Our economy is fundamentally broken

Everyday at MacroBusiness we endeavor to cover a wide range of topics about the Australian economy that are either unreported or misrepresented by the mainstream media. One of the major themes since we began, just 7.5 months ago (I know, it does seem longer), has been the changing face of the Australian economy as private sector credit growth shrinks and resource sector investment grows. This dynamic has created quite a lot of friction in the Australian politico-economic landscape and, unsurprisingly, in our very own forum.

I do, however, think there has been quite a bit of confusion generated about what has been going on in the economy over the last decade, so today I want to take a step back and give some broader analysis of the economy using my own economic measure, something I call GPEC. For those of you who didn’t follow my old blog, GPEC is a concept I came up with in order to measure macro-economic policy. GPEC has 4 components.

  • sustainable Growth
  • Productive gains
  • Employment
  • social Calm

The reason I use this measure is because it fits my overall ideology of how the economy supports a nation. It also provides a multi-disciplinary view of macroeconomic policy, which in my opinion gives a far better measure of economic success than any single metric can.

For example, the misrepresented Keynesian idea that digging holes and filling them back in or building bridges to nowhere fails the GPEC test. It may create employment and social calm, but unless those holes and bridges are needed to increase productivity then it fails the productive gains and sustainable growth tests. This is why, although I consider myself a chartalist , I am very much against scatter-gun stimulus programs.

So what are the key markers of an economy with a high GPEC rating? Well you would hope to see the following:

  • Slow growing real household incomes
  • Low levels of inflation
  • Improving productivity
  • A broad based economy
  • Relatively low levels of debt with business investment making up a large proportion of credit.
  • Low unemployment
  • Low crime rate and high well-being metrics.

So how does Australia rate? And why?

Firstly a definition on productivity from fellow Queensland based blogger Cameron Murray:

Productivity is the key to greater wealth, as an individual, a nation, and a world. Productivity is doing more with less. It is that simple. Unfortunately people often equate productivity with economies of scale and population growth, which leads to a poor understanding how economic growth really occurs.

If a farmer selectively breeds his crop so that the next generation of plants yield 5% more grain, with no further inputs required (no more water, fertiliser, harvesting time etc), then he has made a 5% productivity improvement. The output in terms of grain is 5% higher for the same inputs.

Productivity gains flow through the economy, allowing us to produce more goods over time. When other farmers follow this lead, we find that marginal land can now be used productively. We find that fewer people need to work in agriculture, because each farmer is producing more food. This frees up labour to be employed elsewhere in the economy, producing other goods to satisfy our desires.

Productivity gains normally come from two sources. The first is in the form of new inventions and innovations in the methods of production – a new engine design, a new breed of plant, a new manufacturing technique or a new material. Innovation in the methods of production is THE key driver of our prosperity.

A second way that productivity improves is through economies of scale. Even in the absence of new technology or innovation, we can produce more output with less input by specialisation of labour, and larger and more efficient capital equipment, to achieve economies of scale

So in an economy aiming for higher production you would expect to see a number of key things:

  1. Incentivisation in the tax system to support business investment in research and development, and therefore a proportion of business profits being re-invested to support greater production.
  2. A high proportion of private sector debt being used for business investment in non-financial assets.
  3. Key economic metrics targeting output per unit worked.

For those of you with an interest in functional money (MMT) you will note that the sectoral balance equation shows the linkage between the change in non-financial business assets, private sector savings and the flows in sector balances. See here for more on this point.

So what are we seeing in Australia? Well pretty much the exact opposite of everything I am talking about.

As the Unconventional Economist reported this week household income has actually fallen in real terms over the last 2 years, on top of that we have high levels of  household indebtedness and business investment is far less than 50% of total private sector debt.

What this means is that although we have a private sector that continues to borrow money it is unable to transfer these borrowings into returns in higher income. This is the exact opposite of what you would expect to see in a country with improving productivity. So it is no real surprise that charts of Australian productivity look like this.

What this suggests is that over the last decade or so the private sector has indebted itself to purchase items that have a return on investment below their on-going debt servicing cost. Given that we know that the government sector in Australia has relatively low debt the only place that the private sector could be borrowing this capital from is the external sector, which we know from the following chart is exactly what has been happening.

It should be quite obvious to MacroBusiness readers exactly what Australian households have been doing. They have been borrowing from the export sector in order to pay increasingly higher prices for housing. Now although the above information displays quite plainly that this type of investment has been unproductive, it has been argued by some that housing itself has some productive value as shelter. This maybe true, although I disagree, but the definition of productivity is producing more output using the same or less input. Existing houses and land have already been produced. So how can paying ever-increasing real amounts of money for them be productive? It can’t by definition.

The growing indebtedness of households to their houses has also led to another issue. Due to their high levels of indebtedness, households have limited capacity to support business investment in Australia. This has meant that Australian industries have had to seek off-shore capital in order to support the productive business investment that the Australian public could have been provided via savings if they actually had some. This has become increasingly obvious during the recent mining investment boom.

Again Cameron Murray covered this well on his blog:

The graph below shows the balance of these two items alone (which comprise about 50% investment income). By my reasoning this means that foreigners are buying up more assets – property (the media has taken note of this in agriculture) and shares – and lending more to local households and businesses over time.

 

On primary income alone, Australia was $50billion in the red this past year. It takes a lot of trade in agricultural and mining products to offset this transfer of financial assets, and our best effort was a peak of $23.3billion of net exports of goods and services over the past 12 months with an all time high terms of trade (noting that even the balance of trade is usually negative).

So not only do we usually import more than we export, we sell more domestic assets than we buy foreign assets, and the incomes from the transfer of assets to foreign ownership far outweigh the value of the actual trade of goods and services.

A quick example.  The government owned business Telstra was privatised, and 25% of the company is now foreign owned.  That purchase by foreigners was a transfer of assets to foreign ownership as part of the capital accounts, and the dividends earned on the foreign owned portion now leave the country as part of the deficit in the primary income balance of the current account.  The same applies to foreign purchases of agricultural properties, mining shares, and lending to Australian businesses.

So overall we have unsustainable income and debt , falling productivity, growing indebtedness to foreign entities at the same time we are giving up parts of Australia’s assets that are actually producing income to foreigners. You can see why I give Australia a GPEC fail even though we currently have low unemployment, inflation and still rate highly in well-being metrics.

So what to do ?

Well as I have outlined above we have a couple of major issues:

  • Households are highly indebted on housing
  • Business re-investment in production is limited
  • Government and the financial sector support unproductive investment
  • Innovation through research and development is not an economic priority
  • Household sector has limited capacity to invest in the business sector.
  • In order to support all of this Australia continues to “sell off the farm”

I have my own ideas on how to fix some of these issues and I will attempt to cover them over the coming weeks. But before I ram my ideas down anyone’s throat I am interested in getting some reader contributions to the problems I have outlined above, and obviously open the forum to some discussion about possible solutions.

Comments

  1. Very good summary of what ails us DE.
    What to do? I personally don’t think there is a soft landing available because some real pain will be necessary in order to change our thinking.
    So keep raising interest rates..

  2. GPEC is a brilliant concept and is at least one order of magnitude in far greater importance than the outright silliness debated in conventional macroeconomic circles regarding inflation and wage growth (and the everlasting watching and squirming over interest rates from the RBA)……

    Top article DE.

  3. They have been borrowing from the export sector in order to pay increasingly higher prices for housing.
    .
    Does anyone know the absolute figure of external borrowings out of the $1.043 trillion that has gone into housing?
    .
    APRA and RBA seems to be coy about revealing this figure.

  4. The very fact that household incomes are falling at a time when national income is surging is evidence of a massive failure of economic management.

    The mining boom is delivering massive wealth to the big mining companies and the top 20% income earners in WA. Everyone else is going backwards.

    Some boom eh?

    Miners: The lazier we get the richer we get

    • Well I think you are correct in terms of economic management and outcomes, although foreign investors are also in the mix.

      I do however think that blaming miners without also targeting people who sat by while the public hocked themselves against houses so they couldn’t capitalise on mining wealth is not quite correct

      Maybe I would change your statement.

      Miners: Reminding us we are obsessed with houses while others get rich at our expense

      • Thank you DE Great article. Exact post. Actually it’s not just houses. Building houses is part of the culture in this country that has been so wrong for so many years. As I’ve stated elsewhere we have largely exchanged our wealth for trinkets.

      • Sure, allowing the massive run up in housing debt was another massive failure of economic management. No disagreements there.

        I don’t blame miners for the housing bubble. I do blame policymakers for cheerleading the mining boom, and badly mismanaging the proceeds. How can have a situation where household incomes are falling while national income is growing rapidly? Its a disgrace. It might be great for Fanboy and his mining buddies, but its a disaster for the rest of us.

        BTW, my comment about miners getting richer and lazier was a comment on productivity in the mining sector.

      • “…the massive run up in housing debt was another massive failure of economic management” was another massive failure..THE massive failure.

        We have been rescued by mining – national income rising. It was not going to rise by via any other source. Household income falling notionally in some sectors and not across the board.

        You’re getting there!

      • Well, I do think, no matter what policy is implemented by governments, the bankers have a core duty to assess any loan granted in regard to its risk on the debtor’s ability to pay interest and pay back the loan over a reasonable period of time. In addition, the bankers have to duty to monitor overall debt levels to evaluate sustainability of debt markets. On both accounts the bankers failed miserably but focused on lining their own pockets and influencing legislation. Until those culprits rot in jail, the spirit of the rule of law stays violated. The rule of law is the basis of western society and its continued violation will result in a failed nation. So I hope we soon find our way back to the rule of law.

  5. Walt Disney's Frozen Head

    DE,

    So it looks like the interest on foreign borrowings is sufficient to keep us in a current account deficit despite a mining boom. The structural problems have been a long time forming and will take a long time to fix. This led me to conclude a few months ago:

    “What sovereign wealth?”

    and argued that the servicing of foreign debt was the major block to getting a surplus and, by implication, setting up a SWF, in many comments here:

    http://www.macrobusiness.com.au/2011/08/leigh-harkness-on-the-rba-cad-perspective/

    By focusing on one well performing sector, mining, we seem to be ignoring the bigger picture, which you have shown in your data, i.e. GPEC fail.

    I made a few comments on R&D the other day when another thread headed in that direction. I think the lack of interest in R&D here, certainly relative to the USA or UK, is cultural (personal experience of R&D here and in the UK, USA). (Of course some changes have probably occurred in the USA over the last 10-15 years of emphasis on financial engineering i.e. smart scientists and engineers head to wall street rather than innovate)

    Look forward to reading proposed fixes but I’m guessing you are looking at a 10-20 year time horizon and would have to include a slow and steady deflation of housing.

    • Walt, just a quick thanks for the excellent JPY Reserve Bank article on commodity prices. The stuff on hedging against inflation as a positive feedback I found particularly interesting.

      • Walt Disney's Frozen Head

        Yeah it is definitely one of the better reports out there and puts an RBA report, released around the same time, to shame.

  6. A gold star for this post DE. As a issue it’s the greatest risk we face IMO.

    Chart 2a says a lot, and I’d be amazed if the RBA didn’t know this, but let it continue, or the Muppet’s in Canberra silenced them.

    I’m not sure, in our current form, if we can increase productivity given our labour laws, reducing R&D funding, no priority for engineering, science, and manufacturing.

    With globalisation it’s fine to loose all our industry, redeploy our workers to some new industry (not sure what that is), and import all other non mining items; NO thought to the eventual cost of this path given we’re past peak oil. Also, once you deskill the work force it’s a very long way back.

    The one other item I’d add to this * politics is broken as well.

    I just can’t see anything being done to correct the problems or imbalances by any party.

    • remove party donations and other forms of self interest, pork barreling.

      The politico-housing, banking, bureaucrat interest is very large and it is going to be hard to break.

      Id also like an economic constitution erected

  7. “What this suggests is that over the last decade or so the private sector has indebted itself to purchase items that have a return on investment below their on-going debt servicing cost.”

    You have taken that conclusion based only on the lack of income rises for the last two years and ignored income rises for the previous 8 years and the massive capital returns. When considering “return on investment” it is appropriate to include capital returns. It is obvious that the debt incurred on housing over the last decade has produced a positive return. The capital value of housing has increase by ~$2.5b for only an additional ~$1b of debt. It is ludicrous to suggest that the debt has not produced a positive return on investment.

    “Given that we know that the government sector in Australia has relatively low debt the only place that the private sector could be borrowing this capital from is the external sector, which we know from the following chart is exactly what has been happening.”

    All of the AUD which people have borrowed already existed in the Australian banking system. Some of those borrowed AUD were owned by foreigners but nevertheless those dollars came from with the internal Australian banking system. The people that borrowed made a positive return. The people that lent made a positive return. WIN-WIN.

    • That is the problem with housing zealots they know very little about economics.

      >You have taken that conclusion based only on the lack of income rises for the last two years and ignored income rises for the previous 8 years and the massive capital returns. When considering “return on investment” it is appropriate to include capital returns. It is obvious that the debt incurred on housing over the last decade has produced a positive return. The capital value of housing has increase by ~$2.5b for only an additional ~$1b of debt. It is ludicrous to suggest that the debt has not produced a positive return on investment

      So you completely ignored the part about falling productivity and the fact that housing indebtedness has caused Australians to give up their soveriegn assets to foreigners because of their infatuation with unproductive housing has “overcrowded” their ability to invest productively. Well done !

      >All of the AUD which people have borrowed already existed in the Australian banking system. Some of those borrowed AUD were owned by foreigners but nevertheless those dollars came from with the internal Australian banking system. The people that borrowed made a positive return. The people that lent made a positive return. WIN-WIN.

      FAIL!

      Please read DE’s other work to understand what is actually happenning. Money doesn’t “exist” in the banking system

      http://www.macrobusiness.com.au/2011/08/macro-101-reserves-and-interest-rates/

      • I made two points which I reaffirm.
        1. DE’s following claim is false.
        “that over the last decade or so the private sector has indebted itself to purchase items that have a return on investment below their on-going debt servicing cost”.
        The “return on investment” has far exceeded the debt servicing cost. It may not continue to do so. That is another matter – requiring a crystal ball.

        2. The borrowings of Australians have all come from within the Australian banking system. The interest payments all stay within the Australian banking system and have to be spent on Australian goods and services – they cannot leave. The borrowings did not come from outside of the Australian banking system. No AUD leave or enter the Australian banking system.
        Whether you call the borrowed AUD “money” or not is a quite irrelevant red herring to the point I was making.

        PS – The title of the blog seems rather over the top when one considers that it is being applied to possibly and currently the most successful economy in the world when measured by employment and the wealth, income and well being of its citizens. The title invites ridicule.

      • 1. You again neglected everything I said previously. So I will not repeat myself, but you may want to look up the definition of “sustainable”

        2. Again you need to read more.

        >No AUD leave or enter the Australian banking system.

        Yes they do, Australian dollar reserves move from EAS accounts of Australian banks to the reserve accounts of foreign banks and corporations. That is “AUD leave or enter the Australian banking system”

        In order to return those reserves to the Australia owned entities Australians must give up real goods and services.

        Again FAIL!

      • RE the blog title. It seems DE was comparing our economy to his GPEC criteria. Given the massive slide in productivity, and massive indebtedness, it doesn’t do well according to his own criteria.

        However, when faced with the realities of the world in 2011, maybe you are right that we are one of the the least worse economy around. Although the small resource rich countries are doing well – Brazil, Norway etc. While others apparently in the midst of an EU crisis are also doing well – Switzerland, Germany, etc.

        And mostly they have an advatage with low household debt levels.

      • Foundation,
        No doubt that is true that the balance of debt is higher as a % of disposable income on those two wonderful countries.

        But the interest rates on that debt are pretty low too (<4% in Norway and <3% in Switzerland)

        So in interest rate adjusted terms perhaps our level of debt is a little riskier than theirs?

        http://www.ssb.no/orbofrent_en/
        http://www.engadimmo.ch/en/mortgages.htm

        Our interest rates on mortgage debt fall between 7 and 8%. And indeed, our mortagage rates are about 4% higher than the cash rate, so I do wonder how low they can fall even if the cash rate is dropped a couple of percent in the coming year.

      • Absodamnlutely DE
        It’s been fashionable for ALL current schools of economic thought to ignore the external sector balances (maybe with the exception of the Austrians. In the models it has been regarded as an unlimited source of free funds. I say ‘free’ because the idea of paying back either the interest or principal is never included. So it is effectively free funds for an economy…according to the models.

        In fact a long term balanced external sector is perhaps a key to maintaining a long-term balanced economy. My experience is that nearly all economists cannot even grasp the concept of an external sector. Very strange!

    • “It is obvious that the debt incurred on housing over the last decade has produced a positive return.”

      If it’s so obvious it should be easy to get some data to demonstrate what you’re saying?

      Capital returns are only realised when sold and until then only exist as an optimistic idea in the owner’s mind, which in most cases has to face harsh reality. Anyway, in the event where houses are sold within the domestic economy (vs. foreign interests), large capital gains usually means a windfall for the seller but increased barrier to entry for the buyer. That doesn’t exactly scream productive to me…

      • +1
        And how exactly did “investing” in (not new)property put any value-added into the economy? The gain is quite straightforwardly another persons debt – a debt that is being realised in a slowing of the other tier of quarry Australia’s economy.
        I suppose you could sum up with “I’m alright Jack..”

      • There are a lot more Real Estate agents being employed…good news for sellers of patent leather shoes and leases for German autos

    • Foundation,

      Interesting views there. I guess you are expecting these views to be challenged for the rest of the day, so I may as well contribute my 2c.

      First, are you suggesting that leveraged investing on the basis of expected capital growth is a solid investment strategy? Would have also said that such a position was advisable in the share market back in 2005?

      If not, what is the difference? And why is capital growth not as fleeting as it was in the share market or in housing markets abroad?

      “The capital value of housing has increase by ~$2.5b for only an additional ~$1b of debt”
      In this comment you seem to acknowledge that growth in debt lead to higher home prices, but you don’t imagine that the debt also lead to higher incomes? When someone takes on debt to buy a home, they give the money to the previous owner who then spends it in the economy, generating increases in other people’s incomes.

      So if the debt stops, house price growth stops, and income growth stops.

      I’m not sure what your understanding of the banking system is, but when banks create a mortgage, they create new money which begins circulating. So I am not sure what you mean when you can say “All of the AUD which people have borrowed already existed in the Australian banking system”

      If your point is that we generated the AUD denominated debt internally, then of course we did. But for banks to maintain reserve requirements before (or after) creating that debt, they went offshore for funding. Had they not been able to source funding from abroad, the amount of debt issued would have been limited by the level of domestic savings.

      Don’t worry though, the RBA is all over it, and is happy for it to continue –
      http://www.rba.gov.au/speeches/2010/sp-dg-150610.html

      “It is also an inescapable fact that, with Australia running a current account deficit, some funding for the economy needs to come from offshore. Households, by and large, cannot borrow offshore and the government sector has not had much need for offshore funding. That leaves the corporate and the financial sectors. Of these, the financial sector has a comparative advantage in offshore borrowing, because of the relatively high credit rating of Australian banks, both compared with Australian corporations and, in recent years, with banks in other countries.

      Banks in Australia have therefore established a significant role in intermediating the flow of funds from overseas to Australia. Banks in countries where there are surplus savings, such as those in Europe, play a similar role, though in reverse; they channel funds from domestic savers to offshore.”

      A final question, would you advise your family and close friends to leverage into the housing market at the moment? If not, why not? If so, why?

      • I wasn’t saying anything about what is or is not a solid investment, I was speaking only of the past. DE refers to “return on investment” for the last decade. I was merely highlighting that return on investment must include capital return. When calculating return investment it isn’t necessary to actually sell the investment. Ask any holder of gold what his return on investment has been and he will include the capital return to date.
        Return on investment has nothing directly to do with production – I wasn’t addressing that issue.
        My point on the banking was that all the AUD are generated or exchanged internally and all the interest payments remain in the internal system to be spent on Australian goods and services. I erred when I wrote “already existing”.

      • Would you agree that increasing capital gains today results in increasing debt tomorrow and increasing cost to service that debt?

      • Foundation. You might want to check out the charts in this article by Calculated Risk:

        http://www.calculatedriskblog.com/2011/03/q4-flow-of-funds-household-real-estate.html

        Housing was a fantastic investment in the US until 2007. It’s not looking so good now. After rising to all-time highs in 2007, household net worth has now fallen back to levels not seen since the late 1990s. Yet the debt still remains like a millstone around the necks of US households!

      • Foundation, what are you thoughts on the relationship between the current account and house prices?

        For example, Andrea Ferrero, of the Federal Reserve Bank of New York, published a paper in Feb this year arguing that
        “a progressive relaxation of borrowing constraints can generate a strong negative correlation between house prices and the current account. Households increase their leverage borrowing from the rest of the world so that the current account turns negative”

        https://editorialexpress.com/cgi-bin/conference/download.cgi?db_name=mmm2011&paper_id=360

        My discussion here
        http://ckmurray.blogspot.com/2011/08/current-account-deficits-and-housing.html

      • Return on investment means realised returns Foundation, unless you are a speculator (where you mark to price volatility on the market)

        i.e a negatively geared property owner – either an investor who has a renter yet still has a negative holding cost, or an owner with an “imputed renter” (himself) has a negative ROI until disposal of the asset.

        Capital return can only be included in true ROI calculations at disposal – i.e at NAV levels, but is carried by an investor at NTA levels for risk/budgeting concerns. This also applies to the stock of investment assets (e.g a pool of a country’s residential property) – its NTA is based on the purchase price, not the marginal price of a handful of buyers (less so these days) set on each weekend.

        Of course, this depends on whether or not you call your home an “investment” when its really just a consumption item.

        As for gold you’re half-right. Non-physical gold holders (e.g ETF/CFD) do indeed “mark to market” their speculative holdings, because they are speculating pure and simple.

        Physical gold holders are not holding for a return on their money, but a return of their money.

    • this is a pretty good piece coined by Peter Schiff summarising a debate he had with Art Laffer back in 2006 rgarding the health of the US economy. More and more the things he mentions are starting to apply to our economy, especially re unproductive borrowing.

      http://www.europac.net/commentaries/peter_schiff_vs_art_laffer

      This particular line stands out:

      “Borrowing to produce is the way poor nations become rich. Borrowing to consume is the way rich nations become poor.”

      Bidding up house prices = very little economic utility added.

  8. I think that fundamentally Australia is seeing a rise in non-productive vested interest groups (the real estate lobby being a prime example) taking over policy, the FHOG being a classic. The dumbing down of the media (look at Queensland’s apalling rag – “new property owners to be next millionaires” ) has played no small part in the rot.
    What we need is leadership – only that will get us the to the point where politicians can criticise the media and set out genuine agendas such as tax reform, audit of union finances etc. I know that the words “leadership” and “politician” are difficult to use in the same sentence, but what else it there? Will we have to wait until the Murdoch group are run out of town?

  9. Ripper article DE!

    Though I couldn’t help notice the bit where you said we have low inflation. From what I’m seeing, our level of inflation is uncomfortably high.

      • Good point about falling credit. Goes in line with the growing likelihood that the next move on rates will be down.

      • DE I’m an importer. If the A$ does not continue to appreciate at 15 to 20% per year, we have very real and very serious inflation heading our way. I can give you examples.

        As a demonstration If you look at the publication for the last 6 months of ABS inflation stats both clothing and footware and home furnishings turned from having a negative influence on inflation to contributing positively. You can expect this trend to continue and accelerate given the changes in population and work-place culture in China.

        There are fundamental changes going on in China. The years to come will be VERY different to those that have gone before. So there is no use in looking backwards at prices out of China to predict the future.

    • Funny Evan, I read recently that essentially the US will have to ‘experiment’ the way ahead – usual fixes no longer applicable!

  10. This is an excellent post. It’s also depressing to think how far-removed the current political discourse is from addressing these problems.

    DE, maybe you should start a Progressive Economics lobby group with the following policy planks? (just brain-dumping here):
    – a SWF
    -a wind down of incentives for the housing market
    -research bonds or other financial instruments to extend significant credit to R&D.
    -a clear set of metrics for fiscal expansion performance
    -tax reform
    -a fast train? 😉

    I’d be the first to join and I’m sure a lot would be right behind me.

    • Walt Disney's Frozen Head

      Alex,

      DEs post should make it clear that we are not accumulating sovereign wealth. The interest payment on foreign debt (funding ponzi housing) is twice BHPs record profit. To have a SWF with sufficient funds to weigh against the forces dragging the economy would take a significant amount of time. Leaving aside for the moment other shortcomings, success (in getting a large enough SWF) would be based on an assumption of prolonged commodity prices, particularly iron ore, which in turn implies a prolonged China boom.

      This RBA report linked by Mav also provides some context of our wealth from resources vs wealth from resources from country’s we envy who have SWFs in place. (No mention of current account balances unfortunately):

      http://www.rba.gov.au/foi/disclosure-log/rbafoi-101114.html

      • WDFH
        I don’t have a lot of hope that a SWF wouldn’t be raided by the next BER/NBN Bats for All junket. It would be money just begging to be spread from a helicopter..

      • Walt there are actually two things to consider in terms of an SWF. Maybe you have an opinion on this because it is something I have been thinking about myself.

        In terms of sectoral balance it is true that an SWF would be borrowing from either the government or private sector because we don’t have a CAS. Wildebeest actually had a good article about this on seekingalpha.

        http://seekingalpha.com/instablog/486073-wildebeest/200381-an-australian-sovereign-wealth-fund-what-sovereign-wealth

        However there is another side to this, and that is what effect the setup of an SWF would have on the market. If the setup of an SWF send a message to speculators that Australia is willing to manage its boom then the outcome maybe a decrease in the level of foreign capital investment ( with associated fallout ) and also carry trade, which could potentially lower the currency without the need to lower IRs.

        This however is certainly not my area of expertise, so maybe others have an opinion on this.

      • Walt Disney's Frozen Head

        DE,

        I am wildebeest. I was keeping that avatar for comments specifically related to stuff I have blogged …although I rarely blog. The rest of the time I am “constantly changing avatar.”

        (For those wondering about the sectoral objection to an SWF the Future Fund was an asset transfer so there was no borrowing from the private or government sectors to create it)

        The second point you make seems to mirror the sentiment of H&H the other day. Namely that a SWF would send a message etc. to speculators. In other words it would succeed via a change in perceptions.

        My objection/disagreement is that I do not see how a SWF of sufficient magnitude could be created (in a given time frame) to counter the forces that are behind the carry trade, foreign interest payments, whopping interest rate differential and so on. Your article has data about foreign interest payments that are twice what BHP made in their record profit year.

        The RBA article cited above shows that the countries with the envious SWFs have a resource sector that dominates GDP (also have surpluses though that was not mentioned). For all the hand wringing about the mining boom I contend that (apart from the sectoral argument) there just isn’t enough money there to make a difference in any case (relative to the forces of evil that are stacked up against us). That is why I’d like to see proponents of the “perceptions”/”send a message” based SWFs put some numbers down to convince us skeptics that this could possibly work. i.e. show us some data.

        …I consider myself a chartalist

        On an unrelated matter I was talking to an economist a few weeks back who didn’t like chartalists because, among other things, they supposedly think the government can spend for ever and there is nothing wrong with CADs. My understanding of chartalism is that there are clear constraints on government debt so I dismiss that part but I haven’t read much from chartalists on CADs. What is you view on CADs from the chartalist economic school of thought?

        ps. at the moment in the mid west of WA there are mining ventures that wouldn’t exist without Chinese capital. I mention this because we have banks in this country that are willing to fund ponzi housing (including by borrowing overseas) but not ventures that would actually increase our national wealth. This culture/mentality is why we are going down the plug hole.

      • Walt Disney's Frozen Head

        Oakajee is another good example of how frakked our priorities are in this country. It looks like the only way this thing will eventually go ahead is via Chinese ownership.

        Why are we funding ponzi housing yet having to rattle a tin to foreigners to get this project funded??

      • >I am wildebeest

        Well I am glad I outed you 🙂

        Thanks for your other comments on SWF.. It is certainly something I have been thinking about over the last week or so.

        The issue we have, as I see it at the moment, is that we have a carry trade pushing our currency higher than it would otherwise be. The normal response to that would be to lower interest rates to lower the differential between ourselves and other nations. However we are unable to do this because we have a private sector banking system and government utterly addicted to gaming the economy on houses.

        So we have two choices. Regulate the banking sector more to stop this kind of stupidity or introduce some sort of tobin tax on FX trades.

        >On an unrelated matter I was talking to an economist a few weeks back who didn’t like chartalists because, among other things, they supposedly think the government can spend for ever and there is nothing wrong with CADs.

        Well I can’t speak for others. But I consider both of those comments to be a total misrepresentation of chartalism. Chartalists state that a sovereign nation with a fiat currency is never constraint in its ability to spend its own currency, however this in no way suggests that it should spend with no regard for the outcome. That is exactly what GPEC is about.

        If you have some time check out my old blog where I talk about this concept.

        http://delusionaleconomics.blogspot.com/2011/01/readers-question-another-visit-to.html

  11. Seems to me that it all comes back to Australia’s unhealthy obsession with residential real estate. Get rid of that and most of the rest will fall into place. Once housing prices are back to sensible levels (which I would define as around 3 times average earnings) that will free up huge levels of resources for more productive investment. From a political perspective, management of the processes leading to this outcome will be very difficult. There will be quite a lot of pain for a lot of people.

    What to do? My first step would be to remove tax concessions for negative gearing. These have never made any sense economically. I bet Keating still regrets going back on his decision to reverse their axing back in 1987. Leith’s post back in 2010 made the argument pretty well http://www.unconventionaleconomist.com/2010/06/negative-gearing-exposed.html.

    Next steps? Maybe shake up state and local governments to get their act together with regard to releasing sufficient land. It looks like Barry O’Farrell may be heading in the right direction on this. After that, get rid of the halving of CGT, introduce tax concessions for bank savings accounts instead, R&D tax breaks, incentives for venture capital.

    • Yes, as bad as sending 83% of the profits of mining, a non-renewable resource, offshore is, the housing problem is quite a lot bigger.

      • The resources issue pales in comparison, as Walt says, consider the interest repayment alone on our Ponzi housing foreign debt.

  12. I cannot agree more with you on the GPEC score, DE, and it’s a very clever way to summarise the key priorities that Australian governments should be focussed on as far as the economy is concerned. However my main bone of contention is with the “means” by which these objectives are achieved, which suggests that the problem is perhaps more political than economic.

    What I mean by this is that the country needs a wholesale shift in the prevailing ideology with its blind faith in the primacy of the market mechanism for achieving efficient economic outcomes. The modern industrial economy is essentially a CORPORATE capitalist structure where big business (industry and finance), big government and, yes, big unions, co-exist. Don’t believe me, just Google the word ‘Mitbestimmung’…

    On the other hand, in Australia today we have a failed business sector living with ineffectual government and an almost non existent union sector. Now part of the problem is that Australian unions are also largely trade based rather than industry based, but that’s another story for another day.

    The key thing is that we need a 16th century style economic renaissance in this country which understands and accepts the necessity for the marketplace to be “managed”, rather than allowed to reign supreme when clearly this has failed the nation. This may mean borrowing policy ideas from the big industrial powerhouses of the world; but as it stands at the moment the mantra ‘leave it to the market’ is a poor and pathetic excuse for do nothing!!

    • >What I mean by this is that the country needs a wholesale shift in the prevailing ideology with its blind faith in the primacy of the market mechanism for achieving efficient economic outcomes.

      Yes this pretty much fits with my ideology on this. I do believe that the private sector IS economically efficient because the government cannot be. I talked about this here

      http://www.macrobusiness.com.au/2011/03/the-economics-of-government-service-failure/

      I do however believe that private interests will “game” any system if allowed to, and therefore there must be a regulatory framework in place to punish actions that are against the “public good”.

      This is however easier said than done. But I do have some ideas on this which I will try to share in future posts.

      • >I do however believe that private interests will “game” any system if allowed to, and therefore there must be a regulatory framework in place to punish actions that are against the “public good”.

        Well I don’t disagree with your view, DE, that there is certainly room for government to act as regulator where deemed necessary and in the public interest. But this is merely a subsidiary role; my point is that there is also perhaps a higher role for government to act as producer and thus be an active participant in the marketplace, ie., to lead by example, if you like.

        This is part of the mindset that needs to be changed insofar as the “co-operative” aspect of government intervention, as opposed to the retributive or regulatory funtion, needs to be nurtured and developed. The role of the public sector in this country has for far too long been unjustly demonised and ostracised at great expense to overall national prosperity.

  13. Cameron Murray has missed a vital point about productivity. The relationship between LAND and labour affects productivity too. Read the McKinsey Institute Report on Productivity in the British economy, circa 1996. The OECD has been starting to point out the same thing too – not just about Britain.

    When urban land is overpriced, labour productivity is reduced.

    Here is a simple illustration that everyone can understand. Your local car repair shop. Have you had to wait while the staff juggled parked customers cars, due to lack of space? Any economy where urban land is cheap, will have a lot less of this kind of thing.

    The same goes for the width of aisles in warehouses and supermarkets, the amount of space office workers have, the amount of space a production line has, etc.

    The McKinsey Report also pointed out that when inflated land rents are swallowing a lot more profit, the rate of investment in new capital by businesses, is slowed down.

    They pointed out that cumulatively, this effect over decades in Britain was considerable. Thanks to the “Town and Country Planning Act 1947”.

    Note too, that “primary industries” that bring income in from outside the economy, are MORE OFTEN “land intensive”. It is this kind of business that is most hurt by inflated urban land prices and cumbersome permission processes. “Anti sprawl” policies might as well have been devised by economic Quislings as an act of economic espionage. There are numerous other effects too – I am merely focusing on the “productivity” issue here.

    One related point, is that the inflated urban land prices put a squeeze on businesses, AND drive up the cost of living for workers, leading to wage demands that the businesses are LESS able to meet.

    • Great points. It should be patently obvious to anyone with any intelligence that increased urbanisation and lack of space are a massive curb on productivity.

      As well as the points you make, there’s the fact that in densely-populated cities, public services esp health are very stretched, pollution is high, commute times are long, stress levels are high etc.

      These are big drags on productivity.

  14. The way economist measure ‘economic growth’ is simply flat wrong, and it hides the underlying economic reality. Take the garment industry for instance. They essentially just buy something from China which lands here for $3, and sell it for $29.99 in the shops. The $27 does not represent ‘intellectual efforts’ either as the garment is also designed in China. So most of our ‘economic activities’ is merely ‘economic rent’.

    Innovation will not take place when a businessman can make more from real estate than his real business. Take Harvey Norman for example. 30% of their profit comes from being a landlord.

    http://www.smh.com.au/business/forget-tvs-harveys-real-play-is-other-shops-20110831-1jm2p.html

    So would you bother with selling stuff online when you can make more from collecting rent?

    • “The way economist measure ‘economic growth’ is simply flat wrong”

      +1

      Right on. GDP and its measurement is a Keynsian love child.

      Anything that encourages ongoing govt stimulus to keep an economy alive (positive growth) even if it means burgeoning govt debt is depply flawed.

  15. Urban land price bubbles do not just cause an economy to crash because the bubble has to burst eventually; the inflated urban land prices themselves, undermine the economy to ensure that the inflated prices are unsustainable.

    This is why High Pavletich is right about a median multiple house price of “around 3.0”. There are basic economic reasons why urban land prices settle at a certain level relative to the incomes generated from that urban area.

  16. DE: “For those of you with an interest in functional money (MMT) you will note that the sectoral balance equation shows the linkage between the change in non-financial business assets, private sector savings and the flows in sector balances. See here for more on this point.”

    The referenced article does not show a linkage between the “flows in sectoral balances” and the change in the real value of non-financial business assets.

    What it does contain is this:

    “What could cause an increase in the value of business nonfinancial assets, improving household financial positions? Fundamentally, there are two ways: Businesses could borrow or use their own cash to purchase real assets from the household and government sectors (holding the public sector deficit constant), or else the value of existing business nonfinancial assets can somehow be made to increase. Parenteau suggests policies that would push businesses to purchase real assets. But note that any sort of increase in the valuation of business nonfinancial assets, including intangible assets, would be sufficient to improve the household-sector financial balance. That would include events as insubstantial as a pure inflation, but also real improvements in business productivity. Again, looking beyond where sectoral balances can take us, distribution matters.”

    It leaves open the question of how “business nonfinancial assets can somehow be made to increase”.

    • Thanks paul.

      As always interesting feedback.

      However, given your obvious interest in economics I was wondering if you had any thoughts on the solutions to the issues I stated in the article?

      • Any prescription must stem from an accurate understanding of reality, so the task of improving one’s understanding must come before the task of attempting to prescribe.

        The sectoral balances approach leads people away from a better understanding of reality, for the reasons I have outlined here and elsewhere.

        I doubt there is any solution that involves manipulation at the macro level, because existing models of the macro level are not nearly close enough to being representative of reality. I doubt that they ever will be. Any model that is accurate enough to be useful will become widely adopted and will then significantly change the reality that is being modeled, leading to its own self-defeat.

        Therefore I believe the solution lies in reducing manipulation at the macro level and allowing order and growth to emerge from the micro level, as nature has been doing very successfully with no macro interference since Earth was formed.

  17. This is an excellent summary of the structural issues our economy faces, but to truly address the problem I think you first have to solve the political/personal dimensions that ultimately always act as impediments to major structural reform. To your acronym I would add –

    ORY: Over Rudd’s dead bodY. This represents the vested interest’s aversion to change, which is fundamentally just a desire to maintain profit levels.

    K: Represents the employee/householder’s aversion to change, which is fundamentally just a desire to Keep their job.

    ReG: Represents incumbent politicians’ objective to Retain Government, manifesting itself in reluctance (or practical inability) to provoke the ORY and K factors.

    This gives us the more comprehensive acronym: GREGORY PECK.

    Good luck solving that one.

  18. Thick banks are the problem, want to borrow a million to buy a Mcmansion then “come this way my son sit down and lets see what we can do for you” want to borrow a million to increase your productive capacity and all the gutless banks run screaming “what if you go broke we cant run a business you know, where just bankers” and unfortunately on this point they are too right!!!!!

  19. I’m an old b…..d and my opinion FWIW.

    If, over the last 50 years, we had concentrated on maintaining a balanced economy, including the external account, we would not have these problems. The external sector has been key in all this and, as far back as 1969, Universities were starting to teach that the external sector didn’t matter. Indeed the growth of a service sector was being placed as prime importance. Any argument that a ‘service sector’ was just that, needed industries to service, and would result in negative productivity, was summarily dismissed. The result was some very heated argument at least from one student!
    Nevertheless the philosophy prevailed and remains today. As one prominent professor explained a year or so ago ‘Foreign Debt doesn’t matter because it is never repaid’

    As a result over 50 years we have had a continuous (except for 1971) and growing CAD accompanied by a rapidly increasing ‘service’ sector. The culmination of this trend came in the Howard years as massive private credit creation resulted in an exponentially increasing CAD even in the face of rapidly increasing resource prices.
    The ‘service’ sector is, in fact, a real cause of the CAD and our Foreign Indebtedness. MB was the first place I had seen this issue raised in almost 50 years of being a close observer, and critic, of this economy.

    The reason our economy has been performing comparatively well over the past few years is not because we are so productive or efficient or thrifty or wise or smarter than others. The reason it has performed OK is that we have the highest resources per head of population in the world and we have been willing to sell them off to finance current expenditure and the purchase of trinkets. Wayne Duck even toured the world bragging that Aus had taken up something like 15% (open to correction…was it 10%?) of world savings post GFC. Good Lord!
    The sale of assets has been called Foreign Investment to attempt to hide the reality from Joe Public. I’ll come back to the use of euphemisms sometime. Imagine if we had not the resources to sell off how our economy would now look? Unemployment upwards of 20 odd percent (or 30 odd percent?), extreme inflation, massive dislocation at every level.

    Now. for those who say ‘all we have to do is fix the politico-housing complex’, while I have some sympathy with their intent, the problem is that it now is such an enormous part of the economy that any attempt to rebalance will result in massive dislocation. This will be accompanied by massive closures of retail and empty shopping malls. Coffee shops and restaurants will be shut almost nationwide. Service industries, such as retail etc, will be cut to shreds. However we would still have the entrenched power groups like the legal profession and powerful unions. For example, for reform, the idea that every lawyer is entitled to $500,000 per year has got to go. You start to get some notion of the problems ahead!

    I’ve said it often enough and I’ll state it again. The answer lies back in time. Whatever we do now will be costly to us as a society. However to continue to ignore the problems means we will continue to feel the current vice-grip becoming tighter at an increasing rate. Disaster awaits sooner or later. Franklly I fear the future.

    There is no point in thinking we can reform this without pain. MMT followers of Bill Mitchell claim that if you have idle resources it costs nothing to employ those resources. Unfortunately, with the structure of the economy as it is, with an out-of-proportion ‘service’ sector, any injection into the economy results in a substantial corresponding increase in the CAD and Foreign debt. So you can’t just hand out money. We already have too much which is why we have the CAD. For some parts of the economy to be rejuvenated we first have to shut down large portions of the debt producing sectors. Reform of the system and structure of the economy MUST come first. Any other course cannot work and will fail.

    As someone already observed we are involved in, at least, a 30 year project here. Even then I doubt it is possible. Our profligate shallow ways are too heavily entrenched. Our education system is infected, our universities are infected, our media is infected, our bureaucracy is infected, our politicians are infected.
    All are infected with the idea we can have everything for nothing. The changes now afoot in the world are about to teach us in a very nasty way that this cannot be and that we have built up a monetary, fiscal, and, perhaps, moral debt that is now coming home to roost.

    • The way the current account deficit (and associated foreign debt) has been dismissed by economists and policy elite in this country has always amazed me as well.

      In 2004-05 when the US was having big CAD’s, US economists really considered it the biggest challenge facing the US. But at the time their CAD was lower than Australia’s (which I think got to 7% of GDP) and their net income balance was positive I think (so unlike us, the US CAD was simply the trade deficit and could therefore reverse fairly easily).

      The lesson of the Asian crisis, Latin American crises, Russia etc. was that persistent CAD’s (especially if over 5%) are deadly. All these countries took this on board and framed future policy accordingly.

      What did we do? Continue to amass foreign debt by running CAD’s.

      Rogoff came up with a formula a while back which showed the point where foreign debt as % of GDP mean’t a country could not expect future trade surpluses to stabilize the foreign debt to GDP ratio. I can’t find the formula, but I’m pretty sure Australia has passed this point.

      The usual response to questions re. the foreign debt is “we are not Argentina, because our foreign debt is hedged and our currency floats”.

      What these people overlook is that; in the event of a sudden stop, for a nominal depreciation to reverse the CAD while GDP keeps growing, inflation needs to remain stable vs our trading partners. There is just no way that would happen. Even assuming inflation expectations didn’t increase if the AUD fell suddenly from 1.00 to say .40, consider where the price of oil in AUD would be?

    • Well that’s a bit depressing flawse. You don’t think that a political party run by the likes of DE could turn this around ?

    • Walt Disney's Frozen Head

      As one prominent professor explained a year or so ago ‘Foreign Debt doesn’t matter because it is never repaid’

      Even if it were never repaid it is clearly being serviced and the interest payments exceed our miners profits amidst a commodities boom!! FFS it beggars belief that economists could be blind to this.

      Now. for those who say ‘all we have to do is fix the politico-housing complex’, while I have some sympathy with their intent, the problem is that it now is such an enormous part of the economy that any attempt to rebalance will result in massive dislocation.

      There are no quick fixes to problems decades in the making.

    • Great post Flawse – Very much appreciated.

      Call me vindictive but I want to see the housing mafia lose in a big way. If that means LOSE – LOSE then I am FINE with that. I’m so sick to death of doing the right thing only to be played like a sucker.

      People who spend less than they earn (and subsequently save) are treated like suckers.

      * People with savings can’t get the dole until they’ve canabliised their life savings yet those that squandered their money collect it straight away.

      * Interest get’s taxed at your highest rate

      ETC ETC ETC

  20. Good suggestion BM. Leigh Harkness as Treasurere/RBA Gov
    Unfortunately I fear it may require DE to be dictator!!
    People are not going to like any attempt to fix the broken wheel. And there-in lies a problem. Under Howard, post his GST reform, the Libs really went down the populist road. The current party is following the same formula. They are telling people the whole thing can be reformed without significant dislocation. It’s just the Labor Party that is the problem! It ain’t!!!
    So as soon as any attempt at reform is attempted, with the resulting dislocation,it will be correctly charged that they don’t have a mandate. No reform Govt, Lib or Labor, can last more than three years!

    So every political party will continue to sell off the country, tax, confiscate private property, whatever it takes, so that a feeling of prosperity is maintained, however false, so that they can remain in power.

    It’s just that the rock and the hard place are getting closer and closer!

  21. Hi DE,

    I haven’t read through all of the comments, but just to quickly suggest: I largely agree with your analysis (I’m of the post-keynesian hue of economists). In your consideration of ‘what to do’, there would also be a sociological element built into the political economy. It may be a bit long-winded for you to discuss in any length, but ‘institutionalist’ (i.e. T Veblen, JK Galbraith, J Robinson, etc) social democracy is a big cog in the solution(s).

  22. Please vote! Not sure if it is possible but…
    I think this post by DE is so important it should be held at the top of the site for an extended period!
    It will be a shame if the discussion gets lost.

  23. The Victoria solution:

    Shift taxes away from income/excise towards taxing imports.

    This gets at the root of the problem: trade imbalances and creates an incentive for domestic and foreign companies to make productive investments in manufacturing.

    If it worked for Australia and New Zealand (minus New South Wales) in the late 1800’s when the population was 1/10 of today; protectionism should still yield industries of sufficient economic scale to attain efficiency.

  24. The problem with tariffs on imports is that it doesn’t fix the fundamental problem which is the over-valued dollar. When you protect industries with tariffs you basically sacrifice your exporters. I lived in rural Australia through the last bout of this stuff and its destruction of rural communities. It is not good.
    We need to get the value of the dollar down so that we are running, at least, a balanced Current Account. I’d argue that we ought be always in surplus since much of what we export is dug up and cannot be renewed.
    With a dollar at a level to deliver that balance I think industries can probably sought themselves out on a relatively level playing field.

    • I agree with you on tariffs.

      I think the answer lies in controlling the carry trade. That is, currency speculators who are not providing capital for business investment. ( well actually I would prefer that aussies were doing most of that as I stated in my post )

      The issue is that the usual way to control that behaviour is to lower the interest rate differential between Australia and other nations. But I think we are all aware of exactly what would happen if the RBA dropped rates tomorrow.

  25. DE
    Thank you and I agree the Carry Trade is THE big problem we need to concentrate on.
    Also most people think of 10 or 20% tariffs. Cut the carry trade and we may get a 40% (odd)change in competitiveness!

    I have ranted for many a long year about the insanity of the present ‘free market’ for our currency but the problems have been wildly exacerbated since Big Ben hit the ‘print’ button’

    It always seemed to me insane that if a country wanted to control consumption because of a CAD and rising Foreign Debt then it uses higher interest rates which drive up the currency and makes it’s export and import competing industries uncompetitive and destroys its own society.
    ANY imperfect alternative system is better than that. I don’t care how bad it seems to the conventional type of economists that are around.
    As I’ve said elsewhere I was working in the rural community in the earlier stages of its destruction. It’s devastating.
    So I’m looking forward to your, and other, contributions to possible alternatives.
    Again, ANY alternative is better than what is now happening.

    Just one danger lurking that no one else sees is the inflation problem. I see this because I’m an importer. Serious Inflation is headed our way out of China. Everyone is looking backwards and concluding no inflation ahead.
    Any fall in the currency will magnify this inflation to levels that will themselves cause serious dislocation.

    I guess it is another one of the problems. The value of the dollar has been used to control inflation no matter what the cost in terms of loss of industry.
    I do find it hard to get my head around the thought of “What were this lot thinking?” I guess they weren’t!!!

    The rock and the hard place cometh! There is no avoiding that. The problem is how to stabilise our economic situation without at the same time destabilising the society. I guess that is where political leadership should enter the fray. Fat Chance!

  26. Sorry P.S. For us to finance our own development, which we should do to a large extent even if it is at a slower pace than presently, we need savings.
    To have savings, in the long term, we need positive REAL AFTER-TAX interest rates. I’d suggest 5% is the PRAT figure necessary. So nominal interest rates would now need to be say 10%.
    If you add in the inflation I see coming down the tube, nominal rates would need to be 16% even at the current dollar.
    Build in a 20% decline in the currency and you get a required nominal rate of over 20%.
    Note the increasing interest rates will not quell the inflation if we hold the dollar steady or let it fall!
    OK I’m depressed enough. I’ll quit now while I’m behind!