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Jan 19, 2011

How Labor found itself in a surplus trap

Labor’s abandonment of economic reform after 1996 has left it adrift and the party's adherence to its promised 2012-13 surplus reflects how it let its enemies define its economic credibility.

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Labor carries much psychological baggage from the Howard years. In fact, it’s got the political equivalent of post-traumatic stress disorder. And the greatest damage accrued around economic management.

That’s why we’re having this faintly weird discussion around whether the projected Budget surplus should be abandoned to “pay for” the cost of recovering from the floods.

Labor’s abandonment of economic reform after 1996, as I argued at the end of last year, has left it adrift. This is one of the key reasons why this Government, under both Kevin Rudd and Julia Gillard, has been so bad at framing debates in a way that favours itself. As Paul Keating said – ironically quoted by Wayne Swan after the election last year — politics is an ideas market and if you run the ideas, you run the market. Labor’s dearth of ideas, and its inability to communicate those it has, means its opponents are running the market.

Labor in its first term did a spectacular job of economic management (well, Treasury and the Reserve Bank get most of the credit, but Wayne Swan and Kevin Rudd had the good sense to do as they were advised). But they ended up letting the Coalition make the Budget deficit the de facto measure of its economic competence, particularly during the election campaign. That the Coalition so badly fumbled this exact issue in its post-election discussions with the independents is one of the ironic instances of justice occasionally served up by politics.

But the Government’s oft-repeated commitment to return to surplus by 2012-13 come what may is its admission that it is stuck with a debate defined by its enemies in the Opposition and the media. The projected surplus itself is trivial – a bare $3b – but is therefore of enormous symbolic importance to the government, as if that $3b represented a vast gap between incompetence and astute economic judgement.

You can thank Paul Keating – the “bring home the bacon” version of the dim, distant past – and more particularly Peter Costello for this fetishisation of Budget surpluses. But it’s Labor’s fault that the significant, though hardly massive, fiscal impact of the floods (bearing in mind that the stimulatory “cost” of the rebuilding phase is only part of the fiscal impact, given the lost revenue from farms, miners and businesses who have had to halt business) is being seen entirely through the prism of what it will do the surplus.

The number — a projection two years away, in any event — itself doesn’t matter a great deal. The surplus is simply a tool of political debate, for all sides – even for the business community suddenly changing its mind about the need to curb government spending. That’s why Tony Abbott produces nonsense like the line that the NBN is a luxury that we can now no longer afford. Strangely, he didn’t mention the tens of billions we’re spending on Defence procurement, or the many tens of billion of dollars a year of revenue foregone on tax expenditures, or the tens of billions spent each year, enthusiastically supported by both sides of politics, on middle-class welfare. Even the most cursory glance reveals that there are a whole lot of luxuries in the federal budget.

The Government has one part of its fiscal consolidation strategy correct – to cap extra spending at 2%b real growth and bank upward revenue revisions. What it has been poor at is actually cutting expenditure, for all its insistence that it has made “tough decisions”. Some blame for this lies with the Coalition, which blocked cuts to one of the worst middle-class welfare rorts, the private health insurance rebate, and it’s true that the Government had to balance an uncertain global environment in its first two budgets. But no one believes that in Penny Wong we have a new Peter Walsh ready to spring forth and assail spending ministers, or that she’d receive much support from her Treasurer and Prime Minister if she did so.

A more intelligent debate, led by a Government that had its wits about it, would be around the need to roll back expenditure in politically-sensitive areas to get the Budget on a sustainable footing over the long-term. And all the more so given that, under even the mildest climate change scenarios, the cost of recovering from extreme weather events is going to plague future budgets much more frequently than we’re used to.

Bernard Keane — Politics Editor

Bernard Keane

Politics Editor

Bernard Keane is Crikey’s political editor. Before that he was Crikey’s Canberra press gallery correspondent, covering politics, national security and economics.

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47 comments

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47 thoughts on “How Labor found itself in a surplus trap

  1. ronin8317

    The Australian’s government have a good reason to be a deficit hawk. This is illustrated by this chart from Paul Krugman’s blog.

    http://lh3.ggpht.com/_VgJQTp0Bsf0/TTQ5-dwV2JI/AAAAAAAAACg/o0i3XF2gMts/australia_debt.jpg

    Our private sector is heavily indebted to foreigners, and we need to run a Government surplus to keep interest rate low. While it is nowhere near the monstrosity of USA, we have to consider the wisdom of borrowing so much money from overseas in order fuel our ever rising home prices.

  2. John Anderson

    Bernard Keane is right to say that Labor is unable to effectively communicate its ideas. But I disgree that it doesn’t have ideas. Indeed, you could argue that it has too much on its plate, noting the delicate balance in the House of Representatives could scuttle some of them. What about the MRRT, the Murray Darling water trade-off, mental health, a price on carbon, the increase in the super guarantee and the related Cooper super reforms, rolling out the NBN, the health/hospitals reforms and the related GST trade-off and the plethora of education reforms that Gillard announced during the election campaign but largely ignored by the media? Some of these are huge economic reforms.

    Rather than Labor becoming a captive of the surplus fetish, Keane actually shows how Labor can have its cake and eat it too. That is to say, have a surplus and similtaneously fund the flood damaged infrastructure. For example, a reintroduced private health insurance reform package will pass the Senate with Greens support after 1 July 2011. There’s $2 billion over 4 years. All the MRRT proceeds [that’s billions of dollars] could be allocated to flood damaged infrastructure rather than just some of it. The company tax reduction could be deferred until the the flood bill s is paid for. There is some irony here given the pressure from business [the AIG] to spend up big to save jobs and small businesses and to hell with the surplus.

    As for middle class welfare, it will be a little easier to remove given the Greens’ opposition to most of it. It’s the House of Representatives that could be the stumbling block. So the flood costs are easily financed. What a budget surplus in 2012-13 depends is solid economic growth, the greatest threat domestically to which is the RBA’s penchant for lifting interest rates.

  3. Greg Angelo

    The problem with budget deficits is that they have to be funded, and that funding comes from borrowings and those borrowings have to be repaid. Counter cyclical expenditure financed from borrowings during a recession is sensible to take advantage of underutilised labour and capital resources with the benefits funded from future taxation where the beneficiaries of this expenditure happily repay borrowings whilst they enjoy the benefits. However deficit funding in a tight economy will only lead to inflation.

    As the United States is finding out you cannot run budget deficits forever. Eventually you fall into a debt trap were all you can do is fund the interest on the borrowings that you have made in previous periods. The borrowings to fund the profligate public expenditure on pink batts, the NBN, the BER and now the proposed disaster reconstruction will have to be repaid, and there are already indications that the Reserve Bank is having to offset inflationary pressure in the economy as a consequence of this expenditure.

    There is no problem with public-sector deficits in the short term, provided the capacity to repay is clearly understood. The projected return to surplus is only the beginning of process as the surplus is required to repay borrowings, should government set this as an objective.

    It is interesting to note that the US government has not run a balanced budget for decades and that over $13 trillion of debt has been built up as a consequence of a lack of concern for balancing public sector budgets. This is over USD 46,000 per capita, or about USD 120,000 per taxpayer. Australia’s federal net debt by comparison is relatively small at around $140 billion or about $6700 per capita or $20,000 per taxpayer. However the borrowings for the BER and the NBN will significantly impact on those values with net debt projected to rise to around $168 billion by 2013-14 or approximately 10% of GDP. This represents a net borrowings of around $150 billion under Rudd/Swan/Gillard stewardship with aprojected annual interest bill of somewhere in the vicinity of $10 billion per annum at current interest rates. Unless the budget returns to significant surplus enabling debt to be paid down, we will be saddled with this interest bill in perpetuity. Advocates of deficit funded (borrowing funded) spending without constraint should consider these matters carefully.

    Also those advocates promoting elimination of the health insurance rebate should note that in the past health insurance was tax deductible for income tax assessment purposes. and that elimination of this rebate would force many people out of private health insurance and into the public health system which would not be able to cope. Privately insured patients get a 30% rebate on their medical costs but are still funding the other 70% out of after-tax income.

  4. freecountry

    Budget surpluses are not a “fetish”. Like commercial entities, churches, and most large organizations in general, governments seek to expand themselves. Like most organizations, it is sometimes prudent for governments to spend more than they gain for limited periods of time.

    Unlike other organizations, governments hardly ever have to confront hard limitations on how much they can borrow, or how fast they can accelerate borrowing, because sovereign entities have almost limitless powers to defer the taxation of citizens until another day, or another generation, to pay it off. (Or so it seems, until Ireland or Iceland happens.)

    Also unlike other organizations, voters in a democracy crying out for more expenditure are usually under the mistaken impression that they can get something for nothing, by forcing a richer minority or foreign shareholders to take on most of the tax burden. Majority rules. Explaining that it’s nowhere near as simple as that requires economic explanations that most of the public, and even most journalists, either lack the patience or background to understand, or simply discredit as a bunch of “neoliberal” hocus pocus. To put it as simply as possible: the more uneven the tax burden, the more business tends to fail or move offshore, reducing tax revenue instead of increasing it, reducing the competition for goods available to consumers, and inflating away the value of real wages so workers become poorer even when their nominal wages are rising. (And John Anderson, that inflation is the reason the RBA has such a “penchant for lifting interest rates”.)

    I find it very strange the way the left insists that greed and reckless disregard of risk has broken the credibility of capitalism; while at the same time arguing that indulging people’s greed for public spending, and recklessly disregarding unknown risks to national solvency, is responsible economic management. Insisting that the call for surplus is a mere “fetish”.

    Public spending should shift urgently to areas which can demonstrably reduce costs and risks to the Australian public. Public transport, water management, soil management, energy supply, urban design, alleviation of export bottlenecks, and accumulating a strong capital fund of emergency money for a rainy day.

    All forms of spending should have sunset clauses, requiring periodic review in parliament. Tax revenue must be increased, not by increasing aggregate rates of taxation, but by increasing the base of taxation, through the above forms of spending, and through efficiency improvements in the way we tax. As I’ve said elsewhere, even a carbon tax might impose less deadweight distortion losses than some of the taxes we are using now (the worst of which is capital gains tax which is so dear to the hearts of anti-capitalists).

    Governments state and federal must wean themselves from their political addiction to implicitly guaranteeing house prices and suppressing the building of homes, because this causes a huge drain of people’s present and future income, into paying the interest for overseas loans from which banks fund their mortgages.

    In short, Labor has got to go, Wayne Swan is a bull in a china shop, and the Coalition needs a clean-out because Tony Abbott and de-facto deputy Barnaby Joyce show only a dim awareness of what needs to be done.

  5. JamesH

    Greg Angelo and Freecountry: Base or High-Powered Money is a creation of national sovereign (think for a moment about why that word means both “independence” and “coinage”) governments; in a modern fiat-currency system, it has no existence independent of the actions of governments. When governments tax, they withdraw money from circulation, they don’t “gain” anything by doing so. When they spend, they add money to circulation and don’t “lose” anything by doing so, because the money has no existence outside of government action. There is no law of conservation of money; there is no need for taxation to equal spending; there is no absolute need for national governments to borrow anything at all.

    What is important is that the total money stock (roughly, base + credit extended by banks) and the supply of real goods and services remain in more-or-less balance. It’s better for monetary expansion to lead real supply expansion rather than vice versa, because mild monetary expansion calls real goods and services into the market to match (creating jobs to supply them) while contraction leads to them being withdrawn, deflation, recession, etc; in other words, money supply is the independent variable. Since the money supply has to expand to accomodate economic growth, either governments must expand the base money supply (that is, run “unfunded” deficits) or the stock of private credit must constantly expand; that is, people must take on more and more private debt. The current western world-wide crisis is precisely because people took on more and more private debt until a Minsky crisis hit. Generally speaking, if governments attempt to run surpluses, that is, withdrawing more from circulation than they add, this will only exacerbate the deflation.

    It can be useful to fund infrastructure and other big public sector investments by “borrowing from” (that is, selling bonds to) the private sector because this drains funds from the private sector, thereby preventing the money spent up front on building the infrastructure from triggering inflation and/or an unsustainable boom, and puts the money back in later as the bonds are paid off. But this is an exercise in preserving monetary balance, very different from private sector borrowing which has no other way of raising funds.

    Exports and imports complicate this picture a bit because net exports effectively let us add other governments’ money to our money stock. Thus if we were to run strong net exports sufficient to cover the private spending deficit (from mining, say) the government could run a surplus to prevent the economy overheating. But our exports are basically dependent on other people (particularly the chinese) running deficits (or in China’s case, running down their reserves/surplus); and by simple logic it’s impossible for every country in the world to have net exports.

    Read up on Chartalism and Functional Finance if you want to know more about the basis for these statements.

  6. freecountry

    JamesH,

    That’s all true but it has one flaw: it relies on government discipline to ignore all temptation to expand the money supply for political reasons. We addressed the monetary side of this with an independant RBA–independent but by no means omniscient or infallible–but that still leaves the fiscal side in the hands of politicians.

    Now here is the fly in the ointment: those politicians are immune to any criticism which the voting public does not understand. The consequences of abusing the value of money can be good for the government in the short term, leaving the downside to be borne by others down the track.

    And I ask readers here: How many of you understand what JamesH wrote there about the money supply? Or to rephrase the question, how many of you have, at the very least, studied monetarism at third-year undergraduate level? Not me. I can parrot the reasoning, but I can’t claim to really understand it. And there are competing economic theories about it: Friedman says the money supply should be held constant, like a sailor adjusting the sails to keep a steady course in a changing wind, while Keynes says a wise government should read the wind and change course, expanding or contracting the money supply as conditions dictate.

    The reason Hayek opposed Friedman and favoured a gold standard is not because of its “intrinsic value” (look at the gold markets today, there’s nothing intrinsic about its value) and not because of any mathematical superiority (he agreed with Friedman on that count) but because no government can be trusted not to debase money for the sake of short term glorification and re-election. It’s even easier when a government can shift opportunistically between monetary theory and Keynesian demand theory.

    Budgetary discipline is not a mathematically perfect way to assure workers that the wages they earn today will still be worth something tomorrow. But in the absence of the gold standard or any other objective standard, it is the only one we have. If budget discipline is publicly derided, then you have nothing but your trust in the inspired wisdom of government to assure you that your wages are not being stolen from you, and that your children are not being turned into indentured slaves whose destiny is to pay off our profligacy and have nothing of their own.

  7. Greg Angelo

    Is over 40 years since I studied economics, so my knowledge is at best fundamental and somewhat rudimentary. Whilst I recognise the need for expansion in money supplyto accommodate growth, it seems to me fundamental that governments should not withdraw more resources from the economy for public sector expenditure than it is prepared to generate from taxation in the long run. This includes repayment of borrowings used to fund deficits. I am also aware that expansion of the money supply by government as a stimulatory method provides short-term benefits, but people accepting currency expect it to be of intrinsic value some of the money supply exceeds the value goods and services available the net result is inflation.

    Short-term deficit finance is perfectly acceptable from a counter cyclical stimulus perspective but long-term structural deficits appear to be a significant driver of inflation. Returning the budget to surplus is merely an equilibrium point where the government stops spending more than it is generating in receipts in a specific accounting period. It does not in itself reduce the impact of prior period borrowing because interest is still being paid on the debt used to finance the deficit, on the presumption that government is matching its net consumption with net taxation withdrawals/borrowings from the economy, whilst allowing for timing differences funded by interest on debt.

    I am also aware that expansion of the money supply by government as a stimulatory method a short-term benefits, but people accepting currency expected it to maintain its intrinsic value. So if the the money supply exceeds the value goods and services available the net result is inflation.

    Based on the simple reckoning in my comments above, $150 billion or so to be spent bythe Gillard/Rudd Rudd government over five or six years (before any further outlays on disaster reconstruction) up to 2013 will add $10 billion interest per annum to government outlays. This is approximately $1500 pa per taxpayer. If my understanding is correct I am with Free Country in requiring governments to balance their budgets in the medium term. Accordingly this $150 billion will have to be repaid. There is no free lunch. Future taxpayers will have to cover this current expenditure through increased future taxation or reduced government expenditure to pay down debt. Alternately government can progressively extinguishes this debt in real terms by allowing inflation to increase to progressively rob the financially denominated savings of the community through inflationary erosion of liabilities.

    Also if you have the courage, look at the US debt clock website. The numbers are truly frightening.

  8. JamesH

    Freecountry: I think talking about “indentured slaves” is a bit excessive. More generally, governments here and elsewhere regularly mount election campaigns on the basis of how fiscally frugal they are going to be, how they are going to balance/drive into surplus the budget, etc; which suggests that the special interests who elect them have quite a healthy (or in fact, excessive) concern with “sound” budgetary policy.

    The sad truth is that politicians are only occasionally responsive to “the voting public” and far more responsive to monied interests – look at the spineless ALP backdown over the mineral resource rent tax. The political centre has shifted a long way to the right since Milton Friedman’s day when everyone was concerned about stagflation. (For that matter, Margaret Thatcher couldn’t make Friedman’s money supply policy work – and if maggie thatcher wasn’t able to impose a policy, then it’s basically unimposable).

    “No government can be trusted not to debase money for the sake of short term glorification and re-election” – au contraire, my friend, the major problem of Europe and the US is that they are not debasing their money enough in the current slump; the Euro is inflexible because it has to accomodate both Germany and Greece and so the PIGS are unable to competitively devalue, and the US can’t balance their trade with China because they won’t expand the monetary supply enough to force China to stop pegging the Yuan to the dollar.

    Greg, I think you have missed my point that it is not necessary for governments to “borrow” at all. They can expand spending up to whatever proportion of the real supply of goods and services they want, provided they then withdraw that money through taxation; its the taxation to withdraw money from circulation (or pay back the “borrowing” aka bonds) that prevents inflation.

    You say “Alternately government can progressively extinguishes this debt in real terms by allowing inflation to increase to progressively rob the financially denominated savings of the community through inflationary erosion of liabilities.” But on the whole the community and private sector are in net debt, not in net savings. Certainly my savings are smaller than my mortgage. Mild inflation, if it occurred, would help me more than it hindered me and the same goes for most mortgage and business owners. The losers from inflation are the rent-seeking “industries”: banking and real estate.

    You object to monetary structural deficits but this ignores that we currently run a major real structural deficit: the 12% of un- and under-employed australians who lack jobs to do and consequently are the causes of most crime and social dysfunction in this country. From 1945 until 1972 we had no problems running a more or less continuous structural deficit and guaranteeing 2% unemployment, with very mild inflation, under a far more stringent (because still partly gold-standard and fixed exchange rate) monetary policy than we do now. What we did once, we can do again.

    The US debt clock argument misses the fact that most of that “debt” is in US government bonds held by US banks and citizens. It’s actually a measure of private sector savings held as bonds. The US govt would not issue bonds if the private sector didn’t desperately want to buy them as a safe place to put their savings in the current dire economic circumstances.

  9. freecountry

    JamesH:
    [Freecountry: I think talking about “indentured slaves” is a bit excessive.]
    A bit dystopian, you think? What if I suggested many Australians are already some way down that road, whether they know it or not. Those who pay rent in the capital cities, and those who’ve bought their own home in the last five or so years.

    In the heavily government-controlled land market, and in the absence of a sophisticated understanding of microeconomics in the era of easy credit, these prices have strongly outstripped wages. The excess prices mean that up to half of a worker’s after-tax income, rather than a long term trend closer to a quarter, goes to paying off the windfall gain of an earlier generation.

    The reason this is relevant is because there are various ways of storing the value of the work you do, of which the fiat money it issues is just one example. Land is another. And there have been a series of policies in which government chose to boost confidence in land at the expense of confidence in its own fiat money.

    Real estate is not one of the losers of inflation as you say; it gains from inflation, because most real estate is bought with credit and inflation is the best way to amortize a loan principle. The result has been an average official rate of inflation of around 3% for some people, but a dramatically different rate of inflation–in terms of living standard and alternative stores of wealth–for others, with the younger generations being on the losing side.

    Government gets away with this because the winners are voters, while most of the losers are either too young to understand, too young to vote, or not even born yet. This is just one example of how government undermines its own fiat money, not by conspiracy, but by having very little idea of what it’s doing, and having more pressing things on its mind, such as re-election. That’s why, as you say, “Margaret Thatcher couldn’t make Friedman’s money supply policy work – and if maggie thatcher wasn’t able to impose a policy, then it’s basically unimposable.”

    So I agree when you say, “it is not necessary for governments to “borrow” at all. They can expand spending up to whatever proportion of the real supply of goods and services they want, provided they then withdraw that money through taxation; its the taxation to withdraw money from circulation (or pay back the “borrowing” aka bonds) that prevents inflation.”

    Or to put it another way, yes we should help Queensland rebuild. But no, this does not excuse the government from a budget surplus–indeed, it’s hard to justify why the budget was not already in surplus in 2010 instead of still accumulating debt until 2013. Something has got to give. Please don’t vote for free lunches.

  10. JamesH

    Greg Angelo: The difference is that the amount of money withdrawn by taxation should be the amount necessary to keep inflation controlled, which is not necessarily equal to the amount extended by government. Government spending should complement private sector spending; if the private sector is net saving (as they are now, because everyone is trying to pay down debt) then the government should net spend (that is, run a deficit); if the private sector is net spending, then the government should save; but over the course of a cycle they should net spend, because the money supply has to expand with (and to produce) economic growth and employ the new people entering the workforce. Forcing the government to balance its budget with respect to its own spending, rather than the economy as a whole, is a great way to produce recessions. Indeed, that may be the point; see Kalecki’s classic paper “political aspects of full employment” which is now public domain.
    On your question about the relationship between debt, bonds and deficits I suggest reading this (and linked) webpages by Professor Mitchell, which explains it a lot more clearly than I can at my pretty basic level of understanding:
    http://bilbo.economicoutlook.net/blog/?p=10384#more-10384

    Freecountry: I think we are thinking about different bits of the real estate cycle; if one party is gaining from inflation amortising their loan, then the other party who extended the loan is losing, and landlords are also losing unless they raise rents faster than inflation. I’m quite in favour of relaxing many planning and zoning controls and replacing them with a land rent tax a la Henry George.

    On free lunches: If we don’t deficit spend to take advantage of underutilised resources (in particular, the unemployed), it’s not voting for free lunches, it’s wilfully refusing to eat a lunch we’ve already paid for; because one way or another, we pay for keeping people out of work.

  11. freecountry

    JamesH:
    [The difference is that the amount of money withdrawn by taxation should be the amount necessary to keep inflation controlled, which is not necessarily equal to the amount extended by government.]
    For a given dx change in spending there will be a dy effect on inflation, regardless of whether individuals and companies spend it x or government does. The only way taxation can be used to control inflation is either to divert income into saving (which is better done by superannuation), divert income into paying down debt (in which case that should be the main purpose, not inflation control), or else drop it down the toilet in the form of taxation deadweight losses. In short, inflation control is not a legitimate purpose of taxation.
    [If we don’t deficit spend to take advantage of underutilised resources (in particular, the unemployed), it’s not voting for free lunches, it’s wilfully refusing to eat a lunch we’ve already paid for; because one way or another, we pay for keeping people out of work.]
    What about Laffer curve optimization? What about deadweight loss reduction? Many people are alienated by talk of taxation efficiency, but the thing to realize is, every dollar of deadweight loss is a dollar less of income for somebody, and every $50,000 or so of these is one less job. Workers tell their bosses they need more assistants, and the boss says, sorry but one more worker would cost slightly more than the benefit. No can do.

  12. Greg Angelo

    The term “surplus trap” is a misnomer. Returning the federal budget to surplus means in simple terms an end spending not funded through taxation through borrowings or some other money supply inflation methodology whereby the government spends more than it earns . True believers of course, like children believing in the “magic pudding”think the government should be able to spend as much as it likes without consideration of the source of funds or the ongoing impact of an interest burden arising from borrowings.

    In nominal terms balancing budgets over several annual cycles is considered to be good public finance notwithstanding timing differences involving countercyclical expenditure programs from year to year.. Implicit in the concept of of a deficit budget (spending more than you have earned in taxation receipts) is that in some time the wheel will turn and budget will go into surplus to repay the debt incurred. Forecasting return to budget balance is necessary to indicate to the community that the government is serious about long-term fiscal balance by showing a proposed time when the government intends to bring its it is annual expenditure into line with its taxation receipts. This is the necessaryfirst step before the budget goes into surplus to repay debt.

    As one would understand from reading the comments above the issues of financing deficits, creation of money by governments, budget surplus in deficit is a highly complex area of economic analysis which most people needs to be understood in relatively simple terms. However facile criticism of government intention to return the budget to surplus on the basis that it is some mistake attributable to immature fuzzy faced “spin doctors” or attributing criticism being derived from some category of “class enemy” underscores the shallowness of some contributors appreciation of this issue.

  13. freecountry

    Here’s what’s commonly known as the “surplus trap” syndrome. I gather Mr Keane is familiar with this usage, and is using it as a metaphor for political addiction to surpluses, as David Hand says.

    I cannot agree. As Greg Angelo says, there’s nothing wrong with alternating surplus and deficit through different phases of the business cycle–in theory.

    My problem is the gap between theory and practice. First, it requires a clear signal on when the business cycle is up and when it is down. You would think it’s not that hard–when the RBA lifts rates to normal, it’s time for a budget surplus–but that happened in 2010, so why do we need another 3 years of deficit?

    Second, it requires politicians to decide who’s going to play Santa Claus, and who’s going to play Uncle Scrooge. Not surprisingly, even self-styled “conservatives” like John Howard and Tony Abbott cannot resist the democratic siren call of talking like Scrooge but spending like Santa Claus. Tony Abbott’s $75,000 baby bonus is a great example.

    As for Labor, they like to put on a Scrooge voice but they are very careful to aim it at just one sector, which becomes a scapegoat for everything, supposedly leading us all to ruin. For everyone else, it’s party time. As far as I’m aware, only one federal Labor government ever ran a budget surplus in the last 100 years and that was under Ben Chifley in 1946-49.

    The “business cycle” is a very insignificant thing compared to the election cycle. Governments push their luck as far as they can, then leave their successors to clean up their mess. You cannot trust elected politicians to alternate between surplus and deficit. You have to set a simple rule and train people to expect it will be followed in all but the direst emergencies.

  14. JamesH

    @ Freecountry:

    The statement “For a given dx change in spending there will be a dy effect on inflation, regardless of whether individuals and companies spend it x or government does.” makes several simplifications which I think mislead. For one thing, it ignores the velocity of circulation, which is lower in slumps and higher in booms. More generally, inflation will only result from a positive change in net spending across the economy if real goods and services don’t increase to match the spending. Governments are often better placed to do that because they can construct the infrastructure which enables real production expansion, and they can bring the unemployed into the workforce. History has shown that when the private sector is increasing its net spending, they go for asset speculation on sources of rent: stocks, land, etc; which drives the prices of these assets up without increasing the supply – hence inflation results from the knock-on of higher rents.

    The only way taxation can be used to control inflation is either to divert income into saving (which is better done by superannuation), divert income into paying down debt (in which case that should be the main purpose, not inflation control), or else drop it down the toilet in the form of taxation deadweight losses.

    The counter to this follows from the ideas above. If taxation is targetted so as to discourage rent seeking (e.g. land value taxes, wealth taxes, estate taxes, Tobin taxes, capital gains taxes) and encourage the expansion of production and consumption (e.g abolishing payroll taxes and transfer taxes, raising income tax threshold, R&D discounts) then lower inflation is very likely to result.

    Freecountry, I think your mistrust of politicians is not misplaced, but disproportionate. As Bernard’s article implies, far from Julia promising the world today and worrying about payment tomorrow, she is making the opposite mistake, refusing to pay for needed social programs because of an excessive (in the current context) concern for running a surplus – excessive because it is done for highly political reasons, not out of any economic responsibility.

    Furthermore, it assumes that politicians are the only political animals out there, whereas the private sector is no better and possibly worse. The idea that we have to have a simple rule which is somehow “immune from politics” in practice removes the politics from the public view (parliament) into a private financial capital club (the board of the reserve bank) – and as the recent film “Inside Job” and the obvious revolving door between the US Reserve, the US Treasury and the Goldman Sachs board make clear, this in fact means handing over monetary and fiscal policy to rent seekers without a fight. Look at the makeup of our Reserve Bank Board – do you think they would ever make a decision that threatened financial capital’s interests? Again, I would recommend Kalecki’s “the political aspects of full employment” on why certain capital segments will willingly create recessions in their own interests.

  15. freecountry

    First of all, Julia Gillard is not defending “a surplus”. She is defending a slovenly decision to stay in deficit for three years after the RBA has commenced contraction. By comparing this to a proposal for an even longer extension of deficit, she makes herself sound like a defender of “a surplus”. This is a smoke-and-mirrors trick.

    Second, there will be no surplus in 2013. This projection is contingent on the world behaving predictably, and an increase in mining tax having no effect on overall business investment and business tax revenue. If voters believe (a) 2013 is soon enough to return to surplus and (b) it will actually happen, then I’m sorry to say, Australia’s age of prosperity may well be over and it will follow a long line of once-prosperous countries into decay and decline.

    Third, you have based your argument on big-end-of-town rentseeking to counter my own argument about pork-barrel rentseeking. Which is bigger?

    Fourth, velocity theory is overused politically as a kind of magic trick, like Jesus feeding 5000 people with a few loaves of bread and two fish. More accurately, a worker’s exchange of, say, one day’s labour for a pair of shoes, may be efficient and involve associated trades between many people around him, or it may be inefficient and involve high deadweight losses when those trades do not occur. It may be delayed in time by an intermediate period of saving and investment, or it may be brought forward in time by borrowing, incurring an outflow of interest to the overseas financiers of his bank. Tweaking the system to persuade people to defer consumption less and borrow more than they otherwise would, is just reducing efficiency and lighting the fuse on a time bomb.

    One way or another, the ultimate purpose of all production is consumption. Of all the different ways of measuring the efficiency of converting production to consumption, velocity is the most error-prone and the least meaningful. No wonder Keynes based his whole aggregate demand theory on it. The only economic questions that should be used to assess economic policy are:
    (1) how efficient is it?
    (2) how equitable is it?
    (3) how sustainable is it?

  16. JamesH

    Freecountry, I’m not clear on what point you are trying to make, and I don’t think that what you have said is in fact consistent with your Hazlitt article. He says that velocity is not a constant and I agree; a lot of the rest of his points stem from wilfully ignoring the role of credit, debt, central banks and tax and treating money as just another good, as if we were on a full reserve gold standard. I’m aware that mises.org would like us to be on a full reserve gold standard, but we aren’t.

    A shortfall in aggregate demand mechanically caused by increased savings and decreased velocity (which is in turn caused by people’s subjective desire to hold money rather than spend it) does not just “delay” demand. When people save rather than spend and pay down debt, sales drop. Production stops; stores run down their inventories; people get laid off from their sales and production jobs; those people then have no wages to spend so demand drops further; Those who are still getting incomes intensify their savings behaviour against themselves becoming unemployed or going out of business; deflation starts to occur, which increases the real value of debts and encourages further saving and hoarding behaviour, the value of assets plunges so banks start to fail because the assets against which they loaned are worth a fraction of what they loaned out, etcetera and so on down the spiral. There is no sufficiently powerful private market countervailing mechanism which encourages those with savings to stop saving and start spending. If all around you things are getting worse, you save against when they get worse for you.

    Such a slump can persist indefinitely, there’s no reason for demand to pick up again: e.g. the 19th century Long Depression. In the meantime, a lot of productive output and consumption is permanently foregone, not to mention a lot of lives destroyed. That foregone output and consumption doesn’t all come back when people who “delayed” their deman start spending again.

    Your biblical parable reference is rather hyperbolic and unhelpful. If output and consumption is being foregone, then the right action can actualise it – there’s nothing miraculous about it.

  17. freecountry

    This is all a theory, and Keynesian explanations of past depressions are not universally accepted. We are not all Keynesians now, no matter how shrill Krugman’s ad hominem attacks when he insists that we all should be. Quoting from your link:
    [Third, monetarists — old-style Friedman-type monetarists who focus on monetary aggregates, or the new style which says that the Fed can and should target nominal GDP — are, whether they realize it or not, part of the axis of monetary evil as far as the demand-deniers are concerned.]
    But my objection to Keynesian economic policy is not how well it accounts for the world, but the way it interacts with politics. Long term governments such as China or Saudi Arabia may be able to wield demand theory judiciously. But look what happens when the head of Treasury gives Kevin Rudd some advice so clear, and so simple, that he believes it to be politician-proof:
    [“Go early, go hard, go households.”]
    How was he to know that Rudd would go off on a tangent and make the boosting of house prices his biggest priority? What has that got to do with boosting aggregate demand? With jobs? If you think it through in Keynesian terms, it is a non-productive form of saving and the exact opposite of a boost to aggregate demand. Rudd then goes on to create an artificial building boom, carefully steering it well clear of housing (and thus inflating building costs) lest it increase the supply of houses, lower prices and get him voted out of office by home owners.

    Meanwhile everyone trying to buy a house drops discretionary spending almost to zero–not because their consumer confidence is down, but because that’s the only way they can afford the deposit and service the mortgage!

    And yet these acts of robbery of the Australian public have also been defended using Keynesian arguments. The theory is so easy to abuse for political gain. Like the bible, you can use aggregate demand theory to say whatever you want it to say.

  18. JamesH

    For someone styled “Free Country”, I find your repeated disparaging of democratic governments in favour of authoritarian ones disturbing – though totally consistent with Hayek & Friedman’s own political preferences of course.

    You have retreated to a position that there’s nothing wrong with Keynesian arguments except that politicians will lie about them. But why is this something unique about Keynes’ arguments? What economic theory hasn’t been abused for political gain? The Tea Party is full of gold bugs and extremist Austrians and they are, perhaps non-coincidentally, backed by the Koch brothers resource extracting interests. Thatcher used Friedman to justify crucifying the UK trade unions and David Cameron is currently using deficit hysteria to resume Thatcher’s war on the poor. The very latest economic theories were used in New Zealand in the 80s to justify demolishing their welfare state – that their application led to recession and poverty did not (and does not) appear to have bothered NZ politicians and economists at all.

    If there is no criteria than which side of politics or social class is served to judge theories by (a situation long recognised, e.g. Marx in “Capital”: “Thenceforth, the class struggle, practically as well as theoretically, took on more and more outspoken and threatening forms. It sounded the knell of scientific bourgeois economy. It was thenceforth no longer a question, whether this theorem or that was true, but whether it was useful to capital or harmful, expedient or inexpedient, politically dangerous or not. In place of disinterested inquirers, there were hired prize fighters; in place of genuine scientific research, the bad conscience and the evil intent of apologetic.”) then I will support the theory that enriches the many at the expense of the few rather than vice versa, thankyou very much. But in fact the weight of evidence as well as politics is on Keynes’ side.

  19. freecountry

    You misunderstand the theory of freedom, which suggests that both elite government and the democratic will of the people need to be restrained from having and abusing excess power. Freedom comes first and foremost from clear laws and clear expectations of government, not by giving any agency carte blanche.

    As I said on Thursday, the advantage of Austrian economics over other (perhaps mathematically more sophisticated) macroeconomic models is that it fixes the goal posts somewhere everybody can see them, so voters can judge whether elected government is meeting its responsibilities or not. In monetary theory the goal posts move with one degree of freedom, and in Keynesian theory the goal posts move with two degrees of freedom. Regardless of whether Keynes is “right” or not (and I don’t think he is) those moving goal posts make for some wonderful political illusionist tricks, and we have seen some great ones in the last two and a half years. Tricks to bring the house down.

    You’ve shown your colours with the recommendation of a Tobin Tax and the Marxist interpretation of the 1980s reforms, on which many people disagree with you. So I’ll close my side of this debate with a quote from Nobel Prize Laureate George Stigler. Stigler here is talking about a different topic, that of market competition, but the principle is the same.
    [A famous theorem in economics states that a competitive enterprise economy will produce the largest possible income from a given stock of resources. No real economy meets the exact conditions of the theorem, and all real economies will fall short of the ideal economy—a difference called “market failure.” In my view, however, the degree of “market failure” for the American economy is much smaller than the “political failure” arising from the imperfections of economic policies found in real political systems. The merits of laissez-faire rest less on its famous theoretical foundations than on its advantages over the actual performance of rival forms of economic organization.]

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