QED

Henry redux

by Peter Smith

May 19, 2011

---

Sophisticated fiscal debate

---

Martin Parkinson, the new Treasury Secretary, ended his post-budget speech to Australian Business Economists (17 May) with the thought that we would all “be better served by a more sophisticated debate about ... fiscal policy”. The subtext presumably being that Treasury knows best. Henry has morphed into Parkinson: new person, but with the same allegiance to Keynesian economics. He sounded as though he will continue the close friendship with Wayne Swan and the Labor Government that Henry so evidently and openly established.

Where does that leave us? Quite simply in the hands of economists who are dupes of a crank (Keynes) and who therefore have no idea how the economy works. An extreme statement you might think. Let me back it up by reference to Parkinson’s speech.

In noting that the GFC resulted in a deep global recession he claims that while the world lost 30 million jobs, Australia “created” 700,000. Notice the subtle terminological switch. Australia did not gain jobs as the world carelessly lost them; it created jobs. And, lo and behold, we are told that the stimulus accounted for 200,000 of the jobs created. Hopefully this is a final stab in the dark. In last year’s budget we were given a figure by Treasury of 225,000 jobs (is the difference of 25,000 accounted for by out of work ceiling insulators perchance) and Ms Gillard, with her usual disregard for facts, was spinning a figure of 450,000. In fact, no-one knows how many temporary net jobs might possibly (stretching a point) have been created by stimulus spending. Instead of admitting this we are given figures spun out of models which have as much relationship to reality as CGI in the movies. Is this an example of sophistication?

We were told that Australia “dodged a bullet” because of economic reform put in place by governments over the past 25 years and, of course, because of “the fast-acting stimulus”. Here Parkinson’s slip shows. He noted that one aspect of this reform was the resolve to bring deficit budgets back into surplus. Well excuse me but that was not a 25 year reform Mr Parkinson, it was a Howard and Costello 11 year reform starting in 1996 and ending in 2007. But, in any event, the process of bringing the budget into surplus year after year played no part in Australia dodging the bullet. How could it have done that? What it valuably did was to make the later wasteful and profligate stimulus spending bearable.

A second aspect he noted was the establishment of “robust monetary policy frameworks”. I assume this primarily refers to giving the Reserve Bank independence in setting monetary policy. Again, this had little to do with Australia dodging a bullet. Australia was lucky. We had China and a resources boom and banks that were heavy borrowers of overseas funds to support that boom, which meant that they had little capacity to invest substantial amounts in toxic mortgage-based assets. They would have invested in them in other circumstances. Australian bankers are no brighter than their overseas counterparts. Fortunately too, interest rates were high in Australia, again because of the resources boom, giving the RBA more scope to reduce them.

If the stimulus worked so well in Australia why did it not work in every other developed economy? They all tried it. The United States had a bigger proportionate stimulus than Australia yet from the end of 2007 until mid 2010 the US lost 7 million jobs. But never mind they have their Keynesian economists too, who explained that the number would have been 10 million without the stimulus.

Putting half truths and myths on the public record is not a sign of sophistication, though I admit the alluring and heady power of stimulus policy which you can always claim has worked whatever the outcome.

In one of those amazing leaps of faith of Keynesian economists when faced with the malaise created in Europe by deficit spending, Parkinson assumes that an increase in the budget deficit adds to growth. Thus he believes (unbelievably) that the decline in the budget deficit from $55 billion last financial year to an estimated $49 billion this year will take 1 percent off GDP growth. Moreover he says that if pruning the budget were to proceed at a faster pace than currently envisaged (just the right pace of course) it would likely backfire, and could, by reducing growth still further, worsen the budgetary position.

You really have to take a deep breath to grasp this analysis in the context of the current state of the Australian economy. As Parkinson correctly notes, the labour market is “edging towards full capacity” because of the resources boom. At the same time, the rising exchange rate is reducing the competitiveness of manufacturing and service industries, across Australia, which are not directly benefitting from high commodity prices. Monetary policy has already been tightened significantly and will be tightened further to ward off inflation.

In such circumstances, the non-commodity private sector must be given maximum room to adjust and continue to thrive. Effectively this means minimising interest rate increases, consistent with keeping a lid on inflation, by withdrawing government spending. But apparently Parkinson is fearful that cutting government expenditure will reduce growth, and to such an extent that the budgetary position may possibly worsen? I can only think that this is because Keynesian economics has totally befuddled him?

Earth to Parkinson: we are pushing up against capacity constrains; the more we limit government expenditure to allow room for the productive private sector the more prosperous we will all become and the fewer people will be thrown out of work unnecessarily because of rising interest rates. How to debate this in a more sophisticated way I don’t know, but then I suffer from not being a Keynesian economist.

 

---

Subscribe to Quadrant magazine here…

---