The Australian economy and the decline of manufacturing — what is really happening?
Gerard Jackson
When it comes to Australian manufacturing Australia’s free-market commentariat adopt a blasé attitude. Alan Wood, an economics writer for The Australian, is a good example of what I mean. His response to Electrolux disinvesting in Australia was to comment that “[i]n the age of globalisation, offshore sourcing of production by industries like Electrolux is sensible and inevitable” (Offshore move is inevitable, 15 September 2006).
On the other hand, Tim Colebatch, economics editor of The Age takes a different tack. He noted that though the world economy is estimated to have expanded by 25 per cent since 2001 the volume of Australian imports rose by only 4 per cent while domestic spending leapt by 25 per cent. Now Colebatch was on to something with respect to spending. But being the interventionist that he is he completely missed his own point by arguing that our borrowing should have been invested in industry instead of on “our houses and house prices”.
Alan Wood is not really much better than Colebatch. He and the rest of our “economic rationalists” automatically assume that when companies move their operations offshore it is in response to undistorted economic forces as explained by the law of comparative advantage. Ordinarily this would be so. However, Wood and company do not realise that this law rests on the assumption that trading partners are practising sound monetary policies.
(Colebatch’s comment about housing raises an interesting point about the nature of credit. Many are warning that the size of the debt burden is putting a strain on households and the credit system. As Richard von Strigl put it: “The more credit expansion progresses, the greater will become the share of additional credits in the overall volume of credits within the economy”. [Capital and Production, Mises Institute, 2000, first published 1934]. In other words, the huge debt has been produced by the Reserve’s relentless credit expansion).
Remove the assumption of sound money and we, as Americans say, will find that it is a whole new ball game. I am not alone in this belief. In 1970 Samuel Brittan, a well-known economist with the Financial Times, made a similar — and may I say astute — observation by pointing out that countries with overvalued currencies will become more import oriented while their trading partners become more export oriented.
What this boils down to is that when countries inflate faster than their trading partners domestic industries producing tradable goods will find themselves unable to compete against exports. Their only recourse will be to either shut down or move offshore*. In such a case firms would be moving offshore in response to dysfunctional prices created by a loose a monetary policy. In my opinion this appears to be the case in Australia. From March 1996, when Howard was elected, to June 2006 currency grew by 91 per cent, bank deposits by 143 per cent and M1 by 110 per cent.
By any measure this is a massive monetary expansion. Yet all of our economic commentators, both left and right, have seen fit to ignore it, leaving me to draw the conclusion that for them the money supply simply does not matter. But in my opinion this monetary expansion is the root of our housing boom and the fuel that has been driving the current account deficit and our foreign debt.
The question of the influence of changes in the money supply on exchange rates imports was hotly debated more than 200 years ago. It was called the “Bullionist Controversy”. However, it seems to me that Samuel Mountifort Longfield was the most lucid on this question. He posited the idea that if spending is directed to imports at the expense of investment then the capital structure will shrink. (Joseph Schumpeter credited Longfield with overhauling “the whole of economic theory and produc[ing] a system that would have stood up well in 1890”, History of Economic Analysis, Oxford University Press, 1994).
Using absentee landlords as his active agent Longfield expressed the view that if these landlords spent their rents on buying French dresses and lace for their female companions instead of investing in their Irish farms this could alter the factorial terms of trade for Ireland. This in turn could bring about an unfavourable change in the structure of production. (Three Lectures on Commerce and one on Absenteeism, 1835). John Ramsay McCulloch took issue with this view and argued that it doesn’t matter where a man spends his money. But Longfield’s fundamental point is that spending on consumption at the expense of capital accumulation will eventually lower living standards, something that McCulloch would not deny.
I think it’s pretty clear that if we combine Longfield’s insights about spending on foreign goods at the expense of saving with the views of Ricardo, Peter Lord King et al. on the “price of bullion” then we will find that Longfield’s thinking explains what happens when increased spending on imported goods is fuelled by a monetary expansion.
*Because of the Reserve Bank’s loose monetary policy I believe it is highly unlikely that anyone will be able to tell which firms moved offshore because of a monetary induced change in the exchange rate and which ones moved because of a genuine change in their comparative advantage.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 18 September 2006