October 1999 Newsletter
- but Quiggin gets trounced by Officer
SHOCKS IN VICTORIA - AND FOR ECONOMISTS
The shock Victorian election result has inevitably produced the response that this was an anti-reform, anti-privatisation vote. Indeed, during a Senate Committee hearing (see below) I was facetiously "congratulated" by Victorian Labor Senator Carr, on behalf of the Victorian Labor Party, for having provided the advice that brought Kennett down! (He was referring to the Project Victoria reports produced in conjunction with Michael Porter at the Tasman Institute, mostly before the Kennett Government was elected. These identified the need and scope for major reforms in the provision of government services). A partial response was contained in my article in The Age and the issue is considered further below.
Economists were also subjected to some shocks at the Economists Conference (see below), at which I presented a paper on An Alternative to the AIRC. This received some publicity in the AFR and a letter attacking me from the Executive Officer of Anglicare. The AFR Letters Editor refused to publish my response, which suggested that it was astonishing that, apart from contradicting himself, an official representative of the Anglican Church could seriously argue against lower unemployment.
I used the paper as a basis for a submission to the Senate Committee examining the Government's Bill to amend the Workplace Relations Act 1996 and for a presentation to the NSW Economic Society. The Senate Committee submission is accessible via my web site and my opening statement to the Committee is attached.
As my thinking is further refined, I plan to flesh out how an alternative to the AIRC might be achieved.
There is no doubt that the election result will considerably increase the difficulty of implementing further reform: indeed, whichever party governs (this is being written before the independents' decision on which party they support) there is certain to be some backtracking, if only to accommodate the independents. However, the post-election situation needs to be viewed in a broader context, as my Age article argues.
Why did this shock result happen? Many reasons have been advanced and I do not want here to go over already well-canvassed ground. I do emphasise, however, my perception that in its second term the Kennett Government did far too little to "sell" the benefits of reform and to counter the perception that it had made excessive reductions in spending on basic services. The facts are that, in 1997-98, Victorian taxes were still above the States' average and per head spending on schools, hospitals, social welfare and police (the main areas of debate about adequacy of services) was either still above or only fractionally below that average. Services have been made more efficient - as they should have been - and there is no evidence of a deterioration in quality.
Nor did the Kennett Government adequately respond to the catch-cry that "the bush has been doing it tough." This has been greatly exaggerated, as the excellent (just published) report of the Productivity Commission on Impact of Competition Policy Reforms on Regional and Rural Australia makes clear. The Premier made a number of tours of rural Victoria which were designed to maintain contact. But that is not the same as presenting the facts and putting the situation in perspective.
Why did false perceptions take root? There are many possible explanations, not least being the poor (and biased) performance of most journalists covering the Victorian political scene. But, reform has constantly to be defended and promoted, and it is up to Government to make its case. In my view, the Kennett Government failed badly in this regard.
To give one example, a little before the election a book was published by a number of left-oriented academics "reviewing" (critically) the performance of that government. Fair enough, that is part of the democratic debate! But where was the response? I know of two people who had anticipated such an analysis from the left and who had offered well before the election to produce a document outlining the benefits of reform and what the Kennett Government had achieved. The feedback was that the Government was not interested.
Just as importantly, there was very little critical analysis of the Opposition by either Government leaders or the media. Yet it is clearly still faction-ridden and the unions' influence is also still strong. Bracks has conveyed the impression that he is on top of these worrying features that continue to dog Labor - but he was not seriously challenged on it during the election campaign. How many of those who lodged a protest vote against Kennett had (have) any real idea of the factional/union problems Bracks faces? Were they made aware of how many dirigiste Socialist Lefties he has? Why weren't such potential weaknesses of the Opposition exposed? What were the Coalition campaign managers doing?
Interestingly, the Carr Government has recently agreed to the establishment of a Labor Advisory Council, which gives NSW trade unions a more direct input into policy issues. Would a Bracks Government do the same in Victoria? Would it reverse the industrial relations reforms, as Beattie is doing in Queensland?
Remarkably, since the election an increasing number of analysts has questioned whether Labor is "ready" to govern and, indeed, whether it really wants to govern. It is little short of absurd to find such comments emerging after the election. Why didn't the Government raise it during the campaign?
From my perspective, there were two outstanding features of the Economists Conference, neither of which received any mention in the media.
The first arose out of a presentation by prominent US monetary economist Professor John Taylor who argued that rational expectations theory* has replaced Keynesian and monetarist theories and that new models based on rational expectations have led to the development of improved policy rules for targeting inflation and operating monetary policy. In commenting, Oxford Professor David Hendry pointed out that rational expectations models produced widely varying results and argued that rational expectations theory is fundamentally unsound except in efficient capital markets (when it is of little use) and, in his own subsequent separate presentation, he analysed the causes of inflation in the UK over the past 125 years. His conclusion? That there is no single cause and a "huge amount" (his words) of inflation cannot be explained by economic theory.
To my mind, both these analyses (but particularly Hendry's) reinforce the warning signals we have had over recent years about the dangers of government intervention that seeks to "manage" or fine tune the economy. If no single cause of inflation can be identified, that raises serious questions about any idea that the pursuit of one particular policy can produce a particular inflation result, let alone the Keynesian style policies which seek to trade-off inflation against unemployment. It certainly reinforces doubts I have developed about using monetary policy in a pre-emptive way and it also adds to doubts about relying on estimates of the level of unemployment at which inflation starts to accelerate - the so-called NAIRU (which Federal Reserve Chairman Greenspan is reported to have pretty well discarded as a policy guideline).
This is not to say that anti-inflation policies should be discarded - far from it. Rather, it is to suggest that there are some important explanators of economic behaviour which have not been identified or at least which are difficult to quantify and model. The situation brings to mind the debate over whether the current account deficit (CAD) should be a policy objective. Professor Pitchford has consistently argued that, provided that deficit reflects private sector capital inflow, its size does not matter because it is the result of decisions by private entrepreneurs who will pay the price of any investment failure. To my mind, this has always been a naive and too-theoretical analysis: if large private capital inflows are being induced because government policies are causing distortions in the domestic economy, then that may lead to "over-borrowing" and a foreign exchange crisis, with adverse effects for the whole economy. As Professor David Henderson wrote some time ago, there are "good" and "bad" CADs: the Asian "crisis", and our own experience in the 1980s, supports that view.
In short, economic behaviour and expectations are influenced by policy and institutional arrangements as well as so-called economic fundamentals. For example, if a government has in place labour market regulatory arrangements that discourage (or even prevent) employers from employing, that is likely to prevent any sustained lift in employment from "expansionary" macro policies. Equally, labour market programs designed to improve the supply of labour will not work unless the right policy/regulatory environment exists for employers to take on extra workers.
The second important feature of the Economists Conference was the effective demolition by Professor Bob Officer of the anti-privatisation paper by Professor John Quiggin, whose socialist ideology and support for expanding the government sector is reflected in his frequent articles in Australia's only "business" daily, the AFR. Quiggin's case is based on the apparent fact that the public sector raises capital at a lower cost than the private sector. He points particularly to the differential between the cost of equity capital and bonds, reflected in the premium of 6-8 per cent which equities earn over bonds.
However, Officer pointed out that private debt raisings pay only 30 to 40 basis points more than the bond rate and that Quiggin's analysis fails to recognise that, although Governments do not issue equity per se, such equity exists in practice. Government equity is effectively provided by taxpayers who bear the costs resulting from any deficiency in returns from operations of government enterprises (which although unidentifiable has, in practice, almost certainly been large).
Officer argued that, as no direct estimate can be made of the overall cost of government capital, estimates have to be made from the only available alternative use of funds - the return on comparable private sector investments. Thus, "it is the nature of the cash flows from the investment or the nature of the assets that determine the cost of capital, not the source of funding (this separation of the financing and investment decisions lies at the heart of the famous Modgliani/ Miller propositions)."
Officer also pointed out that, even if it were accepted that the private equity capital market is imperfect, that would not support an argument for having the Government own and operate enterprises: rather, a Government financial intermediary could raise funds in the capital market and on-loan/invest them in private enterprises ( Quiggin's only response to this is that it is not clear how that could be made to work, which is just nonsense).
Financial analysts have worked themselves into a veritable frenzy of prediction of rate increases by the Reserve Bank, and markets have effectively priced-in increases of over 0.75 percentage point in bill rates. This may happen. Yet, as I have argued previously, on any overall assessment there is insufficient basis for a pre-emptive increase in official rates. I say this even after the latest increase in US producer prices. Many analysts seem almost determined to read only those tea leaves of central banker comments that imply rate increases. The other tea leaves are largely ignored.
In particular, very little attention has been paid to the effects of faster productivity growth in keeping inflation low and in justifying apparently high share prices. In Australia, real unit labour costs in the non-farm sector have actually been falling since early 1997, implying an absence of pressure on businesses to increase prices. In the US several Federal Reserve Governors have (almost unnoticed here) pointed to the same benefits there from the apparent speeding up in that country's productivity growth. One well-regarded Governor (William Poole) has reportedly predicted that the US economy would stick to its path of strong growth and tame inflation for some time.
Behind much of this analytical frenzy there is often an assumption that the "authorities" know what they are doing and are working to a plan. In part, this derives from the pre-emptive strategies which central banks have been espousing but whose validity is coming under increasing questioning. Analysts might be better advised to note the reported comment of former Fed vice-chair, Alice Rivkin, that "people have the notion that the Fed has a clear idea of what its going to do next and just isn't telling. That's simply not true."
The shooting of four policemen at Kangaroo Flat by a deranged person enhances concern about the policy requiring police to use minimal force in such situations. Contacts within the police force have certainly expressed their concern to me.
The Stolen Generation Myth
Except for the ABC, the media seems to have stopped reporting stories giving credibility to the stolen generation myth. Although (with one or two notable exceptions) the other side continues not to be put, perhaps such non-reporting may be counted as "progress." One interesting development was The Australian's story on 9 October about a half caste Aborigine who acknowledged that his mother had given him away, did not blame her for doing so and who claimed that discrimination exists amongst Aborigines - "There are two groups. Lighter-skinned Aborigines who control the money and full blood Aborigines who live like dogs."
*Rational expectations theory postulates that the behaviour of individuals reflects a rational assessment of the past and that no systematic errors are made in predicting the future, that is, they will be wrong only because of random non-systematic errors