Chinese growth

Continuing Chinese growth is a major concern for Australia. The fact that China grew at a rate of 7.7 % for the year to September had a beneficial impact on Australian growth. I have long been worried that Chinese spending is not sustainable and as a consequence Chinese growth may not be sustainable.

According to Stephen Roach (Morgan Stanley) [cited in Is China's Economy Speeding Off the Rails?]

Investment in fixed assets like factories and the rail network accounted for more than 95 percent of China’s 7.7 percent growth in the first three quarters of 2009 and made up 45 percent of gross domestic product, which is higher than any major economy in history, according to Stephen Roach, chairman of Morgan Stanley Asia.

Without a surge in consumer spending and with export growth stalled, investment must rise even further to stoke growth, he said in a Dec. 18 speech in Beijing.

“These are ridiculous, unsustainable numbers for any economy,” Mr. Roach said.

Ninety-five percent of growth is a very large component of growth and although China does have large reserves, eventually growth must come from elsewhere. While these assets will eventually produce benefits - one hopes - they will not be affordable for a large percentage of the population.

China may be hit with a slowdown next year as the impact of the investment-led expansion wears off and shipments to the United States, the traditional external source of growth, fail to pick up, Mr. Roach said in an October report. He did not specify how much he thought growth might slow.

Some economists say the high-speed network is symbolic of a stimulus program that places too much emphasis on infrastructure spending and not enough on raising living standards. The average urban Chinese worker made 28,898 renminbi last year, a tenth of the $39,653 average wage in the United States, according data from the U.S. and Chinese governments.

Most Chinese rail travelers will not pay the premium to ride on the fast trains, Zhao Jian, a professor of economics at Beijing Jiaotong University, said in a September interview on Chinese television.

A second-class one-way ticket for the half-hour Beijing-Tianjin trip costs 58 renminbi, about three-quarters of the workers’ average daily pay. A so-called hard-seat ticket on a slower train, which covers the distance in two hours, sells for 11 renminbi.

Passenger reluctance means revenue from the high-speed lines will not be enough to service the debt if railway expansion continues at its current pace, Mr. Zhao said in the TV interview. The Ministry of Railways has 383 billion renminbi in bonds outstanding
“If America had its subprime crisis, in China we have a railroad-debt crisis, or you could call it a government-debt crisis,” Mr. Zhao said in the TV interview.

De-globalisation

McKinsey generally have the best coverage of global capital flows and their latest report shows just how significant the global financial crisis has been for financial globalisation.

In its latest report Global capital markets: Entering a new era McKinsey reports that:

World financial assets fell $16 trillion to $178 trillion in 2008, marking the largest setback on record and a break in the three-decade-long expansion of global capital markets. Looking ahead, mature financial markets may be headed for slower growth, while emerging markets will likely account for an increasing share of global asset growth.

Financial globalization reversed in the wake of the crisis. Capital flows fell 82 percent in 2008, to just $1.9 trillion from $10.5 trillion in 2007.

Declines in equity and real estate values wiped out $28.8 trillion of global wealth in 2008 and the first half of 2009.

Other pertinent points made:

Falling equities accounted for virtually all of the drop in global financial assets. The world's equities lost almost half their value in 2008, declining by $28 trillion. Markets have regained some ground in recent months, replacing $4.6 trillion in value between December 2008 and the end of July 2009. Global residential real estate values fell by $3.4 trillion in 2008 and nearly $2 trillion more in the first quarter of 2009. Combining these figures, we see that declines in equity and real estate wiped out $28.8 trillion of global wealth in 2008 and the first half of 2009.


Credit bubbles grew both in the United States and Europe before the crisis. Contrary to popular perceptions, credit in Europe grew larger as a percent of GDP than in the United States. Total US credit outstanding rose from 221 percent of GDP in 2000 to 291 percent in 2008, reaching $42 trillion. Eurozone indebtedness rose higher, to 304 percent of GDP by the end of 2008, while UK borrowing climbed even higher, to 320 percent.

Financial globalization has reversed, with cross-border capital flows falling by more than 80 percent. It is unclear how quickly capital flows will revive or whether financial markets will become less globally integrated.

Some global imbalances may be receding. The U.S. current account deficit—and the surpluses in China, Germany, and Japan that helped fund it—has narrowed. However, this may be a temporary effect of the crisis rather than a long-term structural shift.

Mature financial markets may be headed for slower growth in the years to come. Private debt and equity are likely to grow more slowly as households and businesses reduce their debt burdens and as corporate earnings fall back to long-term trends. In contrast, large fiscal deficits will cause government debt to soar.

For emerging markets, the current crisis is likely to be no more than a temporary interruption in their financial market development, because the underlying sources of growth remain strong. For investors and financial intermediaries alike, emerging markets will become more important as their share of global capital markets continues to expand.

The major issue in the short-term will be how quickly capital flows recover. Another key issue is how slower growth in mature markets will affect emerging markets' financial systems.

The severity of the also highlights just how amazing it is that Australia managed to avoid a downturn in growth over the 2008-09 financial year. For Tony Abbot to argue that the Rudd govt has achieved little in its first couple of years and for some economists to argue that the fiscal stimulus has been profoundly negative defies any logic. Instead it appears to be simple oppositional politics for the former and blind anti-govt rhetoric for the latter.

If it sounds unlikely, it probably is.

Financial Regulation

Financial regulation is in the news again this week with Obama criticising fat cat bankers for just not "getting it". The administration is frustrated by the opposition to regulation, the continuing payment of excessive bonuses, the spending of huge sums on lobbying and the failure to lend.

There's no doubt that they're not getting it because they don't have to. The problem goes a long way back, including during the Clinton administration, which gave to much credence to the financial sector's power and seemingly enjoyed its support. Indeed many in its economic team were integral players in the financial structure. At least Obama is trying to do something.

In Australia the view from Reserve Bank governor Glen Stevens is that the regulatory problem is related to just 30-40 "bad apple" banks and that regulators should be careful not to overdo the changes.

We should try to ensure, however, that the cost is no more than necessary. The most egregious behaviour was mainly that of 30 to 40 large, globally active banks. They have imposed very large costs on their own banking systems, economies and taxpayers, and on the global economy. But there are thousands of other banks in the world whose risk appetite did not get out of control, that have remained solvent, and that have not needed public capital injections. So it will be sensible to ensure, as far as we can, that the proposed measures act effectively to constrain the worst excesses of the former without unnecessarily shackling the latter.

The real question is why Australian banks did well during the crisis. Was it because of more effective regulation in Australia, the continuing growth of the Australian economy that kept borrowers solvent (compared to the situation in many other countries), the high level of investment in housing and mining that meant that there was less 'loose' money to invest in the types of schemes that brought the US and European banks undone, the lessons of the financial debacle of the late 1980s.

To my mind all of the above played a role, but imagine a slightly alternative scenario where Australia did go into a deep recession and unemployment rose significantly or one where the Rudd govt did not support consumption and housing. Given the significance of home lending for the big banks in Australia, the banks books might not have looked so good if bad debts and the housing market had been affected by rising unemployment.

There is still much that could go wrong and indeed part of the problem for the future might be the belief that Australia is invulnerable and that our policy-makers are omnipotent. There is still a lot of debt in the system and if that debt increases then it makes Australia more vulnerable rather than less.

But the RBA is not worried at all.

Maybe they're right, but is it possible to keep increasing debt?

Climate Change

Climate change obviously is the issue of the week and I'm not going to add too much to the debate except to provide some notes mainly for myself on some key positions.

The best way to get round those skeptical about human-induced CC is to argue that there are benefits to reducing energy intensity and lowering emissions that go beyond whether they will have an impact on the climate.

More money needs to be provided by govts for research into renewables: a basic fact that needs to be reiterated over and over again. (Imagine if some of the costs of the govt's entourage could have been redirected to university research).

A carbon tax would be simpler than a trading scheme but it is unlikely to happen in Australia.

The European scheme and all similar schemes (including the Australian one) are (and will be) subject to manipulation. They risk putting energy supply and abatement at the mercy of speculators.

Going down the tax route would have avoided the complexity issue that makes people suspicious about govt motives. People don't like taxation, but it would have been easier to explain. A low initial tax on carbon emmissions (escalating over time) would have provided a clear incentive to polluters. Revenue raised could have gone into renewables research and to assist the poor to adjust to higher electricity prices.

Higher taxes on fuel would provide incentives to drive less polluting cars. Simple but unlikely in the extreme in Australia (without bipartisan support).

Major reform in Australia is more difficult without bipartisanship. The liberalisation of the Australian economy was made possible by bipartisanship. The GST is somewhat of an exception. Who now really considers the GST as a problem? (Perhaps some in small business, but once systems are set up, people adjust).

European success in meeting its Kyoto targets has a lot to do with the collapse of communism and the creation of carbon credits from Eastern Europe.

Much of the action taken by developed countries to meet targets has little to do with cutting emissions at home (i.e planting trees, cuts in land clearing etc)

For current renewables to be viable requires a high carbon price - estimates range from $US20 to $150.

Between Luck and Vulnerability

I've just published an article on Australian Policy Online.  APO is probably the best source of academic research in Australia - well worth subscribing to for access to new research etc.

The piece is called Between Luck and Vulnerability: Australia in the Global Economy.

It contains an update of some of the stuff in my book and for those nerds who like graphs and tables, there's quite a few of those as well.

Its argument:

As Australians contemplate the lessons of boom and gloom and consider vulnerabilities it is worth thinking about why policy-makers thought we were doomed in the 1980s, according to this paper, because many of the problems of the 1980s remain. While the economy has been more productive, more efficient and, perhaps most important, less inflation-prone, the trade balance, current account deficit, foreign debt and inequality remain as markers of vulnerability.
This paper argues that Australians should be aware of the lessons of Australia’s economic history, that booms are often followed by periods of gloom. Booms do not solve the fundamental recurring problem of Australian economic history: vulnerability to changes in international demand and international financial sentiment. An over-reliance on resource wealth is still a precarious path for Australia’s future, just as it has been throughout Australian economic history.
This is especially the case if growth is supported through high levels of unproductive debt. Australia is more indebted than it has ever been in its history. Australia will remain vulnerable even if China continues to grow into the indefinite future. And it continues to be vulnerable in a world where financial markets continue to be unsettled. With rising concern about global warming it is perhaps more urgent than ever to increase the diversity of Australia’s productive capacity and export profile. If the more dire consequences of warming occur, Australia needs to be prepared to adapt.
To these well-known vulnerabilities we can add a third, vulnerability to rising inequality. Australia cannot control what happens in the rest of the world – we are a minor player in the global economy – but we can control the way we adapt to global events and developments. A fairer society is more likely to continue down the path of economic dynamism and continuous adaptation and less likely to see globalisation as a byword for rising inequality and a process that needs to be resisted.

Government Spending, Deficits and Debt

There's been a lot of spurious stuff written recently about the dangers of deficit financing during the Great Recession. Reading some of the more alarmist stuff one would be forgiven for thinking that the world didn't just dodge a huge bullet - a major systemic financial collapse and a serious depression in the developed world, which would have eventually engulfed the whole world. The negative feedback possibilities were extremely scary. Massive fiscal stimulus made a big difference. As growth returns money will need to be paid back. My major concern is with indebtedness across the system, rather than in the govt sector.

The more alarmist writers always refer to govt debt in gross terms rather than in net terms.
Those interested in the detail can read the earlier post "Public Debt (for Nerds)". What really matters is net debt or more to the point net financial worth and net worth.

There is no doubt that govts cannot keep borrowing indefinitely, just like households and corporations.
One of the main differences between public andf private, however, is the capacity to fix finances through taxation. In the US in the 1990s, Clinton shifted the US debt position relatively easily and then Bush messed it up again.

For an excellent counter-intuitive account of these issues see Robert Frank's article "How to Run Up a Deficit, Without Fear" 

Frank drily notes that:

there are really only three basic truths that policy makers need to know about deficits: First, it’s actually good to run them during deep economic downturns. Second, whether deficits are bad in the long run depends on how borrowed money is spent. And third, eliminating deficits entirely would not require any painful sacrifices.

What! You ask, surely this can't be true? The first point comes directly from Keynes who correctly argued that in times of recession govts should do what they can to bolster spending.

Consumers won’t lead the way, because even those who still have jobs are fearful they might lose them. And most businesses won’t invest, since they already have more capacity than they need. Only government, Mr. Keynes concluded, has both the motive and opportunity to increase spending significantly during deep downturns.
Of course, if the government borrows to do so, the debt must eventually be repaid (or the interest on it must be paid forever). That fact has provoked strident protests about government “bankrupting our grandchildren.”
It’s an absurd complaint. Failure to stimulate the economy would mean a longer downturn. That, in turn, would mean longer stretches of reduced tax receipts, increased unemployment insurance payouts, and depressed private investment. The net result? Higher total public borrowing and a permanent decline in productivity compared with what we would have had under effective economic stimulus.

But govts do have to pay the debt back as the economy recovers.

At full employment, extra borrowing often compromises future prosperity, just as critics say. On President George W. Bush’s watch, for example, the national debt rose from $5 trillion to $10 trillion. Some of that borrowing paid for an expansion of Medicare prescription coverage and a financial bailout a year ago, but most went for a war in Iraq and tax cuts that largely just allowed for additional consumption. Our grandchildren will be forever poorer as a result.

What matters is what govt borrowing is used for - govts can usefully make productive investments that will benefit future generations.

After decades of neglect of the nation’s infrastructure, attractive public investment opportunities abound. It’s been estimated, for example, that eliminating bottlenecks on the Northeast rail corridor would generate $12 billion in benefits at a cost of only $6 billion. These are present value estimates. When government undertakes such investments, our grandchildren become richer, not poorer.

Frank then suggests correctly that in normal times, govts should pay for productive investment with savings rather than borrowings.

But they’d be richer in the long run if we paid for those investments with our own savings rather than with borrowed money, for that would allow our grandchildren to benefit from the miracle of compound interest. Many fiscal hawks insist that the only way to eliminate deficits and pay for additional investment is by cutting government spending. But as California’s experience suggests, that approach often backfires. Government programs have constituents. Those that get the ax are often not the least valuable ones, but those whose supporters have the least influence. California’s schools, once among the nation’s best, are now among the worst.

The solution, of course, is taxation. A dirty word for many, but essential for not only a civilized society but a productive one as well.

To eliminate deficits, we need additional revenue. The encouraging news is that we could raise more than enough to balance government budgets by replacing our existing tax system with one that taxes activities that cause harm to others. Called Pigovian taxes by economists — after the English economist Arthur Cecil Pigou — such levies create a burden that is more than offset by the reductions they cause in costly side effects of everyday activities.
When producers emit sulfur dioxide into the atmosphere, for example, the resulting acid rain harms others. As the 1990 amendments to the Clean Air Act demonstrated, the most efficient and least intrusive remedy was to tax sulfur dioxide emissions. Doing so entailed no net sacrifice, because solving the same problem by prescriptive regulation would have been much more costly.
Similarly, when motorists enter congested roadways, they impose additional delays on others. Here, too, taxation is the best remedy. The time that congestion fees save is more valuable than the fees are burdensome.
When the transactions of financial speculators fuel asset bubbles, they increase the risk of financial meltdowns. A small tax on those transactions would reduce this risk.
When drivers buy heavier vehicles, they increase others’ risk of dying in accidents. This risk would be lower if we taxed vehicles by weight. Carbon dioxide emissions contribute to global warming. Here as well, taxation offers the most efficient and least intrusive remedy.
Anti-tax zealots denounce all taxation as theft, as depriving citizens of their right to spend their hard-earned incomes as they see fit. Yet nowhere does the Constitution grant us the right not to be taxed. Nor does it grant us the right to harm others with impunity. No one is permitted to steal our cars or vandalize our homes. Why should opponents of taxation be allowed to harm us in less direct ways?
Taxes on harmful activities would be justified quite apart from any need to balance government budgets. But such taxes would also generate ample revenue for the public services we demand, quieting the ill-considered commentary about deficits.
In the meantime, however, such commentary continues to render intelligent political decisions about deficits less likely. For example, 58 percent of respondents in a recent NBC News-Wall Street Journal poll said the president and Congress should worry less about bolstering the economy than keeping the deficit down, while only 35 percent said economic recovery was a higher priority.
If we really want to bankrupt our grandchildren, that poll charts a promising course.