Why do we need 3% economic growth to keep unemployment stable? – Part 2

This series started yesterday when I started wondering about the exact reason we needed economic growth to keep the unemployment rate down.

I wrote an introductory post then, explaining I was going to do some learning in public.  (The risk of embarrassing myself is real). Now I want to dive into this a bit more.

It’s true we need economic growth to prevent the unemployment rate rising. I checked and important people believe it.

RBA Assistant Governor Chris Kent has specifically linked changes unemployment to trend growth. “Since about mid 2012, Australia’s GDP growth has been a bit below trend and so the unemployment rate has been rising gradually.”

And he has given us this excellent graph:

Recessions send unemployment spiking. And so can low growth.
Recessions send unemployment spiking. And so can low growth.

Phew! That’s one thing I got right.

The link between economic growth and changes in unemployment is real and it has been formalised in a relationship called Okun’s Law.

Screen Shot 2015-09-09 at 8.47.18 pmI put the word out on Twitter for an explanation and I was swamped with awesome economists offering helpful explanations. Thanks to everybody.

This was the main thing I heard.  Basically:

  • Because of population growth you need growth in output to have jobs for the new people.
  • Because of labour productivity changes (people getting more efficient) you need more output or else you’ll employ fewer people.

This is a nice neat story. If you have 2 per cent labour force growth and 1 per cent productivity gains, you need 3 per cent growth. It’s mathematically sound. I learned something.

So is that it? Are we wrapped up? All silent?

I still find myself with questions. I want to understand things in more than just mathematical terms.

Productivity causes growth. It allows us to produce more, using the same. But we also need growth to compensate for it? This sends me into something of a chicken and egg loop.

I’m aware that chicken/egg scenario is why economics uses maths so much. Supply and demand need to be solved simultaneously. You can’t think through a market equilibrium slowly because you need an answer on both sides at once.

So I could stop here. But I have other questions.

If rising labour productivity is both cause and cure for unemployment, why is it spoken of in exclusively glowing terms? Would we not be as well off, in unemployment terms, without it?

And population growth causes economic growth too. This is what I believe, a belief reflected in articles like these:

Fewer people want to live in Australia in growth risk for RBA

RBA’s Glenn Stevens: Australia may need to rethink growth

If we did not have the population growth, would we still have stable unemployment? This remains my sticking point – my reason for wondering about the deeper reasons and implications of why we need 3 per cent growth.

Seems to me an important part of the existing population is employed creating space for the new population to live in.

While the productivity angle makes sense to me, the population one still gives me pause. Establishing the new capital stock to accommodate the lives of new babies and new migrants is a huge cause of economic activity. More roads, more shops for them to shop in, more buildings for them to live in, more pipes going to their houses, more hospitals for them to be sick in, etc.

New population consumes and works the same as the existing population; but also requires extra spending. I intuitively believe population growth causes a rise in employment so I can’t quite grasp that it’s a wash, unemployment wise.

Whenever I think about this question I think about Japan, where capital is being abandoned as the population shrinks, and (while unemployment is low) secure employment is a problem.

Perhaps I need to think about this differently? Perhaps I need some more empirical evidence? I’ll dive deeper and present what I find tomorrow.

If you have any thoughts on this topic or want to suggest some reading, please feel free to make a comment below.

Want a glimmer of hope? Look at this.

Things look bad.

Today, economic growth figures are coming out (at 11.30am) and for the first time in ages, people are predicting negatives.

Recession talk is in the air. I have my doubts about that. But the talk alone is very suggestive, and there are lots of reasons for it.

Chinese markets are falling, our own stock-market is in a sustained slide, and with all that bubble talk our housing construction sector looks weaker.

Screen Shot 2015-09-02 at 8.36.13 amIs Australia about to get a surge of growth, or a slump?

One way to answer that is to look at what business is up to. In May, we checked in with business spending plans and they gave me intestinal cramps. Things have changed, sort of…

Capital expenditure is what makes your business bigger, lets you employ more people, etc. It’s one of the big signals of future economic growth. And it’s going backwards.

The mining sector is in such a funk that it won’t bring us any growth. This next graph shows the plans the mining industry has for capital expenditure.

The grey bars show actual expenditure. The last one for 2014-15 is the lowest in four years. The white ones are plans for next year. The latest white bar (3rd estimate for 2015-16) is the lowest 3rd estimate in five years.Screen Shot 2015-09-02 at 8.25.14 amThat is having a seriously negative effect on Australia’s total capital expenditure. Check out the increasing steepness of that slope at the end.Screen Shot 2015-09-02 at 8.26.15 am  Manufacturing won’t save us.Screen Shot 2015-09-02 at 8.25.06 am But there’s other parts to the economy. Other selected industries are investing more than ever.

Other selected industries sounds like a miscellaneous grab-bag. But check out the labels on the vertical axes. This is a massive part of our economy. Not only that, it just invested more than it expected, which is more than ever. Plans for 2105-16 are more modest, but increasing fast.Screen Shot 2015-09-02 at 8.24.55 amOther selected industries* includes:

Electricity, Gas, Water and Waste Services
Construction
Wholesale Trade
Retail Trade
Transport, Postal and Warehousing
Information Media and Telecommunications
Finance and Insurance
Rental, Hiring and Real Estate Services
Professional, Scientific and Technical Services
Accommodation and Food Services
Administrative and Support Services
Arts and Recreation Services

In other words, a whole lot of important parts of our economy that we can actually believe in.

And there’s one simple reason why they might grow. Our falling dollar.

Screen Shot 2015-09-02 at 8.57.45 amThe fall in our currency is a bit like being a lobster in a boiling pot of water. Unlike stock market fluctuations it happens slowly and we don’t pay it so much mind. But it matters a lot.

The slow growth of non-mining industries in the last few years can be attributed to our high dollar. America’s incredible recovery from its recession in the same time period can be explained by its low currency.

A falling dollar could flip slow growth on its head. And we’d be too busy worrying about mining to notice.

The current mood of widespread gloom may prove to have been peak fear.

*This whole private capital expenditure data-set excludes healthcare and social assistance, which as we know, is one of the fastest growing sectors of the economy. In Melbourne, a billion dollar new cancer hospital is being built, for example. That’s not in the stats. Further reason to hope.

The Wilting West

A high-vis vest slowly buried in the blowing sands of the Great Sandy desert.

Screen Shot 2015-07-17 at 9.58.41 amA small business owner awake at 2am, wondering if they should talk first to their bank manager or their spouse.

Screen Shot 2015-07-17 at 10.00.44 am Fridges, clothes, tables and chairs all packed into boxes, in a freight train chugging east across the Nullarbor.

Screen Shot 2015-07-17 at 9.57.58 am

I wasn’t panicking about the Australian economy … until I saw this graph

This graph makes my tummy turn into a knot.

capex

[Source: ABS]

It shows how much money business in Australia expects to invest. Businesses invest in new trucks, new computers, new buildings, etc. Investment is what makes businesses grow, what makes the economy grow.

The white columns are spending plans, the grey columns are cold reality. Looking at those last two small white columns,  we see business is terrified.

They show how much money businesses expect to invest in 12 months from July 1 2015. It’s low. Very low. The worst since 2010-11.

We can expect the plans for investment (the white columns) to grow a bit as the year continues, same as in every other year. The third estimate of plans for investment (third white column) is often the biggest. Reality (the grey column) rarely beats that third estimate. This year’s final business investment number hasn’t come in yet (there’s no grey column seven yet in 2014-15) but it looks likely to be the lowest since 2010-11.

And next year’s business investment looks like it will be worse.

WHAT IT MEANS

Low business investment means low economic growth. Low economic growth means higher unemployment.  Higher unemployment means more human suffering. (Why do we need high growth to keep people in work? This is something I wish I understood better about economics.)

The information in the graph comes from a survey the ABS does. The survey happened in April and May, so it would have caught some (but not all) of the Budget leaks about the supposed small business bonanza. Of course we will have more information about the effect of the Budget next month.

But for now, it looks like Hockey’s second Budget is a dud.

Partly, the problem is mining. The end of the mining boom is as sudden as the start, and the cash rivers flowing to projects in WA and QLD are drying up fast.

But the real problem is that other industries are not picking up the slack. Here’s the graph for selected industries excluding both mining and manufacturing. The pattern is the same. Estimate two for next year is 10 per cent less than estimate two for this year. That spells trouble.

capex selected

What can we do?

The federal government should spend more to give the economy more of a boost. They know that and Hockey has been blaming the Victorian government for cancelling the east-west road project.

But given the sacred status of surpluses, there’s little more we can expect from fiscal policy.

Instead, all eyes turn to the RBA. Will it try yet more monetary policy to keep the economy moving? Will it cut interest rates yet again?

Some people think yes. In some ways, there’s nothing else we can do. Even though the RBA has already cut rates to record lows and house prices have gone crazy. So long as inflation is modest next time CPI comes out, another rate cut is very plausible.

But will it work to make those white columns go up? To ultimately make businesses plan to grow and hire more people? To keep people in jobs and prevent the suffering of joblessness? I fear not.

Why we should tax tampons, and everything else.

Tax on tampons is a hot topic, with Tony Abbott and Joe Hockey in major disagreement. The issue was brought into the spotlight via a petition on communityrun.org.

“And how can a bodily function be taxed? Because the government doesn’t consider the tampons and pads we’re forced to buy every few weeks ‘necessary’ enough to be GST-free.

On the other hand, condoms, lubricants, sunscreen and nicotine patches are all tax-free because they are classed as important health goods. But isn’t the reproductive health and hygiene of 10 million Australians important too?”

I didn’t sign the petition, and here’s why

Sanitary items are different from “condoms, lubricants, sunscreen and nicotine patches”, because people already want to use them, and there is no evidence of significant public health risk if usage falls. Also, “necessity” is not the binding criterion for determining what gets taxed – we tax electricity.

“Half the population menstruates and they shouldn’t be financially penalised for it.

If you still aren’t convinced, let’s consider some statistics: on average women, who make up the majority of people who use sanitary products, earn $262.50 per week less than their male counterparts, and they are also statistically at greater risk of living below the poverty line. Furthermore, this tax disproportionately targets those who may already be disadvantaged, that is the homeless and unemployed.

So why force this underpaid, at risk and disadvantaged portion of society to pay more for basic essentials?”

Healthy women menstruate for about half their life. So, less than 25 per cent of the population menstruates. How big is the financial burden of this tax on them?

A 16 pack of brand-name tampons costs $4 at Coles. Let’s estimate a woman spends $10 a month. GST on that adds up to $12 a year.

The number of people who can’t afford tampons because of GST is therefore negligible. The number of people pushed into poverty because of that $12 slug would be small. Most people campaigning against this tax have no trouble affording $12 a year.

So if you want to make a difference to the financial well-being of poor women, this is an indirect and very marginal approach. It comes with real trade-offs – it would cost the government revenue. That undermines the ability of society to support the poor.

Here’s a petition I’d support instead: raising income support payments to a more reasonable level.

WHAT’S REALLY HAPPENING

If this petition is not really about public health, necessity or fairness what’s it about?

People hate paying tax. They really hate taxes they can’t avoid. They then create ex-post reasons why they should not have to pay tax, generally involving the welfare of the wretched. (Their own benefit is merely incidental to the social good they’re pursuing!).

The mining industry showed the way, with its campaign against the mining tax, focused on the health of small towns and communities. The big polluters mimicked this in killing the carbon tax, worrying about the electricity bills of families on the bread-line.

It’s no surprise these tactics have spread – they’re extremely effective!

The crux here is whether there is a link between fairness and avoidability. Is a tax fair only if there’s a way to avoid it?

Unavoidable taxes are the backbone of our revenue raising system. We already raise lots of revenue effectively through big taxes on things everyone agrees are “good,” like earning income and buying clothes. I’ve previously written that we need more taxes nobody can avoid.

Tax theory says not to introduce loopholes. That was the mantra when I worked at Treasury – maintain the integrity of the system. Always use payments to solve problems, because exemptions are not targeted and get exploited.

But perhaps I am out of step with community sentiment.

Hate for (certain) unavoidable taxes goes back a long way – Poll taxes brought down Margaret Thatcher, for example. Also, exemptions to the GST were what bought it enough legitimacy to be introduced.

I sometimes wonder if sin taxes – tax on alcohol and cigarettes for example – are to blame for the way people see tax in general. A lot of people interpret the tax system as a moral agent judging their actions. If I saw all tax as punishment, I’d be furious about paying tax on sanitary items too.

Tax is not punishment, so maybe we should rename sin taxes to something other than taxes. What we should not do is carve up the system with more exemptions.

Exemptions undermine the efficiency of the tax system but also the sense that tax is our common duty.

I see plenty of normal people arguing that big companies that contort themselves to pay very little tax in Australia are “just doing what anyone would do”. The sense that everyone can and will avoid tax at every turn is pervasive.

I don’t mind paying tax because I can see the benefits it brings. (even though I’m quite aware it’s not all spent efficiently.)

“Tax is what we pay for civilized society.” US Supreme Court Justice Oliver Wendell Holmes, Jr.

Thanks for reading this far! If you’d like to agree, disagree or accuse me of obnoxious mansplaining please do so below, and I shall attempt to respond!

The questions raised when the RBA leaks its next rate cut.

Last night, 5 days before the May RBA board meeting, a story appeared on the main Fairfax websites, indicating the RBA would cut interest rates.

Something about this story was unusual.

Written by respected economics journalist Peter Martin, it makes some very bold claims without any sourcing. For example:

“Concern about a deteriorating economic outlook and a resurgent Australian dollar will force the Reserve Bank to cut interest rates on Tuesday, taking the official cash rate to an all-time low of 2 per cent and discounted mortgage rates to just 4.55 per cent.”

How could he know? Normally, such a story obsesses on the implied chance of a rate cut, quotes experts and goes out of its way to show where all the ideas in it come from. Take this Peter Martin story from January for example.

“Inflation is simply not a concern, the Bank’s decision in February need pay no heed to the consequences for prices,” said BT Financial Group economist Chris Caton…

But futures traders marked wound back their bets on a February interest rate cut, cutting the implied probability from 84 per cent to 66 per cent. “The underlying inflation figure came in just above the market’s expectations,’’ explained NAB currency strategist Emma Lawson. “That allowed some pricing of the expected cut to be taken out of the market.””

This new story lacks a single quote, but it isn’t marked as an opinion piece either.

The second pertinent feature of the story was its timing. Five days before the next RBA meeting. Before the last rate cut, in January, there was another curiously insightful story published, by top NewsCorp business journalist Terry McCrann predicting a rate cut. That one also came out five days prior to the meeting.

It is hard to avoid the conclusion the RBA is briefing key journalists on what it will do next.

Two key questions occur to me.

1. This is a big new deviation in the RBA’s communications strategy, which until now had relied on officials making public speeches. Speeches have the advantage of being clearly attributable. If definitive information is being given out, why not give it out in a transparent way?

2. If the RBA can brief journalists on what it will do five days in advance of the board meeting, what exactly is the board meeting for?

The RBA board is stacked with high-flying people chosen for their ability to contribute to the making of monetary policy.

As well as the RBA Governor Glenn Stevens and his 2IC Philip Lowe, the board table has

  • John Akehurst, director of CSL
  • Roger Corbett, chairman of Fairfax
  • John Edwards, director of the Committee for the Economic Development of Australia
  • Kathryn Fagg, director of Boral
  • Heather Ridout, chair of the Australian Super Trustees Board
  • Catherine Tanna, managing director of Energy Australia.
  • John Fraser, Treasury Secretary

Are these great loci of business and economic acumen merely a rubber stamp for the calculations of the RBA?

I suppose it’s obvious that the RBA drives the meeting – it has the staff working on the question of rate cuts month in and month out. They provide the chair, set the agenda, and doubtless distribute packages of graphs to all present.

But now I wonder if the board meeting is really a discussion at all, or whether the gathered brains chew sandwiches while the RBA shows a power point presentation, concluding by presenting the next movement of the official cash rate as a fait accompli.

If that’s the case, ought we have a board and a board meeting at all?

It might be time to sell your shares and your house

Another big financial crash could be coming.

There is a lot of evidence that markets are doing that thing they do. Getting out of whack.

It’s hard to believe that this could happen again so soon. In the past, major financial events have been interspersed with decades of good times.

But to count on history repeating would be … brave.

Here’s the symptoms of the problem. Stocks are super high, with the US markets setting records:

DJIA high
Source CNN

That could be a good thing right? Companies get high valuation when they have high earnings. And high earnings mean a healthy economy!

Hmm. 

Price to earnings chart
Source

This chart shows a ratio of stock prices to company earnings. It shows that prices sometimes get well out of line with earnings and the market can’t sustain that.

How can this happen?

As anyone who has played monopoly knows, the more times people pass Go, and the more money in the system, the higher the asking prices for trading properties. 

The same thing can happen at a much bigger scale. The more cash in the global economy, the higher asset prices are.

Here’s evidence that cash is swilling around in the global economy like burger wrappers in the passenger footwell.

Greece government bond yields
Source

The Greek government can now borrow money at 6 per cent. In 2012 they had to pay over 30 per cent. That’s how much cash is lying around. Even though Greece’s problems remain dramatic (e.g. 27 per cent unemployment), money managers are happy to give €€€€ to the government. Similarly in Spain, where unemployment is 25 per cent, bankers are happy to lend money to the government at the lowest interest rates since 1789. Seventeen. Eighty. Nine. 

Meanwhile Dutch interest rates are at their lowest in 500 years.

You can also spy the global economy’s excess cash in the way Facebook is buying things like WhatsApp, for $19 billion, and in the near-record valuation of Apple even as iPhone enthusiasm is being studied by historians. 

Here’s how the New York Times describes it:

“Around the world, nearly every asset class is expensive by historical standards. Stocks and bonds; emerging markets and advanced economies; urban office towers and Iowa farmland; you name it, and it is trading at prices that are high by historical standards relative to fundamentals.”

Australian stocks have rallied hard in the last two years, and here’s a chart of Australian house prices, just to show that our assets are not immune. 

House prices
Source

Global markets have not got to this point without a reason. The billions pumped into the economy by central banks doing quantitative easing explains the surplus cash. 

The Bank of International Settlements has said that this has caused capital “misallocation” on a scale similar to the GFC. 

So what could happen next?

The United States is now planning to stop its five-year quantitative easing program, this October

The billions a month it “printed” will cease to arrive at the banks and they will have to go back to more old-fashioned ways of finding capital.

Then, we find out if economic growth can catch up fast enough to make all those high prices make sense, or if everything crashes. 

Plummeting asset prices in North America and Europe would hurt us, no doubt. But a fall in China has already begun and that simultaneity would be the worst case scenario.

Last time round, China was basically immune from global financial contagion. But this time, everyone agrees China is in an asset bubble that is already ending. 

china property prices
Source: Economist

If asset prices fall fast in China and the West at once, it will be time to move your savings into something very very safe.*

*You know I’m not a financial advisor, right? Right.