Good Question Barry

Peter Martin highlights an excellent column by Barry Hughes, but the part of the column I’d stress is not the idea that the RBA shouldn’t be slowing the economy (and as a result increasing unemployment).  As Hughes says, this is appropriate to prevent the current increase in price rises in our economy entrenching itself into inflation.

But as Barry says- referring to Glenn Stevens’ comments:

On this short-term response he cannot be faulted, but what comes after the emergency is controversial. Hitherto, bureaucrats have fudged their unease over recently falling unemployment with a tautology that Australia was coming closer to capacity (the production equivalent of the natural rate). Now, they have been emboldened by rising inflation to break cover.

In addition to Stevens’s judgment of a “pretty fully employed” economy, Treasury said at budget time that future growth would have to be dependent on new productive capacity “rather than any [my emphasis] further soaking up of spare capacity”. In other words, Australia has reached its unemployment limits.

These thoughts have been lurking in the background for some years. For example, for more than three years since February 2005 (when unemployment exceeded 5 per cent) the bank has warned about a need to keep spending growth within the limits of potential gains in output. Economists recognise this as code for no further falls in unemployment.

But is higher inflation a one-off from external food and oil shocks or is it a consequence of an overheated economy? As Stevens admits, wages still show no general symptoms of overheating, while the issue of the whereabouts of full employment remains unsettled in the research literature.

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Michael Kalecki
Michael Kalecki
13 years ago

Nick,

We hadn’t approached NAIRU when the RBA intervened to slow the economy.

Does this not mean those estimates of 4.7% were well off the mark and indeed the figiure may well have a three in front of it.

Would not both the RBA and Treasury readjusting their estimates?

observa
observa
13 years ago

“But is higher inflation a one-off from external food and oil shocks or is it a consequence of an overheated economy?”
Perhaps these guys can explain it all to you fairly succinctly-
http://www.atimes.com/atimes/Global_Economy/JF25Dj03.html
My only advice is not to get too close to central bankers if you don’t want a big dry cleaning bill for some pesky tar and feathers.

observa
observa
13 years ago

Now I’m no expert but the experts might like to recall that old MV=PQ equation again and think about PQ consisting of 3 broad parts. The real economic domestic PQ, the real foreign PQ(as it affects imports and exports) and the domestic assets PQ(ignoring the foreign assets one as stable) which that domestic money supply and velocity support. Increase the money supply with a heap of new household formation baby boomers in their youth and the reaction is swift and obvious. Not so when they’ve had their kids and are at the peak of their earning and savings capacity, thinking about retirement nest eggs and the Winnebago. A subtle switch begins with the assets PQ which might start to impact the real economic PQ, especially if central bankers keep feeding the money supply. No matter there’s always imports which might begin to rise in price (exchange rate mechanism), except if Asians spooked by a meltdown decide to work harder(low pay rates)and save harder to ameliorate that, in order not to be in such a position again. Central bankers oblivious to all these gradual structural changes keep on with business as usual piling on the money as the economy demands because they see no problem with the real domestic PQ. Welcome to their problem now should the players in those other PQ parts of the equation suddenly adjust their thinking and behaviour. The Austrians would simply say we told you so dummies.

observa
observa
13 years ago

When you think about in real terms, MDC baby boomers real savings should have been pouring into the capital hungry developing countries as real investment, but did it? No, it was really funny money that’s trying to find a home in commodities, or commodity streams now and the MDCs are up to their tits in debt for inflated assets now and their central bankers are running around like headless chooks wondering why their blue sky has fallen. Meanwhile the Austrian economists are wryly pondering how long it will take Keynesians to understand how hard it will be to unwind all those years of malinvestments now and what will be needed to ensure it never occurs again. We live in interesting times again.

An interesting side issue to all this is our shiny new, non-xenophobic, Tampa sorry, Rudd Govt dealing with those massive Chinese SWFs wanting to buy our commodity streams with our funny money now. Should we be trotting out the ‘R’ word with his recent take on that now?

Mark Hill
13 years ago

We can’t have unemployment lower than 5%?

Time for some microeconomic reform, no doubt.

observa
observa
13 years ago

Let me give you an anecdotal look at how China’s workers have impacted Australian building costs. As a tradey you have to constantly make economic decisions over tools. How much for how long and how many in the kit. Chinese workers have changed the equation dramatically. Cordless tools are a no-brainer as the tradey needs quick charge, long plateau, sudden drop off batteries, so forget the handyman, slow charge, immediate taper stuff. It’s the battery quality you pay for, albeit the Makitas, etc can use Chinese workers to build to their quality specs and keep costs down overall. Power tools are a different category now. Take the chippy’s stock in trade the Makita 9″ power saw($350). Yes he has the old faithful for first fix, but now he has a GMC 7.25″ ($48) and uses that frequently because he could buy a pack of 3 tungsten carbide blades for $10 vs $30 for one blade for the Mak. The GMC has a 3 year replacement warranty (only for no-commercial use), but how would they know if you keep the receipt in the warranty file and the unlikely happens. A personal credit card is a personal credit card, whether you’re using it to track business or personal expenditure. Since he mostly cuts 45mm maxm. thickness timber the GMC is fine(and lighter), although the blades are not as good(you’ll find that out cutting MDF or chipboard with their abrasive glues, where High Speed Steel is useless) However they’re both equally useless should he hit a nail or say a staple ripping down a door to size. Another one from the pack of 3 is much gentler on the wallet then. Same deal with an Ozito planer for $58 cost(yes that includes GST Chinese workers)Makita replacement planer blades are around $35 bearing in mind they’re all reversible for a new cutting edge once and equally useless if you hit that staple in the door. I have a Hilti rotary hammer drill(replacement cost around $750) on the shelf now because the universal chuck won’t hold the clip in masonary bits any longer and a new chuck is $140. It’s done some incredible work and there’s none better at the job but a Chinese copy of an old Kango design for $78 does me now for the last 3 years. They’re $69 now although I saw them out for $50 once recently, bearing in mind they come with spare brushes, standard drill chuck, 3 masonary drill bits and a spade and point jackhammer bits. Those bits have knocked down a few brick walls with ease that the Hilti never could. Yhis sort of cost allows the tradey to carry more marginal use tools like a recipro saw, Chinese made Bosch multitool instead of the dearer German, Fein Multimaster and so on, all making the tradey more productive at lower cost. That’s what Chinese workers have been giving our economy for years now, right down to the chep, occasional use, inverter welder I can sling on my shoulder and whip up a ladder with the solar cutout welding mask and fix a structural steel stuffup in a flash. And while all this was going on with low interest rates, I wasn’t too concerned about high cash balances in the Company chequing account and making them work. That’s what central bankers in ivory towers couldn’t and wouldn’t have known all those years, with all those individual decisions aggregated together and they never, ever will. That’s the fundamental lesson of Austrian economics.

Tel
Tel
13 years ago

I really find it annoying the way economists attempt to collapse the dimensions of any problem (usually down to a single dimension) thus destroying any meaning in their measurements. Unemployment is not a “rate” it is people, many people, each one of them with their own story including skill sets, age, ability, education, objectives, etc.

The Australian economy (and the US for that matter) has been stratifying, so the rich are getting richer, the poor are getting poorer and the middle is getting emptier. There’s a bunch of reasons for this. Unions in Australia used to be strong, and unabashedly Socialist. Whole industries were union operated and wages were pretty much set in those industries regardless of individual ability or initiative (I’m talking 1970’s here). Similarly, governments were committed to public healthcare, public education, moderately generous welfare, etc. This enforced a system where no one was horribly badly off but almost no one was fantastically well off either. The difference between a basic factory worker’s wage and a highly skilled worker’s wage was not all that large.

Since then, unions have become less popular, they have been losing members, they have become less relevant to their remaining members and have lost the ability to control industries. The Hawke and Keating governments were part of this, Howard finished the job and Rudd seems unwilling to kowtow too easily either. Along with this, more Australians are self-employed, our economy is more “globalised”, generally Socialist sentiments are no popular anymore and Australians are more willing to see themselves as Capitalist economic agents. Add to this, political pressure has swung towards being somewhat less generous w.r.t. welfare (although Australia is still fairly generous). At the same time, China has been eating away at our industries starting with the low-skilled mass production jobs, while technology has also been eating away at low skilled labouring jobs.

The final result: if you have good skills then for you unemployment is very low. If you can do something complex that is difficult to outsource to India or China then you will be in demand. On the other hand, for those people without skills (including young people right out of school and ex-factory workers) unemployment is high and it is tough to find a job. The pay scale of each job probably reflects supply and demand more now than it used to 30 years ago and the skilled jobs have seen steady pay rises, while the unskilled jobs have gone backwards in real terms. This social split has been ignored by economists of all schools. Similarly, if you want more capacity then just start investing in training some of those young people who got ripped off by John Howard’s failed education policy or start retraining the older people who have given up trying. That is going to require public investment (yes, the taxpayers will have to put money into long term social infrastructure). This is about 10x more important than fussing around with various ways of measuring inflation. The inflation has already happened while the banks were handing out easy money and asset prices were pumping up like a rubber balloon, with each asset being collateral for yet larger loans to bid up the prices of even more assets.

observa
observa
13 years ago

Knock, knock! The debt collector is at the door-
http://business.theage.com.au/imf-finally-knocks-on-uncle-sams-door-20080629-2yui.html
Either that or it’s the Austrians asking where’s all ya gold chaps?

Mark Hill
13 years ago

“I really find it annoying the way economists attempt to collapse the dimensions of any problem (usually down to a single dimension) thus destroying any meaning in their measurements. Unemployment is not a rate it is people, many people, each one of them with their own story including skill sets, age, ability, education, objectives, etc.”

Well you can stop being offended because it is untrue. Unemployment is a rate. People like to know what is their rough chance of being on the dole. The rate is useful, but economics is not to blame. Others are. Minimum wages for example don’t take into consideration different skill sets, ability, education, objectives, etc.

Blame someone but don’t blame economists whom largely argue against wage regulation.

“Whole industries were union operated and wages were pretty much set in those industries regardless of individual ability or initiative”

Why on earth is that good? You are praising unions and wages policy for treating everyone the same but attacking economists for doing this (even though we don’t). I can’t understand why you would hold such positions which contradict and one of which is untrue.

“The difference between a basic factory workers wage and a highly skilled workers wage was not all that large.”

So why not just everyone work in factories? Why bother studying to be an electrician or a doctor?

“Along with this, more Australians are self-employed, our economy is more globalised, generally Socialist sentiments are no popular anymore and Australians are more willing to see themselves as Capitalist economic agents.”

This is a problem, why?

“China has been eating away at our industries starting with the low-skilled mass production jobs, while technology has also been eating away at low skilled labouring jobs.”

That is just not true. Australia has comparative advantage in the manufacture of elaborately transformed manufactures. Wage rates are different because they are different types of labour, in short, Australian and Chinese labour does not compete. We have very little intra industry trade with China.

“The final result: if you have good skills then for you unemployment is very low.”

Before you implied that high skilled workers should not be rewarded very well. How are you going to build skills if people don’t have an incentive to study or do that work?

“while the unskilled jobs have gone backwards in real terms”

Have they? Where is your evidence? Comsumer durables are ludicrously cheap right now. The starting wages in the WA mining industry can be 90k p.a. I’ll hazard a guess that is higher in real terms than in 1977 with a higher standard of living.

“Similarly, if you want more capacity then just start investing in training some of those young people who got ripped off by John Howards failed education policy or start retraining the older people who have given up trying.”

Again: Why will they take the training if they get paid less in real terms like you seemingly prefer they would?

“social infrastructure”

Can you define this?

“This is about 10x more important than fussing around with various ways of measuring inflation.”

10x ? Have you measured this? This sounds like a scalar, not a vector. I thought you were opposed to such measurements.

You are also wrong. Inflation kills off employment. Refer to Okun’s Law for more details. Inflation has to be a primary priority of any Government.

“The inflation has already happened while the banks were handing out easy money”

Banks don’t cause inflation. Any money lent out is first deposited because of previous economically productive activity. The process can only continue if productive activity continues, unless the base is being eroded by a central bank.

As for the results of inflation, either we have credit mispricing caused by constant monetary disequlibria or other micro-founded mispricing in fixed assets of the economy. If the cycle goes on, it actually will eventually cause a recession, because of mispricing, investments will be diverted to less productive projects and labour productivity will fall and total output can fall. (The Austrian School again, obby.)

Tel
Tel
13 years ago

Hey Mark, you are welcome to bring your own dearly held prejudice to the table, but please don’t ascribe motivations to me other than what I actually wrote.

I judge unions by one standard and economists by another standard because the two have different stated aims, and different roles to fill. A union’s primary function is to serve its members, trying to push up wages and improve working conditions. The secondary aim of unions tends to be maintaining control over some sector of the workplace (keeping a closed shop) and pursuing centralised bargaining which is pretty much a way of grabbing power in order to achieve the primary aim. Every organisation has an additional purpose which is to justify its own existence and unions are no different in that respect. By this standard, the Australian unions of 1970 were successful, but since then they have dwindled in their power and their ability to achieve their goals. I suggest that they will have some reinvention to do in order to make themselves relevant again but that’s another story.

Economists, on the other hand, have the stated aim of studying and understanding an economy. An appropriate standard to judge an economist is whether their theories can explain current events in an elegant manner, and whether they have the ability to accurately predict future events (or at least predict the outcome of various possible actions). An economist should not start with a political barrow to push and then search for reasons to justify the original assumption, so the ideal economist takes the stance of a neutral observer.

My potted history of changing political sentiment in Australia was not intended to explain the good and bad of unionism. It was an example of how an “unemployment rate” cannot capture, in a single figure, even a rough description of the social change that is hiding under the numbers. In terms of using the unemployment rate as a guide to how difficult it might be to get a job — there is such vastly higher variation between individual circumstances than there is in the national figure that no one ever uses this as a guide, simple seat-of-the-pants guesswork is more accurate.

Australia has comparative advantage in the manufacture of elaborately transformed manufactures. Wage rates are different because they are different types of labour, in short, Australian and Chinese labour does not compete. We have very little intra industry trade with China.

I recently visited the closing down sale of a local clothing manufacturer and had a chance to talk to the owner, who had let all the staff go, and was merely selling off anything still on the premises in order to empty the building. He told me that he had been in the business for 35 years, had done well out of it but there was absolutely no future profit in textile manufacture in Australia because the Chinese imports were always lower in price. There’s an “index” available from the ABS called A2304533X which is part of 5206.0 and it includes clothing, leather and footware. The peak was about 1990 and it has been on the decline ever since. I would say that we did try to compete with China, but we lost the competition. There used to be factories full of sewing machines in the Sydney city around Surry Hills, and Alexandria, now those areas only support retail and housing.

Again from the ABS, stats for Aus manufacturing:

Knitting mills, 1994 employed 6579 people for $170.7M, 2006 employed 2116 people for $81M
Leather tanning, 1994 employed 2864 people for $82.0M, 2006 employed 1905 people for $67M

There’s lots of others, and the volume of trade is going down as well as the wages and employment so it’s not some amazing boost in efficiency and those dollar figures are not even adjusted for inflation so the real difference is even larger.

Then we could talk about the Australian whitegoods industry. I actually have an electric stove made by Davell (see http://www.davell.com.au/) who don’t make stoves anymore but they are still bending sheetmetal, mostly for office shelving and cupboards. You can go to Bunnings or Ikea to find the Chinese-made competition, generally selling for a lower price (but probably also lower quality).

The Australian automotive industry has certainly seen better days, but most of the metal-related manufacturing has shown small growth between 1994 and 2006, however this is also the sector that gets the biggest government support, plus protection from imports so it is arguable how well we would do on a level playing field. I’m not sure whether an automotive counts as “elaborate” enough, but last time I took one apart it did seem pretty complex.

10x ? Have you measured this? This sounds like a scalar, not a vector. I thought you were opposed to such measurements.

You can’t measure something that hasn’t happened yet. My comment was a prediction about the future effect of a policy choice. As with all economic predictions, lick a finger and stick it in the air, this happens to be the policy that I believe will give the best payback to the nation overall. I’m yet to find an economist who gives a warranty on their predictions.

Banks dont cause inflation. Any money lent out is first deposited because of previous economically productive activity. The process can only continue if productive activity continues, unless the base is being eroded by a central bank.

We can observe that speculation does occur and most often this speculation is supported by high-risk borrowing. The recent housing bubble is one example. Your theory pretends that such speculation is impossible, or that speculation does represent “economically productive activity” which is highly questionable, especially for that proportion of the speculators who got it wrong and bought into the height of the bubble (and let’s face it, these bubbles always end with someone as the sucker). Speculative bubbles have been a feature of Capitalist economies for a least the past few hundred years, maybe longer. Sometimes bubbles have ended with a run on the banks and people losing their savings, other times there has been government bailout and everyone ends up paying.

I have no idea what you think the Reserve Bank of Australia is doing to “erode the base” but pretty much all they control is the overnight interest rate so I’m wondering what should the RBA have done to prevent the current situation? Maybe they should go back to forcing the banks to deposit some fraction of all loans, but if banks don’t create inflation then what is?

As for the definition of “social infrastructure”, this is my definition: the knowledge in people’s heads, plus the non-contractual relationships between people (e.g. friendship, trust, etc) plus any innate abilities people might have. Since we as a society have decided that slavery is a bad thing, the ownership of this “social infrastructure” is not transferable. If Fred and Joe are close friends, then Fred cannot meaningfully sell this friendship to anyone else. If you are paying someone to be your friend, then they are obviously not really your friend. Similarly, you cannot buy or sell trust. If I’m paying an employee $25k and I think they might be dishonest, then paying them $50k won’t make them any more honest.

The lack of convenient transaction records makes it tempting to believe that either this “social infrastructure” does not exist, or it is completely irrelevant to economic activity. However, concepts such as trust are very important to being able to do business at all. Similarly, the job market is quite different to the stock market. 100 BHP shares are exactly that, doesn’t matter which particular 100 shares you might be holding, if you sell them on Monday and buy them back on Friday then they are still no different. Every job and every employee are a bit different and every time a person changes jobs there is some disruption. A good manager will spend time on “team building” but there’s no simple recipe for how to achieve that. What usually happens is they spend $X on a team building exercise and then make a note that they have $X worth of team built.

Mark Hill
13 years ago

“so the ideal economist takes the stance of a neutral observer”

I actually hold back fairly radical libertarian views. I am not biased as an economist. The empirical results and mathematical laws argue reject Keynes, socialism and make communism impossible. These are some realities people have to accept. Over on the ALS blog we discuss Government intervention in the economy when it is justified (when it actually is justified) – and ask that the Government does so in the least damaging way.

“It was an example of how an unemployment rate cannot capture, in a single figure, even a rough description of the social change that is hiding under the numbers.”

No one will actually argue with you about that. Unemployment has a multitude of causes.

Australian clothing and footwear industries have been heavily protected for decades and were probably never viable. The level of protection shows that any competition was artifical. Without the subsidies, Australian firms would have never of engaged in labour intensive production of simple goods.

The volume of trade is going down? I thought imports and exports were increasing, as a general trend.

Australian whitegoods have gone offshore, to New Zealand for example because labour on costs such as payroll tax and compulsury insurances make production more expensive here. It is part of the reason for Australian direct investment in New Zealand.

“Im yet to find an economist who gives a warranty on their predictions.”

That is because most of us are honest. I don’t understand why you are talking about the ineffectiveness of predictions and cost benefits tests then support production in industries which require large sums of subsidies and high rates of implied, effective protection.

You are incorrect about bubbles. All I suppose is that there is a micro level mispricing which creates an arbitrage opportunity, and the mispricing is supported by non market institutional factors. You suppose if there was no lending, there would be no bubbles, hysteria, fraud, fads, panics, greed, fear or lack of knowledge by market participants of the differences between their individual and aggregated behaviour.

I think your assumptions are far more unrealistic than mine which is shown tp be true empirically and anecdotally.

Banks are not 100% levered and have accounts and pay insurances to central authorities. This has virtually nothing to do with inflation and merely creates moral hazard as it is a form of deposit insurance, which is partly to blame for the US savings and loans crisis in the early 1990s.

You want to invest in something you can’t measure. This quantity you speak of encompasses tacit knowledge and the like. How do you even know that your investments are having any desired effect if you cannot measure the outcome? After all, you said you can’t measure something which doesn’t already exist, how do you predict something you cannot observe?

“A good manager will spend time on team building but theres no simple recipe for how to achieve that.”

There is also no reliable way to measure that. This is not a reason to abandon financial reporting and investment in tangible assets. To ignore the measurable value of labour, human and knowledge capital is also short sighted.

People take on work to earn incomes, to fulfil their needs. Work is ambiguous, but why people work isn’t. What people do with their incomes is entirely their own business.

So far all you have proven is work is ambiguous – a seemingly good basis to argue for a free labour market.