Saturday, April 12, 2008

An idea for the 2020 summit

Alert friends will recall a time I aspired to ALP hackdom. That time, having past and having altered my view, created my skepticism; good ideas infrequently go realised. There is, unfortunately, a wide chasm between our political machines, and our industry, and between the great ideas of the educated population. Happy we should be then at Chairman Kevin's thousand blooming flowers in Canberra next weekend. It will be a talkfest, and little will come of it, but it at least provides a forum outside the media, the political machinery, and the moneyed lobbies for ideas of all colours to blossom. Below, despite my absence from the forum, is my contribution.

The expansion of supply is key to improving prosperity. A friend recently had difficulty digesting this, during an argument, proposing instead that prosperity be encouraged by more, bigger, income transfers.

Of course such a proposal is nonsense.

The only way to make everyone better off is to have more stuff created. The incentive to produce fewer things under a regressive, ultra-re-distributive tax regime exists, and so limits prosperity.

Instead, the affluent society will (in some disagreement with St Galbraith) create instead a tax regime which looks both to supply-side-expansion, and medium-run re-distributive targets. Such a scheme would limit excessive income disparity (which we social progressives find abhorrent), and maximise the productive possibilities of our industry. How? To be viable, it would increase the marginal productivity of our least-productive employees in our most efficient businesses.

What would the scheme look like?

Keeping in mind this proposal is where tax policy meets industry polity, its architecture, and effects should look a little like this;

  • Firms would have a portion of their company tax payments returned to them as vouchers to be redeemed at recognised training bodies, for spending on (or at least given priority to) employees earning under a certain threshold, or over a certain age
  • Firms would, presumably, have a better clue of what skills are required in the marketplace than unguided (or unknowing) individuals, and so training programmes---the more productivity-enhancing of which would proliferate under the scheme---would better suit economic conditions of the time
  • More profitable firms, which pay more tax, and are better at their business, would benefit more than struggling firms, which pay less tax and would receive fewer vouchers. This would stimulate the efficiency-creating winds of Schumpeter's 'creative destruction', and so increase output in aggregate
  • Labour productivity would otherwise increase (this is simplified, and design of this policy must consider that many poor have difficulty learning, which contributes to their poverty). Productivity increases would be, in the medium run, be matched by wage increases---a general rule which seems to hold.

Any crusade against inflation must directly target productive-capacity constraints. Making more stuff, and printing fewer dollars, goes a long way! In tandem with the current monetary-policy tightening bias of the RBA, a sensible policy allowing our most demanded industries---which are currently more profitable, and would be the recipients of such grants---to address their capacity constraints, would help. The issue also of providing real, immediately-applicable skills training to low income earners also sits well with a progressive social agenda. Yay.

Wednesday, April 9, 2008

The great de-coupling myth

Current economic circumstances allow us to test an interesting proposition, that an increased degree of economic integration can actually allow two economies to grow in different directions. This view, put forward by Eichengreen and Krugman (and Discussed by Frankel, 1999) would suggest that increased integration would lead to increased specialisation---a situation under which exogenous shocks affect the two economies differently. Antithesis to this view, is the conventional wisdom, held by Frankel: an increase in economic integration will lead to increased income correlation.

It has been interesting to watch, then, the popular media speculating China's present rate of growth can be maintained, or at least remain relatively high, in the face of a US recession. Not one to believe what Fairfax tells me, I decided to check this out, and you can too. Pull off the quarterly growth data for China and the US from 1979 (a handy reference year, as China began to open up) off the OECD website. Now, test the income correlations between the US and China for every business cycle (1979-1982, 1982-1991, 1991-2001, and 2001-2007). What is quite surprising, that is, if you are a true believer in the de-coupling myth, is the increase in income correlation (with fewer, smaller, errors) for every subsequent business cycle in that period. This would tend to suggest, at least in this example, that the conventional wisdom would seem to hold: increased integration between China and the US has further 'coupled' their economies; there is no 'loose caboose'.

What does this mean? Basically, we could say that should this model not break down instantly, that should the US be in recession (which it almost certainly has started), China will indeed slow. This is partly due to lower US demand for Chinese goods, partly due to the currency effect (to be discussed in a future blog) and partly that lower US demand for foreign goods will, ceterus paribus, lower foreign demand for Chinese goods. Exports make up some quarter of the Chinese economy, and from my figures, I'd predict about a 10-12% fall in this. This would equate to a cut of some 2.5-3% off current Chinese economic growth. Should current orders not be scrapped, this will probably set in in the third and fourth quarters this year.

What will this mean for Australia? Thankfully, Australia's exports to China contribute less to the manufacture of durable manufactureds, and more to fixed capital investment---think iron ore and coking coal (which is used to make steel). Fixed capital investment in undertaken on a long-view basis, and is less elastic to short-term income fluctuations than other areas of investment. Indeed, demand for Australian commodities would be likely to rise should the US slow. This would occur if China decides to enact countercyclical fiscal policy in fixed capital expenditure---build freeways and powerplants to employ workers affected by a slow in export growth.

Please feel free to comment.