Recent Graphs on the World and Australian Economies

If you're ever looking for up-to-date graphs on the world and Australian economies, the Reserve Bank of Australia's Chart Pack is a great place to start.

For the world economy as a whole it is clear that growth has slowed over recent times. This is clearly the case for the advanced economies, but is also true for China, India and the rest of Asia.

The graph shows just how significant was the decline in growth in 2008. That rapid recovery there had a lot to do with government spending throughout the world. Increasingly it looks clear that governments throughout the developed world, but especially in Europe may have tightened fiscal policy too quickly leading to lower growth and ironically an inability to pay off debt through the increased tax receipts available when growth is higher. Britain and Ireland are great reminders of the wisdom supposedly learnt in the Great Depression: cutting spending during a recession leads to ... continuing recession! Ta da.

Japan's miserable growth performance continues.

 

High growth in East Asia has also decelerated.

As have the miracle economies of China and India.

Australia continues to do well considering the world economy.

The latest figures from the ABS show that growth in Australia in the December Quarter was slower than expected at 0.4 per cent.

Growth in Australia over 2011 was 2.3 per cent, which is below trend. 

All of those seasonally adjusted downturns went for one quarter only, which means they don't signify a recession.

In terms of contributions to growth, it seems surprising that manufacturing contributed more than mining in 2011!

The manufacturing sector's employment performance was not so good.

One of the consequences of austerity in Europe is higher unemployment. Sustained high employment is never a good thing in countries with strident Nationalist political parties.

 

One bright spot for macroeconomic policy is subdued inflation. Some commentators were warning that inflation was in danger of getting out of control in early 2011. This view now appears to be overly hawkish. 

 

Even worrying trends for higher inflation in China and India have reversed.

Inflation in Australia also remains subdued and is on the way down.  

 
As Gregory and Sheehan point out many of the price increases over 2011 occurred  in just a few categories:

Over the three years to the June quarter of 2011 five sub‐groups, out of a total of 90 in the CPI and accounting for about 12% of the index, have provided 40% of the growth in the CPI, and 44% of the growth over the past year. The five groups are lamb and mutton, fruit, vegetables, utilities and tobacco. These five groups in total have risen by 11.9% per annum over the past three years, while the rest of the CPI rose by 1.8%; over the past year the five groups rose by 16.7% and the rest of the index by 2.2%.

Bad luck for those who like lamb chops and three veg and some fruit for dessert (standard evening fair in my family in the 80s. 

China's fiscal and monetary stimulus has clearly come to an end.

What happens to that red line over the coming year will be significant for Australian exports of coal and iron ore.

Next post we'll consider Australian finance and trade. 

Basic Economics for Australia

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

The Australian Economy: A Deficit of Long-Term Thinking?

The flood levy has caused most of the usual suspects on debts and deficits to come out and spruke their position, whether it's "increasing taxes is always bad" or "deficits are not really a problem for Australia". While my sympathies definitely lie with the latter rather than the former, I can't help but feel that we should have been building a rather large fiscal surplus over the past 20 years 'without a recession'.

While going into deficit was a necessary move by the Rudd government, the real question is whether the fiscal balance should have been in better shape before the crisis, given the mining boom and the long period of growth before the global financial crisis (GFC). Given Australia's recovery from the downturn and the increase in export prices the Gillard government certainly should be aiming to get a large surplus together sooner rather than later.

Being critical of the pro-deficit position is not an argument for less infrastructure spending, but for increased tax on super profits, especially in the mining sector, but perhaps also in the banking sector. Remember that Australia's mineral resources (whether you think we should be mining them or not) are non-renewable. Once they're gone, they're gone forever. They should be seen as the property of future generations as well as the present generation of Australians. Using taxes from mining profits to build infrastructure or to fund research into renewable energy sources makes sense on an inter-generational basis and would contribute to higher standards of living across the Australian population now and into the future.

If we look at GDP growth since the early 1990s it makes it even clearer that we should have built up a big surplus over time.

There have been only three crosses into contraction since the recovery from the early 1990s recession. This is a remarkable turnaround from the situation between 1974 and 1992 when we had three recessions and 2 other downturns. Australia has had a remarkable turnaround since the early 1990s from the seemingly terminal decline of the 1970s and 1980s.

The reasonable fiscal position of the federal government in 2008-09 made a big difference for Australia's ability to ride out the GFC and more importantly not suffer the public debt problems that the Europeans and Americans are now faced with.

But let's not forget the continuing problem of private debt in Australia. As the following graphs clearly show, Australia remains vulnerable to changes in international financial supply.

After a little dip during the GFC, Australians have returned to the unprecedented debt levels of 2007-08. The question that always need to be asked is just how high can debt go? The answer will have a lot to do with external conditions. In an expanding global economy with Asian flourishing, many Australians could probably push their debt out even further. But if this occurs a day of reckoning will eventually come. A growth slowdown in Asia because of a political shock or just the effects of boom and bust may slow growth in Australia causing rising unemployment, more defaults on debts and so on.

The other issue is the graph on the right, which shows the percentage of annual income paid in interest. Now if the Reserve Bank of Australia (RBA) were to increase interest rates because of inflationary fears and you can bet they will if there is even the faintest whiff of price pressure, the pressure on household finances will increase proportionally. The pain of Queensland households has helped to reduce the pain of households in the rest of Australia.
As the following graph shows, household net worth went down considerably during the GFC, while liabilities stayed relatively flat. While dwellings wealth has recovered financial assets have quite a deal to go before they get to pre-crisis levels.

The safe path would be for governments to encourage gradual deleveraging of households (and the private economy in general). Also important is a decreased reliance on foreign funding, perhaps through an increase in the super levy to 12 per cent as mooted in the Rudd government's aborted 2010 tax plans.

If we turn to inflation we can see why the RBA believes that price pressures almost got away from them before the GFC and why it now has a bias towards tightening. As the RBA governor said recently it's been rare that the RBA believes that it tightened too soon.

The high Australian dollar has also helped things on the inflation front. The following graph shows tradable and non-tradables inflation. Tradeables are those goods and services which can be exported or imported, while non tradables are not subject to export competition).

Tradable inflation has helped to keep overall inflation much lower and a higher exchange rate helps this as it makes the costs of imports lower.

There is no doubt that the Australian economy has performed remarkably since the early 1990s. This amazing overall performance (it's important to remember that not everyone has benefited) has been accentuated by the fact that the economy came through the GFC with little long-lasting damage when compared to most of Europe and the United States.

The following graphs on commodity prices make it entirely clear just how big a boost resource exports have given the Australian economy. Base metal prices have done well, but have some way to go before they match their peak, while rural goods have surpassed their previous highs.

Australia's two biggest exports iron ore and coal have increased enormously in value since a long period of stasis before 2000. China's increased steel use has been very good for Australia, but just how long prices can stay at these levels must be exercising the minds of miners in Australia. It should also be a subject of considerable concern for government in Australia given the 'untaxed' super-profits being made by our majority foreign-owned mining sector.

Overall, however, commodity prices have matched their previous peak before the GFC and as the terms of trade shows are now approaching the post-war high associated with wool demand created by the Korean War.

The terms of trade is an index-measure ratio of the average price level of exports to the average price level of imports. It effectively reflects the capacity of a given quantity of exports to pay for a given quantity of imports, and provides an important indication of the strengths and weaknesses of the economic structure. A rising or falling terms of trade indicates the possibility of improving or declining living standards, because if what we sell earns relatively more than what we buy, we will be relatively wealthier. Because the terms of trade is a ratio, increases can be a result of export prices increasing at a greater rate than import prices, or export prices increasing while import prices are declining, or export prices declining at a slower rate than import prices. Of course, a rising terms of trade doesn’t stop us from buying more things than we sell, which we have made a habit of for much of our history! Improvements in the terms of trade are not reflected in GDP figures, but improvements do contribute significantly to increases in national disposable income.

One thing that studying history has helped reinforce in my head is that good times don't last forever and that the history of the Australian economy is a history of boom and bust as the graph of the terms of trade makes clear. From the peak of 1950 until the late 1990s the terms of trade had been on a 50 year downward trend. It would be extremely optimistic to believe that we began a 50 year upward trend 10 years ago. But maybe I'm just being too negative!

All graphs from the RBA Chart Pack

Going beyond the headlines on government spending

.
Ross Gittins had a very good column on the weekend about the Government's Building the Education Revolution Spending.

Media reporting and opposition politicking have left many people with the impression much, if not most, and maybe even all of the billions spent on school buildings under the Rudd government's stimulus package has been wasted.

It's an impression based on the piling up of unproved anecdotes about waste or rorting of particular school building projects. Which means it's an impression that's not genuinely ''evidence-based''.

Enough anecdotes have been produced to demonstrate that some degree of waste has occurred. But that's hardly surprising: there's a degree of waste involved in most spending, public or private.

The real question is how significant that waste has been. And no amount of piling up of unproved allegations can satisfactorily answer that question. Only a thorough investigation of the complaints can determine the extent of the waste and the reasons for it.

It's important to understand - as most people don't - that news reporting practices aren't intended to give us a representative picture of what's happening. Indeed, what's ''newsworthy'' is often quite unrepresentative.

It's worth considering that news reports on the BER spending are not representative of what has been a wholly worthwhile program.

There is no doubt that there has been some significant and probably unavoidable waste (given the haste of the spending). Governments will need to study the roll out to avoid such excesses next time. My guess is, however, that the eventual realisation will be that the production of new buildings and facilities has been an overwhelmingly positive development for schools.

Internationally renowned economist Joseph Stiglitz praised the stimulus as perhaps the best designed in the world and left no doubt about where his political allegiances lay:

"You would have had high unemployment, you would have had capital assets not fully utilised, that's waste," Stiglitz told a conference in Sydney.

"So your choice was one form of waste versus another form of waste. It's judgment of what is the way to minimise waste, no perfection here, and what your government did was exactly right."

By contrast, Stiglitz said Abbott had "praised the architects of the global financial crisis" and could lead Australia into difficulty.

This is what he said in full on the 7.30 Report

JOSEPH STIGLITZ: I did actually study quite a bit the Australian package, and my impression was that it was the best - one of the best-designed of all the advanced industrial countries. When the crisis struck, you have to understand no-one was sure how deep, how long it would be. There was that moment of panic. Rightfully so, because the whole financial system was on the verge of collapse. In that context, what you need to act is decisively. If you don't act decisively, you could get the collapse. It's a one-sided risk.

KERRY O'BRIEN: There's been a lot of criticism of waste in the way some of Australia's stimulus money was spent. Is it inevitable if you're going to spend a great deal of government money quickly that there will be some waste and can you ever justify wasting taxpayers' money?

JOSEPH STIGLITZ: If you hadn't spent the money, there would have been waste. The waste would have been the fact that the economy would have been weak, there would have been a gap between what the economy could have produced and what it actually produced - that's waste. You would have had high unemployment, you would have had capital assets not fully utilised - that's waste. So your choice was one form of waste verses another form of waste. And so it's a judgment of what is the way to minimise the waste. No perfection here. And what your government did was exactly right. So, Australia had the shortest and shallowest of the downturns of the advanced industrial countries. And, ah, your recovery actually preceded the - in some sense, China. So there was a sense in which you can't just say Australia recovered because of China."

Three Graphs and a Silly Question: Debt and Housing

The latest speech from the Reserve Bank Governor Glenn Stevens, entitled Some Longer-run Consequences of the Financial Crisis contained the following excellent table.

Source: http://www.rba.gov.au/speeches/2010/sp-gov-200710.html#f3

Stevens argues that there are three main lasting international legacies. The first is the "fiscal burden" of the crisis involving both financial sector bailouts and discretionary fiscal stimulus. In relation to the bailouts he argues:

Note that this is not necessarily a permanent burden since, if carried out successfully, the ownership stake can be sold again in due course. In fact about 70 per cent of the funds invested by the United States in banks have been repaid, and the US Government expects to make an overall profit from these capital injections.2 Nonetheless for a period of time governments are carrying a little more debt than otherwise as a result of the provision of support to the banking system.

In relation to fiscal stimulus:

while there was a lot of national variation, for some countries this spending was quite significant relative to the normal pace of annual growth in GDP. To the extent that the packages had measures that increased spending for a finite period but not permanently, the result is a rise in debt of a finite magnitude, but not an ever-escalating path of debt.

Debt ratios, he suggests are being exacerbated by the magnitude of the crisis and the anaemic recovery in Europe and the United States.

According to the IMF, for the group of advanced economies in the G-20, the ratio of public debt to GDP will rise by almost 40 percentage points from its 2008 level by 2015. Fiscal stimulus and financial support packages will account for about 12 percentage points of this. Close to 20 percentage points are accounted for by the effects of the recessions and sluggish recoveries. Another 7 percentage points comes from the unfavourable dynamics of economic growth rates being so much lower than interest rates for a couple of years

... the major countries generally are going to have significantly higher public debt relative to GDP after the crisis than before, and the debt ratios will continue to rise for several more years.

This was largely unavoidable. ... Generally speaking, the public balance sheet has played the role of a temporary shock absorber as private balance sheets contracted.

... At present that additional cost is, in some countries, reduced compared with what it might have been due to the low level of interest rates on government debt that we see. Moreover had the debt not been taken on it could well be that the economic outcomes would have been much worse, so increasing fiscal and other costs. Nonetheless this lasting debt servicing burden is a real cost.

A fairly balanced position from out Governor.

The second long-term implication is the increased role of government in the financial sector.

the intervention was broader than just a temporary period of public ownership – as massive an event as that has been. Take guarantees. Once the Irish Government guaranteed its banks, governments all over the world felt bound to follow suit in some form or other – expanding or (as in our case) introducing deposit insurance, and guaranteeing wholesale obligations (for a fee). The feeling was probably most acute in countries whose citizens could shift funds to a bank guaranteed by a neighbouring country without much effort.

Stevens acknowledges the fact that governments simply must shore up the financial sector in a crisis. The consequences of not doing so are too catastrophic to contemplate. The question for the future is how do governments shape the system so they do not have to make such forceful interventions in the future.

So some central banks, like their governments, have found themselves in very unusual terrain. It is terrain: in which the relationship between the central bank and the government is subtly changed; where the distinction between fiscal and monetary policy is less clear; from which it may be hard to exit in the near term; and a side effect of which may be wastage, over time, in some elements of market capability.

The third implication is the changing regulatory agenda:

In a nutshell, what regulators are pushing toward is a global banking system characterised by more capital and lower leverage, bigger holdings of liquid assets and undertaking less maturity transformation. It is hoped that this system will display greater resilience to adverse developments than the one that grew up during the 1990s and 2000s.

The implication is that the costs of intermediation - the role played by banks in bring borrowers and lenders together - will rise, which in turn will have broader economic effects. The first, Stevens contends, is lower growth and possibly less lending. Stevens observations on the potential impact of regulatory changes are worth quoting at length.

First, I think we ought to be wary of the assumption of a mechanical relationship between credit and GDP. ... did the steady rise in leverage over many years actually help growth by all that much? Some would argue that its biggest effects were to help asset values rise, and to increase risk in the banking system, without doing all that much for growth and certainly not much for the sustainability of growth in major countries. Some gradual decline in the ratio of credit to GDP over a number of years, relative to some (unobservable) baseline, without large scale losses in output may be difficult to achieve but I don’t think we should assume it is impossible.

Secondly ... we have to remember that there is a potential benefit on offer too: a global financial system that is more stable and therefore less likely to be a source of adverse shocks to the global economy in the future. ...

Thirdly, however, the reforms do need to be carefully calibrated with an eye to potential unintended consequences. One such consequence, obviously, would be unnecessarily to crimp growth if the reforms are not well designed and/or implementation not well handled.

Another could be that very restrictive regulation on one part of the financial sector could easily result in some activities migrating to the unregulated or less regulated parts of the system. Financiers will be very inventive in working out how to do this. If the general market conditions are conducive to risk taking and rising leverage ... people will ultimately find a way to do it. Of course while ever the unregulated or less-regulated entities could be allowed to fail without endangering the financial system or the economy, caveat emptor could apply and we could view this tendency simply as lessening any undue cost to the economy of stronger regulation of banks. But if such behaviour went on long enough, and the exposures in the unregulated sector grew large enough, policymakers could, at some point, once again face difficult choices.

In the discussion afterwards, Stevens gave short shrift to one question.

Source: http://boardroom-pc.streamguys.us/files/RBA/RBA20100720_GS_final_1/

Now this question should worry a few people given that it shows just how ignorant people in financial companies can be about the countries they have an interest in. At least he got to ask the Governor a question and is now 'informed'.

The answer shows that the RBA is not really worried about debt at all - either public or private (household). Although the Governor is less sanguine than some in the RBA about growing household debt even further.  

Two other graphs both support and question the governor's benign outlook on public and private debt respectively. The first is from Peter Martin's excellent economics blog.  It's original source is from a Treasury analysis of Public Debt in Australia, which I have covered a while ago here and here.

Source: http://petermartin.blogspot.com/2010/07/wednesday-column-debt-free-got-any.html

 

But while the RBA is not particularly worried about household debt or about the housing market, others continue to warn that Australia's house prices are bubbling. According to the Economist:

House prices in Australia rose by 20% in the year to the end of the first quarter, faster than the 13.5% recorded in the 12 months to late 2009. More concerning, however, is our analysis of “fair value” in housing, which is based on comparing the current ratio of house prices to rents with its long-term average. By this measure Australian property is the most overvalued of any of the 20 countries we track. A frothy property market was one of the reasons for the Reserve Bank of Australia raising interest rates six times between October and May. Since then, the bank has become more sanguine about the state of the market. It cited “some signs that the earlier buoyancy in the housing market was easing” when keeping interest rates on hold in June.
 

For those wanting a more 'balanced' view of the prospects for Australian housing see Rory Robertson, "Extreme predictions on house prices will continue to be wrong". Robertson argues:

Average prices could rise a bit further or fall a bit over the coming year, but they will not collapse, as happened in the US and Japan.

Claims that there is a "bubble" in Australian housing markets don't stand up to serious scrutiny.

Investment legend Jeremy Grantham sees a bubble based on his calculation that housing trades near 7.5 times family income today versus about 3.5 times in earlier times.

Prices supposedly are around twice what they "should be". And "sooner or later" they will return to the "normal" multiple of family income.

Don't bet on it. For starters, the Reserve Bank estimates Australia's price-to-income ratio is near five times income, not seven times, removing any need for home prices to fall that first 30 per cent.

The step up in Australian house prices and housing debt relative to incomes over the past decade and a half was largely a function of the sharp drops in average inflation and interest rates delivered by the early-1990s recession.

These downshifts in inflation and interest rates are structural rather than cyclical. So don't expect the price-to-income ratio ever to return to three times, a level typical in Australia's long gone, bad old days of high inflation.

The recent 30 per cent drop in US house prices is a very poor guide to what might happen here.

Why? Well, because Australian and US housing and mortgage markets are like chalk and cheese. The relative strength of our economy -- 5 per cent unemployment here versus near 10 per cent there -- is part of the story.

More importantly, we have carefully supervised banks and mortgage markets that offer only "full recourse" loans. Australians know they cannot "walk away" from their mortgages without serious financial penalty. There is no "jingle mail" here.

And our home lenders generally hold their loans for the full term, so take very seriously the need to assess whether any would-be borrower is a "good risk" or not.

For those who worry that the level of Australia's mortgage debt is simply "too high", the Reserve Bank has estimated that three-quarters of all mortgage debt is held by the top 40 per cent of income earners.

Home ownership has been steady near 70 per cent for decades, yet the home ownership rate for households with heads aged under 35 years is just 40 per cent, down from 50 per cent in the late 1980s.

The bad news is that young people are finding it harder to buy where they want to live.

The good news is that -- contrary to some claims -- not everyone is overgeared. Some 60 per cent of younger households -- many with steady jobs and good incomes -- do not have a mortgage at all.

According to Robertson we should not worry about simplistic debt to income ratios and should not forget high immigration and chronic under supply of new housing.

Having won his bet with Steve Keen (an easy target) Robertson is feeling reasonably sure of himself:

Australian home prices are relatively high in part because, rather than "spreading out" across our continent, most of us choose to compete to live on the same best-located bits of ground near the beach.

With housing, you get what you pay for.

I'm not so sure.

No Bubbles in Sight?

For those wishing for an antidote to negative news on the housing market, the person to read is Christopher Joye. (The institution to follow for optimism on debt is the Reserve Bank of Australia). I must admit that despite a lot of study, I simply have no idea whether there is a bubble or not in the Australian and Chinese housing markets. (After being a long time pessimist I fear being too optimistic and being wrong again in reverse).

Luckily I'm not paid to be either an optimist or a pessimist. What I think is obvious is that increased debt does lead to increased vulnerability as the RBA Governor recently warned about.

But that doesn’t mean it would be wise for that build-up in household leverage to continue unabated over the years ahead. One would have to think that, however well households have coped with the events of recent years, further big increases in indebtedness could increase their vulnerability to shocks – such as a fall in income – to a greater extent than would be prudent.

It may be that many households have sensed this. We see at present a certain caution in their behaviour: even though unemployment is low, and measures of confidence have been quite high, consumer spending has seen only modest growth. This may be partly attributable to the fact that the stimulus measures of late 2008 and early 2009 resulted in a bringing forward of spending on durables into that period from the current period (though purchases of motor vehicles by households – a different kind of durable – have increased strongly over recent months). But the long downward trend in the saving rate seems to have turned around and I think we are witnessing, at least just now, more caution in borrowing behaviour. Of course this will have been affected by the recent increase in interest rates but the level of rates is not actually high by the standards of the past decade or two. We can’t rule out something more fundamental at work.

We can’t know whether this apparent change will turn out to be durable. But if it did persist, and if that meant that we avoided a further significant increase in household leverage in this business cycle, it might be no bad thing. Moreover if a period of modest growth in consumer spending helped to make room for the build-up in investment activity that seems likely, perhaps that would be no bad thing either.

Fortunately, however, for those who don't like to sit on the fence like I (and the Governor it seems) do, there are definite proponents of boom or doom that you can read. For doom read Steve Keen; for boom (but not bubble) read Christopher Joye.

Joye's arguments are very persuasive and he always brings interesting data to the table. But I'm still concerned about the level of private debt in Australia. Most commentators are much more focused on public debt (partly because economists as a bunch are generally anti-govt and pro-market as a first principles assumption).

The problem with private debt is that there is no political constituency to develop policies to keep it down, as there is with public debt. Despite democratic pressures that encourage higher spending and lower taxation - what the Marxist James O'Connor in the 1970s called the "fiscal crisis of the state" and what others on the right called the "crisis of democracy" - eventually governments have to face the judgement of those from whom they borrow or tax.

While the 1980s did not signal the demise of the state as many predicted it did stop the growth of the state - at least while growth remained subdued. As Lindert (2004: 22) points out: "For all the often-reported “crisis” or “demise” of the welfare state, all one really sees after 1980 is a slowdown, not a decline, in the shares of GDP that welfare-state taxpayers put into such programs."

Recent events have shown just how important states remain in the global economy and I'm imagining that the last few years will show a considerable growth in the size of the state throughout the world. But as in the 1980s, this growth cannot continue and the constituencies in favour of fiscal retrenchment are reasserting themselves despite the uncertain nature of the recovery. Last week's G20 meeting was divisive compared to previous meetings and the major divide was over appropriate fiscal stances. (Just quietly those pesky global imbalances are unlikely to go away with the Germans tightening policy and the Americans keeping things pretty loose.

Retrenchment is well under way in Europe as countries as diverse as Greece and Ireland deal with fiscal crises. The Irish have decided to take harsh medicine and as a consequence the Irish population is going through hard times. Greece is another story and the major problem is actually building up a decent tax base. In other words, Greek authorities need to get people to pay tax. The Germans are major advocates of fiscal retrenchment, much to the annoyance of the United States.

One of the excellent points made by David Lindert (2004: 6) in his seminal study of social spending Growing Public is that governments are constrained by democracy:

There is no clear net cost to the welfare state, either in our first glance at the raw numbers or in deeper statistical analyses that hold many other things equal … It turns out there are many good reasons why radically different approaches to the welfare state have little or no net difference in their economic costs. Those reasons are many, in terms of an institutional list, but they boil down to a unified logic: Electoral democracy, for all its messiness and clumsiness, keeps the costs of either too much welfare or too little under control.

But what are the restrictions on the expansion of private debt? Governments have encouraged the growth of debt through taxation policies for housing and company debt.  And financial liberalisation has massively increased access to credit. Don't get me wrong. I'm not anti-financial liberalisation. I would much rather live in an era where access to credit is not rationed and the financial sector is innovative and consumer oriented. But like all good things there is need for balance.

Rather than deal with the consequences of private debt in Australia, governments have attempted to underpin debt through subsidies, guarantees and . There is a good reason for this - any major pay down of debt in Australia will lead to lower spending. Now I hope that the optimists are right, but in the back of my mind is the continuing worry about what level of debt is too much.

Undoubtedly Australia has survived a very big stress test, but it did so by increasing public debt to maintain private debt. As Keynes supposedly once said: "the unsustainable cannot be sustained".


Reference:
Peter H. Lindert (2004) Growing Public: Social Spending and Economic Growth since the Eighteenth Century, Cambridge, Cambridge University Press.

The Debate between Expansionists and Restrictionists

Right now there is an important debate going on in the United States and Europe between those who think the major aim of economic policy at the moment should be to do something about growing fiscal deficits and those who believe that the major aim should be to maintain economic activity.

Mohamed El-Erian argues that we need to go beyond what he calls "the false growth vs austerity debate" He argues that at this his weekend’s G20 meeting

In one corner stand the “growth now” camp, arguing that expansion is a pre-requisite to service their debt sustainably. Without it tax receipts implode, investment is turned away, and meeting future debt payments is harder. This camp abhors Europe’s shift towards austerity, questions Tuesday’s tough UK budget, and urges countries like Germany to adopt expansionary policies. Some advocate additional fiscal stimulus even for high deficit countries, like the US.

This debate he argues is "incomplete" and backward looking and countries need "to adopt both fiscal adjustment and higher medium-term growth as twin policy goals."

Squaring the circle of growth and fiscal stability needs policies that focus on long-term productivity gains and immediate help for those left behind. This means first enhancing human capital, including retraining parts of the labour force, and increasing labour mobility. Then new emphasis on infrastructure and technology investment is needed, with greater support for scientific advances that promise increased productivity. Finally all nations must begin an honest assessment of the social frictions coming in the next few years. In some countries (like the US) this means an urgent bolstering of social safety nets.

...

The world is facing deep structural challenges yet its leaders are stuck in a short-term, cyclical mindset. Until they break out of it we will see little more than fruitless discussions, national policy flip-flops, and a troubling lack of global policy harmonisation. Without action our future will be disappointing global growth and periodic sovereign debt crises. Let us hope this, if nothing else, is enough to bring the two camps together.

Paul Krugman is a major protagonist in this debate on the side of the expansionists. He is very critical of such views, implying that this is simply restrictionism.

In The Long Run, We Are Still All Dead

So, reading Mohamed El-Erian, I’m somewhat at a loss about what he’s actually saying; what, exactly, is the policy recommendation? But in any case, here’s what struck me: he writes,
The world is facing deep structural challenges yet its leaders are stuck in a short-term, cyclical mindset.

I disagree. If anything, we’re suffering from the opposite problem. Talk to German officials about high unemployment and the looming threat of deflation, and they ramble on about the demographic challenge and the cost of pensions.

I mean, why shouldn’t we be focused on the business cycle? We’ve suffered the worst cyclical downturn since the Great Depression; in terms of unemployment and output gaps, we have recovered almost none of the lost ground. Millions of willing workers are idle because of lack of demand; let them stay idle, and we can turn this into a long-term structural problem, but right now it is precisely a short-term, cyclical problem.

So saying that we need to focus on the long term, and not worry our little heads about trivial short-term issues like the highest long-term unemployment rate since the Great Depression, may sound like wisdom — but it’s actually folly.

Oh, and one more point — not about El-Erian, but about quite a few policymakers and economists: the attempt to shift the discussion away from the short run is not, as often portrayed, an act of vision of courage. On the contrary, it’s an act of cowardice, an attempt to evade responsibility for a disastrous state of affairs that we could fix, but choose not to.

Keynes had it right:

But this long run is a misleading guide to current affairs. In the long run we are all dead. Economists set themselves too easy, too useless a task if in tempestuous seasons they can only tell us that when the storm is long past the ocean is flat again.

What is most interesting for me as I read these debates are the implications for Australia. And just how different the situation is in Australia. This seems to be another 'world' that they are writing about. This is increasingly being explained by the argument that the global financial crisis should be seen as the North Atlantic financial crisis. (NAFC doesn't have as sweet a ring as GFC and makes me think of a football club from Adelaide).

Australia's fiscal position is relatively sound and the nature of the political debate in Australia ensures that even the small level of public debt is seen as a 'problem' that requires immediate action. One of the reasons why the Rudd govt introduced the Super profits tax was to bolster the ability of the budget to return to surplus sooner than originally planned.

We are in a very good position right now, but as always we continue to be vulnerable. Our success (and we could do better) has been built upon long-term growth and increases in national income bolstered by the terms of trade effect (relative increases of export prices over import prices). But eventually what happens in Europe and the United States matters to Asia and to us. China has continued to expand because of a huge fiscal stimulus and in turn growth in Europe and the United States has been bolstered by budgetary stimulus, financial guarantees and bailouts, and low monetary policy.

Without govt efforts the world would now be in a deep financially-induced depression. This is what the restrictionists and ant-govt zealots need to realise. Equally, however, expansionists need to (eventually) think about the growth of govt debt. This will involve both sides of the fiscal equation - spending and taxing.

We now live in a more globalised world economy. One of the benefits of that is that increased growth and the advancement of many developing countries with China and India showing rapid rates of growth. But globalisation increases vulnerabilities to negative effects as well. The aim of the G20 should be to foster the increased economic cooperation necessary to manage an increasingly globalised world economy. But international cooperation is no easy thing! States will have to continue looking after their own interests first, but a bias towards expansion in depressed areas will be beneficial for globalisation in the long-run.

The government's insulation scheme and fiscal stimulus

If you're looking for a balanced view of the govt's insulation or Building the Education Revolution schemes, The Australian newspaper is not the place to find it. The Australian has been running hard on a campaign against the govt, worried perhaps that the Opposition under Tony Abbott is not doing an effective job.

There is no doubt that there has been some significant rorting and that some builders have made inordinate amounts of money. The BER and the insulation schemes will provide important lessons for govt schemes and contracting, but they do not negate the important role of the stimulus during the worst of the crisis. Although the govt could have done a better job in its management of the contracts, the improvements in school infrastructure will be overwhelmingly beneficial.

A good way to consider the impacts of these schemes is to imagine the normal practice of building and insulation instalment and consider accident rates, fires, rorting etc and then consider these percentages in relation to the significant increases in the rate of building and instalment. Only then will we get an accurate representation of the problems associated with the programs.

If you want a more balanced account of these developments then I think it is worth reading Rodney Tiffen's "A mess? A shambles? A disaster?"

TO EVALUATE the achievements and failings of the scheme, it is important to recognise that home insulation was already a sizable industry. The government’s policy did not introduce new activities; it radically increased the scale of existing practices. So, in assessing the government’s responsibility for developments during 2009 and early 2010, the task is to disentangle which problems arose from an accentuation of existing sub-standard practices and which occurred because of an emphasis on quantity over quality and a drop in standards as new operators flooded into the industry. While some conclusions – for example, that the standard of work fell – are plausible, we can’t know for certain because there are no baseline measures of previous practices and outcomes.

In 2008, 3.18 million Australian dwellings (or 61 per cent) had insulation, and approximately 67,000 homes were insulated each year. The largest number of insulated homes had batts in the ceiling; a minority used foil. On average, between eighty and eighty-five fires per year were attributed to insulation faults, but no breakdown is available to show which of these arose from newly installed insulation and which from longer-standing insulation.
The Rudd government’s scheme was unprecedented in its scope, aiming to insulate two million homes in two and a half years at a cost of $2.45 billion. By the time the program was suspended last month, 1.1 million homes had been insulated with $1.4 billion approved for payment. These installations amount to roughly half the number of homes that had no insulation in 2008. It should also be remembered that the work done was disproportionately in older dwellings, which no doubt added to the difficulties of safe installation.

The benefits of home insulation have not been questioned by any of the program’s critics. The Department of Environment estimated that insulation would cut the normal household’s energy bills by around $200 a year. According to one estimate during the controversy, putting ceiling insulation in 2.2 million homes would save as much energy as taking a million cars off the road; a more conservative estimate said that 1.1 million insulated homes was the equivalent of taking 300,000 cars off the road. Another estimate said that ceiling insulation cuts household energy use by up to 45 per cent, while the Total Environment Centre said it would cut it by 25 per cent in centrally heated homes and 18 per cent in space-heated homes. Whatever the actual figures, the environmental benefits are clearly substantial.

When the program began, home insulation had few special regulations, although it was, of course, subject to normal work and safety provisions and employers’ duty of care. No certification was needed to enter the field, and indeed insulation was frequently installed by householders themselves. The lack of licensing and training in the area allowed sub-standard work to be completed and sub-standard occupational safety procedures to be followed. Although the numbers and proportions of each almost certainly increased as a result of the stimulus, the lack of existing safeguards also meant that an unknown number of instances of both shortcomings probably occurred in the past but had passed beneath the public radar.

Both licensing and training have been dramatically improved as a result of the program. As the increased scale and perhaps the decline in the quality of some work exposed more problems, the department mounted a national training and audit program, largely filling the regulatory vacuum that had permitted the previous abuses and problems. At best there is a grey area here. On the one hand it can be argued that it would be unreasonable for the department to anticipate all of these issues, and it can be argued that it acted fairly quickly once problems became apparent. On the other, should it have anticipated that such an expansion of funding would attract problematic operators and practices, and therefore acted pre-emptively?

“Every new fire and its front page headline will remind voters of the Rudd government’s recklessness and ineptitude,” the Australian’s columnist Janet Albrechtsen has written. Politically, she is surely correct, but that will happen largely because of the media’s innumeracy and lack of historical perspective. Under the program, the number of installations rose from 67,000 a year to 1.1 million; the number of fires rose from around eighty to 120. In other words, as Crikey’s psephological blog Pollytics has demonstrated convincingly, there is no statistical evidence that the existing problem of fires became worse with the program. Rather, because fires from insulation were now newsworthy and previously hadn’t been, this was seen as a new problem, one caused by the new policy, whereas in fact the number of insulation-related fires increased only slightly in absolute terms, and there was a decrease from previous patterns in proportional terms.

I think in coming years, commentators will look back on Australian economic policy during 2007-09 and realise that the govt  and the Reserve Bank did a pretty good job in keeping the Australian economy out of recession.

We can't blame the media for being sensationalist, but we don't have to play their game and believe the hype.