I come across new evidence every day that supports the Modern Monetary Theory (MMT) perspective on fiscal policy. Today the Australian Bureau of Statistics released the latest Construction data which provides very clear testimony to the effectiveness of the recent fiscal interventions in Australia. So I thought I would devote this blog to exploring some of the characteristics of this data and see what it means for assessing the impact of the fiscal stimulus in Australia. The conclusions that I draw are consistent with the insights that many different data series are telling us at present. The fiscal stimulus was effective and as it is withdrawn by a budget surplus-obsessed government the economy is suffering. The data today is a further nail in the deficit terrorist coffin.
In early 2009, the director of the Australian Housing Industry group said (Source)
January was another poor month for the construction industry, with the relentless pressures of tight credit conditions and deteriorating economic sentiment driving a further decline in activity
The following graph is taken from the latest edition of the Australian Industry Group–Housing Industry Association’s – Performance of Construction Index – which “is a is a leading economic indicator of business activity in the Australian construction industry, covering residential building, non-residential building and engineering construction”.
You can see that as the world recession deepened in the second-half of 2008, the index fell sharply as the industry began to contract. The pattern was replicating the performance of the construction industry in past recessions.
So things were looking dire and the construction industry employs a lot of people in Australia. In response, the Australian government acted quickly and introduced a staged fiscal stimulus of substantial proportions (relative to GDP and the responses of other governments).
The Australian fiscal stimulus and construction
In Australia, the first fiscal stimulus package (October 2008 – the Economic Security Strategy) mainly consisted of cash handouts to pensioners and families. There was an extension to the First Home Owner Grant Boost and some training places offered.
However, the second package (the Nation Building Package) focused on infrastructure development. This was followed in February 2009, as the recession looked like deepening with the $A41.5 billion (that is, economically significant with respect to GDP) allocated to the Nation Building and Jobs Plan.
While there were further cash handouts the bulk of the proposed spending was focused on the contruction sector (educational infrastructure development, social and defence housing and the home insulation scheme.
The early cash payments timed initially to coincide with the xmas spending rush in December 2008 were designed to put increased purchasing power into the hands of those who would spend it quickly. The evidence supports the argument that this occurred.
The infrastructure spending was concentrated on schools and there were several arguments mounted to support this part of the stimulus plan. First, there are schools in every locality – where people live and work. Second, the construction industry is big with about 1 million workers and it always contracts severely in a recession. Third, construction in schools could be implemented without delay (land availability, less applicable local planning regulations). Fourth, the specific building plans could be used throughout the nation.
This part of the fiscal stimulus was thus designed to support an industry that typically contracts early and significantly in any economic downturn.
A further $A$22.5 billion was announced in the May 2009 budget for the Nation Building Infrastructure program.
It was clear that private construction was in decline but the stimulus packages (specifically the school hall packages) was kickstarting the overall construction industry and preserving employment in that sector.
The following graph shows what happened to construction industry employment relative to employment overall.
The following butterfly graphs are constructed from ABS Labour Force by Industry data. They are employment indexes set at 100 for the peak in total employment in the 1991 (left-panel) and 2009 (right-panel) downturns. They show the four quarters before the peak and the 12 quarters after the peak for the 1991 recession and 7 quarters after the peak for the current episode. They provide a very good picture of the different fortunes encountered by total employment and employment in the construction industry during the respective downturns.
It is clear that the construction industry and total employment in the current downturn behaved very differently to the 1991 episode. The 1991 recession saw typical behaviour and a reluctance by the federal government of the day to engage an early and signficant fiscal stimulus. The willingness of the Australian government in 2008 to introduce a substantial fiscal intervention sets the two periods apart.
The next graph is taken from the ABS Construction Work Done data released today (August 25, 2010) and ABS National Accounts data and shows the annual growth in Total Construction (blue bars) and real GDP (red line) from September 1987 to June 2010. The period captures the 1991 and early 2001 downturns and the recent downturn.
It is clear in the 1991 and 2001 downturn total construction fell in line with real GDP contractions. But the pattern was broken in the recent downturn.
The next graph compiles butterfly plots for total construction, public construction and private construction for the 1991 and 2009 downturns. The construction of the butterfly graphs are explained above.
The behaviour of this important recession bell-weather sector was starkly different this time largely as a result of the fiscal stimulus which was targetted on the construction sector.
This graph shows the recent period is more detail. It serves to reinforce the point that I am making in this blog. The blue arrow shows the one quarter contraction in real GDP that occurred just before the stimulus impacts began to take effect. After that the surge in spending supported both positive real GDP growth and a strong construction sector.
Some might argue that the easing of monetary policy also had an affect. The Treasury estimated that it was very minor compared to the fiscal impact.
Chart 10 shows Treasury’s estimates … of the effect of the discretionary fiscal stimulus packages on quarterly GDP growth. These estimates suggest that discretionary fiscal action provided substantial support to domestic economic growth in each quarter over the year to the September quarter 2009 – with its maximal effect in the June quarter – but that it will subtract from economic growth from the beginning of 2010.
The estimates imply that, absent the discretionary fiscal packages, real GDP would have contracted not only in the December quarter 2008 (which it did), but also in the March and June quarters of 2009, and therefore that the economy would have contracted significantly over the year to June 2009, rather than expanding by an estimated 0.6 per cent.
They also estimated the impact of the rapid reduction in interest rates by the Reserve Bank on GDP growth rates and concluded that:
…this fall in real borrowing rates would have contributed less than 1 per cent to GDP growth over the year to the September quarter 2009, compared with the estimated contribution from the discretionary fiscal packages of about 2.4 per cent over the same period.
So discretionary fiscal policy changes are estimated to be around 2.4 times more effective than monetary policy changes (which were of record proportions).
Construction in the US and Australia
The following graph compares the fortunes of the construction sector in Australia and the US from the first quarter 2007 to the June 2010 quarter. The US data comes from the US Census Bureau. The lines are indexes set at 100 in the first quarter 2007.
The graph provides some of the explanation as to why the Australian economy has been less severely affected by the recession. The differences have been driven by the different focus and scope of the respective fiscal interventions.
Fiscal stimulus and waste
There has been a lot of discussion about the waste of the fiscal stimulus packages. The words of Joseph Stiglitz resonate on this issue.
Here is the relevant exchange in regard to the stimulus packages and the allegations of waste:
Interviewer: I’m not sure how much you know about Australia’s stimulus packages in response to the crisis, but to the extent that you do, how did the quality of Australia’s stimulus compare with that in the US and elsewhere, in terms of its effectiveness?
JOSEPH STIGLITZ: I did actually study quite a bit the Australian package, and my impression was that it was the best – one of the best-designed of all the advanced industrial countries. When the crisis struck, you have to understand no-one was sure how deep, how long it would be. There was that moment of panic. Rightfully so, because the whole financial system was on the verge of collapse. In that context, what you need to act is decisively. If you don’t act decisively, you could get the collapse. It’s a one-sided risk.
Interviewer: There’s been a lot of criticism of waste in the way some of Australia’s stimulus money was spent. Is it inevitable if you’re going to spend a great deal of government money quickly that there will be some waste and can you ever justify wasting taxpayers’ money?
JOSEPH STIGLITZ: If you hadn’t spent the money, there would have been waste. The waste would have been the fact that the economy would have been weak, there would have been a gap between what the economy could have produced and what it actually produced – that’s waste. You would have had high unemployment, you would have had capital assets not fully utilised – that’s waste. So your choice was one form of waste verses another form of waste. And so it’s a judgment of what is the way to minimise the waste. No perfection here. And what your government did was exactly right. So, Australia had the shortest and shallowest of the downturns of the advanced industrial countries. And, ah, your recovery actually preceded the – in some sense, China. So there was a sense in which you can’t just say Australia recovered because of China. Your preventive action, you might say pre-emptive action, prevented the downturn while things got turned around in Asia, and they still have not gotten turned around in Europe and America.
I always remind readers that there is no greater waste than persistent unemployment. It dwarfs all other inefficiencies.
Further, I am often asked in media interviews about the waste involved in the fiscal intervention. I always make the point that it is possible that some parts of the stimulus intervention (a relatively minor proportion of total funds spent) were problematic in terms of adminstrative issues. I refer to the now-scrapped insulation program. There has been a major beat up about this program in the media but the facts are in dispute. I would conclude it wasn’t a very good program but the facts that are available are very blurred.
But the point I made was that large-scale stimulus interventions of the type taken by the Australian Government – which in international terms was early and large relative to GDP – are very complicated and you can expect some administrative inefficiencies. Imagine if the private sector had to ramp up investment spending within a quarter or so – what do you think would be the outcome of those projects.
I also indicated that the neo-liberal era has been marked by a major reduction in Departmental capacity to design and implement fiscal policy – given the obsession with monetary policy and the major outsourcing of “fiscal-type” government services to the private sector. Many of the major Federal government policy departments are now just contract managers for outsourced service delivery. So with the voluntary reduction in “fiscal space”within the federal government over the last 20 years or more it is no surprise that the overall capacity of the government machine to implement efficiently and speedily complicated nation-wide infrastructure programs has been diminished.
This is a lesson for the future in my opinion. We can no longer deny that fiscal policy is required to address serious swings in private spending. Monetary policy has been proven – categorically – to be ineffective in dealing with aggregate demand failures of the sort we have witnessed in the current crisis. In that context, governments must develop forward-looking capacity to ensure that it has project implementation skills when they are required.
Having said that, I also point out in interviews that while complex interventions will not be perfect in design or execution you have to consider what would have been the case if we had have followed the Chicago school (or the Harvard school) line – and left it to the private market to sort the mess out. It is clear to me that we were facing a repeat of the Great Depression such was the damage to the financial system and the plunge in real output in the major economies.
Finally, the Australian downturn was less severe than we thought at the time of the intervention. It is easy to look back with the benefit of the 20-20 vision and say that in some areas too stimulus was provided. I am also asked about the price distortions in the trades area where builders and plumbers etc that are working on public infrastructure projects are now reportedly charging increased fees to contract private work. I question the veracity of that claim in fact – given the data doesn’t show any major blowout in labour costs etc.
But the major point is that at the time the stimulus packages were designed and announced, the Government believed we were on the precipice of another Great Depression. The international events demonstrate that the crisis has been very severe. So the government rightly assumed that there would be major idle labour skills available to be brought back into productive work. That was a reasonable assumption and the fact that the downturn hasn’t been as bad as that demonstrates that the fiscal stimulus has been very effective.
However, I also always stress that I would have concentrated the stimulus on efforts to provide public sector jobs to the most disadvantaged workers who bear the brunt of unemployment and underemployment. They are still idle and without sufficient income. It would have delivered much more to the economy than competing for tradespersons with other “private” demands for those services, however, weak they were at the outset of the crisis.
I also remind people of the relativities here. You might like to read this article by Mike Carlton in last Saturday’s Sydney Morning Herald (August 21, 2010) – Worst idea ever? That batty claim was never going to fly .
In his eloquent style, Carlton documents the scandalous purchases of the navy Super Seasprite helicopter by the previous conservative government in Australia. This article is in the context of the Opposition leader Tony Abbott screaming about the waste of the fiscal stimulus packages during the election campaign that has just finished. Carlton says:
Tony Abbott is either a barefaced liar or he has a mind like Swiss cheese. “This is the worst-managed program in living memory, bar none,” he spluttered on Wednesday, banging on again about the government’s roof insulation scheme.
Hardly. That distinction belongs to the Howard government’s grand plan to acquire the Super Seasprite helicopter for the navy, an epic fiasco that blundered along for 12 years and squandered well over $1 billion before it was scrapped.
It is worth reading the full article because it documents the incompetence of the conservatives when they were in government and the scandalous waste that the public purse endured under them while they were cutting back in social policy areas.
Very parochial digression: Lying property developers leave Newcastle alone – for the time being
While on the construction theme, it was announced yesterday that the GPT group has withdrawn its plans to invest $A600 million on the inner city Newcastle development. The company said that the state government was to blame because it would not yet commit to pulling up the rail line that serves this area of the town.
The property developers want the government to rip up the rail (at public expense) and hand over the land to them for their profit. All the conservatives in town with links to the development – that is, stand to benefit in dollars – are aghast at the news.
The local state member who has been pushing the development and promoting fraudulent reports that are being used to give the development plans legitimacy which they do not deserve is now threatening to resign. My advice: tender the resignation immediately and don’t worry about us we will not miss you for one second.
There is a very strong grass roots lobby fighting to save the rail line – Save our Rail – which deserves all the support it can get.
The truth will come out but I suspect that GPT is really struggling with debt as the GFC continues to play out and can no longer risk the development anyway.
In late 2008 I wrote an Op Ed about GPT and the rest of the dirty business just after the Hunter Development Corporation (a local group of pro-market developers and business interests) released a fraudulent report supporting the tearing up of the rail line.
Large property developer GPT recently unveiled a revitalisation plan for Newcastle. It followed up with an advertising blitz and has lobbied major figures around town to engage their support.
It renewed pressure to eliminate the rail into Newcastle. The new Premier is rumoured to be supportive with reports that “public sentiment” now favours scrapping the rail. I wonder where those “reports” originated from.
GPT has also threatened to withdraw should their demands be rejected.
While Newcastle badly needs revitalisation, puerile, “bully-like” threats are no way to engage a community contemplating large changes to its public spaces.
There are also other sources of finance.
While I support initiatives that increase secure well-paid employment opportunities and efficient use of public space, there has been a lack of quality information provided to allow a full appraisal of the costs and benefits of the proposed development.
Plans to revitalise urban centres that have become decaying hulls like Newcastle typically bring growth and employment to the areas where investment is concentrated.
Development will undoubtedly generate employment, at least in the construction phase.
However, the net benefits of the proposal are disputable because GPT’s economic “research” is unsound.
Overall, their retail growth projections are too optimistic given current economic realities. The recent retail spending boom was fuelled by unsustainable
credit growth and the coming recession will force consumers to spend more carefully and contain their debt.
GPT commissioned a report from Callaghan Institute, which despite its formal name doesn’t even have a WWW site. If an undergraduate student had submitted the same analysis to me for examination I would have failed it.
The Report is carefully “selective” in the questions it asks so as to put the GPT proposal in its best light. Such selectivity is unacceptable in public debate. Here a few of many examples from the Report.
First, it estimates that 2,720 jobs will be created if the State Government tears up the rail line after Wickham and extends roads to the harbour. But it fails to examine the alternative of building better access crossings with the line intact which would also generate thousands of jobs.
Second, San Diego is used as an exemplar of the benefits of better harbour and city linkages. But the Report doesn’t mention that San Diego kept the heavy rail line which bisects its city centre and harbour and linked the two using improved crossings; a bike path along the line and light rail extensions to other city locations. San Diego provides a case study for integrating heavy rail into the development proposal.
Third, the Report ignores the “substitution” losses that would arise elsewhere in the region if the plan proceeded. Economic activity has to be supported by a population base which spends. The danger is that Hunter population growth will not be sufficient to sustain the new retail capacity and so the development will compete for spending that underpins retail jobs elsewhere in the region.
Business may be attracted back to the city centre but other Hunter businesses will lose that trade and these losses need to be estimated.
Fourth, the report estimates major jobs growth in construction. The quantum is debatable but, in general, infrastructure projects like this generate lots of work during the building phase. But the size of the estimated construction employment growth is so large relative to the available Hunter construction workforce, that supply will be strained. Building costs will increase throughout the region. These impacts should be estimated.
The other “unstated” reality is that most of the new jobs will be casualised low-paid positions in retail. The development proposal doesn’t provide for inner city residential capacity which is affordable to these “key workers”.
I don’t support a proposal where a relative few high income earners enjoy living close to the beautiful beaches and harbour while being “serviced” by a low income workforce that is “shipped in” each day. All income groups should be able to live close to these assets.
Further, the rail line makes these assets accessible for residents in the hinterland who have no alternative transport, such as Hunter kids.
The Report offers the same flawed analysis used by developers last time they wanted the rail scrapped. While no valid economic case exists to date, there are many cultural, social and equity reasons to keep the rail.
In summary, two things are required before development should proceed. First, better economic estimates of all the costs and benefits are needed. Second, community engagement as to what the public spaces should look like and what transport is provided to access them.
As a dislaimer – I am a relatively regular rail user and live in the area under attack from the developers.
So from the macro to the very local. But if more citizens were as effective as the Save our Rail group and carried the fight to macroeconomic issues, the deficit terrorists would have a harder time of it.
That is enough for today!