At last week’s National Cabinet meeting (August 21, 2020), the governor of the Reserve Bank of Australia continued to play a political role in the economic debate despite hiding behind the veil of ‘independence’ from such matters. A few weeks ago, the federal government claimed the state and territory governments were not doing enough by way of fiscal stimulus to reduce the job losses associated with the pandemic. The Federal government is essentially trying to force the political consequences of its own failure to increase its net spending by enough and the resulting real economic damage that has resulted onto the states and territories. The RBA governor seems to be playing along with this agenda. Last Friday, he called for the states and territories to double their fiscal stimulus outlays (by $A40 billion) and stop fussing about credit ratings. The problem is that if they did that, the conservatives would immediately start claiming the debt was unsustainable and would damage the states’ credit ratings. Just as they regularly do to advance their political agendas to cut the size of state governments. While the mainstream economists urge ‘fiscal decentralisation’ they do so because they know states are not currency issuers and will then be open to attacks about tax burdens etc, which then bias the political debate towards cutting services etc. In general, the spending responsibilities should be at the level of the currency-issuer. And, the RBA governor should get back to fulfilling the legal charter of the RBA – to ensure there is full employment and price stability. His institution is achieving neither – with negative inflation and massive labour underutilisation. If he really wanted to increase job creation he could signal that the RBA would purchase any debt issued by governments at all levels who announced, and, made operational, large scale job creation programs. That would work.
Some mainstream views
The existence of vertical imbalance is common in federal systems, but is mostly more pronounced in the Australian case (Austria and Belgium are exceptions).
The mainstream treatment of vertical imbalances is to claim that without hard ‘budget’ constraints at the state level, the states will overspend and then push the political responsibility on the federal government to make necessary transfers.
The mainstream literature claims that where sub-national governments have autonomy over borrowing, they spend more, which then undermines the federal fiscal position.
So, they claim that if the state-level jurisdictions are borrowing to fund their spending (they are currency users remember) then according to the IMF (Source):
… there are also potential impacts on the cost of central government borrowing through a crowding-out effect.
That is, rehearsing the flawed claim that government borrowing pushes up interest rates and damages private interest-rate sensitive expenditure (investment etc), which is considered to be more productive than public spending.
So the standard sort of nonsense.
The mainstream literature also extols the virtues of so-called ‘fiscal decentralisation’, where the major spending responsibilities occur at the local level to ensure local officials are more accountable.
And, then, according to the IMF:
… citizens can ‘vote with their feet’ by relocating to jurisdictions that provide the type and quantity of public goods that better fit their preferences, increasing the potential benefits from fiscal decentralization …
There is also the so-called “Leviathan hypothesis”, which claims that:
… decentralization is a mechanism that can help constrain the size of the public sector and provide incentives for the efficient provision of public services …
Why? Because apparently citizens prefer lower taxes, which then constrains the capacity of the government to offer services.
While the Modern Monetary Theory (MMT) literature does not broadly discuss tax systems in any structural way, although there is work being done on this question, MMT economists reject the basis of the decentralisation movement, which mainstream economists claim improves efficiency.
From an MMT perspective, pushing more spending responsibilities to the local level but then force the local units to rely on debt to fund the spending, exposes local communities to harsh variations in spending if bond markets work against a particular regime and also will lead to a lack of uniformity across the national space, thus undermining notions of a collective people.
It is better to have governmental structures where the large spending responsibilities are aligned with the currency-issuing capacity of the government.
The fiscal decentralisation idea, exploits the concept of ‘subsidiarity’, which dominated the discussions during the Maastricht process that created the Eurozone. And reflect on that mess.
The term, subsidiarity, a long-standing concept in political theory (as far back to Aristotle).
The Oxford Dictionary defines subsidiarity as “(in politics) the principle that a central authority should have a subsidiary function, performing only those tasks which cannot be performed at a more local level”.
The concept was popularised by the Roman Catholic Church in the 1931 encyclical, Quadragesimo Anno, which pronounced that “It is a fundamental principle of social philosophy, fixed and unchangeable, that one should not withdraw from individuals and commit to the community what they can accomplish by their own enterprise and/or industry” (Pope Pius XI, 1931).
The idea is thus generally taken to mean that in a federal structure, issues should be managed at the most decentralised level that is effective.
There is often an emphasis on the advancement of the ‘common good’.
British economist John Maynard Keynes used the concept of compositional fallacy to expose the flaws in conservative mainstream economics during the Great Depression.
Keynes demonstrated that the mainstream free market economics approach was prone to these fallacies, which are logical errors that arise when something is claimed to be true in general by dint of some specific part of the whole being true.
The important point in relation to the allocation of competencies across the levels of government is that there are some functions that have to be performed at the aggregate level in a federal system if the overall system and its components are to function effectively.
The fiscal policy capacity to offset major asymmetric private spending fluctuations is one such function and is intrinsic to the ability of the overall system to achieve common good, however, broadly that is defined.
When mainstream economists invoke ‘subsidiarity’ as a means of achieving common good, they also fail to understand the imperative for a federal fiscal or treasury competency.
Lower entities in a federal system cannot achieve desirable ends if they are denied access to support from the currency issuing level of the system and further constrained in the size of deficits they can run.
Think about the way this principle has been applied in the Eurozone system – the fiscal responsibilities were pushed down to the Member State level but the lack of trust (within a common currency) across those States, led to the introduction of unworkable fiscal rules, that biased those fiscal interventions to being procyclical (that is, destructive).
That is background.
The Australian situation
Australia is a federal system, the design of which reflects the colonial suspicions that dominated before federation in 1901. There are three levels of government: federal, state and local, with the latter being creatures of the state legislatures.
There are serious vertical imbalances in the design of our federation.
This means that:
1. The States are currency-users (with limited capacity to raise revenue) but have the largest share of the spending responsibilities. The states rely on what are referred to as ‘narrow’ and ‘inefficient’ tax bases such as stamp duties on real estate transfers.
2. The Commonwealth is the currency-issuer with limited expenditure responsibilities – it also collects income taxes (personal and corporate).
I won’t go into the historical record of how states gave up income tax rights during WW2 and how Section 109 of the Constitution has been used by the federal government to override any return to State income taxing ever since.
To overcome that imbalance, there has been large financial allocations from the Federal to the State level via the Commonwealth Grants Commission. This process has historically been highly politically compromised and subject to pork barrelling, particularly as it is common for the states governments to be dominated by the opposite party that is in power federally.
The imblance has intensified since 2000, when the Australian government introduced a broad-based value-added tax (the Goods and Services Tax) and persuaded the States to abandon a number of taxes that they were constitutionally allowed to levy, but which were not efficient vehicles (for example, payroll taxes).
The deal was that the Commonwealth would compensate the States for the revenue loss through GST redistributions but the formula used provides disproportionate gains to some jurisdictions over others.
The responsibilities for service delivery are distributed accordingly (Source).
During the pandemic, the distribution of Australia’s constitutional responsibilities and powers across the levels of government, particularly Federal-State relations is now becoming a major topic of dissent.
All our State and Territory borders are closed – so we cannot move between jurisdictions (without special permits which are extremely limited).
The tensions that have arisen are not unique to Australia of course. We can see the claims of the corporate sector across most nations urging governments at all levels to abandon lockdowns.
I am on the public record supporting the lockdowns, because the evidence is that they suppress the virus infection rates and reduce the death rates. Personally, I have not been able to go to my Melbourne office for 10 weeks now which is highly inconvenient. But I still support the border closures.
I do think, however, that some flexibility has to be given to border communities, who have to traverse borders on a daily basis in the normal course of their lives – work, shops, health care, schools etc.
The campaign to open the borders is gathering pace though and was a central topic of the National Cabinet (State Premiers and Federal Ministers) meeting last Friday (August 21, 2020).
Enter the Reserve Bank of Australia …
Last Friday, the governor of the RBA addressed the National Cabinet meeting and claimed that:
1. The States and Territories should double their net spending – that is, spend an additional $40 billion on job creation.
2. This would reduce the federal deficit and debt needed to deal with the crisis.
He claimed that the reluctance of the States and Territories to spend more was driven by their determination to protect their credit ratings.
The Prime Minister has been also making the same claim.
As we have seen, the RBA governor has regularly played a political role, despite claiming that the RBA is independent of the political process.
See my most recent analysis of this – RBA governor adopts a political role to his discredit (August 18, 2020).
As an aside, I rejected a few comments on this blog post last week because they were just saying effectively – that I was wrong and should apologise because I wasn’t using mainstream analysis. More or less that point.
They did not address why the mainstream analysis failed to explain the data. They just reasserted the mainstream myths.
The point is that there are more than enough sites that propagate mainstream thinking. I don’t intend my blog site to add another space for this nonsense to be made public.
If you feel aggrieved that your mainstream narrative has been rejected by my editorial rules, then start your own blog site. You are free to do that.
And it is futile then bombarding me with ‘open letters’ accusing me of censorship.
There are no minutes published from the National Cabinet meeting but the Prime Minister issued a – Media Statement (August 21, 2020) – where he said that:
The Governor of the Reserve Bank of Australia, Philip Lowe, and the Treasury Secretary, Steven Kennedy, provided National Cabinet with an economic update. Both reiterated that the biggest economic challenge that faces Australia is jobs and unemployment.
The Governor outlined there is a need for a coordinated focus from all levels of government on three key areas:
1. Income support programs which includes the substantial investments already made in JobKeeper and JobSeeker;
2. Investments in our physical capital including infrastructure and human capital via skills and training; and
3. Greater ease of doing business through lower and efficient taxes and less regulation
He also told the media that:
The level of commonwealth investment in fiscal intervention in this crisis is well over 15 per cent of our economy … As a share of state product, the states in total (have committed) around 2.5 per cent …
Now that ranges across states and territories but the Reserve Bank governor called on the states and territories today to lift their fiscal investment over the next two years in programs of the nature I have outlined … to the tune of 2 per cent of GDP or $40 billion over the next two years …
Right now, all of the announced measures of the states and territories are currently sitting in the vicinity of just shy of $48 billion. So the governor is saying there needs to be an additional $40 billion on top of that by the states and territories over the next two years.
Then the corrupt ratings agencies bought into the fray claiming that there was ‘plenty of room’ for states to borrow more.
I will respond to those claims presently.
But we should step back to what has been happening pre-pandemic.
The following graph shows the contributions to GDP growth between the March-quarter 2018 and the March-quarter 2020. The component contributions are in points, while the GDP growth in in percent.
The States and local areas of government have not lagged (proportionally) in ‘consumption spending’ contributions and have outstripped the federal government in terms of capacity building (investment) by a significant factor.
The contribution of the states to growth via its infrastructure programs has been substantial – particularly the large public transport projects in Melbourne and Sydney.
In some quarters, for example, June-quarter 2017, the state infrastructure spending was the difference between negative overall national growth and positive growth – 0.74 points contribution to overall growth of 0.65 per cent. In that quarter, the federal contribution was -0.12 points.
Further, in that quarter, the States and local consumption spending contribution also outstripped a declining federal contribution.
The point is that as the federal government systematically pursued a fiscal austerity bias, in the face of negative private investment contributions and household consumption expenditure being driven by increasing (and record) levels of household indebtedness, Australia’s growth rate plummetted to below 2 per cent and nearly 1.5 points below trend.
If the states and territories, particularly Victoria and NSW, had not introduced their large-scale public works programs, Australia would have been in recession much sooner.
So it is a bit much for the Federal government, which has all the currency power, to now claim that its lack of willingness to use that capacity that has caused the resulting rise in unemployment and underemployment, should be offset by pushing the states and territories into even more debt.
First, the data shows that the Federal fiscal stimulus which consists of “expenditure and revenue measures worth A$164 billion (8.6 percent of GDP), has been put in place through FY2023-24, and the majority of which will be executed through FY2020-21.” (Source).
So the Prime Minister’s claim that the federal response has been “well over 15 per cent of our economy” is an overstatement.
The federal government is clearly not expanding its discretionary deficit enough. I estimate it could easily expand it by $A100 billion more given the scale of unemployment and broader labour underutilisation that has arisen since March.
Second, the constitutional problems (vertical imbalance) do not preclude large-scale federal spending on infrastructure either alone or in partnership with the states and territories.
The Australian government should invest much more in our national broadband infrastructure to reverse its poor decisions not to provide fibre to the home and to force the NBN development agency to recoup costs.
It has sole constitutional authority to do that.
Trying to penny-pinch some years ago as part of their obsessive surplus pursuit has left Australia with a second-rate and expense Internet infrastructure at a time when more people are now relying on it for work purposes (home offices etc).
Further, there is a 400,000 shortage of social housing in Australia as a result of past austerity decisions from governments (federal and state).
With the construction sector contracting as a result of the pandemic, this would represent a perfect opportunity for the federal government to provide massive tied grants to the states and territories to build suitable public housing to help low-income earners.
Third, the federal government is not looking ahead at the climate problems that have not gone away. It could provide states and territories with massive tied grants to invest in renewables, particularly energy production and distribution, which since the states privatised those utilities has become increasingly unreliable and expensive.
Fourth, the university sector is now in crisis as a result of being excluded from the federal wage subsidy program. Institutions are cutting staff in the thousands and we will be left with a hollowed out research and innovation capacity as a result.
It is madness to hack into that capacity. This is a federal responsibility.
Fifth, imagine a few years down the track – the conservatives will hammer state and territory governments for having high debt ratios and forcing higher tax burdens on their citizens to maintain spending levels.
And then, they will demand spending cuts which would undermine service delivery.
There will be screams of risks to credit ratings – and the parasitic ratings agencies will be out there stirring the furore (because they make money that way).
The sensible strategy, given the scale of the pandemic, is the federal government to use its currency-issuing capacity to increase its fiscal stimulus and provide ample grant support to the states.
The principle of subsidiarity is fine but, if not moderated by an understanding of the capacity of the currency-issuer in a federation, will deliver situations where an austerity bias becomes the norm.
By denying its own fiscal capacity and pursuing its surplus obsession, the federal government has for years imparted an austerity bias down to the local level.
In part, the massive infrastructure projects that I mentioned above in Melbourne and Sydney were the result of trying to catch up from the years of public investment neglect by a succession of neoliberal state governments.
Sixth, the RBA governor would have offered more sensible advice if he said the states and territories might expand their stimulus outlays while the RBA would purchase any debt issued.
Up until now, the states and territories have announced fiscal stimulus packages worth “$32.9 billion (1.7 per cent of GDP)” (Source).
Between March 20, 2020 and now, the RBA has purchased $11.1 billion worth of state and territory public debt in the secondary markets.
The RBA could do much more if it really thought the states and territories should borrow more.
The RBA governor is clearly playing a political role at present.
The Federal government is trying to force the political consequences of its failure to increase its net spending by enough and the resulting real economic damage that has resulted onto the states and territories.
The RBA governor is playing along.
He should get back to fulfilling the charter of the RBA – to ensure there is full employment and price stability.
His institution is achieving neither with negative inflation and massive labour underutilisation.
If he really wanted to increase job creation he could signal that the RBA would purchase any debt issued by governments at all levels who announced and made operational large scale job creation programs.
Then we would see something sensible.
That is enough for today!
(c) Copyright 2020 William Mitchell. All Rights Reserved.