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September 23rd 2011 print

Steven Kates

Depressing economic news

There were two related bits of news this week, both depressing in their own way.


There were two related bits of news this week, both depressing in their own way. 


The first was the downgrading by the IMF of their forecasts for economic growth for the world’s developed economy, which in this case included Australia. The world is travelling less well than IMF had supposed it would and are casting a more pessimistic view of things to come. 

The IMF, like all other economic agencies, builds its economic models around some Keynesian variant of aggregate demand, so that more public spending ought, in its view, lead to a more robust economic outcome. 

It remains incredible to me to see how shallow economics as a discipline has become. Let me therefore state as emphatically as I can: only value adding economic activity can create economic growth and employment. Wasteful public spending cannot. 

Economists no longer know this. It is not taught and while in some vague sort of way is understood at some superficial level, when push comes to shove economists revert to Keynesian aggregate demand and act as if government spending money on whatever nonsense a government chooses to waste its money on is equivalent to private sector firms spending money on value adding investment projects. 

The fundamental equation of all modern macroeconomic theory (using only its domestic economy version) is Total Production = spending by consumers on consumer goods and services + business spending on investment projects + government spending on whatever governments choose to spend their money on. Or in its short form version Y = C + I + G. 

Increased G is in every way seen as identical in its effects as increased I. If there is any differentiation made at the textbook level I haven’t seen it yet. 

So look. I can turn you the reader of this post into a better economist than the majority of the actual certified economists of the world who follow in this Keynesian tradition. Just remember this: if whatever is produced cannot be sold in the open market at prices that cover their cost of production, the economy has, to that extent, gone backwards rather than forward. 

This would be true whether it was a private business or the government. It is only that it is far more likely to happen with governments than with a profit seeking business that makes public sector spending so unproductive. 

Public spending past some basic minimum – administration, the legal system, police, national defence, fundamental infrastructure – almost invariably wastes more resources than is put back into the economy. You will never, ever achieve recovery based on higher levels of public spending. 

That economists generally do not seem to know this is a scandal. But because they don’t know it, they are always expecting a recovery that never eventuates. The only recovery we will ever get will take place when government spending goes down as a proportion of total GDP. Then and only then will we be putting in place what is required to achieve an economic upturn. 

This change in policy is coming. The obtuse President of the United States, who is being abandoned by even his closest ideological brothers, has proposed no immediate cuts in spending, only cuts in the never never. Meanwhile, he seeks to increase taxes on “the rich” by some $1.5 trillion. This is a proposal absolutely dead on arrival. There is not a shred of economic credibility in it; it is all political posturing which by no means indicates it is valueless to the President himself as part of his re-election campaign. It is only valueless to the citizens of the USA if they are actually looking for better economic times. 

But so far as economics is concerned, there is not a single mainstream economic theory, not even the most Keynesian of models, that would tell you higher taxes is even a partial answer to recession. There may be some Marxist trope somewhere that sees a more equal distribution of post-tax income superseding recovery, but aside from something along those lines, no one anywhere would countenance an increase in taxation at a time like this, whether on the rich or on anyone else. 

The second bit of depressing news is that Australia’s own Wayne Swan has been named by the magazine Euromoney as Treasurer of the Year. I am happy to see, generally speaking, Australians picking up awards and prizes whether deserved or not. But this one filters directly into our political system and will give Swan and the government he is part of a credibility he and it do not deserve. 

The award is in my eyes directly related to the story from the IMF. Every economy across the developed world is sinking. I don’t think there is a serious success story to be found anywhere amongst the developed economies of the first world. Therefore, the award was given to the Treasurer of the least worst affected economy, which is ours. 

Here the economy is as quiet as can be. We have never recovered fully from the GFC, debt is now a serious problem when just three years ago we had none at all, and inflation is beginning to show serious signs of taking off. And after stabilizing the banking system, the only actions taken by the Treasurer to promote recovery – that is, all of those various forms of stimulus – have only damaged our growth and employment prospects well into the longer term. 

Two matters allowed the economy to show relative resilience. The first has been the Chinese demand for resources. The mining industry has been the one and only bright spot in this economy. Almost everything else is in the doldrums. 

But the second part was the fantastically sound economy that was bequeathed to the ALP by the previous government. There is a lot of ruin in a nation, as Adam Smith once said. The economic policies of the previous government added to the amount of punishment the Australian economy could withstand, which has been the capital which the present government has been continually drawing down upon. 

What is a shame is that there is no award for The World’s Best Former Treasurer which Peter Costello would win in a walk. Why he didn’t win World’s Best Treasurer when he actually was the Treasurer is all you need to know about the gnomes who write for Euromoney and the Keynesian theories economists base their policies on.