At the AFR today, Professor Warwick McKibbin offers us a ball tearing narrative for our times. It’s worth taking some time to dissect this piece as it is rare that we get something beyond the usual drivel. McKibbin begins:
Many policymakers fail to realise that a long-term transformation of the global economy is under way and the upheaval in established industries, reflected also in Australia, is not just a result of the mining boom or the Dutch Disease that commodity booms can spawn.
The implications of the global transformation are important for us as it will affect the rates at which our multi-speed economy adjusts, as well as the terms of trade and the capacity of the federal budget to respond.
The emergence of China and India has caused a growing structural shock for Western economies, as there has been a big change in production and consumption that has changed global relative prices and comparative advantage.
In short, production is moving where labour is cheapest. Western economies de-industrialise as Eastern economies industrialise. McKibbin then usefully profiles the US response to this:
Countries affected by the crisis have made the mistake of not adjusting their economies to this long-term structural shift, mistaking structural shocks for inadequate demand.
The 2001 recession in the US was met with loose monetary policy that led to further misallocation of global capital, setting the scene for the crisis in 2008, which was met again with demand management policy when the major problem was structural change and capital misallocation.
What an enormous relief it is to see a serious intellect and policy insider embracing two ideas here. The first is that the US was largely responsible for the post-millennium housing bubble, not China via the savings glut thesis. Although it is true that by 2005/06 the flow of Chinese savings into US long bonds was retarding the effect of interest rate hikes, by that time the horse had well and truly bolted, let loose by profligate rate setting under “easy” Alan Greenspan. Anyone who has tracked the writing of Doug Noland over the past decade knows exactly what I’m talking about.
The second idea is “capital misallocation”, which is an Austrian economics concept that in any boom you get overexcited capital doing stupid and ultimately unproductive things. To my mind it is probably the most important idea produced by the Austrian school and should long ago have been embraced by central banks, enabling them to not so actively manage the business cycle, but rather stand back and allow busts to transpire (this would of course lead to more and smaller recessions but would help prevent the kind of loing-cycle debt reckoning we now face). Bravo!
Mckibbin then moves his argument to Australia and there he sees a confusion between policy aimed at offsetting Dutch disease and the real need to adapt to the larger de-industrialisation trend:
If policy is based solely on forecasts about whether China will keep buying our minerals, then Australia is making a big mistake.
…In Australia, the 2012 budget was framed against a backdrop of major structural adjustment from a changing global economy, a collapse in productivity and major risks from Europe. Yet the budget focused on income redistribution and rapid fiscal consolidation with the goal of reaching a surplus in 2012-13… instead of investments in labour market flexibility, significant tax reform and removing impediments to incentives to innovate, this government has chosen to use the proceeds to consume the boom.
In short, we are making the same mistake that the US did in 2001, only we’re using fiscal policy to make it, not interest rates.
This article is dense but I really recommend you click through to read the original. It is powerful when considered closely. As an advocate of addressing Dutch disease, this is the most potent expression of the argument against that I’ve seen for some time.
I completely agree with Professor McKibbin on his assessment of the shortcoming of the Budget, not to mention the government’s total failure to prepare the body politic for the transformation described. However, I remain uncomfortable with the vagueness of the outcomes of the argument. Letting the transformation run its course without seeking to mitigate or manage it in some way leads me to the conclusion that de-industrialisation in Australia would accelerate and leave us denuded of industries that will be competitive once commodity prices and the dollar fall. At that point the skills and capital to make them work again would be beyond us.
Still, reinvesting big sums of the commodity windfall into infrastructure (hard and soft) and reform to prepare the nation to compete afresh beyond its good fortune is inarguably a great idea.