the 1930s — and with Spain clearly headed for a double-dip recession, that makes three of Europe’s big five economies members of the worse-than club. Yes, there are some caveats and complications. But this nonetheless represents a stunning failure of policy.

And it’s a failure, in particular, of the austerity doctrine that has dominated elite policy discussion both in Europe and, to a large extent, in the United States for the past two years.

O.K., about those caveats: On one side, British unemployment was much higher in the 1930s than it is now, because the British economy was depressed — mainly thanks to an ill-advised return to the gold standard — even before the Depression struck. On the other side, Britain had a notably mild Depression compared with the United States.

Even so, surpassing the track record of the 1930s shouldn’t be a tough challenge. Haven’t we learned a lot about economic management over the last 80 years? Yes, we have — but in Britain and elsewhere, the policy elite decided to throw that hard-won knowledge out the window, and rely on ideologically convenient wishful thinking instead.

Krugman goes on to talk about the United States, whose policy-makers he believes need to be more focused on expansion, despite the high level of government debt. Those following the US debate know that many economic and political commentators believe that there needs to be austerity à la Britain if the United States is going to break out of along period of low growth.

But this is madness, at least in the short-term. Krugman is thankful that the Obama Administration did not follow the expansionary austerity stupidity.

Which is not to say that all is well with U.S. policy. True, the federal government has avoided all-out austerity. But state and local governments, which must run more or less balanced budgets, have slashed spending and employment as federal aid runs out — and this has been a major drag on the overall economy. Without those spending cuts, we might already have been on the road to self-sustaining growth; as it is, recovery still hangs in the balance.

And we may get tipped in the wrong direction by Continental Europe, where austerity policies are having the same effect as in Britain, with many signs pointing to recession this year.

The infuriating thing about this tragedy is that it was completely unnecessary. Half a century ago, any economist — or for that matter any undergraduate who had read Paul Samuelson’s textbook “Economics” — could have told you that austerity in the face of depression was a very bad idea. But policy makers, pundits and, I’m sorry to say, many economists decided, largely for political reasons, to forget what they used to know. And millions of workers are paying the price for their willful amnesia.

Too many people think of an economy as just a big household. It's a good thing for families to increase their savings during a downturn - it's a little boring perhaps, but a good idea - because if times get even worse, i.e. if you lose your job or get fewer hours, then extra savings will perhaps help you and your family get through tough times.

This is not true, however, for an economy as a whole. The more people save the less they spend, leading to what Keynes called the 'paradox of thrift', wherein ‘virtuous’ efforts to reduce debt cause a decline in demand and a downturn in the economy.

Remember that GDP = private consumption + gross investment + government spending + (exports − imports). That is:

GDP = C + I + G + (X - M)

Simple maths would tell you that if you reduce private consumption or government spending and don't get a corresponding increase in investment, then the end result will be an economic contraction.

The problem for Australia, as I highlighted recently, is the end of the debt-fuelled growth model that spurred growth from the early 1990s til 2007. This is a major structural change for the Australian economy, although it might be better seen as the end of an earlier structural change that began with financial liberalisation and gathered pace as credit markets expanded over the 1990s and kept going until 2007 when the music stopped and not everyone found a chair.

As I outlined in that late 2011 post:

The growth of household debt as a percentage of disposable income grew rapidly over the 1990s and 2000s rising from:

48% in September 1990 to 156.7% in June 2007 to 150.8% in September 2011.

Debt for housing is 89.7 % of total household debt.

Investor housing debt is 29% of total household debt.
Interest payments as a percentage of disposable income reached a high of 13.4% in June 2008 to a low of 9.3% in June 2009 to 11.4% in September 2011. (see my article Structural Shenanigans for graphics).

So ... household debt remains at high levels and the inability to continue to grow debt even further undermines an important source of growth over the past 20 years.

Think about it.

The growth that occurred after the recovery of the 1990s recession was augmented, buttressed and sometimes driven by the expansion of household debt by around 100% of disposable income.

If we were to have the same favourable conditions over coming years this would mean that household debt as a percentage of disposable income would have to go to 250% of income.

While I've always been a keen user of credit cards, even I couldn't sustain the amount of debt repayments as a percentage of disposable income that this level of debt implies.

While households in aggregate have less room to move in terms of increasing GDP (the C part of our GDP equation), government in Australia (the G part of the equation) has much more room to move if things go badly in Europe, Asia and the United States.

We must hope that those successful communists in China keep managing their economy in such a way that benefits Australians. Over the short and medium-term it continues to be important that we debate the wisdom of increasing reliance on the mining sector and on China.

Recent Political (and other) Cartoons

2012-01-24T12:04:00.000+10:00

The Chinese Economy: A Drag on Australia in 2012?

2012-01-12T16:49:00.002+10:00

One of the most interesting commentators on the Chinese (and global) economy is Michael Pettis. A consistent theme of his newsletter (which you can receive by asking him to send it to you!) is that many economic commentators don’t understand or at least downplay the significance of global imbalances and the concept of the balance of payments.

I’ve long argued to my students in the course Power in East Asia that Chinese purchases of US bonds are not a straight forward indicator of growing Chinese power (indeed I might have been a little more forceful than that). The belief that the Chinese could simply stop purchasing US bonds would require them to change their growth model and is not likely to happen anytime soon. But even if they did, it would not be the disaster for the US economy that many commentators seem to think.

Pettis writes:

One of the more absurd fears that still pops up every few months is the panic over the possibility that foreign central banks (i.e. the Chinese) might stop “lending” to the US government. If they ever decide to stop buying US Treasury bonds, the argument goes, US interest rates would soar and the US government would suddenly find itself unable to fund its fiscal deficit

…

Chinese “lending” to the US government is not a discretionary decision that they can choose or not choose to do – it is the automatic consequence of a growth model that requires a trade surplus to absorb domestic overcapacity – the idea that the US government needs foreign funding is based on a very fundamental misunderstanding of the balance of payments. The US government does not need foreign buyers for its bonds. On the contrary, it is in Washington’s best interest that foreign central banks sharply reduce their purchases of USG bonds.

He then explains why recent reduced purchases of US bonds have not led to an increase in interest rates.

US interest rates have very little to do with foreign purchases of US government bonds.

Why? Because foreigners do not fund fiscal deficits. They fund current account deficits, and as an accounting requirement the size of the current account deficit is exactly equal to the net foreign funding.　 Capital account inflows must exactly match current account outflows.

The direction of causality can go either way. If investment in the US is so high, for example, that it is impossible for US savings to supply the full demand (as occurred during much of the 19th Century), then the US must import foreign capital to make up the shortfall. The difference between domestic US investment and domestic US savings, of course, is equal to the net amount of foreign savings imported into the US, and is also equal to the US current account deficit. In this case soaring US investment causes the US to have a current account deficit and leads foreigners to fund this excess investment.

But as he then points out the direction of causality is not clear cut. While the CAD is equal to saving minus investment, rising ‘investment’ might be spurred by capital inflows, rather than the other way round.

But the direction of causality can also run the opposite way. Suppose foreign central banks have decided for domestic reasons (for example in order to generate domestic employment) to accumulate hoards of US government obligations and so run a trade surplus. This will cause a surge of net capital inflow into the US. In that case the US must run a current account deficit equal to the net inflow.　

There are several ways this can happen. One way is for the surge in foreign capital inflows to cause a sharp rise in what otherwise would have been unnecessary or unfunded investment – the real estate bubbles in Spain and the US might be obvious examples of this. Another way is for foreign savings to displace domestic savings, perhaps by funding a credit-fuelled consumption boom.　

But Pettis argues that in some ways this beside the point, what many commentators miss is the simple maths involved. Net capital imports equal a current account deficit. The real issue for the US and China at the moment is what happens if foreigners, particularly the Chinese stop buying bonds. Rather than cause interest rates to rise and a collapse of the economy, the result is actually beneficial for growth. This is because:

if there is a reduction in net foreign capital inflows there must also be a reduction in the US current account deficit.　

The results are not necessarily benign.

In Spain, for example, it will happen as a collapse in domestic demand and high levels of unemployment.

For the US, however, the result is likely to be better because reduced capital inflows will further reduce the value of the dollar leading to an increase in exports and therefore a rise in employment.

US interest rates on the other hand are likely to remain unaffected

First, the decline in US unemployment will result in a decline in fiscal expenditures since the main reason for fiscal expansion is to reduce unemployment. Second the reduction in unemployment and the increase in business profits will increase tax revenues. Lower spending and higher revenues means less borrowing, and so fewer foreign purchases of US government bonds will be matched by fewer US government sales of bonds.

Remember that saying that the US needs more foreigners to buy US government bonds in order to keep interest rates low is exactly the same as saying the US needs a bigger current account deficit in order to keep interest rates low.This cannot be true.

So the question of whether the China buys US bonds or not is more dependent on the Chinese growth model of running current account surpluses.

… this is hard to predict since it is based more on political factors than economic ones.　 China’s current account surplus has contracted quite dramatically in the past four years, not because of domestic rebalancing, of course, but because of forced foreign rebalancing, and there are many who think the trade balance may actually go into deficit next year.　

Pettis thinks it is unlikely that China will slow export growth anytime soon because of the view that this would be a disaster.

Huo Jianguo, head of the Ministry of Commerce's research unit, was much more explicit. Last week he warned about the consequences of slow export growth.

China needs annual export growth of at least 15 per cent to ensure stable economic expansion as the rate of domestic investment cools, the head of the trade ministry's think-tank said in comments published yesterday. "We just can't tolerate the simultaneous fall in investment, consumption and exports," Huo Jianguo, head of the Ministry of Commerce's research unit, told the Shanghai Securities News. "A growth rate of 15 per cent [in exports] is basically a benchmark and any growth below that would start to affect employment."

Beijing has pledged to stabilise exports and boost imports next year to balance trade as part of efforts to bring equilibrium back to the economy and insulate it from the effects of deteriorating external demand.　 Many international economists believe China's growth has been fuelled by a reliance on investment spending, creating asset bubbles and overcapacity problems that pose more serious structural challenges than shifting external trade conditions. But Huo said concerns about falling exports were growing.

"In fact, the investment-driven model of 2009 has changed, exports are playing an incremental role in overall growth - so when export growth eases, people get nervous." Huo noted that at least 80 million jobs are related to exports - many of them held by migrant workers and therefore vital for social stability.

This is likely to lead to an increase in trade tensions. Remember the basics of global trade: not everyone can run a trade surplus. If the US and countries like Spain in Europe want to run a surplus or reduce their deficits, this will mean that China, Japan and Germany etc will have to reduce their surpluses.

Chinese and German trade surpluses must be matched by deficits elsewhere. Chinese and German export success must be matched by a willingness of other countries to buy their products. Now in an ideal world, a country’s trade surpluses would lead to increases in the value of its currency. In Europe this can’t work for individual members of the Eurozone and between the US and Asia equilibrating mechanisms are restricted both by Asian currency policies and perceptions of the US as a safe haven for capital.

Pettis then turns to the growing costs of debt service in China caused largely by excessive infrastructure investment. Growing debt is a real problem for China.

As we saw in the last debt crisis, a decade ago, debt-servicing costs are only manageable in China thanks to financial repression – i.e. extremely low lending rates funded by even lower deposit rates -- which implies a huge transfer, equal to several percentage points of GDP annually, from household savers to corporate and government borrowers. Households, in other words, typically clean up banking messes.

…

The problem with this solution is in what it implies about future growth in demand. If investment is being wasted, it must be reduced or it will create a debt crisis eventually. If the external environment is tough, the demand impact of a sharp drop in investment cannot be made up for by a surge in the trade surplus – in fact the trade surplus may actually contribute negative demand. So where will the demand come from needed to pull the Chinese economy? The only possibility is a surge in domestic consumption.

The solution of increasing consumption in China is often seen as a relatively simple phenomenon that will occur over time, almost as a matter of course. But recent years have seen decreases not increases in consumption. (although see here for an alternative view)

Indeed, one of the growing narratives by the Gillard government and particularly Treasurer Wayne Swan is the opportunities created by China that go beyond the mining boom. Swan argues that the growth of the Chinese middle class will create an export bonanza for Australia.

Of course, the mining boom is only one part of a much bigger and evolving story about the influence of China's rise on the world. The China story is not just a mining story; it's also a story of its dynamism and the spectacular growth we're seeing of its middle class. China's rapid growth is delivering hundreds of millions of people into a burgeoning middle class.

It's important here to distinguish between the complex and subtle process of ‘middle classing' and the simple process of ‘urbanising'. Some of China's many millions of internal migrants have achieved lifestyles that qualify as middle class, but the vast majority have not, at least not yet. It is the present and prospective shift of China's current working class and working poor into empowered consumers that will mean so much to Australia.

This, according to Pettis, might be a longer-term project than Swan seems to think.

Can consumption possibly surge? No, not if the household sector is going to be forced to clean up the banking mess again. This is the same problem that caused household consumption to drop after the last banking crisis from a very low 46% of GDP in 2000 to an astonishing 34% in 2010.　

Policies aimed at boosting consumption by offering incentives to purchases household goods and cars will no doubt increase spending on these items but …

since those subsidies were ultimately paid for by the household sector, the policies did not translate into an overall surge in consumption because there was no net increase in household wealth. In fact during both of those years consumption continued to decline sharply as a share of GDP.

The problem for China is not excessive saving, given that they save at about the same rate as other Asian countries. Instead the real problem is that household income is such a low share of GDP.

This means that the only way to boost consumption is redistribution from rich to poor or from the state to households.

When we add in the possibility of a continued decline in house prices throughout China, we may start to feel some kind of wealth effect dragging consumption growth down even further as a share of GDP, although I am not sure I am too worried about that. The housing boom seems to have mainly benefitted speculators, and I don’t think that it translated into a significant increase in consumption when housing pieces were on their way up. In that case it shouldn’t matter too much on the way down either, although it is better to wait and see what happens.

In the case of houses, prices are definitely falling in China, according to Pettis.

So it is debt that is the big problem, but past options used to 'solve' earlier debt problems are probably not available again.

This time however I really doubt that the debt crisis can again be resolved by financial repression, since household wealth is already far too small a share of GDP, and expected GDP growth prospects much lower than in the past. Remember that if GDP growth slows sharply, the only way households can continue permitting that their share of GDP declines, as it has for the last thirty years, is if household income growth drops to zero or even goes negative.

Slower growth and an already-low share of GDP will mean that it will be politically very difficult to force households to clean up the mess another time. Add to this the problem of illiquidity in the banking sector, which is going the become an increasing problem over the next few years as borrowers have trouble repaying loans and will require more-or-less permanent ever-greening, and I think there will be much greater appetite for a real liquidation of bad debt.

Australia is vulnerable to these potential problems in China and Australians are increasingly dependent on the Chinese Communist Party managing a rapidly growing, but increasingly unbalanced economy! But lots of people have thought that the Chinese growth model was unsustainable before, so I wouldn't take too large a bet on it collapsing.

Although given the reasonably high percentage of equity (shares) in my super accumulation fund I am in a way betting on Chinese growth continuing for a little while at least. Over the longer-term it is likely that China will continue to demand resources from Australia. It's the medium-term - the next 2-4 years that worries me.

If you wanted to short the Chinese economy - that is a take abet against continuing high levels of growth in China - then shorting Australian resource stocks would be a good strategy.

For what it's worth I think the Chinese authorities are likely to be able to cover up problems for a little while yet. Next year, however, is another betting opportunity.

Debt Denouement?

2011-12-22T15:18:00.002+10:00

Debt is the major problem facing the world economy at the moment. But it's not as clear cut as many commentators make out. The recent focus has rightly been on Europe and on the sovereign (public) debt crisis. (See here and here and here and here for earlier posts on debt).

For Australia there are two types of debt to worry about directly and another type indirectly. Indirectly Australians need to worry about the reactions of European and American policy-makers to their public debt problems.

As many commentators have recently pointed out, contractionary fiscal policy in a time of economic stagnation, fear and credit anxiety is likely to lead to - surprise, surprise - contraction. To think otherwise is slightly ridiculous. The real question is whether the decline in the price of sovereign debt is worth more to getting the economy back on track than attempting to support growth with limited fiscal resources.

Directly, Australians need to worry about their own foreign and household debt. Both are private forms of debt and are of course related. Households have borrowed from the banks, who have sourced some of their funding from overseas lenders. The balance of offshore borrowing by the banks has improved since 2007, but it is still very important as the banks keep telling us when they decide not to pass on the full weight of RBA interest rate cuts.

A post from Leith van Onselen covers the possible negative impact of rising household debt for younger Australians.

Last week, the Reserve Bank of Australia’s (RBA) Bulletin noted how high housing costs are disproportionately affecting younger Australians:
Median housing debt-to-income ratio for Australians under 39 years of age has risen 29 per cent in the six-year period to June 2010, compared to the 20 per cent rise for the oldest Australians in the same time.

The increases leave younger Australians with a median housing debt of 333 per cent of household income or more than double the 159 per cent for the over-60 crowd…

“The increase in the cost of housing has affected younger households, whether renters or purchasers, more than other age groups”, said the report…
Now the Galaxy Australian Debt Study has found that younger Australians are more stressed about repaying debt than any other generation:
People aged between 24 and 35 topped the debt anxiety list, with nine in 10 concerned about making debt repayments.

Big purchases such as a first home were largely to blame for the stress, with 55 per cent of people in this age group nominating rising rents and mortgage repayments as their biggest financial concern, according to the Galaxy Australian Debt Study…

“While most Australians are trying to be financially responsible, it is worrying that people aged 25 to 34 appear to be feeling the greatest strain,” Matthew Strassberg, senior adviser at Veda, the debt investigation company which conducted the survey.

The survey also found 15 per cent of people in this age group were likely to apply for more credit over the next six months, compared with 9 per cent in the remainder of the population.

This is where it can all go wrong, Mr Strassberg said.
“It is concerning that there are people struggling with their current debt levels but are turning to more credit as the answer, potentially edging closer to a debt spiral,” he said.
“While people can have large credit commitments, the debt spiral begins when a person starts slipping behind on payments and seeks yet more credit as the solution.”

The bi-annual Galaxy survey reveals Australians are facing unprecedented levels of debt stress as 82 per cent of the population worry about meeting debt repayments, up from 75 per cent in September 2010…

The research also suggested one in five Australians were struggling to pay off their credit commitments.

As a means of coping with the stress of debt, 87 per cent of consumers have chosen to cut back on everyday spending and lifestyle, 49 per cent have cut back on groceries and 35 per cent received assistance from family or friends…
“Borrowing from family and friends is common, so is wanting to access superannuation early.
That more people are worried about repaying debt now than in September 2010 is interesting given that the official ratio of household debt to disposable income has fallen over the past year, from 154% in September 2010 to 151% in September 2011. Perhaps the reasons for the rising anxiety levels have to do with:
Housing prices falling. 90% of household debt relates to mortgages. And with home prices now falling, households are losing the ability to simply sell-up, repay outstanding debt, and walk away.
The economic (employment) outlook is far less certain, owing to the slowing domestic economy (outside of mining) and overseas concerns (including Europe and China).
With the baby boomers starting to retire, and needing to liquidate their housing assets to fund retirement (remember: they own roughly half of Australia’s housing assets, including 57% of all investment properties), the question beckons: will younger Australians be in the position to buy these homes from the boomers at current prices?
From the above studies, the answer is doubtful.

The phenomenon of high debt and the consequent need to

In an article I wrote a couple of months ago I considered three structural changes that were affecting the Australian political economy.

The first structural change is the long-running shift away from manufacturing towards services and the more recent revitalisation of the mining sector. This has come, to some extent, at the expense of manufacturing and important service industries such as tourism and international education.

The second structural change - and the one I'm focused on in this post - is the shift away from debt-financed consumption and rising housing prices to a higher rate of saving – generally considered under the description deleveraging or more simply the paying off or consolidation of debt.

Perhaps we should call this the end of an earlier structural change that began with financial liberalisation and gathered pace as credit markets expanded over the 1990s and kept going until 2007 when the music stopped and not everyone found a chair. The growth of household debt as a percentage of disposable income grew rapidly over the 1990s and 2000s rising from:

48% in September 1990 to 156.7% in June 2007 to 150.8% in September 2011.

Debt for housing is 89.7 % of total household debt.

Investor housing debt is 29% of total household debt.

Interest payments as a percentage of disposable income reached a high of 13.4% in June 2008 to a low of 9.3% in June 2009 to 11.4% in September 2011.(see Structural Shenanigans for graphics)

So ... household debt remains at high levels and the inability to continue to grow debt even further undermines an important source of growth over the past 20 years.

Think about it.

The growth that occurred after the recovery of the 1990s recession was augmented, buttressed and sometimes driven by the expansion of household debt by around 100% of disposable income.

If we were to have the same favourable conditions over coming years this would mean that household debt as a percentage of disposable income would have to go to 250% of income.

The question I often ask myself at times like Christmas is how much debt could I get into. Now not owning a house means that this would probably be unproductive debt spent on expensive dinners and wine and presents.

But regardless of what I spent it on, at some point the debt burden becomes too much to service and I either have to pay it off, reschedule it or declare bankruptcy. Extrapolate this task across households across the economy and you can see why a major source of growth has at best stabilised and at worst gone into reverse.

This is the change that may matter most of all for Australia in 2012 as households save more and the "paradox of thrift" exacerbate the impacts from overseas.

People start to feel pessimistic about their spending capacities and if growth slows further then we could end up in a negative spiral.

Another reason why people are feeling pessimistic is that the value of assets has fallen significantly since 2007-08.

The fall in the share market may matter more in Australia than elsewhere because more Australians have their super invested in shares than anywhere else.

As a matter of interest, the third structural change causing anxiety in the community is a tentative shift towards a less pollution-intensive economy through the establishment of a carbon price and support for renewable energy through a variety of schemes and policies.

The first two structural changes are long-running and largely unavoidable without significant and perhaps costly policy interventions, which could cause more problems than they fix.

The third involves a greater level of immediate political choice. But government has the ability to encourage a shift towards a more diversified, future oriented economic structure.

And though policy change associated with this is likely to have only a minor impact in the short-term, the way that debate has polarised the community has added to negative perceptions of the Gillard government.

Next year should be an interesting year. But just as problems could occur it's also possible that Europe will sort out its mess, China will gradually begin to shift from high investment to higher consumption. If the Communists can manage the Chinese economy through another period of global crisis then maybe everything will be hunky dory in 2012.

Let's hope that those focused on vulnerabilities and negative spirals (like me) are wrong and the boomers are right for at least one more year.

Recent Political Cartoons (and a few others)

2011-12-14T14:44:00.000+10:00

Renewable Electricity Generation in Australia

2011-12-06T15:37:00.000+10:00

Renewable Sources of electricity production have been growing rapidly in recent years, but the contribution of solar still remains minuscule as I reported here a little while ago. I imagine most people would be quite surprised by the figures.

The Clean Energy Council has just released a report on the state of Clean Energy in Australia.

Though the news reports laud the achievements we still have a long way to go before we can call ourselves a clean energy country.

Most of our renewable contribution to electricity production (remember that electricity and energy are two different concepts with the former a component part of the latter).

Basically about 10 per cent of our electricity generation is accounted for by renewable sources.

So what are these renewable sources. Most important of course is hydro power, which has benefited from high rainfall, allowing more run-off and hence more electricity generation. Wind is obviously next most important and most of the most significant proposed increases in renewable generation are wind projects.

Solar accounts for very little of this. Indeed Solar in total accounts for 2.315% of 9.64%, which equals 0.22% of total electricity generation.

Undoubtedly, solar installations have been increasing rapidly.

But the benefits of generous state schemes to pay households for solar contributions to the electricity grid are only available to those able to afford solar systems on their roof tops. This means poorer households and renters gain no benefits and have at the same time seen significant increases in electricity costs.

Although there is debate about the reasons for electricity price increases, there is no doubt that electricity prices have increased. The CEC reports that "Electricity prices in Australia have risen about 30 per cent over the last four years." The CEC argues:

There are several factors behind the recent price rises. By far the largest is the need to
replace and upgrade the ageing poles and wires of the national electricity grid, some of
which have been in service for more than 40 years. Recent estimates suggest that more
than $130 billion will be necessary to upgrade the network over the next decade, growing
to $220 billion over 20 years.(1) Research indicates that these network costs will cause price
rises of up to 66 per cent in NSW and Queensland by 2015.(2) Similar increases are likely in
other states and territories.

Other reasons for power price rises include the increasing cost to generate electricity with
both coal and gas along with the increased use of energy-intensive appliances such as
air-conditioners and flat-screen televisions, which increase peak demand for electricity
and overall costs.

1 K Orchison, Coolibah Pty Ltd, Powering Australia, 2011, page 19.
2 P Simshauser, T Nelson, T Doan, AGL,The Boomerang Paradox Part 1: how a nation’s wealth is creating fuel poverty, The Electricity Journal, 24(1), 2001,
pages 72-91.

They are rather more sanguine than others about solar rebates:

According to analysis prepared for the Clean Energy Council by ROAM
Consulting in 2011, the combined cost of both small and large-scale renewable energy
comes to approximately $78 per year for the average Australian household. This works
out to $1.50 per week. By 2020 the cost of renewable energy is expected to make up
between 4 and 7 per cent of the average household power bill.(3)

3 J Riesz and J Gilmore, ROAM Consulting, The True Costs and Benefits of the Enhanced RET, 2011, page iii

Cartoons of the Past few Weeks

2011-11-28T11:31:00.000+10:00

International House Prices: Australia Compared

2011-11-28T08:30:00.002+10:00

The Economist has just released the latest version of its interactive global house price graphic. They explain it this way:

The Economist has been publishing data on global house prices since 2002. The interactive tool above enables you to compare nominal and real house prices across 20 markets over time. And to get a sense of whether buying a property is becoming more or less affordable, you can also look at the changing relationships between house prices and rents, and between house prices and incomes.

Whichever way you look at it - and it's worth moving the dates around to get a good idea of the changes - Australia has done 'better' than nearly anywhere else. But we too are now in decline.

If you push the date to start at Q1 2007, you get a real insight into how house prices have fallen in the rest of the developed world.

Going back to 2000, Australia has done well - if you think rising house prices is necessarily a good thing (and I don't). Japan has done particularly poorly (falling prices are not a good thing either)

Going back even further to 1990 and the country that stands out the most is South Africa with an amazing rise in house prices. Australia still stands out, but the most interesting figure is the gradual rise in house prices in Germany - no boom there, just a gradual orderly rise (the best of all outcomes in my view). And look at that fall in the Celtic 'tiger' - financialisation not looking like such a great idea now.

The Economist has been a long-time bear on Australian house prices arguing that:

SOME four years after house prices peaked in much of the rich world, housing remains over-valued, when compared to its long-run relationship with housing rents and income per person. Housing prices in Australia, Canada and France, which had only a slight wobble in 2008 before climbing to new highs, look particularly frothy. In contrast, prices in America have fallen so far that they now look cheap when compared against both rents and income. But given the huge stock of foreclosed homes that is yet to come on to the market, the chances are that they could yet fall further.

From this accompanying article The Economist reports:

Never before had house prices risen so fast, for so long, in so many countries. Yet the bust has been much less widespread than the boom. Home prices tumbled by 34% in America from 2006 to their low point earlier this year; in Ireland they plunged by an even more painful 45% from their peak in 2007; and prices have fallen by around 15% in Spain and Denmark.

The suggestions from the overvalued nature of house prices against income increases and rent changes is particularly bracing.

The ABS and other private sector organisations argue that house prices have fallen further than the 2.2 per cent listed here.

Superannuation (Pensions)

2011-11-23T16:10:00.001+10:00

Ever wondered why Australians are so obsessed by the economy?

There are lots of reasons given, including these in a recent speech by former Reserve Bank governor Ian Macfarlane.

I think it's got a lot to do with the fact that Australians have a higher percentage of variable rate mortgages than most countries. meaning that decisions by the RBA (a key piece of economic news) matter more to Australians than those people in countries where mortgages are fixed. According to the RBA:

In some countries, including Australia and the United Kingdom, variable-rate loans predominate, whereas in New Zealand and Canada, fixed-rate loans of between two and five years are more common; in the United States and some European countries long-term fixed-rate mortgages predominate. The features offered on housing loans also differ significantly across countries; for example, loans with redraw facilities and flexible repayment structures are relatively uncommon in many continental European countries.

It's also got something to do with the globalisation of the economy and the efforts by the Labor governments of the 1980s and 1990s, particularly Paul Keating to 'educate' - persuade and coerce - Australians about the need for change.

But it might also have something to do with the fact that more Australians have their super tied up in shares than anywhere else. This graph from the OECD was reproduced on MacroBusiness:

The Indian and Chinese Diasporas

2011-11-23T06:30:00.000+10:00

From The Economist:

The major question is what is the significance of these external communities for the future development of their economies and international relations? 1.3 million Chinese in Peru?

US Troop Deployments Around the World

2011-11-22T15:30:00.001+10:00

From The Economist:

Three significant events that changed troop deployments: World War II, Vietnam and post-September 11th.

According to The Economist:

THE American government is keen to show its commitment to security in Asia by putting boots on the ground there. As this analysis shows, the number of American troops (Army, Navy, Marines and Air Force active duty personnel) in Asia is only slightly smaller than the number in Europe, where Americans in uniform are largely a hangover from the carve-up of the continent at the Yalta conference in 1945. Indeed, the one lesson that can be drawn from the data is that today's strategic priorities can shape deployments for decades to come, long after the original reason for putting G.I.s in a particular region has gone. Another is that American forces do not pay much attention to Africa, despite the number of active or dormant conflicts there. The methodology used for this analysis has changed slightly from 2006 as the Department of Defence reports deployments in Iraq and Afghanistan based on contributing troops rather than actual boots on the ground, but that does not seem to make a huge difference, at least to this chart

Equal Pay, Housing, Employment and Bonuses

2011-11-22T09:47:00.000+10:00

Equal Pay

Good news for workers in the ‘care’ sector – mostly women http://www.pm.gov.au/press-office/gillard-government-deliver-historic-payrise-social-and-community-workers.

Now for childcare workers because there’s probably no more important job than looking after very young children. Childcare in lower socio-economic areas should have subsidized teachers to increase educational opportunities and outcomes for families that don’t have the time or inclination to read to and stimulate their kids. But what to do about those that don’t work and don’t care?

Housing

Information on owners and renters from http://www.abs.gov.au/AUSSTATS/abs@.nsf/Lookup/946A456AE7DA949DCA25773700169C7B?opendocument

“The proportion of households [i.e. outright owners] without a mortgage has declined from 42% to 33%, while the proportion with a mortgage has risen from 30% to 35% in 2007-08. The decline in outright home ownership may reflect increasing uptake of flexible low-cost financing options which allow households to extend their existing home mortgages for purposes other than the original home purchase”

“Australia's preference for a free-standing house on its own block of land is most evident among home owners. Of the 5.5 million households that owned their home in 2007-08, 88% lived in separate houses (graph 10.8). Over a half (56%) of all renter households lived in separate houses; 30% lived in flats, units or apartments; and 14% lived in semi-detached dwellings.”

“At the 1966 Census of Population and Housing, 71% of all occupied private dwellings were either owned outright or owned with a mortgage by their occupants. Following the 1967 Referendum and changes to the Census Indigenous question in 1971, the Indigenous count increased 45%. Lower average Indigenous home ownership rates at that time, compared to the population as a whole, contributed in part to the decrease, to 69%, in average home ownership recorded in the 1971 Census. Since then the rate of home ownership in Australia, as measured in the Census, has ranged between 68% and 70%”.

Employment

The ABS has a very revealing interactive graphic on employment, showing the growth of mining sector employment and the decline of manufacturing jobs.

See http://www.abs.gov.au/ausstats/abs@.nsf/Latestproducts/6202.0Main%20Features2Oct%202011?opendocument&tabname=Summary&prodno=6202.0&issue=Oct%202011&num=&view=
For specific figures on employment by industry see http://www.abs.gov.au/AUSSTATS/abs@.nsf/DetailsPage/6291.0.55.003Aug%202011?OpenDocument

For a primer on understanding labour force figures see http://www.abs.gov.au/ausstats/abs@.nsf/Lookup/6202.0main+features999Oct%202011

No Bonuses

From Nicholas Taleb in the New York Times

“Consider that we trust military and homeland security personnel with our lives, yet we don’t give them lavish bonuses. They get promotions and the honor of a job well done if they succeed, and the severe disincentive of shame if they fail. For bankers, it is the opposite: a bonus if they make short-term profits and a bailout if they go bust.”

“Banning bonuses addresses the principal-agent problem in economics: the separation between an agent’s interests and those of the client, or principal, he is supposed to represent.”

Renewable Energy

2011-11-15T13:22:00.000+10:00

Renewable energy sources have been growing rapidly but still constitute a minuscule amount of total primary energy production.

Hydro power still dominates renewable energy production, although solar and wind power have been growing rapidly from a very small base. Hydro power is likely to gradually lose its dominance given the rapid growth of wind and solar power, although both have a long way to go.

From The Economist's Daily Chart.

According to The Economist: "Solar power saw the biggest leap in 2010, with the installed base jumping 70% compared with 2009 to 40 gigawatts. Wind power also grew strongly, adding 24% of generating capacity. Yet the biggest source of renewable electricity, hydropower, and the smallest, geothermal, both only added 3% to capacity".

Not surprisingly North America lags both Europe and Asia.

While these figures sound impressive, it's worth getting a grip on the reality of renewable energy production. To get an idea of the scale of renewables compared to other sources of energy, you can go to the International Energy Agency's website and in particular look at the World Energy Outlook.

The latest report reveals some very interesting graphs both backward and forward looking.

While economists often worry about the level of renewable subsidies they pale into insignificance when compared to fossil fuel subsidies. As the IEA reports:

Energy subsidies – government measures that artificially lower the price of energy paid by consumers, raise the price received by producers or lower the cost of production – are large and pervasive. When they are well-designed, subsidies to renewables and low-carbon energy technologies can bring long-term economic and environmental benefits. However, when they are directed at fossil fuels, the costs generally outweigh the benefits.

Fossil-fuel consumption subsidies worldwide amounted to $409 billion in 2010, with subsidies to oil products representing almost half of the total. Persistently high oil prices have made the cost of subsidies unsustainable in many countries and prompted some governments to try to reduce them. In a global survey covering 37 countries where subsidies exist, at least 15 have taken steps to phase them out since the start of 2010. Without further reform, the cost of fossil-fuel consumption subsidies is set to reach $660 billion in 2020, or 0.7% of global GDP (at market exchange rates).

...

The share of energy subsidies going to renewable energy is poised to continue to grow. Global renewable-energy subsidies increased from $39 billion in 2007 to $66 billion in 2010, in line with rising production of biofuels and electricity from renewable sources. Despite a projected decline in unit production costs due to cost reductions and rising wholesale prices for electricity and transport fuels, subsidies would need to expand even further to meet existing targets for renewable energy production. In all three scenarios most renewable energy sources need to be subsidised in order to compete in the market.

In 2035, subsidies to renewables reach almost $250 billion in the New Policies Scenario. Onshore wind becomes competitive around 2020 in the European Union and 2030 in China, but not in the United States by the end of the projection period. All other technologies require continuing subsidies.

While the current position is marginal the IEA predicts their use will grow rapidly up to 2035.

Solar, wind, geothermal etc are included under "Other". That's it that red section - can't see it? That's because it's so small. Biofuels and hydro are of course renewables as well.

The big reduction has been in oil usage (after the twin 1970s oil shocks). "Other" has increased by a factor of 8 but still accounts for less than 1 per cent. Nuclear has grown considerably as well and coal has increased its share.

Some other interesting graphs are below. All latest stats. Remember there is a distinction between electricity and total primary energy supply.

When it comes to electricity supply, coal still dominates.

The Internet and the Death of Retail?

2011-11-12T12:03:00.008+10:00

[O]ne of the most harmful habits in contemporary thought, in modern thought even; at any rate, in post-Hegelian thought: the analysis of the present as being precisely, in history, a present of rupture, or of high point, or of completion, or of a returning dawn ... I think we should have the modesty to say to ourselves that, on the one hand, the time we live in is not the unique or fundamental or irruptive point in history where everything is completed and begun again. We must also have the modesty to say, on the other hand, that . . . the time we live in is very interesting; it needs to be analysed and broken down, and that we would do well to ask ourselves, ‘What is the nature of our present?’ ... With the proviso that we do not allow ourselves the facile, rather theatrical declaration that this moment in which we exist is one of total perdition, in the abyss of darkness, or a triumphant daybreak, etc. It is a time like any other, or rather, a time which is never quite like any other.
Michel Foucault 1983

The end of everything we call life is close at hand and cannot be evaded.
H.G Wells 1946

Is the Internet killing traditional bricks and mortar retail? There's no doubt that retailers are doing it tough at the moment, but the Internet is only one of a series of problems facing the sector. The major concern about the Internet for the retail sector is prospective, rather than current, loss of sales.

The major short- to medium-term problem for retailers is the paying down of debt by Australian households and the end of debt-fuelled consumption. This is reflected in increased saving by Australians. Together these pressures are damaging confidence about future possibilities for retailers to make money with their traditional model.

While many in the industry want the government to 'do something' to fix things, it's clear that adaptation to changing consumption habits and technologies will be essential for medium to longer-term retail survival. In this post I consider a variety of statistics and measures about the impact of the Internet on the retail sector and outline some of my own experiences. I conclude that the future has not yet arrived and that retail sector still has time to adapt to change that is happening more slowly than many imagine.

According to the Productivity Commission (PC) there are "140 000 retail businesses in Australia, accounting for 4.2 per cent of GDP and 10.7 per cent of employment". This makes it one of the most important sectors for employment after "health care and social assistance", at 11.4 per cent of employment. (For a detailed account of the structure of the Australian economy see here)

Let's begin by something close to my heart - books. I buy a lot more books from overseas suppliers than I used to because they simply are much cheaper. Books from the Book Depository (no postage) and Amazon are generally less expensive than bookshops or online suppliers in Australia, although not always, especially for Australian books (Fetch, for example, provides an online comparison service for online book purchases).

The longer-term worry for book sellers might be from eBooks rather than overseas suppliers of paper copies, but currently it's online sales that are the major threat. So what are the numbers? Luckily the Department of Innovation, Industry, Science and Research has just produced a report on the Book Industry. Its market analysis estimated that "the total value of books sold in Australia during 2010 was $2.3 billion", with "online book sales worth $280 million in 2010, or 12 per cent of the total book market."

In a survey of "1,000 Australians, 53 per cent of books purchased online in 2010 were bought from overseas online booksellers". If we tie these two figures (improperly) together we get a figure of about 6 per cent of total sales bought from overseas book sellers.

The analysis also reported that:

Adjusted for inflation, the total value of books sold in Australia increased by an annual average of 1.1 per cent from 2001 to 2010. Relative to other retail industries, the Australian book industry underperformed over the past decade. It performed more favourably, however, when compared against other creative industries in Australia and overseas book industries.

So what about eBooks?

Australians purchased approximately $35 million worth of eBooks in 2010, which is equal to 1.5 per cent of the total value of book sales for that year. The eBook market in Australia is projected to reach between $150 million and $700 million in 2014, representing between 6 per cent and 24 per cent of total estimated book sales.

Between $150 million and $700 million? That's a fairly big grey area of $550 million. In other words, they have no idea.

So people are still buying hard copy books, just not from Borders anymore. Borders might have been a great store to visit, but you would have to be making a last minute purchase, uninformed or insane to buy books there. The mark up on books (and CDs) at Borders was ridiculous when compared to the Book Depository or even other bricks and mortar book stores. I can remember trying to buy my son a copy of the yearly AFL Record at Borders and finding out that their price was about $8 dearer than the recommended retail price.

Still my son and I used to love going to Borders at the mall to browse and we miss it now that it's gone. I hope that bookshops survive, but generally I only buy books from book stores when I want the book for someone else as a last minute gift or for my son when he's finished his last one and doesn't want to wait the 4-5 working days the Book Depository takes to deliver.

It's not all bad news for bookshops. Recently I visited Avid Reader in West End, Brisbane, on a Saturday morning. My son bought some books and I bought a coffee. The shop was packed with browsers and, it seemed, buyers. If there's a future model for bookshop, Avid certainly looks like it. If Avid or Riverbend Books in Bulimba can't survive I'd be extremely worried for all book shops.

But it's not just books of course that are facing growing competition from the Internet, StrawberryNet is considerably cheaper for skincare, cosmetics and perfume and less trying on the olfactory system than than those huge, smelly sections of department stores. Buying a pair of ASICS Gel Kayanos will set you back $250 at Rebel Sports, but I've seen them online (from the US) for just over $100.

The higher Australian dollar and the GST exemption on purchases under $1000 are also factors in the appeal of overseas Internet purchases, but the major factor in the excessive price differential appears to be high mark ups by retailers to cover employees, rent and profits (obviously).

I know that my friends increasingly look to the Internet for many different types of goods, but as someone once said "the plural of anecdote is not data" so it's important to try to get some indication about the total level of Internet purchases. (Apparently the original quote was "the plural of anecdote is data", but I much prefer the later more cynical version!)

According to the best estimate of the PC, "online retailing represents 6 per cent of total Australian retail sales - made up of 4 per cent domestic online ($8.4 billion) and 2 per cent from overseas ($4.2 billion). The Reserve Bank of Australia reports that there are "no official data on the total value of online purchases, although a range of industry estimates suggest that these purchases are equivalent to around 3 per cent of household consumption".

Note that total retail sales and household consumption are different measures. Nevertheless it is clear that both the PC and the RBA acknowledge that sales have grown rapidly in recent years from albeit low bases.

While there are some structural breaks in the data due to changes in reporting over time, the data on domestic spending show rapid growth in online purchases over recent years. Since 2005, the value of online spending on debit and credit cards has grown at an average annual rate of more than 15 per cent, although over the past year there has been little change in this type of spending. In contrast, traditional card spending has increased at a slower average rate of around 9 per cent since 2005. It is important to note that despite the stronger growth in online spending, online payments account for only around 10 per cent of total domestic payments on credit and debit cards.

According to the RBA:

The data on payments made on Australian cards at overseas merchants include payments made when Australians travel overseas, as well as payments made by Australians for online purchases from overseas merchants. In total, the value of international electronic purchases has grown at an average rate of 15½ per cent since 2005, which is faster than the growth in electronic domestic purchases of 10 per cent.

To buy online obviously requires access to the Internet and that has grown rapidly as well. The Australian Bureau of Statistics (ABS) reports that "at the end of June 2011, there were 10.9 million Internet subscribers in Australia" a figure which excludes "Internet connections through mobile handsets".

Internet usage increased at an annual rate of nearly 15 per cent and increased by 4.4% since the end of 2010. Significantly 95 per cent of connections are now broad-band and 87 per cent of Australian Internet users are accessing download speeds of 1.5Mbps or greater. All of this adds up to greater Internet penetration and the potential for further inroads into traditional retail.

International purchases have not just been spurred by the Internet, but by the massive increase in the number of Australians travelling overseas. As the RBA reports:

It is likely that much of this growth in international purchases reflects the significant increase in the number of Australians travelling overseas. In 2010, Australians made around 6¼ million trips overseas, excluding business-related trips. This has increased by 55 per cent since 2005, with this growth in travel leading to increased spending overseas. In addition, the appreciation of the exchange rate has made foreign goods and services cheaper. While this has reduced the value of a given quantity of foreign goods and services in Australian dollar terms, it is also likely to have led households to increase the quantity of purchases abroad. Although it is not possible to specifically identify online offshore purchases, the data suggest that the share of this type of purchase in total spending remains relatively low. In aggregate, total spending at foreign merchants – including spending by Australians travelling abroad – is less than 4 per cent of total payments.

According to the ABS, the real change is in the number of Australians going overseas with the number of foreign visitors remaining relatively static. Increases in overseas travel means less domestic travel and less domestic spending.

Visitor Arrivals, short term

Resident Departures, short term

So Internet and international purchases are growing rapidly, but with a long way to go until we can definitively announce the death of traditional retail.

Another way the RBA considers the growth of Internet purchases is by considering "the number of inbound postal items delivered through the Australia Post network". While it doesn't seem that long ago that pundits were arguing that email would kill traditional postal services since 2005, "the total number of items delivered has increased at an average annual rate of around 10 per cent, in contrast to an average annual decline of 1 per cent in the total number of domestic and outbound postage flows."

Another measure is the "steady increase over a number of years in the number of Google searches for ‘Amazon’ and ‘eBay US’". As the Australian dollar appreciated from mid-2010 these searches increased significantly.

Another thing close to my heart are movies and television. I wonder how long video stores will survive? Will they also find new ways to stay profitable like Australia Post and other parcel deliverers? Or will they gradually fade away as more and more people connect their televisions to the Internet?

People have long been predicting the death of the video store, but they continue to survive and appear to be doing reasonable business, at least whenever I visit. Still it's not really a business with great growth prospects. I certainly wouldn't be encouraging anyone to invest in a video store right now. Perhaps technologically adept Internet store employees will create businesses to help people like me set up their television and Internet combinations!

The reasonably tech savvy, especially 'the downloaders', probably still account for only a minor percentage of DVD watchers. Nevertheless Torrent Freak reports that 15 per cent of all torrent downloads of the final episode of Lost "originated from Australia, despite the country representing only 0.3% of the world’s population", proving that Australians are both reasonably technologically competent and frustrated by the lack of immediate access to popular shows.

Another report estimated that one million Australians accessed illegal downloads via BitTorrent sites in April 2009, a figure that no doubt would have increased since then. Rolling Stone reveals that most illegal downloading (as a percentage of total downloads) occurs outside of the US and Europe, but "fewer than 20 percent of Internet users worldwide pay for downloads of individual songs, and even fewer pay for downloads of full albums".

The difference between the US and Europe and the rest of the world is borne out by a mid-2010 survey of 7000 illegal downloaders who reported that they "would pay for them if there was a cheap and legal service as convenient as file-sharing tools like BitTorrent".

Such findings tie in with my personal conversations with friends and students, many of whom tell me that they would be happy to pay for legal downloads as long as the costs are not too great and they could get immediate access. A friend recently laughed at me when I told them I still occasionally bought CDs i.e. the physical item in a plastic case. Students are always amused when I show a video (as in VHS) in class. Video, of course, was once the wonder technology: "You mean I can record a television program?". I wonder what young people think of those who still buy vinyl, let alone those who continue to use reel-to-reel players.

***

Like so many things in the world today, we tend to imagine a possible future and then 'teleport' it back into the present as though it were already the current reality. This has probably always been true as Dan Gardner outlines in Future Babble: "Excited predictions of the amazing technologies to come — Driverless cars! Robot maids! Jet packs! — have been dazzling the public since the late nineteenth century." Gardner outlines how Herman Kahn published a book in 1967 called The Year 2000. In it he wrote that "by the end of the century nuclear explosives would be used for excavation and mining, 'artificial moons' would be used to illuminate large areas at night, and there would be permanent undersea colonies." As you might realise, he was wrong about this and he was also wrong when he argued that the Soviet Union would be "one of the world’s fastest-growing economies at the turn of the millennium".
I also vaguely remember visions of future technology in the 1980s, such as the hopes for full immersion virtual reality. If I remember correctly it was almost certain that by 2011 we'd be able to lose ourselves completely in virtual worlds and not just by looking at computer screens. But perhaps I was just watching too many 'futuristic' movies.

As Ferdinand Mount wrote quite some time ago, apocalyptic visions are more interesting than the idea that things will gradually change.

Of making end-of books, there is no end. Whitaker’s Books in Print, 1994, lists 150 books entitled The End of ... Among those things designated for termination are Art Theory, Beauty, British Politics, Central Planning, Christendom (by Malcolm Muggeridge), Comedy, Conversation, Education, Elitism, Empire, Eternity, Gin-and-Tonic-Man (a book about public relations), Housework, Innocence, Insularity, Laissez Faire, Marriage, Modernity, Motherhood, Philosophy, Punishment, Science, the Cold War (six titles), the Family, the Novel, the World, Time and Zionism – not to mention the most celebrated post-war exercises in Endism, Ideology and History.

Things generally tend to fade away rather than end completely. But not always. I remember writing an essay in the course "Soviet foreign policy" in 1991, thinking that the Soviet Union would gradually change rather fall apart as it did. Wrong. Still, while Soviet-style central planning appears to have fallen off the back of the history bus, desires among authoritarian governments for more centralised control has not.

In various places in the back streets of Brisbane (and no doubt other cities) one can see the remnants of old delicatessens, butchers and the like, seemingly gone forever. But more recently, the corner shop appears to have made a bit of of a comeback, in parts of Brisbane at least. The New York Times recently had an article on how to order cuts of meat from butcher shops, which apparently are making a comeback in New York.

The world is changing rapidly and the Internet is playing a big role, but we're not as close to the future as we might think. More recent figures show that retail has not been doing as badly in recent months.

Recent figures show that retail as a whole is not in as bigger hole as the news stories seem to suggest. Turnover has increased over the past 3 months and the interest rate cut should make a difference as well, especially coming just before Christmas.

According to the ABS: "In trend terms, Australian turnover rose 2.4% in September 2011 compared with September 2010.

The following industries rose in trend terms in September 2011: Food retailing (0.5%), Other retailing (0.6%), Cafes, restaurants and takeaway food services (0.6%) and Household goods retailing (0.5%). Clothing, footwear and personal accessory retailing (-1.4%) and Department stores (-0.4%) fell in trend terms in September 2011.

All states and territories rose in trend terms in September 2011: New South Wales (0.4%), Western Australia (0.7%), Queensland (0.2%), South Australia (0.3%), Victoria (0.1%), Tasmania (0.7%), the Northern Territory (0.5%) and the Australian Capital Territory (0.3%).

Traditional retail will have to adapt, but it won't die. People will still want to walk around shops and buy things legally, but the days of soft profits and complacency seem to be numbered!

From 1956:

Cartoons of the Week

2011-11-10T21:37:00.001+10:00

The Size of the Mining Sector

2011-11-09T14:11:00.000+10:00

The mining sector is directly related to about 9 per cent of gross value-added (one way of calculating GDP - i.e. the production measure). But obviously the mining sector makes a bigger contribution than this through a range of indirect effects on other sectors of the economy, particularly construction.

In the Reserve Bank of Australia's August Statement on Monetary Policy they had an interesting little Box on "Measuring the Mining and Non-mining Sectors"

Measuring the output of any particular sector is difficult because of the numerous interconnections between sectors. In the production side of the national accounts, the ABS estimates gross value added (GVA, defined as gross output less non-labour intermediate inputs) for the mining sector, which, at around 9 per cent of GDP, is the second-largest single sector after finance and insurance.

However, this estimate does not include the value of output in sectors closely linked to mining production: for example, when Queensland coal production fell around the start of this year, so too did output of rail transportation and port services partly because coal exports had fallen. Furthermore, this measure does not include most investment in mining, which is typically attributed to the value added of the construction (and other) sectors.

Another approach uses data from the expenditure side. Based on a number of assumptions, it is possible to come up with alternative estimates of output in the mining and non-mining sectors, at least at the annual frequency. This is broadly the approach used by Statistics Norway in estimating ‘offshore’ and ‘mainland’ GDP. A simple estimate of output related to the mining sector can be obtained as follows[2]:

- the volume of resource exports, which is available at a quarterly frequency

- plus real investment by the mining sector, which is available on an annual basis in the annual national accounts

- less an estimate of the imported component of mining investment. Given that there are no official data for this, the estimates that follow are RBA staff estimates, based on data for total capital imports and information from liaison with mining companies.

Given the uncertainties, any results are best treated as illustrative. Overall, the estimates suggest that activity in the broadly defined mining sector represented around 14¾ per cent of GDP at current prices in 2010/11, with mining exports of 12½ per cent of GDP and ‘net’ mining investment (excluding the imported component) around 2¼ per cent.

These estimates also suggest that activity in the mining sector has grown at a faster pace than in the non-mining sector over the past three decades. Activity related to the mining sector has grown in real terms at an annual rate of about 5½ per cent over this period, while activity in the non-mining sector has grown at an annual rate of about 3 per cent. The gap between growth in the mining sector and the rest of the economy has increased somewhat in recent years after narrowing in the first half of the 2000s. Over the six years to 2010/11, annual growth in non-mining sector activity is estimated at around 2¼ per cent, versus growth in mining activity of 6¼ per cent.

There has also been significant divergence in the experience of industries outside the mining sector, with growth in some services sectors quite strong, but weaker growth in some trade-exposed sectors.

The RBA notes, however, that the contribution of the mining sector goes well beyond these measurements ... as does the contribution of the manufacturing sector. They are concerned with income effects, but there are also service industries etc. I'm on the lookout for an impartial estimation of these indirect effects (i.e. one not funded by the mining sector itself.)

It should be stressed that these estimates are based on that part of output that is directly related to the mining sector and do not capture the broader income effects throughout the economy. As the Bank has noted frequently, recent developments in the mining sector and in commodity prices have had a range of flow-on effects throughout the economy, including via wealth effects, higher dividend flows to households, higher tax and royalty payments to governments, and effects on the exchange rate (which have reduced the price of imported goods and services for households and businesses).

What the graphs show is the greater level of volatility in mining gross value-added and GDP.

as mining investment and exports continue to increase, growth in the non-mining economy is likely to remain slower than growth in overall GDP. As the structure of the economy adjusts to the large change in global relative prices, the increased size of the mining sector means that overall GDP will be more affected by any volatility in mining sector activity. This highlights the importance of data that will allow more detailed analysis of the mining and non-mining sectors.

Mining Investment, Foreign Ownership, Taxation and Redistribution

2011-11-06T18:05:00.001+10:00

Recent arguments that the mining tax increases the risk of investing in Australia are absurd. As Clancy Yeats argues:

conflating Australia's situation with that of Greece is exactly what some in the business community are carelessly doing. How could this be so? I'm referring to that favourite catch-phrase lobbyists use when trying to undermine a policy they oppose: ''sovereign risk.''

This phrase has been used ad nauseam by business groups, miners in particular, in their fight against policies they don't like - none more so than the mining tax and carbon price. With mining tax legislation coming into Parliament this week, expect the shouting to continue.

For all the bluster, sovereign risk means something completely different. It refers to the risk of a radical change in the economic environment for an investor - think of the 50 per cent ''haircut'' Greece's creditors will wear.

Putting these rather large semantic differences aside, how has Australia's ''sovereign risk'' problem affected investment?

As figures published today show, the proposed changes have done little to stem the flow of mining cash flooding into the nation. Despite all the complaints about pricing carbon and taxing mining profits, the quarterly Deloitte Access Economics Investment Monitor shows the value of definite projects swelled by 51.3 per cent to $406.8 billion in the year to September.

Boardrooms may well have thought carefully about the new policies while considering these mammoth projects, but it didn't stop them. Nor has the tax threat stopped proposals for investments that may still come to fruition. The value of possible projects leapt by 31.8 per cent in the year, to $256.9 billion, today's report says.

All up, the total pool of investment under way or on the drawing board has reached a staggering $894.1 billion.

But if you want reassurance from a more august institution than the Sydney Morning Herald, let's compare some recent quotes from the Reserve Bank of Australia's recent Statement on Monetary Policy.

Mining investment grew strongly over the first half of the year. Since the August Statement, a final investment decision for the Wheatstone LNG project has been announced, lifting the total value of LNG projects currently underway or committed to around $146 billion. With work done already at high levels, mining investment is likely to increase to around 7 per cent of GDP over the next few years.

The second concerns the fate of other areas of the economy:

The high level of the exchange rate is having a contractionary effect on a number of non-mining industries, particularly manufacturing and some service industries, including tourism and education. Manufacturing and services exports remain well below their pre-crisis levels; exports of education related services have been particularly weak over the past year, partly reflecting tighter access to student visas.

It is interesting to note that despite the patchwork our two-speed economy thesis. manufacturing exports have grown again after the global recession.

Employment in manufacturing has also suffered significantly, although service sector employment has grown over the past year.

In terms of foreign ownership of the mining industry, the RBA argues it is about 80 per cent.

However, the foreign ownership share of the mining industry is also significantly higher than for other industries. Most estimates suggest that effective foreign ownership of current mining operations in Australia is around four-fifths, although this varies significantly by commodity and by individual mine. Accordingly, in the balance of payments much of the investment in this sector is treated as being financed from abroad. This includes retained earnings that accrue to foreign direct investors. In recent years, mining has accounted for a large share of the foreign investment inflows into Australia. Importantly, a number of committed LNG projects are wholly foreign-owned, which means much of the investment over the next few years will be funded entirely by offshore parent companies. This should see an increase in measured foreign direct investment flows into Australia.

This leads to a persistent net income deficit (component of the current account deficit).

Australia’s net income balance is the net sum of income flows associated with the stock of Australia’s debt and equity assets and liabilities. Australia has a persistent net income deficit due to the large stock of net foreign liabilities and because foreigners are estimated to consistently earn higher yields on their investments in Australia than Australian residents receive on their investments abroad. The mining sector mainly affects the net income deficit via the share of mining profits that accrue to foreign investors (through dividend payments and/or reinvested earnings on direct investment). While such data are not available by industry, total reinvested earnings on foreign direct investment have steadily increased as a share of GDP, in line with strong mining profits in recent years. Given the outlook for the mining sector, this trend is expected to continue.

Reinvested earnings are stated as a positive for foreign ownership of the mining sector, but of course profits do eventually flow out of the country.

This is one of the reasons why it makes good sense to tax them at a higher rate so that taxes for other sectors of the economy could be lowered and superannuation payments increased.

One of the arguments given for why we should tax the mining industry at a higher rate is the argument that it will deter investment (and re-investment).

As current and future plans make clear. This is pure bunkum. (I can think of a few other descriptions for this thesis, but I'll leave them for private conversations!).

Business Power and the Revitalisation of Rent-Seeking

2011-11-02T13:05:00.000+10:00

Increasingly the best writer on economics in the major papers is Jessica Irvine. Going through my google news alerts I found this cracker of an article about rent-seeking and the negative effects of lobbying, especially in relation to the mining tax. It also covers pretty well why I favour freer trade over protectionism.

Some of the salient points of the article:

Australia is in the grip of a rent-seeking epidemic and the rent-seekers are winning. Sure, seeking special protection and privileges from government for one's own industry is a long-standing tradition among Australian business. They used to seek tariffs on imported goods and other protectionist shelters. Today, they mostly seek ways to pay less tax.

The thing is, all government interventions in the economy create winners and losers. But often it is a small group of potential losers that have the self-interest and resources to mobilise against the changes, while the winners, for example the millions of consumers who benefit from lower import prices under trade liberalisation, are disparate and not as inclined to organise in favour of the change.

...

Every dollar spent on rent-seeking is a dollar less reinvested in expanding business or investing in new technology. So this new outbreak of rent-seeking not only duds taxpayers out of money, it threatens our future wages and living standards, too.

Rent-seekers have adapted cannily to the politics of the day. As politicians have moved to a poll-based ''we want what the people tell us they want'' credo, big business has begun to pour money into expensive advertising campaigns to sway popular opinion; witness the anti-mining tax and anti-carbon tax campaigns.

The mining industry's investment of $22 million for an advertising campaign to sway public opinion against raising an extra $60 billion in tax from highly-profitable mining companies is surely the most successful rent-seeking mission in Australian history.

Unions can rent-seek, too, seeking higher wages without offering higher productivity or government mandates that mining companies should use their services.

All this rent-seeking used to take place away from the public eye through hidden political donations and good old-fashioned long lunches. But today, thanks to new rules around donations and lobbyist registers, rent-seeking is increasingly played out in the public sphere, spearheaded by a proliferation of telegenic ''spokespeople'' working for business associations.

There's the Business Council of Australia, the Australian Chamber of Commerce and Industry, and the Australian Industry Group, as well as state-based business chambers. Each battles with the other for supremacy.

They are supplemented by a multitude of industry-specific associations. The retail industry is a good example. Retailers can be represented by the Australian National Retail Association, the National Retail Association, the Australian Retailers Association, the United Retail Federation, the National Independent Retailers Association or the Bulky Goods Retailers Association, to name but a few. And yes, they are all separate bodies.

...

Politicians and the media cop most of the blame these days for the dumbing down of the political debate. But let's not forget this entire industry of rent-seekers who are doing the best they can to muddy the waters of good public policy and confuse everyone.

Politicians need to wake up to the way they are being played. The public needs to switch on their rent-seeking bullshit-ometers when watching the next round of self-serving business advertising and learn to think: ''Well, they would say that, wouldn't they?'' And the media needs to rediscover its love of man bites dog tales and stop giving these guys a free kick. [listen up The Australian]

...

Australians have invented our unique brand of corporate rent-seekers, and far from standing up against them, we've often been complicit tools in their trade, shifting our opinion on public policies in response to their self-interested advertising campaigns.

When government thinks it's doing what the public wants, but what the public wants is in fact what big business wants it to want, we have a problem.

For more on rent-seeking see here.

And to finish off with a pertinent song by The Hives http://en.wikipedia.org/wiki/Rent-seeking

Cartoons of the Week(s)

2011-11-01T23:45:00.000+10:00

House prices

2011-11-01T21:48:00.001+10:00

While mortgagees are likely to be happy about the 0.25 per cent cut in interest rates, they are less likely to be happy about the data released by the ABS today.

You can bet the media will be more focused on the cut than the decrease in house prices!

A 5 per cent fall in Brisbane - year on year - is particularly noteworthy with half of that fall coming in the last quarter.

Some interesting data on China, India (and Australia)

2011-10-27T17:21:00.000+10:00

Those wanting a good summary of India's development, especially in comparison to China and its impact on Australia should read

"India's long-term growth potential and the implications for Australia"

by Ben Ralston, Wilson Au-Yeung and Bill Brummitt

Some of the graphs provide are excellent.

Chart 1: Working age population as a proportion of population

This means that India is better set up demographically than China for the future. In countries like Australia there will be more old people to support and the retirement age will no doubt push out to 70 as people generally live longer. (My heart bleeds for those Greeks who believe that shifting the retirement age beyond 55 for "arduous" jobs represents severe sacrifice)

Chart 2: Long term projections — India, China and G7

Of course much could go wrong!!

Chart 3: GDP per capita as a proportion of the US

The interesting thing about this projection is that in the 1980s it was assumed that Japan would soon match US GDP per capita, which is an important indicator of real progress.

Chart 4: Population of India and China

Both countries it seems will need more girls if there are not to be a lot of young men without girlfriends and wives!

Chart 5: Participation rates for India and China

India still has a long way to go to encourage more workers to participate in the formal work sector. Changes in regulations will probably increase the participation rate in India in the future, providing further advantages for the Indian economy.

Chart 6: Australia’s exports of education services to India

The authors report that:

Currently around 11 million Indian students are pursuing higher education — but this
represents just 11 per cent of the nation’s 17-23 year olds. The level of unmet demand
for university places runs at around 4.7 million places each year.

Government policy is directed towards increasing the Gross Enrolment Ratio — the
ratio of actual students to potential students — to 25 per cent by 2022.

To supply the necessary places, India intends to set up around 1,500 new higher
education institutions, at least one central university in each state, and 14 new
innovation universities.

The opportunities for Australian universities, whether in terms of partnering with
Indian institutions during this growth phase or attracting more Indian international
students to Australia are clear.

In terms of vocational education and training, the scope of opportunity is also
impressive. The Australian Government has identified opportunities to increase the
delivery of Australian vocational education and training (VET) qualifications in India.

At present only 2-2.5 per cent of India’s population undertakes formal VET training.
However, it is estimated that some 500 million people will require training by 2022 —
over 21 times Australia’s population. The current capacity of the Indian VET system is
around 4.3 million training places.

The challenge for India is enormous and India recognises that it cannot achieve these
goals alone.

The scale of needs in India has seen our exports of education services to India
experience roughly a 28 fold increase in dollars spent over the 15 years to 2010.32 These
exports remain at very high levels and the whole trade is now on a much more
sustainable path after the Government’s series of visa reforms.

It seems that there will be more Australian academics in India in coming years!

While the opportunities that India's growth represents to Australia are huge, the education sector shows that things can go wrong. The breakneck expansion of the sector led to many shonky operators, especially in the VET sector. The high Australian dollar has probably also had a negative effect on Australia. Why study in Australia when you can study in the US more cheaply.

House Prices

2011-10-27T13:52:00.000+10:00

This is from the Australian (if you want to get a story on The Australian but don't want to pay, simply put the title into google and click on the link ... this will get you the full story).

Maybe one day I might even be able to buy a house in a suburb I would want to live in!

The real issue is whether prices will stagnate at this level for a while or continue to fall.

Meanwhile falling house prices no doubt make homeowners feel poorer, even if it doesn't really matter whether your home is worth 550k rather than 600k as long as you're not selling it.

National Bank Just Awful

2011-10-26T08:08:00.006+10:00

These two articles appeared in my google news alerts side by side:

"Big banks head for $24bn profit, but slowdown looms"

and

"NAB seeks right to evict renters"

The first story reported that:

National Australia Bank will begin the banks' reporting season on Thursday with a likely $5.35bn cash profit. The bank, Australia's fourth largest by market capitalisation, is expected to show the strongest revenue growth as a result of its aggressive approach in mortgages.

The second story reported that:

RENTERS face being evicted without notice when owners default on home loans if the National Australia Bank wins a Supreme Court battle against Victoria's Sheriff. ...

In a case that could have far-reaching implications for Victoria's renters, NAB has taken the Sheriff to court after it failed to evict the tenants of two Ivanhoe East properties.

The mortgagor of the properties defaulted on repayments to NAB after letting them out without the bank's knowledge, prompting it to seek repossession orders.

NAB wants the Supreme Court to force the Sheriff to evict the tenants without it needing to comply with the Residential Tenancies Act, which requires renters be given 28 days' notice.

A tenant of one of the properties, Darren Burke, said the uncertainty and stress had forced him to consider moving home.

''I've got an 84-year-old mother living with me and the last thing I need is the stress for her. She thinks we're going to be kicked out every five minutes,'' he said.

''If the owner goes belly up and can't pay their mortgage, that means the bank can come in and say to every person: 'Right, here's your eviction notice, get out!' ''

In court documents, NAB argues the Sheriff should enforce a warrant of possession on the homes without requiring the bank to go to VCAT and give the tenants notice.

But the Sheriff has refused to act on the warrant because the Tenancies Act obliges owners to give the tenants notice ''to the exclusion of any other law''.

''At the very least, there is a right [of tenants] to receive notice to vacate,'' says the Sheriff

It's probably not very often the role of Sherrif has been seen so benignly!!

No wonder the banks have a bad reputation in Australia.

Why is the Gillard government so timid about the mining tax?

2011-10-25T15:33:00.001+10:00

BIS Shrapnel has recently conducted a report (see here for coverage) that contends that the mining investment boom will continue for the next 5 years with total investment reaching $375 billion.

That's a lot of money. So why do we still not have a mining tax?

One can imagine the possibility that by the time the mining tax is ready to come in, the boom will be (temporarily perhaps) over, putting pressure on the government to abandon it. This could be the case even though a profits-based tax would be better for the miners than a volume-based tax during a downturn in prices. It's certainly not better for them when profits are high, but that's the whole point. The resources are non-renewable and the profits made from selling them overseas should be more equitably shared.

We can only imagine what could have been achieved if we had had a profits-based mining tax for several years, not only in terms of productive government expenditure in infrastructure, but in the ability to reduce taxation for those industries facing difficulties in the patchwork economy.

Warnings by the mining sector about the negative impact of the carbon tax and the potential mining tax on future investment are bunkum.

Why Japanese Debt is better than Greek Debt ... and Australia Compared

2011-10-18T16:29:00.001+10:00

A lot of guff is written about debt. Part of the problem stems from a failure to distinguish between types of debt - between public and private debt, between foreign and domestic debt and between gross and net debt. I've written about these issues before here and here.

The graph from The Economist shows clearly why the public debt situation in Japan is less worrying than Greece's, despite Greece having a considerably lower level of gross debt.

Gross debt is the preferred focus of news media because it sounds more extreme.

What matters is net debt and how much debt is owed to foreigners.

The problem for Greece (and Italy, Ireland, Portugal and Spain ... perhaps even France) is that they are stuck with the Euro, which means they can't devalue or inflate their debt levels down. This makes bondholders worried that the eventual outcome will be the departure of some countries from the Euro or default. The two options may of course be related.

Imagine the scenario of Greece going back to the drachma or Spain to the peseta. Both currencies would suffer a large devaluation against the Euro and the dollar - the currencies in which a large part of their debt is denominated in. So while they would get a competitive boost from the devaluation, their debt would expand in local currency terms.

There are no easy options for Europe at the moment.

Interesting to note that a majority of US debt is held domestically. Despite the US debt to China being such a big issue and an indicator of US weakness in relation to China, US debt is more of a problem for China than the US.

Eventually Japan too will have to face up to the issue of just how much debt can you get yourself into before it's unsustainable.

Australia's public debt situation is remarkable by comparison as the following graphs from The Final Budget Outcome for 2010-11 released recently. Neverthless, as I recently argued in "Structural Shenanigans in the Australian Economy" for Australian Policy Online, Australia's private foreign debt and household debt is still a major issue for the economy.

Cartoons of the Week

2011-10-17T12:01:00.000+10:00

Basic Economics for Australia

2011-10-14T17:00:00.003+10:00

This is the best article I have read on the economics of recent policy changes for quite some time. All students (and perhaps Coalition politicians) should read it.

Jessica Irvine

Economics by book not for Abbott

October 14, 2011

Economics textbooks are hefty objects. Many a kinked neck and curved spine have resulted from children being forced to lug such weighty tomes between school and home.

Whether many students manage to read and absorb the often turgid contents of such books remains an open question.

But the Prime Minister, Julia Gillard, and the Treasurer, Wayne Swan, have proven diligent students. Many of the hallmark economic policies of this Labor government - pricing carbon, the mining tax, fiscal stimulus and even efforts to cap middle-class welfare - could be torn straight from the pages of your typical HSC economics textbook.

Forcing big polluters to pay for the pollution they emit is economics 101. To an economist's mind, pollution is the ultimate example of an ''externality''. Externalities arise when the total costs or benefits of an activity are not borne entirely by the producer of that activity, but are imposed, in part, upon the rest of society. This can be a good thing. Investments in new technologies can produce ''positive externalities'', or ''technology spillovers'', if the resulting new technology is of potentially wider application.

That is why economists often support government subsidies for research and development. Without such subsidies, the market would produce less investment in this new technology than would be socially optimal. Any economics textbook will tell you such externalities are a case of market failure, where the level of activity produced by the free market is not socially optimal. Society is better off when governments intervene to promote the activities that generate positive externalities, or to discourage activities with negative externalities.

When your neighbour strikes up her lawnmower at 7am on a Saturday, no doubt she is doing it because it is the best use of her time. But her actions create a negative externality - noise - which affects all within earshot. The neighbourhood as a whole would be better off - enjoying more sleep and harmony - if she did not engage in such industrious activity so early in the morning. That is why local councils commonly impose curfews on the use of loud machinery, to control the noise externality.

Pollution is the textbook example of such a negative externality. If producers are not forced to pay for the pollution they emit as part of their production process, they tend to do more of it than would be socially optimal. Pollution imposes a cost on the rest of society - through global warming, increased severe weather events and drought - that is not borne by the producers themselves. Making polluters pay, even if they pass some of this cost on to consumers, corrects for this externality and gives them an incentive to pollute less.

The economic theory behind the government's proposed minerals resource rent tax is similarly standard economics fare. Economists are always looking for ways to raise tax in a way that interferes with economic activity as little as possible. Land, being immoveable, is the ultimate example of something good to tax - land can't move to avoid the tax. Natural resources are also largely immoveable, making them an obvious target for taxation.

But instead of setting an arbitrary annual tax based on the volume of mineral extraction - like state mining royalties - economists consider it far more efficient to tax natural resource producers as a percentage of their profits. In particular, it makes sense to tax mining companies on their ''above normal profits'', that is, not just the reasonable rate of return required to tempt them into extracting resources in the first place, but the return they receive in excess of that due to the scarcity of the resource and the monopoly power they have over production at a particular mine. This is the essence of the mining tax.

The government's multibillion-dollar stimulus program unleashed at the beginning of the global financial crisis was also by the book. It is no overstatement to say it represents perhaps the finest example of Keynesian fiscal stimulus employed by any country to date. With private demand in retreat, the government stepped forward quickly with public demand to prop up growth and employment, helping Australia to avoid recession. Crucially, the stimulus was designed to be temporary, so when the economy was on the mend the withdrawal of stimulus ensured government policy was Keynesian on the upside, too.

Carbon tax, mining tax and fiscal stimulus: a holy trinity of good economic policies that, instead of earning Labor a reputation for fine economic management, have somehow bred only discontent and fear.

Because while Labor has proved a good economics student, it has proved a woeful economics teacher, failing to impress upon voters the important and prudent nature of its reforms.

It has no doubt faced fierce opposition in building the case for good economic policy. Labor swallowed the economics textbook whole, but choked politically in the process.

But in Tony Abbott's hands, the economic textbook seems little more than a handy blunt object with which to whack one's opposition. The Opposition Leader appears hell-bent on styling himself as some sort of economic Antichrist.

Where Labor seeks a market-based solution to the problem of climate change, Abbott wants a multibillion-dollar system of grants, where the government will pick winners for funding to reduce emissions.

Where Labor seeks a minerals resource rent tax in line with Ken Henry's recommendation, Abbott wants to axe the tax, meaning a return to inefficient state mining royalties.

Abbott lampooned the government's fiscal stimulus to such a degree that it is not at all clear he would attempt any such action should global economic conditions deteriorate.

I was at the lunch earlier this year at Melbourne University when Abbott slapped down a roomful (outdoor tentful, actually) of Australia's most respected economists for their advocacy of a price on carbon. ''Maybe that's a comment on the quality of our economists,'' the Rhodes scholar and Sydney University economics graduate chided his audience.

Certainly, the comment raised some eyebrows. But mostly, the reaction seemed one of ''well, he would say that wouldn't he?''

Tony Abbott has made it abundantly clear that the arguments set out in economists' textbooks do not impress or interest him.

Read more: http://www.smh.com.au/opinion/politics/economics-by-book-not-for-abbott-20111013-1ln1b.html#ixzz1ajjutopH

Surprise, surprise ... the rich have got richer

2011-10-14T12:43:00.000+10:00

Today the ABS reported that

Richest households 15% richer

The wealthiest 20% of households have increased their average net worth 15% since 2005-06 (CPI adjusted), while the poorest 20% of households saw only a 4% rise, according to the Australian Bureau of Statistics (ABS).

These wealthy households had an average net worth of $2.2 million per household, and accounted for around two-thirds of total household wealth. The poorest 20% of households had an average net worth of $32,000 per household, which accounted for 1% of total household wealth.

The average wealth of an Australian household in 2009-10 was $720,000, up 14% (CPI adjusted) since 2005-06.

There were differences in the average levels of wealth between the states and territories. Average net worth in Queensland, South Australia and Tasmania were below the national average.

Household wealth was more concentrated in metropolitan areas. The average net worth of households located in capital cities was $772,000 as compared with $629,000 in areas outside of capital cities.

Owner-occupied homes were the main asset held by Australians. Mortgages on them were the main liability, with over two-thirds of Australian households owning their own home either outright or with a mortgage.

For households who owned their home outright (2.7 million households), the average value of the home was $541,000. For those households with a mortgage on their home (3 million households), the average value of the home was $521,000, and the average mortgage outstanding was $188,000, giving a net home equity of $333,000.

One in five households owned property other than their own home, including holiday homes and rental properties.

Superannuation was the main financial asset held by households, with three-quarters of all households having some superannuation assets.

For households with superannuation, the average value of their superannuation was $154,000, but for half of these, the value was less than $60,000.

More information can be found in Household Wealth and Wealth Distribution, Australia, 2005-06 (cat. no. 6554.0).

Other interesting stats

"Sixty-nine percent of households own their own home either outright or with a mortgage"

It also notes the important distinction between means and medians

DISTRIBUTION OF WEALTH

While the mean household net worth of all households in Australia in 2009-10 was $720,000, the median (i.e. the mid-point when all households are ranked in ascending order of net worth) was substantially lower at $426,000 (table 7). This difference reflects the asymmetric distribution of wealth between households, where a relatively small proportion of households had high net worth and a relatively large number of households had low net worth, as illustrated in the following frequency distribution graph (S1).

As shown in table 2, over 1.2 million households (16%) had net worth less than $50,000, with 77,000 of these households having negative net worth (1% of all households).

S1. DISTRIBUTION OF HOUSEHOLD NET WORTH, 2009-10

Another measure of wealth distribution is provided by the net worth shares of groups of households at different points in the wealth distribution. The following graph (S2) shows that, in 2009-10, households in the highest net worth quintile held 62% of the total net worth of all households, while a further 20% was held by households in the 4th quintile. By comparison, the lowest three quintiles held, in total, 18% of total net worth.
S2. Net worth, Percentage share of total

It also notes the distinctions between WEALTH and INCOME [for example while I might have a reasonable income, I have no wealth :-( ]

Wealth is distributed between households somewhat differently to income. While the 20% of households comprising the lowest net worth quintile accounted for only 1% of total household net worth, they accounted for 12% of total gross household income. The 20% of households comprising the lowest gross household income quintile accounted for 4% of total gross household income but 13% of total net worth (table S4).

The differences in the distribution of wealth and income partly reflect the common pattern of wealth being accumulated during a person's working life and then being utilised during retirement. Therefore many households with relatively low wealth have relatively high income, especially if they are younger households. Conversely older households may have accumulated relatively high net worth over their lifetimes, but have relatively low income in their retirement.

In addition, some households have low or even negative incomes due to business or investment losses, but still have relatively high levels of net worth. ...

The lowest equivalised income decile had a higher mean equivalised net worth ($309,000) than the second to fifth equivalised income deciles. Average equivalised net worth of households in the highest (tenth) income decile was more than double that of households in the ninth income decile ($1,158,000 and $477,000 respectively).

Of course the stage of life you are in matters considerably as well

Life cycle stages

A typical life cycle includes childhood, early adulthood and the forming and maturing of families. ...

Of the selected life cycle groups, the group with the highest mean household net worth was couple only, reference person aged 55 to 64 ($1,317,000). Many of these people are either nearing the end of their time in the labour force or have recently retired, that is, they are at the end of the main wealth accumulation period. People over 65 had lower net worth on average ($1,111,000 for couples and $572,000 for lone persons), at least partly reflecting a run-down of assets to support consumption in retirement. These older cohorts may also have had less opportunity for capital accumulation in earlier decades, for example, because women had lower participation rates in the paid work force.

Lone persons aged under 35 had the lowest mean household net worth, at $151,000. The mean household net worth of couple only households with a reference person aged under 35 was $237,000 (or $119,000 per person). These couple only households had almost twice the level of mean gross household income of the young lone person household ($2,128 per week compared with $1,152 per week). The mean age of the household reference person in both household types was 28, that is, they had had the same amount of time on average to accumulate wealth.

One parent, one family households with dependent children had a mean net worth of $276,000, compared to $827,000 for couple family households with dependent children. Differences in relative age did not contribute significantly to this substantial difference in net worth, since the average age of parent was 41 years for the one parent families and 42 years for couple families. Home ownership for the one parent family households was about half that of the couple family households (40% and 77% respectively)

Interesting stuff.

Cartoons of the Week

2011-09-15T16:31:00.000+10:00

More to the point ... here's my workspace where it all happens

Dreams and Nightmares

2011-09-06T22:56:00.000+10:00

I've recently written a very long paper on Australian-Asian relations called Dreams and Nightmares: Australia's Past, Present and Future in Asia. It was written for the Institut français des relations internationales (it's in English).

Cartoons of the Week

2011-09-05T12:13:00.000+10:00

China's Steel Industry

2011-09-05T00:16:00.002+10:00

A Reserve Bank of Australia paper from 2010 by James Holloway, Ivan Roberts and Anthony Rush on China's steel industry makes interesting reading in the light of the problems of the Australian steel industry.

Some of the main points:

Growth has been rapid with the period from the mid-90s to the mid-2000s most significant. Growth fell during the financial crisis and recovered on the back of extensive fiscal stimulus by the Chinese government. My guess is that it will slow over the next few years.

Since the introduction of market-based economic reforms in 1978, the Chinese economy has grown strongly, recording an average annual growth rate of around 10 per cent. Over this period, Chinese steel production has also expanded rapidly, growing at an average annual rate of 7 per cent during the 1980s, 10 per cent during the 1990s and close to 20 per cent in the 2000s (Graph 1).

China's percentage of global production has increased rapidly.

China now accounts for around 45 per cent of global steel production, which is significantly higher than its share of 15 per cent at the start of the decade

The Chinese government has attempted to consolidate the industry increasing the percentage of production by the large state-owned firms.

In 2008, there were more than 660 companies producing crude steel, with thousands of other firms producing finished steel and steel-related products. The top 10 producers accounted for less than 50 per cent of crude steel output, with the next 75 companies accounting for an additional 30 per cent (State Council 2009, CISA 2009). Most of the larger Chinese steel producers are state-owned, while a significant proportion of the smaller producers are private companies. Geographically, the industry is widely dispersed. The coastal provinces account for around 65 per cent of crude steel production, with the concentration of steel production in the north-east of the country partly reflecting proximity to major iron ore mines, particularly in Hebei and Inner Mongolia ...

In July 2005, the National Development and Reform Commission issued a formal policy on steel that sought to spur consolidation by increasing the concentration of steel production among large producers, and to protect the environment by reducing energy consumption and eliminating obsolete production capacity. Targets for industry consolidation through mergers and acquisitions or closures of small- to medium-sized firms were outlined. In June 2010, the State Council updated these targets, announcing that the production share of the 10 largest steelmakers was to rise from 44 per cent in 2009 to 60 per cent by 2015, with a goal of cultivating three to five very large, internationally competitive iron and steel conglomerates (State Council 2010).

Steel can produced from iron ore and coking coal or from scrap. In Western countries a good deal - about a half to two-thirds - is produced from scrap. In China it is mostly produced from scratch.

Crude (or unprocessed) steel can be produced either directly from iron ore and coking coal using the blast furnace/basic oxygen converter method, or from scrap steel (and other inputs) using the electric arc furnace method. In the United States and Europe, where the electric arc furnace technology is commonly used, between one-half and two-thirds of steel is produced using scrap. In contrast, in China more than 90 per cent of crude steel is produced by steelworks using blast furnaces and basic oxygen converters (World Steel Association 2010). This reflects difficulties with the supply of electricity in some parts of China and low domestic availability of ferrous scrap, due to relatively low household consumption of steel-intensive manufactures and limited scrap collection and processing systems. The prevalence of the converter method has important implications for resource demand: on average, each tonne of Chinese steel requires around 1.7 tonnes of iron ore and more than half a tonne of coking coal as inputs. This helps explain the significant increase in China's demand for these resources over the past decade.

China has significant iron ore reserves but they have lower iron content than ore from Australia (62 per cent), Brazil and India (both 65 per cent). Not only is Chinese ore more expensive to process, but much of it is located "inland in the north and west of China. While steel mills in the north-east are close to major iron ore mining precincts, it is costly to transport ore to steel mills located elsewhere in the country."

Increased iron ore shipments have benefited Australian iron ore producers enormously

Strong demand for steel has seen the imported share of iron ore supply increase from around 10 per cent in the late 1980s to more than 50 per cent currently, although over the past five years China's iron ore output has generally kept pace with growth in steel production. This reflects a number of factors, including the high price of imported iron ore and the temporary downturn in steel demand associated with the global financial crisis. More recently, iron ore imports have remained at a high level, having picked up sharply as the Chinese economy recovered from the downturn in late 2008 and early 2009 aided by the substantial fiscal stimulus, although domestic production has also been strong.

In recent years, more than 80 per cent of China's iron ore imports have come from Australia, Brazil and India. In an effort to diversify supply, Chinese policymakers have encouraged direct investment by Chinese companies in iron ore exploration and iron ore mines abroad. To date, numerous investments have been made in West Africa, South America, Central Asia, Russia, Australia and Canada, many of which are large in scale. While efforts to diversify supply may have implications for the Chinese steel industry's sourcing of raw materials in the future, the likelihood of continued high rates of economic growth suggests that China's imports of raw materials will remain high.

China has also become more dependent on coking coal imports.

[I]n the first half of 2009, coking coal imports surged, with a pronounced effect on Australian coking coal exports to China. This surge reflected a combination of factors, including a strong rise in steel production, a significant decline in international freight rates, and lower Chinese production of coal owing to efforts to consolidate the coal sector and mine closures or renovations for safety reasons. While China has extensive reserves of coking coal, many of its existing deposits are relatively inaccessible and therefore costly to mine. Many of these deposits are also far from major steel-producing areas.

Steel is mainly used in the development of buildings, structures and machinery, with the construction industry accounting for "more than one-half of steel consumption".

Worryingly for steel exporters, China's steel exports have increased since 2006, although they have varied.

Since 2006, China has been a net exporter of steel products. The early 2000s saw a large increase in steelmaking capacity, partly reflecting an increase in the number of small- and medium-sized firms; this growth in capacity translated into higher production, some of which flowed onto the international market. Since China's accession to the World Trade Organization in 2001, the volume of steel exports has increased noticeably; however, steel exports have not recorded sustained growth, and over the past few years have been declining as a share of total domestic production. At times when steel production has risen faster than domestic demand for steel, such as during the 2008 slowdown, China's steel exports have surged, only to decline again when domestic demand for steel has recovered, as was the case during 2009.

Note that these are net exports, China still imports higher quality steel from abroad.

There may be continuing opportunities for developed countries to push their credentials for higher quality steel products. The Australian government could assist the industry especially for steel use within Australia by insisting on rigorous quality testing for imported steel and for restricting contracts that lock out Australian producers. But protecting the industry by tariffs or insisting that projects must use a quota of Australian steel would be a backward step for the Australian economy.

Zealous economic liberals pronounce any suggestion that governments should assist industries as closet protectionism and ironically put their faith in the Chinese Communist Party to keep the Chinese economy growing at 10 per cent or so until the 2030s, I have less faith.

The CCP will need to rebalance the Chinese economy away from excessive investment and when the inevitable adjustment occurs the Australian resource sector will be negatively affected.

Australia needs to debate continuing economic vulnerabilities and consider the potential problems of a less diverse, resource dependent economy.

Cartoons of the Week

2011-08-29T12:04:00.000+10:00

China, Mining and Manufacturing

2011-08-23T21:03:00.001+10:00

Interesting allegations about Chinese contract stipulations about sourcing from China in a Wayne Swan interview with Fran Kelly on ABC Breakfast

KELLY: In terms of productivity, what about making the most of the manufacturing we do do? You did suggest yesterday the Government would announce more this week to follow up on union calls for a more effective local content policy. What are you talking about? Are you talking about direct incentives or tax incentives to encourage resource companies to buy Australian?

TREASURER: No, what we're talking about is that Australian firms should have the chance to pitch for business on a commercial basis. Now what I've heard from several businesses and from several sources is that some Australian businesses are not even getting the opportunity to pitch for the business on a commercial basis. I'm a bit disturbed by that so I'm going to examine those claims closely with the industry because I do think it is important that Australian business gets the opportunity to maximise the business that flows from these investments.

KELLY: Some of those claims - let me go to one of those claims because I've heard it too around places that some of the big miners signing contracts with China for instance over gas and other resources, within that contract it's mandated they buy Chinese equipment, not Australian.

TREASURER: Well, I'm a bit disturbed by that.

KELLY: Is there something you governments can do about that?

TREASURER: Well, I certainly intend to follow up that claim and ascertain whether it is true or not, and I would be very disturbed if that was the way it was going in some of the big projects. There are many people who are getting work out of these big projects. They are absolutely massive and there are lots of Australian businesses that are getting work and I'm aware of many of them. I've seen them in operation but if we are getting those sorts of practices creeping in that's not good and it's not good for the country. So I intend to look at those quite closely.

KELLY: And the report that suggests only 10 per cent of steel being used - massive amounts of steel - in projects like Gorgon and Olympic Dam, only 10 per cent of it is local. Are you critical of Australian resource companies for not buying locally made steel?

TREASURER: Well, certainly some of the steel will be imported and I don't think anyone would be surprised about that but if Australian manufacturers who are offering good product aren't getting the chance to get their head through the door then that's worth looking at very, very closely.

While I'm against forcing companies to buy Australian., I'm also against companies being forced not to. If you're going to have a freer market-based economy, governments must be extremely vigilant against anti-competitive behaviour.

Just how good has Australia's economic performance been?

2011-08-22T20:55:00.000+10:00

A good aggregate indication of a country's economic performance is real GDP per capita (GDP per person).

The graph from The Economist shows that the best performer over the last 3 and half years have been China and India. Argentina has also done very well, a fact that may give Americans and Southern Europeans some faith in the ability of an economy to recover from financial disaster! Indonesia has also been a quiet achiever.

What you might notice is that the best performers have mainly been emerging economies with Taiwan and South Korea as exceptions.

Australia's position is also fairly good, especially in comparison to other developed economies. Canada is still 1% below its pre-crisis level and America is down 3.5%. Britain has performed even worse. So while many might complain about wasted spending. In a time of stagnation policy-makers in Britain and the United States would do well to remember that cutting sending at such a time is likely to exacerbate the situation.

US Inequality in a Nutshell

2011-08-22T13:22:00.002+10:00

The difficulties of doing something about inequality in the United States are numerous, but as Paul Krugman once said the explanations for inequality are more sociological than economic. Globalisation or economic openness are not responsible even if they provide persuasive arguments to explain why rising inequality is inevitable.

If governments want to do something about inequality they could, but they would require popular support to do so. At what point does rising inequality in the US cause a rethink amongst the population that political interventions are required to lower inequality instead of increasing it?

Unfortunately for egalitarians, the economic crisis has led to a right-wing populist backlash against government, rather than a left-wing populist backlash against corporations and the wealthy.

One of the richest men in the world Warren Buffett has written an excellent article in the NYT called "Stop Coddling the Super-Rich".

Buffett wonders why the rich haven't shared in the necessary sacrifices required to deal with the economic crisis.

OUR leaders have asked for “shared sacrifice.” But when they did the asking, they spared me. I checked with my mega-rich friends to learn what pain they were expecting. They, too, were left untouched.

While the poor and middle class fight for us in Afghanistan, and while most Americans struggle to make ends meet, we mega-rich continue to get our extraordinary tax breaks. Some of us are investment managers who earn billions from our daily labors but are allowed to classify our income as “carried interest,” thereby getting a bargain 15 percent tax rate. Others own stock index futures for 10 minutes and have 60 percent of their gain taxed at 15 percent, as if they’d been long-term investors.

The most appalling fact is that the rich get these benefits at the expense of middle class and poor workers.

Last year my federal tax bill — the income tax I paid, as well as payroll taxes paid by me and on my behalf — was $6,938,744. That sounds like a lot of money. But what I paid was only 17.4 percent of my taxable income — and that’s actually a lower percentage than was paid by any of the other 20 people in our office. Their tax burdens ranged from 33 percent to 41 percent and averaged 36 percent.

Buffett argues that higher taxes would not stop investment as many corporations and financiers argue.

Back in the 1980s and 1990s, tax rates for the rich were far higher, and my percentage rate was in the middle of the pack. According to a theory I sometimes hear, I should have thrown a fit and refused to invest because of the elevated tax rates on capital gains and dividends.

I didn’t refuse, nor did others. I have worked with investors for 60 years and I have yet to see anyone — not even when capital gains rates were 39.9 percent in 1976-77 — shy away from a sensible investment because of the tax rate on the potential gain. People invest to make money, and potential taxes have never scared them off. And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what’s happened since then: lower tax rates and far lower job creation.

And it's gotten worse over time.

Since 1992, the I.R.S. has compiled data from the returns of the 400 Americans reporting the largest income. In 1992, the top 400 had aggregate taxable income of $16.9 billion and paid federal taxes of 29.2 percent on that sum. In 2008, the aggregate income of the highest 400 had soared to $90.9 billion — a staggering $227.4 million on average — but the rate paid had fallen to 21.5 percent.

Buffett's solution is to tax those earning over $1,000,000 a year at a higher rate.

Job one for the 12 is to pare down some future promises that even a rich America can’t fulfill. Big money must be saved here. The 12 should then turn to the issue of revenues. I would leave rates for 99.7 percent of taxpayers unchanged and continue the current 2-percentage-point reduction in the employee contribution to the payroll tax. This cut helps the poor and the middle class, who need every break they can get.

But for those making more than $1 million — there were 236,883 such households in 2009 — I would raise rates immediately on taxable income in excess of $1 million, including, of course, dividends and capital gains. And for those who make $10 million or more — there were 8,274 in 2009 — I would suggest an additional increase in rate.

My friends and I have been coddled long enough by a billionaire-friendly Congress. It’s time for our government to get serious about shared sacrifice.

The problems with taxation go much deeper than this, but Buffett's plan would make a good start.

Sub-Standard and Poor in Cartoons

2011-08-17T19:50:00.001+10:00

The reputation of Standard and Poor took a big hit when they rated toxic mortgage securities as AAA grade. They've now downgraded US debt from AAA to AA+, but US debt remains in significant demand despite the political crisis in the US.

These cartoons tell the story fairly neatly ... and a Peanuts for good measure

Australia, China and the US

2011-08-16T17:55:00.000+10:00

For those students in 7007IBA a recent article by Paul Dibb about the Australia, China and US relationship covers some of the themes we discussed in our Seminar on Security and Defence.

Dibb's piece is called China: Not about to attack Australia

In it he offers a critique of White, Babbage and Sheridan's views about the strategic triangle between Australia, China and the US.

It is quite premature to advise that Australia should encourage the US to accommodate to the realities of Chinese power, as my colleague Hugh White insists. It is downright dangerous to suggest that Australia must develop the military capability to tear an arm off China, and even provoke revolt inside China, as Ross Babbage argues. It is also incorrect, as Greg Sheridan would have us believe, that historically no country has ever developed a navy the size of China’s without going to war.

Structural Change in the Australian Economy

2011-08-15T13:05:00.001+10:00

While this might seem like a boring topic, it's probably one of the most important medium to long term economic issues facing us as Australians.

I have recently written a piece for APO, called Structural Shenanigans in the Australian Economy. The APO is the best source of information on Australian policy issues. It is run by Peter Browne from Swinburne, who given the amount of work he does must never sleep!

Click on the link above if you want a read or paste this into your browser http://www.apo.org.au/commentary/structural-shenanigans-australian-economy ...

The Shift in Economic Power

2011-08-10T21:49:00.001+10:00

Interesting stats from The Economist's Daily Chart.

Since the end of 2007 the developing world has grown by 20 per cent, while the developed world* has failed to get back to where it was. This has accelerated the shift in economic power towards the developing world.

But note the crossover is still a forecast.

*definition of developed economies based on 1990 data: Australia, Austria, Belgium, Canada, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Japan, Luxembourg, Netherlands, New Zealand, Norway, Portugal, Spain, Sweden, Switzerland, United Kingdom, United States.

Another chart shows just how bad this recession has been in the US compared to previous recessions ...

All the more reason why the US needs to be less concerned about debt right now and more concerned about growth and employment.

Stagnation, debt and inequality

2011-08-10T10:07:00.000+10:00

The following is from the Unconventional Economist (Leith van Onselen), who I encourage students to read via the Macrobusiness Superblog. Your parents (or you) might benefit from a reading of his (and Delusional Economics') views on housing.

Leith highlights a report from Societe Generale’s Albert Edwards. This is a negative view of the global economy, but one I have long worried about since preparing the manuscript for The Vulnerable Country from 2006.

As we see a short-lived economic recovery failing only two years into the cycle and a plunge back into recession, we remind investors that this was exactly the Ice Age template that Japan showed us. A fragile recovery undermined by private sector deleveraging collapses as a semi-bankrupt government tries to rein in runaway deficits…

I and many others have been pointing out for a long time now the simple fact that the global economy has been living way beyond its means for years. A massive transfer of income to the very rich has occurred while middle class real incomes stagnated. The middle classes only tolerated this because Central Bankers created housing booms to keep the impoverished middle classes borrowing and spending to give them the illusion of prosperity and stop them from revolting. I believe the Fed and Bank of England, in particular, were wholly complicit in this ‘daylight robbery’.

These unsustainable private sector, debt mountains were transferred to the public sector in 2008 to prevent the adjustment to the depression-era reality that the debt unwind would undoubtedly have brought about. Yet, those debts are as unsustainable in the hands of the public sector as they were in the private sector. Central bank polices haven’t changed though. Print and print and print. And if that doesn’t work, print some more. And as London burns, the point I have always made is that the US and UK are not like Japan in one very special way. Although Japan suffered a decade of pain it is a very homogenous, equal society (see below). The UK and US are not…

In the Eurozone, the markets are now realising what should have been obvious from the start. The authorities are in very little position to halt the rot. During the bubble (aka The Great Moderation) the Eurozone had the same mechanics of mutually assured economic destruction that was seen on a grander scale between China and the US, viz the excessively loose US monetary policy causing a housing and spending boom that resulted in a huge trade deficit, financed in the main by a willingly mercantilist China printing money ad infinitum to keep their fixed exchange rate link (incidentally it’s a bit rich for the Chinese to complain about the US profligacy when they are just as bad when it comes to cranking the printing press).

The Eurozone has been no different to this unstable US/China nexus, with some member countries enjoying (suffering?) super loose monetary policies through no fault of their own (unlike the US), leading to housing and spending booms causing huge trade deficits funded in the main by Germany with a Chinese-style trade surplus, with their banks lending money to the deficit nations in the periphery to keep the party going.

So, during the Great Moderation, although the overall trade situation of the Eurozone seemed to be in external balance with the rest of the world, under the surface the situation was always every bit as unstable and poisonous as the US/China situation…

Edwards makes several important points about the problems at the heart of current global problems and much of it can be slated back to rising inequality, the third of the key vulnerabilities facing Australia, but obviously much more acute in the US and UK.

If globalisation (meaning here the proclivity towards freer trade and finance) is to remain sustainable then it has to be accompanied by redistribution of opportunity and of wealth, otherwise populists of the right (and left) will gain increasing leverage over political processes and lead to a return to insularity.

The massive transfer of wealth to the rich in the US is not seen, unfortunately, as a cause of US problems by supporters of the extreme right. Instead mild efforts to maintain growth in the US are seen as signs of rising socialism.

The US economy is in deep trouble not because its debt is unsustainable - its not - but because the political process is broken. Some basic measures to raise taxes on the very rich and make corporations pay tax, at the same time as increasing spending on worthwhile labour market programs and infrastructure development would make a big difference.