A bit of a different blog today. I was rummaging through some boxes of papers today in search of some “non-digitised” notes which I wanted to consult as part of the development of our macroeconomic textbook, which Randy Wray and I hope to get out sometime next year. I came across some old drafts of papers I wrote in the early 1990s which had handwritten annotations etc. The old way of doing things. I thought it was interesting to compare the final published version of one such paper with the unpublished draft. That is what this blog is about – looking back to an article I wrote in 1993 (“Demystifying the Deficit”). A little journey back in time – but with alarming overlaps with what is going on today.
Before I go to my archival material a lot of readers have asked me to situate Black Labour in the debate (similarly the Blue Dog Democrats).
I don’t want to write “When you’ve got friends like this – Part X” blogs all the time so I suspended my research into Black Labour for today because the blog might have headed down that road again. Apparently, if I keep writing these sorts of blogs I will have no friends left.
But didn’t Groucho Marx say:
Please accept my resignation. I don’t care to belong to any club that will have me as a member”.
The “so-called progressive club” that is. (-:
But I came across some extraordinarily co-opted material anyway.
Take this article – Cut to the chase: 15 political truths for the centre-left – which was published by the self-styled centre-left Policy Network. The various writers that are assembled under this portal are getting a lot of attention in the UK Guardian at present.
For example, see this article Labour urged to stop dithering over deficit reduction (December 1, 2011) and Labour must make fiscal honesty the key to responsible capitalism (December 1, 2011).
I think the flooding of the Policy Network rhetoric in the Guardian sadly compromises the independence of that newspaper. But that is another story.
The article in question was part of the Policy Network’s “Priorities for a new political economy: Memos to the Left” and was presented to the Progressive Governance Conference in Oslo on May, 12-13 2011. It was published on the Policy Network portal on May 10, 2011.
The paper attempts to outline a manifesto for the “centre-left” (whatever that is) to allow them to “extract the right lessons from the crisis” and to define a “progressive political action plan”.
While each of the “15 Ideas” were interesting, I choose only to consider Idea 7 in this blog which was entitled “Fix your fiscal accounts – the progressive way”.
Accordingly, we read:
There is nothing progressive about large fiscal deficits and high public debts: when public finances blow up and need to be fixed in an emergency, it is the poor and the vulnerable who end up footing the bill.
It is much better to strengthen fiscal accounts before a crisis – and to do it the progressive way. The first thing is to get the timing right. A weak recovery is not the time to tighten fiscal policy sharply. But if markets see no indication of tightening, they may abort the recovery themselves. The way out of this conundrum is to commit to adjustment, backload it, and make credible any promises of additional future tightening. This may require setting up fiscal rules and independent fiscal councils …
That sounds like a neo-liberal prescription to me. My view of progressive policy ignores the fiscal position and focuses on the substantive issues. If you have high unemployment then the deficit – whatever it is – is too small.
The only rule that the government should be guided by is that aggregate demand has to be such that all productive inputs are working according to their desires.
Fiscal rules and fiscal councils erode democracy and usually impart conservative biases to policy (such as, using the neo-liberal NAIRU as a benchmark).
The concept of public finances “blowing up” is not a progressive one. What constitutes a blown up situation?
If it is rising bond market yields, that further extends the neo-liberal construction. Currency-issuing governments can ignore bond markets which are really just arenas where some of the corporate welfare is delivered in the form of risk-free government annuities (bonds).
A progressive position is to break free of the grip that debt markets place on the capacity of governments to pursue public purpose. Under those circumstances, what could constitute an “emergency”?
A rapid rise in unemployment is an emergency and requires a rapid budget expansion.
What does “strengthen fiscal accounts” mean in progressive language? I would say that we would be moving to a stronger position when the government was expanding its net discretionary position to engender growth and reduce unemployment. According to these (so-called) progressives that would be a weaker position.
Financial markets are dependent on government not the other way around when that government issues its own currency. I consider it a neo-liberal position to assert that “if markets see no indication of tightening” then bad things will happen.
What exactly can the markets do to a progressive government that uses its fiscal capacity appropriately to fill the real spending gap between non-government spending and available real productive capacity?
Not buy government debt? A progressive wouldn’t issue debt!
Sell the currency down? Perhaps, but a progressive would declare illegal or tightly control most of the financial transactions that are not associated with real production and so that would reduce that capacity.
Persuade firms not to invest in productive capacity? Perhaps, but the capitalists chase profits and no firm is going to resist going for market share by maintaining enough capacity if aggregate demand is growing.
What else? Not a lot. The financial markets cannot “abort the recovery themselves” unless the relevant national government allows them too. The ascendancy of the “markets” is a government construct. Our representatives became co-opted and bought off. The progressive challenge is to reclaim our states and make them work for us and not to adopt a timid resignation that the markets have the power.
Most importantly, fiscal policy should never be guided by context-free rules (backloaded adjustments, promises of future tightening etc). It is a moving feast and should be defined by what is happening in the non-government sector combined with the socio-economic mandate that the government wishes to pursue.
Sometimes budgets have to be tightened, other times loosened. There should never be a “tightening bias”.
Black Labour is not a progressive movement.
Empirical context of the 1993 article
To appreciate the context that the article was written within I created the following graphs. The left panel shows the annual unemployment rate in Australia from 1861 to 1993 while the right panel shows the quarterly growth rate in real GDP from the first-quarter 1985 to the third-quarter 1993 (the article was written in October 1993). In the left-panel, the Great Depression of the 1930s stands out.
By the time I was writing this article, Australia had gone back into recession. The Federal Government’s refused initially to intervene as the 1991 recession (our worst since the Great Depression) deepened.
It was a Labor Government at the time and they had become obsessed with budget surpluses. Eventually they reluctantly intervened with a relative modest (but very late) fiscal stimulus but it was too late – the economy was already back in recession. It took the rest of the decade and then some for the unemployment rate to go back to the November 1989 level (the low-point in the previous cycle).
Demystifying the Deficit
The article appeared in the Arena Magazine in the October-November 1993 edition. The following text is the final published version and I have annotated it with the extra information I discovered today.
The final version presented below had to fit into a word constraint which largely explains the edits. While I would have written a few things differently now I thought you might be interested in reading what I might have written in 1993 if blogs were the go.[1993 TEXT BEGINS]
The budget deficit is often paraded by economists, politicians and so-called financial market experts to set out a case against an active fiscal policy. It appeal lies in its seeming simplicity.
We are given the easy-to-understand homily of the family budget and told that if the family or government lives beyond its means then trouble looms.[Comment: In my original draft – which was edited by me to meet the word limit I had added after this sentence]:
Indeed, the idea that the government is just a big household has not relevance to an economy where the government issues its own currency.
The fact is that the budget outcome is far from unambiguous. In this regard, it is one of the most misunderstood and misused concepts that creep out of economics into the public domain. The current debate about the state of the Federal Budget is a good example of how misleading “rationalist” rhetoric can distort the policy process and impair the operation of the economy.[Note: at the time the term “economic rationalist” was popular in Australia. We use the term neo-liberal now – one who believes in the myth that private markets self regulate and deliver optimal outcomes for all]
It is true that the annual budget documents represent the major statement of policy direction for the Federal Government. Intuitive reasoning might conclude that the actual budget figures measure in dollar amounts the policy choices being made by government and hence its impact on the economy.
But this is not really possible without first analysing the nature of the deficit.[Comment: original draft had this extra sentence]:
We have to distinguish between good deficits where the government spending and taxation decisions support real GDP growth with strong employment outcomes and low unemployment from bad deficits which result from the collapse of taxation revenue with insufficient public spending. The latter is associated with stagnant growth or recession and high unemployment.
So while a deficit reflects expenditure larger than budgeted income, this is by no means an indicator of government policy or intention. Nor does the family analogy help in grasping the complexity of government budget necessities.
According to that analogy, the deficit indicates a more-or-less immediate need to raise income contain expenditure. But this overly simplistic thinking, which is viewed by its adherents as common sense, takes no account of cyclical processes, or of the knowledge of economic relationships critical for proper economic management.[Comment: original draft had this extra sentence]:
Household spending faces intrinsic funding constraints which do not apply to the Federal government. Further, government deficits are required to support growth when private spending is insufficient.
Economists who are not bent on misusing the budget outcomes for ideological purposes by appealing to some of these popular perceptions, make a clear distinction between structural (or full-employment) deficits and cyclical deficits.[Comment: original draft had this extra sentence]:
This relates to the earlier distinction between good and bad deficits.
The actual figure which is published and is most often quoted in debate is the sum of these two components. Put simply, the budget outcome is influenced by the state of the business cycle as well as chosen fiscal policy parameters.
When the economy enters a period of slow economic activity, and output and employment fall, taxation receipts (both income and indirect) fall and transfer payments rise (principally unemployment benefits). This causes an increase in the budget deficit even though the fiscal policy parameters (tax rates, benefit rates, government spending programmes) have remained unchanged.
The deficit will fall again, without any necessary change in fiscal policy, if the economy increases its activity (more tax and less transfers).[Comment: original draft did not have the last phrase in parenthesis but had this extra text]:
With higher levels of output, income and employment, the government receives increased tax revenue and pays out less in unemployment benefits (without changing any policy settings). Economists refer to these cyclical shifts in government revenue and spending – the automatic stabilisers. They are so-named because in a downturn they serve to put a floor in total spending in the economy and in an upturn work to contain aggregate spending.
The budget deficit figure is appealing, because, in a single number it summarises the complexity of policy decisions. But to use it as an unambiguous summary of discretionary fiscal policy choices, we need to separate the impact of the business cycle (the cyclical component) from the impact of the policy choices (the structural component).
How do we calculate the structural component? We define some notional full employment/unemployment rate, and using the current policy settings we work out what the budget outcome would be (with the implied higher tax revenue and lower transfer outlays).[Comment: original draft had these extra sentences]:
Defining full employment is highly controversial and the economic rationalists use a concept referred to as the NAIRU (Non-Accelerating-Rate-of-Unemployment) which they claim is unchanging in the face of the business cycle but defines the unemployment rate consistent with stable inflation.
The concept has evaded empirical scrutiny and fails to consider the so-called structural changes in the labour market (skill obsolescence) that themselves cyclical in origin but reversible. The attempts to empirically define the NAIRU produce outcomes that appear to track the actual unemployment rate up and down which makes the concept fairly useless as a guide to policy.
Full employment should always be defined in terms of the number of jobs that are needed to satisfy the desires of the workers for jobs.
The difference between the structrual balance and the actual budget outcome published is due then to the economy not being at this full-employment level of activity, rather than to discretionary government policy. Any structural deficit is due to deliberate policy decisions.
So prior to judging how much impact the deliberate policy stance is having on the economy we have to decide how much of the actual deficit outcome or estimated outcome is structural.
Currently the actual budget deficit is estimated to be around $16 billion, which is a very high figure.[Note: I would now have written “a very high figure in absolute terms relative to our past history”].
But before we get worried by it we should put it into the context of the persistently high unemployment and slack growth which plagues Australia (and the rest of the world).
How many commentators do this?
While it is a complex task to compute the structural component, some simple calculations can give us an idea. Using six per cent unemployment as an arbitrary benchmark and taking pre-1993-94 fiscal policy settings, we can estimate what the budget deficit would be at that higher level of activity.[Comment: original draft had this sentence instead of the last sentence above]:
[Note: the actual unemployment rate in November 1993 was 10.9 per cent]
Given the unemployment rate at the end of 1989 (6 per cent) as the growth cycle peaked as our benchmark and taking pre-1993-94 fiscal policy settings, we can estimate what the budget deficit would be at that higher level of activity. We should not assume that full employment is reasonably defined as being consistent with a six per cent unemployment rate. However, this is currently about what the Treasury estimates the NAIRU to be and to neutralise objections to the analysis based on disputes about what constitutes full employment, we adopt the six per cent benchmark.
Based on ABS data and Treasury’s own data base, after estimating the gains in tax revenue and the savings in transfers as a result of the higher level of economic activity, the rough calculations reveal that the structural deficit at the end of June 1993 was approximately $6 billion, or around 1.5 per cent of GDP, a far cry from the $16 billion of the actual budget outcome.
Further, in the 1993-94 Budget, the government has factored in large indirect tax gains over the next four years which alone if realised would more than wipe out this structural component.
So the only reason we would still expect to see any deficit by 1996-97, the current fiscal setting unchanged, would be before the economy is still languishing at high unemployment levels.[Comment: original draft had this extra sentence]:
This is not to say that eliminating the structural deficit is a responsible fiscal strategy. A deficit of around 1.5 per cent of GDP has historically been associated with full employment and provides the spending impetus to support the private sector saving intentions.
The next question is whether that is an appropriate degree of stimulus to be putting into the economy by choice. Another way of posing this question is to ask whether budget deficits are ever warranted. Some say the budget should always be balanced. Their reasoning is briefly as follows.
Total national savings is the sum of private household saving and government saving. Governments save when the budget is in surplus and dissave when in deficit. If the government budget is in deficit, this must be financed by drawing down private savings via bond issues or by increasing overseas indebtedness (via current account deficits).
The reduced availability of funds and the higher interest rates crowd out private sector investment. The moral epithet usually invoked says that public spending is largely wasteful and replaces more productive private spending.
This argument is seriously flawed.
Firstly, public spending is not inevitably unproductive, even when it is only for consumption purposes like education and health. Public infrastructure serves as a backbone for private-sector investment and national development. Further, spending on education, for example, reduces the costs of training to the private sector and increases the productivity of the labour force.
Secondly, the idea is based on the notion that private-sector investors are champing at the bit to increase productive capacity and are only constrained by available private-sector savings. This is patently untrue. Recently there have been substantial incerases in corporate profit levels, yet private investment remains flat.[Comment: original draft had this extra sentence]:
The empirical evidence is that private investment is substantially driven by confidence and with high and rising unemployment, firms will not invest in new capacity if the existing capacity is sufficient and there is considerable uncertainty relating to realisation of sales.
In previous times, many potential investment resources were frittered away by the private sector chasing speculative gains.[Note: this was written at the start of the growth surge in the financial sector aided by the deregulation that the government introduced in the erroneous belief that this would “grow wealth” for all of us]
Thirdly, the idea is based on the old classical loanable funds doctrine which conceived of savings as a fixed pool which could only be increased by reducing consumption as interest rate changes (rises) made future consumption cheaper. Any reduction in savings was, obviously, simultaneously a reduction in investment (both being related in opposite ways to interest-rate changes).
Yet one of the significant steps which Keynes made was to point out that savings could be released without any decline in consumption in the short term via portfolio adjustments between cash holdings and other financial assets. But more importantly, both savings and consumption could increase as output grew.
So if a budget deficit contributed to growth the savings pool would also grow and investment expenditure could also be financed.[Comment: original draft had this extra sentence]:
This observation led some economists to say that investment brings forth its own savings by which they meant that investment spending created multiplier effects which stimulated national income and some of the extra income would be saved.
Fourthly, the idea of budget deficit-motivated growth only makes sense when the other components of growth are absent. In particular, investment can only be starved for funds when there is too much expenditure demand. Governments have to use deficit stimulus when private-sector demand is low.[Note: I would now express the investment constraint more clearly in real terms]
In that instance, it is nonsense to talk about damaging expenditure that is patently non-existent. Moreover, the costs of not attempting to stimulate the economy in terms of wasted human and physical resources are so large that modest negative effects on private expenditure in the short run are small by comparison.[Comment: original draft wrote the last sentence in this way – which I think was better on reflection]:
Moreover, the costs of not attempting to stimulate the economy in terms of wasted human and physical resources are so large that even if there were modest negative effects on private expenditure in the short run they would be small by comparison.
So at a time of low private-sector activity and high unemployment the government must use its spending and taxaction policies to stimulate the economy. There is no dynamic in the system which would get the economy going again in the absence of this fiscal stimulus.
Properly targeted spending with some monetary growth must remain the priority of the government. The relatively small structural deficit currently existing could even be increased in the short run without any damaging consequences.[Comment: original draft wrote the last sentence in this way]:
The relatively small structural deficit currently existing is too small once you consider the persistently high unemployment and could be increased in the short run without any damaging consequences like inflation. The persistent inflation that we carried over from the OPEC decade (mid-1970s) was eliminated in 1991.
It is the poor private investment performance which really lies at the heart of Australia’s problem and necessitates a higher structural deficit than would otherwise be justified.[Comment: original draft wrote the last sentence in this way]:
… otherwise be justified in relation to the need to maintain price stability.
Australia has a moribund entrepreneurial class which has not shaken off the effects of our long historyof guaranteed profit under protection. It sees business as predominantly an activity based around asset speculation.
In the mid-1980s, this class was given unprecedented opportunities to use the higher profits from the Accord-motivated income redistribution, lower corporate taxation and a depreciated dollar to increase productivity and per capita income.[Note: the Accord was the Federal government wages policy which engineered real wage cuts for several years in the 1980s on the pretext that the capitalists would use the redistributed profits to create more employment and, ultimately, real wages growth. The unions became totally compromised by their association to the Labor government and this period, arguably, started the demise of the union movement. They had become co-opted to the neo-liberal agenda]
The funds were largely squandered in share and property transactions. This necessitated higher interest rates to moderate the economy to bring the external debt into manageable proportions. The debt was largely a legacy of the private-sector binge. The slower economy has led to the budget deterioration.[Comment: original draft wrote the third last sentence in this way]:
[Note: to avoid stirring erroneous claims I now never refer to a rising budget deficit as a “deterioration”. In 1993, I was using the term in the common parlance which I now consider to be misleading and focuses the discussion on the wrong thing]
Given that the Federal government became increasingly resistent to using fiscal policy, the RBA considered it necessary to increase interest rates to moderate the economy to bring the external debt into manageable proportions. Monetary policy is a blunt instrument and the long time lags involved introduce a bias to increasing rates too far and holding them at those levels for too long.
Once again, with low inflation and extremely modest wages growth, corporate profits are booming, but there are insignificant levels of private capital formation. There is always an excuse. Too much regulation here, too many restrictive costs there. Yet we forget that two of the most regulated and highest taxing economies (Germany and Japan) dominate the world.[Note: by this time Japan was wallowing in the immediate aftermath of the asset price bubble]
The unfortunate truth for all of us, and especially the poor and disadvantaged, is that we ultimately rely on private investment for employment and prosperity. That is the old problem of capitalism, and no matter how sophisticated the disguise over the class structure, it will not disappear.
The budget deficit is just another smokescreen which capitalists and their agents use to obscure their own failings.[END OF 1993 ARTICLE]
There were many smaller edits – a word or two here or there – but the final draft was not that much different to the penultimate draft that I had to cut to get within the word limit.
At the time I had not gained the position of professor (I was a lecturer).
I consider the arguments used in that article remain applicable and I wouldn’t have written it much differently.
What followed – during the rest of the 1990s – was an acceleration in the neo-liberal deregulation and the massive accumulation of private debts. The financial sector that I had identified as the problem in this article became a much larger problem and has delivered the death knell to that method of organising the monetary system.
The problem now is that it is taking a long time for the population to work through all the narratives to reach that inevitable conclusion. Meanwhile, the lying politicians remain in charge and co-opted by the elite lobbies that are dominated by the financial sector interests.
It took 30 odd years to create this mess and it will take a fair time to get out of it.
My current role is – as I considered in then – to provide the analytical case to reject the mainstream approach. And to just keep pushing down that road!
You might conclude that I have been bashing my head against the brick wall for all of my career and you would be pretty right. Some time I will stop!
The Saturday Quiz will be back sometime tomorrow – even harder than last week!
That is enough for today!