Tonight we consider the tale of two countries with some other snippets of good taste included for interest. In the last few days the Japanese government has announced the largest fiscal stimulus in its modern era (since records have been kept) while Ireland announced its 2010 budget which has been characterised as the harshest in the republic’s history. Both countries are mired in recession with only the most modest signs of any recovery. So on the face of it this is one hell of a juxtaposition. What gives?
Yesterday’s UK Times newspaper (December 26, 2009) presented economic commentary that was stark in its juxtaposition. Without noting the underlying issues that connected the articles, the Times reported that the:
… new Japanese Prime Minister, has stunned a nation already mired in huge public debt by unveiling the country’s biggest ever postwar budget … aimed at “saving people’s lives”.
Ireland, the first eurozone nation to enter recession, is struggling to emerge from beneath a blizzard of frighteningly negative economic statistics after Brian Lenihan, the Finance Minister, delivered a stinging Budget this month with a target of cutting €4 billion (£3.6 billion) in spending …
So on the one hand, it is fortunate that there is fiscal leadership in Japan and the capacity to implement it.
But on the other hand, the Irish do not have the willingness to provide fiscal leadership in their winter of recession which might reflect the voluntary constraints they have imposed on their fiscal capacity courtesy of their EMU membership.
So perhaps the best advice to the Irish is to catch the ferry – although that might no longer be the boon it has historically represented. In the past the Irish could find better labour market opportunities in Britain and they left in droves. Now, with the lack of fiscal leadership in Britain one wonders whether life there would be better these days.
But for the Irish things are very bleak indeed.
The Times article on Japan – Debt-laden Japan shocked by £630bn spree to save lives’ reports that
Yukio Hatoyama, the new Japanese Prime Minister, has stunned a nation already mired in huge public debt by unveiling the country’s biggest ever postwar budget: a 92.3 trillion yen (£630 billion) spending spree aimed at “saving people’s lives”.
The unprecedented budget, which supposedly shifts Japan’s fiscal spending focus “from concrete to lives”, comes amid rising concern about the solidity of sovereign debt in the world’s second-largest economy.
The new budget will require additional debt issuance of Y44.3 trillion — within the Government’s expected band, but still at a level that will raise Japan’s debt-to-GDP ratio to nearly 195 per cent.
First, it only requires the additional debt issuance because the Japanese government legislates that it continues gold standard practices that are totally unnecessary in a fiat monetary system.
Second, the rising debt is a safe place for the Japanese to park their savings and provides them with an income flow. The domestic bond market in Japan is “very loyal” and the Bank of Japan never has trouble placing public debt into the bond markets. What is not often understood about Japan is that there is no formal superannuation system so people save for their own futures.
Third, there is no risk of sovereign debt default in Japan. Zero. Even putting this into a paragraph which followed references to “mired in huge public debt” shows the ideological nature of the journalist and the fact that they do no understand the first principles of a modern monetary economy (or choose to display the ignorance to advance the former).
The conservative analysts are all scurrying about noting that it is the first time since the Second World War that “new debt issuance has exceeded tax revenues” which just tells me how deep the recession has been in Japan and nothing more than that. You can imagine the debt-armageddon scenarios that are going about at present in Japan. I suppose it keeps people busy dreaming up this nonsense.
Fourth, the interesting part of the story is that there is now a discrete policy shift going on as a result of the political changes in Japan that arose from the last election – that is, the ascendency of the Democratic Party of Japan (DPJ).
The shift will see the government reduce its obsession with public infrastructure development as a vehicle for huge fiscal injections and instead put the spending power into poor households. The Times said:
Mr Hatoyama swept to power in August with grand promises that the era of wasteful public spending would end. Japan’s unnecessary and notoriously expensive “roads to nowhere” public works projects would be curtailed and the money diverted to supporting beleaguered households … The budget plan will contain Y53.4 trillion in policy spending; 51 per cent of that will go to social security programmes. This is the first time that social security has received more than half of policy spending, reflecting the new Government’s focus on jump-starting consumption rather than the big public works projects carried out by former administrations.
Many mainstream economists have been calling for a consumption tax rise to repair the fiscal hole. Yes, what hole? Others have been saying that there should be less government spending and more tax cuts. Hatoyama had promised tax cuts to businesses during the election but appears to have reneged on that.
The debate about the relative merits of tax cuts and spending increases to stimulate a badly recessed economy has been growing over the last year – and it is not confined to Japan. The issue comes down to the relative magnitudes of public spending and tax multipliers.
The usual analysis is that government spending multipliers are more expansionary (larger multipliers) than cutting taxes because some of the tax cut is saved while all of the spending is injected into the demand stream. It is a conclusion that is consistent with modern monetary theory (MMT).
Of-course, the neo-liberal bias is towards tax cuts (supported with obvious rhetoric such as “empowering individuals”) rather than government spending (“more socialism”). Last year, Greg Mankiw, contrary to what he requires students to learn in his (terrible) textbook, seemed to come around to the argument that tax cuts are more expansionary.
My advice to Team Obama: Do not be intellectually bound by the textbook Keynesian model. Be prepared to recognize that the world is vastly more complicated than the one we describe in ec 10. In particular, empirical studies that do not impose the restrictions of Keynesian theory suggest that you might get more bang for the buck with tax cuts than spending hikes.
He also quotes several studies in support of this claim. Unfortunately, each one of them is either inapplicable to the current situation or he misquotes the study. On one such study, Mankiw says that “recent research by Christina Romer and David Romer looks at tax changes and concludes that the tax multiplier is about three: A dollar of tax cuts raises GDP by about three dollars”. Other writers have investigated this point and rejected Mankiw’s interpretations.
For example, DeLong who has investigated the matter (and spoken personally with one of the Romers) says:
It is somewhat puzzling that Mankiw appears to believe that the Romers do think that tax multipliers are larger than spending multipliers, as they do not, and this is something that he could have very easily checked.
In fact, the Romers’ article “does not distinguish between the two, referring only to the “substantial multiplier … due to the procyclical behavour of investment”.
The pro-tax findings rely on the tax cuts stimulating investment (capital formation) by easing interest rates and/or business charges and further assume that spending increases drive interest rates up. Besides many other questionable methodological issues in the papers, the mainstream assumption that budget deficits drive up interest rates and crowd out investment are just plain wrong in a modern monetary economy.
If you don’t believe me – please explain Japan! Japan is my favourite complex and complete (fully-specified) non-linear dynamic economic model with full stock-flow accounting consistency. It saves me having to muck around with Matlab or whatever using highly simplified models due to tractability constraints!
Anyway, at a time when the Japanese economy is still beset with deflation and historically high unemployment rates (although only just over 5 per cent), the government is displaying strong fiscal leadership.
It has assessed that it is better to direct public spending at the poor (who will likely spend more as a percentage of their marginal income than others) rather than continue the tradition of large public works programs in a nation that risks concreting itself over.
The important point is that it recognises its on-going role to plug the spending gap left by non-government saving (and the export collapse) and it recognises it has the capacity as a sovereign issuer of its own currency to run large deficits. In this sense, the Japanese government is placing a premium on keeping unemployment low and is resisting the mainstream pressures (from analysts, credit rating agencies, etc) to cut back the deficit.
The following graph shows seasonally adjusted monthly unemployment rates for the US, Australia, Japan, Ireland and the UK from January 1982 to November 2009 (using official data from the relevant national statistical offices).
Even though Japan has been through one of its worst economic downturns, the unemployment rate is just above 5 per cent and is falling. Australia, the so-called best performer of this group in terms of GDP growth rates etc (it resisted a “technical” recession) still cannot manage to get our official unemployment rate below Japan, which has been mired in recession.
The experience of the US, UK and Ireland in this context also stands out. And it is to Ireland that I turn next.
The experience of Ireland is almost diametrically opposed to that of Japan. The Times article Celtic Tiger finished off by debunked ‘miracle’ reports that “Brian Lenihan, Finance Minister of Ireland, delivered a stinging Budget” for 2010.
Here is the full Irish Budget if you are interested.
The Times reports that:
The worst Christmas in the history of the modern independent Irish State? … many are wondering if 2010 can be any worse than the outgoing year.
For the nation’s public sector workers, pay next month will reflect cuts of between 5 per cent and 20 per cent, levels of reduction not experienced since the 1920s, even when not taking into account previous levies imposed since the Celtic Tiger economic “miracle” began unravelling a year ago.
Ireland, the first eurozone nation to enter recession, is struggling to emerge from beneath a blizzard of frighteningly negative economic statistics after Brian Lenihan, the Finance Minister, delivered a stinging Budget this month with a target of cutting €4 billion (£3.6 billion) in spending.
Ireland’s economic data is well-known now and shocking. Its unemployment is over 12 per cent; it endured a national output loss of 11.3 per cent on its level a year ago; and its inflation rate is minus 3 per cent (that is, a serious deflation) which will further impoverish indebted house owners. Consumption spending has dropped by 20 per cent since the onset of the crisis.
The Irish government has injected €54 billion into the main financial institutions as insolvencies “more than doubled in 2009”. House prices “have fallen by 26.7 per cent since February 2007 and now stand at October 2003 levels”
Ireland was the protype asset price boom fuelled by an out of control banking sector. The Times reports that by 2007 “the country’s houses were the most overvalued in the Western world and construction accounted for one fifth of national output.”
The automatic stabilisers in Ireland have been signficantly responsible for driving the budget deficit towards 12 per cent of GDP so dramatic has the collapse in income generation.
The problem though for Ireland is that it is part of the Euro Monetary System (EMU) and its 12 per cent deficit (as a percentage of GDP) is according to the Maastricht rules out of order irrespective of the state of the economy.
The government already tightened discretionary fiscal policy in April 2009 by withdrawing €3 billion (increasing taxes and cutting spending). Most of the new spending initiatives since the crisis has been to prop up its financial institutions.
In November, the EC gave the Irish government one year extension (to 2014) to get its budget deficit back in line with EMU rules.
So with that sort of outlook why would you entertain a “stinging budget”? Why not follow Japan’s example of fiscal leadership and underwrite aggregate demand to get employment growing.
But in the last week, the Irish government has delivered its “harshest budget in the republic’s history” which is a direct consequence of being in the Euro system.
The problem is that Ireland is an example of a country which moved to a fiat monetary system after the collapse of Bretton Woods in 1971 but, subsequently, decided to impose voluntary constraints on their fiscal capacity and act as if they are still operating in a “gold standard” world. In this case, the constraint is that the Eurozone governments voluntarily conceded their currency monopolies to the European Central Bank without also ceding their fiscal responsibilities.
They also decided, as a consequence, to voluntarily impose the Stability and Growth Pact (SGP) which represent a denial of the essential opportunities available to a sovereign nation.
In contrast to countries operating with their own sovereign fiat currencies, such as Japan, Eurozone countries must formally borrow in order to run deficits. Thus the intertemporal government budget constraint applies to Eurozone countries, and will severely limit the capacity of the public sector to fund recovery plans.
Ireland will eventually emerge from the recession when investors resume building capital but it will take much longer than it should as a consequence of its membership in the EMU.
In the meantime, people will become impoverished and a generation of youth will lose access to employment and skill building opportunities and endure life-time disadvantages as a consequence.
From a MMT perspective it is just plain stupid and criminal for governments to indulge their citizens in this way.
Britain continues in the own-goal tradition
Meanwhile, the Irish probably are not better off fleeing to Britain. This article in the Guardian – If I wasn’t so polite, I’d have manned the barricades – summed up a lot of what people must be thinking.
In one section it says:
Meanwhile, directors of the Royal Bank of Scotland, having helped bring the economy to its knees, effectively attempted to hold the country to ransom: if you don’t allow us to continue paying obscene bonuses to our star players, then we shall all resign, they said. They even tried to admonish us for having the cheek to ask for rigour and discipline in their bonus structures.
How can we compete with the galacticos of world banking, they whined, if you don’t allow us to pay them properly? They were asking us to believe that there is some enchanted golden mean in global finance, the knowledge of which is only granted to a chosen few mystics and necromancers. They alone have the power to heal our broken economies and we, the idiot punters, would do well not to interfere.
Meanwhile The Times reports that millions are facing pay freezes or cuts in 2010 as the economy shows no signs of coming out of recession – “Up to two-thirds of companies in the private sector plan to freeze or cut pay next year — a substantial increase compared with this year”.
So real wages are being cut in the UK by a combination of nominal wage freezes or cuts; higher inflation (very modest) and rising taxes as the British government tries to tell the electorate that it is fiscally responsible.
Where is renewed aggregate demand going to come from when you cut the incomes of those who provide the majority of the spending – the consumers?
The British government has already imposed a wage freeze on its public servants to “save money”. This quote from David Frost, the director-general of the BCC, sums up how stupid governments behave when they either fail to understand their options under a fiat monetary system or refuse to use them for ideological reasons:
We face a tough year ahead — it will be a really long haul. The stark reality is that business finances are still under incredible pressure and they are doing everything they can to keep hold of cash.
Wage freezes and cuts are unpleasant but have ensured unemployment has not risen like it did in previous recessions. So far all the pain seems to be felt in the private sector. There have been no such measures in the public sector.
So in the last recession the Government actually cut public sector employment to “save money”. This time they are just cutting pay which still underminines aggregate demand.
We learned the lesson about trying to systematically cut wages in the Great Depression. Things became worse.
In a time when productivity is rising still (which means living standards can rise in material terms) it would be a denial of any reasonable “contract” with workers to be cutting real wages, however that was engineered.
Sectoral wage cuts (for example, the public sector versus the private sector) or industry-specific cuts alter the relative wage structure (some workers are falling behind compared to the “market”). As alternative opportunities arise the cutting sectors will lose labour in order of skill.
Further, while opportunities are limited, the retained labour force is likely to lose morale which directly impacts on their productivity. There are industry studies which show that absenteeism, increased theft, sabotage are all ways in which a demoralised workforce deal with engineered wage cuts.
The December 23, 2009 edition of the New York Times carried the story – Banks Bundled Bad Debt, Bet Against It and Won – which catalogues again how the big investment banks (Goldman, Deutsche Bank etc) set themselves up beautifully prior to the crisis to gain no matter what happened.
The NYT reports that:
At Deutsche Bank, the point man on betting against the mortgage market was Greg Lippmann, a trader. Mr. Lippmann made his pitch to select hedge fund clients, arguing they should short the mortgage market. He sometimes distributed a T-shirt that read “I’m Short Your House!!!” in black and red letters.
Deutsche, which declined to comment, at the same time was selling synthetic CDOs to its clients, and those deals created more short-selling opportunities for traders like Mr. Lippmann.
… and Goldman continues to enjoy cheap credit from the US government (via the Federal Reserve).
China – just don’t buy their stuff!
Some troubled US residents have started a Economy in Crisis homepage. It is hard to determine the group that is behind it but it has Ron Paul, the conservative Republican on its front page and some other conservative economists writing articles.
Their main issue appears to be that they want to restrict trade to reduce the US “reliance on imports”. They complain that the US economy has allowed foreigners to buy their assets; can no longer manufacturer competitively and therefore requires tariff walls to be reinstated; is allowing foreigners to gain control over US industry; is dependent on the Chinese for credit and budget deficit funding and has outsourced too much of its manufacturing, research and design.
It is also concerned with “the record levels of personal, government, and trade deficits”.
Their economic analysis talks about “out-of-control spending and excessive tax breaks” which have led to “the country being over 10 trillion dollars in the red. In order to finance its operations, the U.S. must borrow money from its economic competitors through the sale of Treasury Bonds”.
They also claim this spending and the “free trade” treaties that the US have entered into have blown the current account out and as “jobs have fled the country, so too has ownership of American corporations”.
So it is a real hotch potch of nationalism, Austrian school economics, mainstream economics and US pride where some of the statements contradict others.
They clearly have no understanding of how the monetary system operates, which I could spend some time analysing but won’t.
But the point I want to make (briefly) is that they are for freedom and democracy and choice – but fail to recognise that the principle developments they are concerned about reflect just that – market choices.
China can only do what the Americans and everyone else it trades with allow them to do. They cannot sell a penny’s worth of output in USD and therefore accumulate the USD which they then use to buy US treasury bonds if the US citizens didn’t buy their stuff.
Last time I checked there were no rules in shops requiring Americans to purchase this stuff. Presumably, people buy imported goods made in China instead of locally-made goods (which are more expensive) because they perceive it is their best interests to do so.
I find these “freedom” campaigns curiously contradictory. They hate government involvement in the economy yet propose complex regulative structures (for example, tariffs) which would increase government control on resource allocation and, not to mention it, force citizens (against their will) to purchase goods and services they reject in an open comparison (on price and whatever other characteristics).
They also provide various estimates of how many foreign companies have bought assets in the US economy. But what about US ownership of foreign assets abroad? Is this group going to force US companies to divest of their foreign holdings?
Some of this reminds me of the scares that pervaded the US in the 1980s when the Japan’s Mitsubishi Estate Co. bought control in 1989 of the Rockefeller Center. Then I recall there were the same sort of screams about foreign ownership taking over. As I recall they went broke and sold back to US interests anyway.
What about US trade surpluses to some countries? Is this group advocating they prevent those from happening?
What about US militarism interfering with other nations? Is this group going to advocate no more foreign incursions by the US? How will the massive US military-industrial complex then survive?
Are they really prepared to say to Americans that they should take a lower standard of living by artificially constraining imports (via tariffs) and give away more of their resources to foreigners (via exports)? Are they not aware that tariffs typically do not protect employment over time anyway?
For the rest of us – that is, non-Americans these gee-up groups that have become very vocal as a result of genuine anguish seem an odd quaint to say the least.
Meanwhile … closer to home
Yes, ABC news today is reporting something we already knew – Australians rack up record debt.
Essentially, as a consequence of the Federal government not reforming the banking system, we are now setting ourselves up for the next crisis, especially if the government does not continue to support aggregate demand.
Stay tuned for more on this issue as time passes.
That is enough for tonight.