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December 07, 2008

The Country is in Recession Yet the Commentariat Still Cannot Spot What is Wrong
by Gerard Jackson

The media is not the only place where economic commentary is woeful: Parliament is even worse. Malcolm Turnbull, leader of the Opposition, declared that Australia can avoid recession while maintaining a budget surplus. He then made the accusation that the Labor Government was talking up "inflation and, as a consequence, talk up interest rates." And this joker thinks he is fit to be Prime Minister.

Andrew Robb, another bright spark from the Opposition benches, accused Prime Minister Rudd and his Treasurer, Wayne Swan of "talking down the economy". Both of these characters are spouting rubbish. What makes them particularly reprehensible is their refusal to even acquaint themselves with basic economic principles. It's time someone confronted this arrogant pair with the fact that Australia is already in recession and has been for some months and that the foundations of this bleak fact were laid down during Howard's reign.

What confidence can we have in politicians who seriously assert that you can talk an economy into a recession? Unfortunately, Robb and Turnbull's economic idiocy is what passes for sound economic commentary within the upper ranks Liberal Party, thanks to those ignorant party bluebloods who cannot tell the difference between an icicle and an isoquant.

It also seems that this pair is also making a fetish out of budge surpluses, completely unaware of the bleeding obvious that what really matters is not deficits or surpluses but the level of government spending. In this respect the Howard had absolutely nothing to brag about. I fear, however, that Robb and Turnbull lack both the imagination and the intellect to grasp this simple point. (I don't know why it is, but Liberal politicians adamantly refuse to even consider solid economic arguments. Perhaps this is one of the reasons Liberals frequently referred to as the "Stupid Party").

I pointed out last week that the state of manufacturing was telegraphing the presence of recession and that it would get worse. Moreover, there was no way in which Rudd's $10 billion payout to families and pensioners could reverse the process. Liberals are not the only ones who cannot get a grip on economic theory. Treasurer Wayne Swan proudly parroted the Australian Bureau of Statistics' figure showing that during the September quarter real gross domestic product (GDP) rose by a seasonally-adjusted 0.1 per cent.

As I have pointed a thousand times, GDP does not measure growth. Moreover, it does not even give a genuine gross figure. What matters is total spending, especially by business. From a fairly quick look input-output data 2004-05 and published by Australian Bureau of Statistics, I estimated that total spending was about three greater than consumer spending. The means that nearly two-thirds of total economic activity is carried out by business. (The American Bureau of Economic Analysis has been taking account of intermediate spending for some years. At least someone gets it, unlike Australia).

Regardless of what the textbook says, including intermediate spending in the national accounts is not double counting. If this were so then firms would not include this spending in their books. Moreover, if this spending suddenly ceased the economy would implode. In addition, GDP cannot be gross because it is based on the value-added approach that, as Paul Samuelson put it, "refused to include all the expenses shown on each firm's business income statement". But these expenses are just that -- expenses incurred by the firm. Without these expenses the firm would cease to exist.

(What we seem have here with respect to Samuelson is a case of malinvested intelligence that has done a great deal of damage to economic policy-making. It just has not occurred to the vast majority of economists that what is sound accounting practice for the firm is equally sound for the national accounts).

Omitting this intermediate spending results in a gross misreading of the direction of the economy. If this spending were taken account of the result would show the economy to be in recession and to have been in that state for sometime. Failure to recognize this fact leads to the economic commentariat making ridiculous statements. Terry McCrann argues:

It would have been grossly irresponsible for the RBA to have started cutting interest rates in the face of that extraordinary building surge in national income -- running at 7-8 per cent a year in real terms! Which was taking place in a fully employed economy. That huge surge in national INCOME didn't fully spill over into spending, with GNE -- gross national expenditure -- increasing at a fairly steady pace around 4.5 to 5 per cent a year through 2007-08. Before starting to slip to a 3.2 per cent annualised rate in the June quarter and then 2.4 per cent in the September quarter. (Held to ransom by cut-price exports, The Australian, 6 December 2008)

McCrann admits that the "surge in national income" was due to China's demand for Australian resources. So what? By drawing attention to GNE and GNI he was completely overlooking -- as he always does what is happening to total business spending. The Australian Industry Group has been painting a very grim picture of the state of manufacturing.

In its last report it stated that "manufacturing activity fell for a sixth month in a row in November". Its performance manufacturing index is down from 53.8 in November 2008 to 32.7 for last November. Production for the same period was down from 55.0 to 30.4. It is just not credible that spending on intermediate goods was maintained even as its PMI for the same period as above fell from 53.8 to 32.7, a drop of 39 per cent. Taking account of the fall in intermediate spending would clearly show Australia to be in recession

Michael Stutchbury, The Australian's economics editor, is another one who does not get it. Unthinking following the orthodox line he supports the Reserve Bank's efforts to "pump up household income and so encourage people to spend, even if they feel poorer", a policy that "aggressively" cutting official rates should help. (Income protection, 3 December 2008).

The Reserve has cut the cash rate to 4.25 per cent as it responds the only way it knows how, and that is by rapidly expanding the money supply. This is the only way in which it can "pump up household income". In other words, the bank is inflating the currency again, something that its asset sheet and monetary aggregates clearly show.

If this lot had a grasp of basic capital theory they would be forced to conclude that directing spending to consumption will surely make matters worse because business spending is what keeps the economy afloat. Therefore an expansion in consumer spending could come at the expense of manufacturing. The Reserve evidently thinks that slashing the interest rate will spur recovery (and the way things are going we could see the rate drop to 3 per cent some time next year), particularly if it reinforces consumer spending. I doubt if it ever occurred to any RBA official that promoting consumption in time of recession is the last thing that needs be done.

It's bad enough that our economic commentators are utterly clueless on the boom-bust cycle. But this ignorance is made worse by the failure recognise that the Reserve's anti-recession policy is one of rampant inflation and the very same policy that got us into this mess in the first place.

Gerard Jackson
BrookesNews.Com

Gerard Jackson is Brookes economics editor.

Copyright © 2005-2009 Gerard Jackson

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