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Why Rudd's spending binge cannot save the economy

Gerard Jackson

Monday 25 May 2009

The economic commentary swirling around Rudd's budget reveals how bad economic thinking is in Australia. What none of our so-called pundits have grasped is that government spending in the form of borrowing from the public is never stimulatory — and it certainly is not Keynesian. When the government borrows from A to put B to work it is not expanding aggregate demand but merely transferring purchasing power from one person to another. A fundamental economic fact that every classical economist fully understood.

The Keynesian approach consists of monetary expansion to fund deficits and government borrowing. In case you are wondering, this is called inflation. Unlike Rudd and Treasury head Ken Henry the devious Mr Keynes knew exactly what he was about. He also understood the inherent inflationary danger of such a policy. This is why in in 1937 he publicly called on the British government to end new public works projects, warning it against the inflationary effects of any "general stimulus" even though unemployment stood at 12.5 per cent. (T. W. Hutchison, Keynes v. the 'Keynesians'...?, The Institute for Economic Affairs, 1977, p. 11).

What we need to look at is the money supply. A vital factor in the economy's behaviour that our all-knowing economic commentariat keep overlooking. (This lot even manage to talk about the Reserve's monetary policy without ever referring to the money supply). Reserve figures show that since last September all measures of inflation have been falling. They also show that the prices of materials used in manufacturing started to drop in the same month and that the CPI flattened out at the same time. Therefore it should be no surprise to see that GDP also started to slow in September and has obviously continued to do so.

After M1 began a slow contraction in December 2007 the Reserve pumped up it up in the following May to June period by nearly 9 per cent, which averaged out annually at about 54 per cent. Since then M1 has been basically flat. Yet the fact that all the inflationary indicators have been slowing since September 2008 has not been linked to the Reserve's monetary policy by our economic pundits. Furthermore, from September to last April the Reserve's assets have been declining. Unless there has been a sudden and significant change in its monetary policy this can only mean that it is still not making a serious attempt to inflate the money supply.

It has to be clearly understood that without a significant monetary expansion — which I am not recommending by the way — the government's spending spree will be as effective as Ken Henry's sterile Keynesianism which — it should be noted — failed to predict the downturn and the credit crisis in the US. Treasury and Reserve officials refuse to acknowledge the that manufacturing is a leading indicator in the boom bust cycle. The May Australian Industry Group report for April showed that manufacturing had suffered its eleventh consecutive contraction. The following table shows just how dire the situation is and it ain't getting better.

March 2009
% change
March 2008
Average wages
Source: The seasonally adjusted Australian Industry Group-PricewaterhouseCoopers Australian PMI

Last year I warned readers that manufacturing was signalling that the Australian economy was in recession. Nevertheless, our economic punditry insisted that the country had successfully weathered the international financial crisis. So not only are we in recession we have politicians and their economic advisors trying to foist on us the same lousy economic policies that got us into this mess in the first place.

Enter Ken Henry who is clearly rattled by the criticism that Rudd's spending policy is irresponsible. Well, he should be rattled. After all, he's one of the geniuses who advised Rudd that rocketing government spending and debt was just what Australian economy needed. Climbing on to his high economic horse he huffed that:

Apparently, the right time for a 'Keynesian revival,' involving the spending of large amounts of public money, is when tax revenue is strong and rising, a normal feature of economic boom times.

Ken Henry Treasury
Treasury Head Ken Henry's 'Keynesian' advice will do grave damage to the Australian economy
Two points here. First, it is clear that the policy is not really Keynesian. Second, 'Keynesian economics contributed mightily to our current plight. As for Henry’s Pollyanna forecasts, these are as worthless as his economics. What can we expect when multipliers play a key role in Treasury models. But there are no Keynesian multipliers. The Keynesian multiplier is a myth. No wonder Treasury cannot get anything right.

In a recent speech Henry revealed how awful the Treasury's economic thinking really is when he called population growth, the participation rate, the employment rate, average hours worked, and labour productivity economic drivers. According to Mr Henry by "simply multiplying together these five things" we get economic output. (Terry McCrann. Treasury analysis utter and appalling fantasy, The Australian, 23 May 2009). Henry's economic views really are scary.

Allow me to once again repeat a basic economic fact: entrepreneurship drives an economy and savings fuel it. Savings are what produces capital accumulation, otherwise called economic growth. The idea that GDP and growing productivity always indicate growth is a grave error. A situation can actually emerge where GDP and productivity continue to rise even as the capital stock is consumed and heavy unemployment continues to burden the economy. This is what happened in the US during the Great Depression. For example, from 1929 to 1936 labour productivity rose by 25 per cent while net capital formation plunged by minus 15.2 per cent. (W. Arthur Lewis, Economic Survey 1919-1939, Unwin University Books, 1970, p. 205.)

Joe Hockey MP
Looking like Shadow Minister Joe Hockey will make the same mistakes he made with labour market reform
The response of the Liberal Party to Rudd and Henry's financial depredation has been appallingly weak. The Shadow Treasurer Joe Hockey released a brief report detailing the size of the forthcoming deficits and debt. And that was it. There was no attempt to explain why Rudd's reckless financial bender cannot work. It's a painful fact that Hockey is a typical Liberal politician. The type who demand 10 second sound bites and slogans. The last thing they want is anything that would force them to actually think.

It was this attitude that destroyed the Liberal Government's case for labour market reform. Hockey was part of the team that was supposed to explain the benefits of free labour markets while also refuting the government's critics. He failed dismally because he refused to do his homework. When provided with data that refuted the policy's critics he refused to consider it because that would have required an effort on his part, not to mention an inquisitive intellect. We are now getting a repeat performance with Rudd's economic policies.

Gerard Jackson is Brookesnews' economics editor

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