Is falling unemployment bad news for the Australian economy?

Gerard Jackson
BrookesNews.Com
Monday 11 December 2006

I have been warning for sometime that Australia was running an unsustainable monetary boom that could only result in recession. The much maligned and grossly misunderstood Austrian school of economics basically sees the ‘boom-bust’ cycle as being caused by monetary factors but consisting of real factors.

As I have explained so many times before, the artificial lowering of interest rates through the process of credit expansion causes firms in the higher stages of production to over-invest relative to the lower stages of production. (I use the term ‘relative’ because general over-investment is impossible: A fact that Austrians have stressed more than once).

This inflationary process discordinates the production structure by creating malinvestments, i.e., investments brought into existence by credit expansion and which become unprofitable once the expansion ceases. Eventually industry finds itself in a profits squeeze as demand for its products declines while factor costs, particularly labour, rise. In the meantime labour productivity also declines. (Kieren Daviesm, ABN Amro chief economist, said falling productivity means that unit labour costs have risen by 5.3per cent, the fastest in 15 years. Needless to say, inflation is edging up to 3 per cent).

Another feature that puzzles commentators is the phenomenon of falling unemployment and productivity even as manufacturing output slackens. What happens here is that GDP continues to grow along with the demand for labour. The Reserve Bank of Australia recently stated that domestic demand is rising at a rate of 3.8 per cent, which means it is running hot. It’s at this stage of the boom when some commentators warn that we now have a “two speed” economy. But what we are really seeing, however, is the inflationary process becoming more visible.

However, University of Griffith economist Tony Makin would argue that the mining boom is the cause of the profits squeeze. Two things here: First, the process I briefly explained would still occur in the absence of a mining boom. Unless one of these economists is going to argue that it was a resource boom that ended the Clinton recession. Second, the resources sector is obviously not competing away tens of thousands of factory workers and pumping up the prices of capital goods.

Some readers strongly disagree with my Austrian analysis. They agree that this is what happened to the Clinton boom, and that I did predict this process, but Australia is different. No it isn’t. Profit margins are being squeezed by falling productivity and rising production costs. This is exactly what an Austrian would expect.

The Australian Bureau of Statistics reported that 250,000 new jobs have been created this year. Moreover, it is reported full-time employment leapt by 57,400 last November, lowing the unemployment rate to 4.3 per cent. Shades of the Clinton recession. (The good news is that these employment figures have put paid to Professor Gregory’s arrant nonsense about wages and the demand for labour*).

(I should like to add that I spent sometime — to no avail — trying to warn Liberal Party MPs that despite what they had been told any productivity gains from the deregulation of the labour market would eventually be followed by falling productivity as unemployment fell. This situation could only be averted by a rapid increase in capital formation).

A profits squeeze always results in falling investment. And this is precisely what we have now got. But economic commentators like Terry McCrann tell us to be happy and not to worry because we have “an extraordinary and extraordinarily sustained increase since mid-2003” (Herald Sun, Retail numbers don’t tell us much of the future, 1 December 2006).

What Mr McCrann overlooked is that since mid-2003 to September 2006 bank deposits rose by 36 per cent and M1 by 35 per cent. In addition, Reserve Bank Assets rose by nearly 59 per cent during the same period. Since March 1996 to the present bank deposits have risen by over 130 per cent and M1 more than 100 per cent. Furthermore, from October 2005 last September currency leapt by 11.3 per cent, bank deposits by 21 per cent M1 by 19 per cent. Now this is what I call a monetary roller-coaster . And yet Australia’s economic commentators cannot see anything wrong with this picture. Do they really think that last October’s $1.3 billion trade deficit that saw a flood of consumer goods and capital goods enter the country has absolutely nothing to do with the Reserve Bank’s monetary policy? I fear it is so.

Now there is nothing wrong with Australia importing capital goods. The problem starts when those imports are being paid for out of a credit expansion that sooner or later the Reserve Bank must put an end to.

*Unemployment and wages: facts the Liberal Party ignore and the unions refuse to debate

The Liberal Party is still floundering on free labour markets

Gerard Jackson is Brookes’ economics editor

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