Why Ken Henry gets it wrong

Oh to have economists in government service

In the aftermath of the last budget, Mr Rudd said that Mr Abbott had a ‘frightening’ lack of knowledge of economics. If that is true, it is all to the good. The last thing we should wish for is a prime minister who thinks he’s an economist. Economics is best left to economists, but there’s the rub.

When we look at profligate governments, those in debt and getting deeper into debt, like those responsible for governing the UK, the US, Greece, Portugal, Spain, France, Ireland, and so on; there are presumably professional economists in the background. Over the past ten and twenty years of government overspending, some senior public servants, trained in the rigorous discipline of economics, must surely have been giving consistent and fearless advice that it would all end in tears. It would seem not. Otherwise it seems unlikely that such profligacy could have gone on without mounting objection.

Take Ken Henry for example; he was fervent and open in his support of massive government spending to combat the GFC. We need the stimulus package and we need it now; summed up his advice. There was no sign at all of him urging some modicum of restraint.

Wherever we look, the economics profession in government service appears to have been hijacked by interventionist Keynesian ideologues, posing as economists. These so-called economists believe in the spurious and curious notion that economies are driven by spending rather than by making. Spending has become the measure of progress. There are three mutually reinforcing factors at work. One is the way economics is taught; the others are the bolstering factors of the national accounts and economic models.

For the most part, economic advisers to governments have been taught macroeconomics through the prism of Keynesian economics; as though they are one and the same. They come away believing that boosting aggregate demand through government spending is the way to produce growth and prosperity. They put aside all that they learn in microeconomics about the complex way market economies work. Can they do that and still be economists? I don’t think so. But you might say, if they’re wrong, won’t experience show it. That is where the other two bolstering factors come in.

When the national accounts come out, the emphasis is on what contribution consumer spending has contributed to growth, or government spending, or residential and non-residential construction spending. Spending is the sine qua non of performance.

Take one: the government spends taxpayers’ money to build a school canteen, at a reasonable cost. Take two: the same canteen is built at an inflated cost. Take three: the canteen having been built at an inflated cost is immediately blown up and demolished. Which of the three takes would be recorded as having a greater contribution to growth? You guessed it, ‘take three’. And there is more. If in fact, government takes resources away from the private sector, which might have used them productively, and uses them wastefully; this will be recorded, and written up, as the economy being saved from a decline in private sector activity by government spending.

Economic models use numbers of interrelated equations and data from the past. At their clumsy and proximate best, they provide a rough guide to what on average over a lengthy period might have caused what in the past. They cannot be used to predict the future (note to Henry re the RSPT). Nor can they be used to show what has caused what over any short time horizon. Nevertheless, we had Henry advising the Government that the wasteful stimulus schemes had created 225,000 jobs; not because anyone had actually identified and counted the jobs and assessed whether they represented a net gain in jobs, but because a model had said so. And, this misuse of modelling resulted in a complete fiction being put on the public record.

Government spending will always be recorded in the national accounts as having contributed to output and growth, dollar for dollar. The economic models will always show that any increase in government expenditure creates jobs. That is the way the national accounts and economic models work

Unemployed rose from 8 to 10 percent in the US despite its fiscal stimulus; and the stimulus worked to create many jobs we are told. In Australia, unemployment stayed well below early predictions; and the fiscal stimulus worked to create many jobs we are told. So we have quite different results but the same story.

We have in Keynesianism an undisprovable theory. The outcome can always be construed to show that government expenditure has created growth and jobs. This fiction can be countered only by economists. Where are they? Well they are clearly not advising governments; they are mostly in academia as threatened minority groups or in conservative think tanks. We need them in government departments before we all eventually go down the Greek road.