Catallaxy Files

Political cartoons can be very unfair, very offensive and cutting. The Victorian Police Force are the butt of a very funny Indian cartoon.

While I did laugh when I saw it, the fact of the matter is that Indians have been the victim of serious crimes in Victoria and the police, rightly or wrong, have not been perceived as being proactive as they should have been. This is no laughing matter. For that reason this is a good political cartoon. Rather than being indignant, Victoria Police should ignore it, and concentrate on catching the crims.

The latest issue of the IPA Review has a piece I wrote on the stimulus package. I’m reproducing it here – there may be small editorial differences between this version and the published version.

‘Timely, targeted and temporary’ is a phrase we have heard a lot over the past eighteen months. ‘Go early, go hard, go household’ is now being widely credited with having averted an Australian recession. Yet we now hear that some of the stimulus money is being held over to 2011-12 when economic growth is forecast to be quite strong. This makes a mockery of the ‘temporary’ and ‘timely’ claims being made.

We know the government went hard on the stimulus; according to the OECD Australia spent nearly five percent of 2008 GDP in order to avoid a recession. That stimulus consisting of two packages of $10.4 billion and $42 billion is being estimated to add one percent of GDP growth in 2008-09 and one and a half percent in 2009-10. It is not clear that spending five percent in order to gain about two and a half percent is money well spent, but that was the choice made at the time.

The government didn’t just go ‘household’, it also went ‘school hall’. Australian schools will almost all have brand new halls; whether they want them or not. The horror stories being published in The Australian on a semi-regular basis demonstrate the silliness of this whole proposal. Single-pupil school have new school halls, schools due for closure have new school halls, while large schools where students cannot fit into existing facilities will get new school halls that remain too small for the student numbers. In short, the government adopted the kind of one-size-fits-all approach where centralised bureaucrats excel so well.

This type of macro-wastage is just the tip of the iceberg. Stories are also beginning to emerge of micro-wastage. Over-charging by contractors will haunt these projects for so time.

A plumber friend of mine has recently tendered for a number of jobs created via the government school hall scheme. Despite having quoted 3 times his normal price he has won 85 percent of the tenders. However, in each of these tenders he has not included the cost of plumbing required to get to the actual hall. So once his job is complete no water will be able to travel to or from the building unless they engage him to do more work. He believes this will add an additional cost of 100 %.

If all the money is being spent on the halls themselves it is an open question as to who will pay for the water to be actually connected. No doubt, the Commonwealth will try to shift the cost onto the States or even the local school communities. A lot of lamington drives and school fetes are going to be needed to tidy up this mess.

Anyone with the temerity to ask questions or even criticise the spending has been pilloried as being hard-hearted and indifferent to the hundreds of thousands of Australians who would be thrown out of work but for the stimulus. To put that claim into context, even with the stimulus the increase in unemployment has been 217, 900 people between February 2008 and September 2009. Yet the government continues to claim it has ‘saved’ jobs.

The government has identified a new enemy, ‘academic economists’ – those who argue against the stimulus package are also labelled ‘blackboard economists’. This labelling is by Senator Doug Cameron (ALP, NSW) who has no tertiary education and qualified as a fitter and turner before becoming a union official. Not that there is anything wrong with that. In the Government Senators’ Minority Report to the recent Senate Inquiry into the Stimulus Packages (page 53) we see this astonishing statement (emphasis added).

A view was expressed by a minority of academic economists that Governments should do little, if anything, to limit the impact of deep recessions on the economy and workers. The retrospective advice from a minority of academic economists who are completely opposed to government intervention in the economy demonstrates the difference between “blackboard economists” and those economists who have responsibility for fiscal and monetary policy of a real and practical nature.

It is probably not appropriate to describe this sort of statement as a brazen lie, but it is extraordinarily misleading. Of the four academic economists who appeared before that Senate inquiry three argued against the packages – three out of four is simply not a minority.

Furthermore the advice of the three academics was hardly retrospective. Tony Makin, for example, has written many articles over the past year criticising government policy. I appeared at the February 2009 Senate Inquiry and argued against the package at that time. The Hansard records me as saying (emphasis added)

In my opinion, the package does not contain enough stimulus relative to the spending that it contains, and the spending that it does contain is of poor quality. This kind of stimulus package has a very poor track record of success, and economically we cannot really expect it to succeed.

The other thing that I want to emphasise is that the government is not doing nothing, if you will forgive the double negative. The Reserve Bank has lowered interest rates quite substantially over the last while and the automatic stabilisers will kick in as unemployment starts rising, tax receipts start falling and welfare payments are being made. So there is no urgent need to rush a package of this magnitude through the parliament at this time. That does not mean that the government should not be doing anything at all; but, in my opinion, it should not be doing this.

I went on to recommend that payroll tax cuts be undertaken or that a GST holiday be adopted. It is not at all clear that advocating a cut to payroll tax constitutes being indifferent to the ‘economy and workers’.

But rather than consider the merits of the arguments being put to them, the Government Senators chose the smear (at page 58-9).

One of the defining features of the global financial crisis is that its causes and remedies have undermined the central tenets of neo-liberal economics. Those academic and business economists who subscribe to neo-liberal economic theory have been quite active in recent times defending their faith.

Neo-liberal economics is a ‘faith’, and a discredited faith at that. As Milton Friedman famously remarked, ‘there is good economics and there is bad economics’ and unfortunately we now have a government that is hostile to good economics. This cannot bode well for the economy at all.

This raises the issue of the type of economics practiced by Ken Henry – the governments’ economic advisor. When asked about the role of academic economist, Dr Henry replied

whilst being very aware of those issues for many years, I can tell you that, confronted with the crisis that the world has been dealing with these past 12 months or so, those few quibbles with the use of expansionary fiscal policy—or expansionary monetary policy, for that matter—or other actions of governments to prop up credit markets are not ones that I considered should detain us for too long. They were rather quickly put aside.

That is all well and good. It is his job to advise government, and if government wants to pursue a range of policies it is his role to advise on those policies and perhaps even implement those policies. Henry, after-all is a public servant, it is not his place to make policy.

The difficulty with that perspective, however, was a 30 October 2009 front page article in the Australian Financial Review. The article by John Kehoe relates how Henry’s mother saved the Australian economy. Apparently, Mrs Henry had phoned her son during the weekend that the government was fashioning its first stimulus package and told him she was worried about the economy. We then read,

With his mum worried too, the Treasury secretary decided there was no choice but to advise the Prime Minister to instigate the bank guarantee scheme and the first $10.4 billion of a series of stimulus packages credited with saving Australia from the full impact of the global crisis.

To be sure, some poetic licence may have been employed in the telling of the story; nonetheless this is a very troubling anecdote.

We know that no formal modelling was undertaken in support of the first stimulus package. We now know that the package was accepted by government on Henry’s advice and say-so. But what does he, or the government, hope to gain by bringing his mother into the debate? Is this some effort to portray Henry as a dutiful son, thinking of his mother while spending the national treasure?

Certainly, it does detract from a very significant backflip. Last year we were being told that the government was ‘unapologetic’ about its package. Now Henry is saying

History may judge that first stimulus package as too early, too large or the configuration of it was wrong, but my view was that we needed to do something big and do it quickly.

‘Too early, too large and wrong’ just isn’t as snappy as ‘go early, go hard, go household’ but that is just what some blackboard economists were saying all along, and maybe Henry is coming around to that view.

[youtube=http://www.youtube.com/watch?v=X8BCnX8LIIY&color1=0xb1b1b1&color2=0xcfcfcf&hl=en_US&feature=player_embedded&fs=1]

(HT: Climategate)

Israel Kirzner is one of the least known of the great Austrian economists. When I speak to students about their reading they often tell me that they are reading Mises or Rothbard or Hoppe, seldom Hayek and never Kirzner. Many of those same students also tell me that Hayek is some sort of sell-out; that comes from reading Rothbard.

I think more people should try Kirzner – I’m in the process of reading his The driving force of the market: Essays in Austrian Economics. In this book he tells of his first encounter with Ludwig von Mises – and a statement Mises made at that meeting.

“The market,” Mises began, “is a process.” (See also the statement in Human Action (1966, p. 257): “The market is not a place, a thing, or a collective entity. The market is a process.”)

I used to teach that very quote to my final year Investments students in the very first lecture – What is a market?. I would then go onto talking about efficient markets and so on.

I first encountered Kirzner in 1991 (August 19 to be precise) when he gave the inaugural Ludwig Lachmann Memorial lecture at the University of the Witwatersrand, Johannesburg where I was a graduate student. He didn’t present at all well. He read his paper and appeared to be editing it as he read. It is reproduced as chapter three in The driving force. It reads much better than he presented it and perhaps after neary 20 years I’m a bit more sympathetic to the argument than I was at the time.

Anyway, Peter Boettke and Frederic Sautet are editing Israel Kirzner’s Collected Works. The first book off the rank is his The economic point of view. This is a bit annoying, as the Mises Institute republished that book a couple of years ago. The Mises Institute also have other Kirzner material online. The Collected Works however promise to be very good and I’m looking forward to the completed set (in about five years). In the meantime read the online stuff – he is very good and well worth it. What I particularly like about Kirzner is that he is inclusive and not exclusive. He believes, correctly, that to gain the greatest appreciation of the insights of the Austrian School that you have to understand both Mises and Hayek.

In other book news, Liberty Fund have published the Collected Works of Henry Manne – also well worth reading.

Tony Abbott suggested that we should have a look across the Tasman and see what the New Zealanders are up to.

TONY ABBOTT: But at high price. And if you look across the Tasman, New Zealand has done just as well it seems as Australia without going into anything like the same level of debt and deficit that we have.

Okay. The problem is, as Peter Martin points out, is that New Zealand went into recession. Australia didn’t. Of course, that doesn’t mean that we have nothing to learn from the Kiwis and them from us, but it does seem to blunt Abbott’s point somewhat.

The argument now getting traction is that spending heaps of money to avoid a recession is worthwhile at almost any cost. The reason being is that the jobs market is permanently damaged by recession. This is especially so for new entrants. So it seems that if we have two consecutive quarters of -0.1% growth that new job market entrants have permanently depressed job prospects, but if we have only one quarter of -0.2% followed by a 0% quarter then everything is okay. I don’t think so, but that seems to be the logic.

So I had a look at the relative unemployment rates in Australia and New Zealand.

I don’t want to trivialise the trauma of unemployment but there isn’t much in that – especially as New Zealand had 5 quarters of negative growth and Australia had just one quarter of negative growth.

I think Abbott needs to attack the government on their handling of the economy. But I’m not sure that throw-away lines are the way to go.

This did give me the oppourtunity to revisit a graph I first presented to the Senate in October. At the time I didn’t have data for New Zealand, but I was able to get a GDP growth figure and include New Zealand in the graph. Australia is the red square, New Zealand is the green dot.

Update: I couldn’t find the argument earlier about why ‘avoid a recession’ and unemployment, but now have found it. It is from a speech David Gruen made last month.

But in contrast to this calculation, in my view, cost-benefit analyses of policies aimed at avoiding recessions need to take into account that recessions are disequilibria phenomena in which markets don’t clear for extended periods of time. It is worth providing a brief summary of some of the benefits of avoiding a recession that would not be relevant if a recession was instead simply an equilibrium market outcome.

The first, and most obvious, benefit is that involuntary unemployment is lower than it would otherwise be. Among other things, lower involuntary unemployment implies less long-term unemployment and hence less skill atrophy and less general disaffection with society on the part of the long-term unemployed. The Treasury estimates presented in Chart 9 imply that the fiscal packages reduced the peak unemployment rate by 1½ percentage points. I suspect, however, that this is an underestimate, both because it was calculated using conservative fiscal multiplier estimates, and because it takes insufficient account of the favourable feedback loop that I spoke about earlier when discussing the impact of expansionary macroeconomic policy on confidence.

But there are further benefits to avoiding a recession that would need to be taken into account in a realistic cost-benefit analysis of discretionary fiscal stimulus. Recessions break productive links between firms, and between firms and workers, when firms that would otherwise be viable over the long-term are driven into bankruptcy by a recession. In other words, plenty of the destruction that occurs in a recession is not creative destruction.

Finally, recessions do long-lasting damage, particularly to that cohort of people entering the labour market at the time the recession hits. Thus, for example, university graduates entering the labour market in a recession suffer sizeable initial earnings losses, losses that persist for a period estimated at between eight and fifteen years – that is, long after the recession has ended (Oreopoulos et al., 2006, Kahn 2009).

Update II: Conrad reminds me of an Andrew Norton post looking at graduate employment and recessions.
Update III: Nicholas Gruen has a (semi) related post here. (Observant readers will note that both Gruen brothers are being mentioned in the same post. A first for catallaxy, I think).