The Liberal Party’s extraordinary leadership turmoil, and the likelihood that yet another Prime Minister is cut down before serving out their full term, has many wondering if the political system is broken.
The Liberal Party’s extraordinary leadership turmoil, and the likelihood that yet another Prime Minister is cut down before serving out their full term, has many wondering if the political system is broken.
By Adrian Rollins
Now that the Band-aid has been ripped off the Coalition’s torn leadership, what does this portend for the nation’s economy?
Among the many self-inflicted wounds of Malcolm Turnbull’s trouble-plagued prime ministership, his dogged pursuit of business tax cuts stands out.
Turnbull expended substantial political capital and effort on the measure, lambasting opponents like the Labor Party and badgering waverers like Pauline Hanson’s One Nation. Despite setback after setback, the Liberal leader did not waver from his support for the policy, which he said was essential to sustain the country’s economic competitiveness.
In the end, it was all for nought. Though tax cuts for businesses with a turnover of less than $50 million have been passed into law, a Bill to provide similar relief for larger firms has today been rejected by the Senate.
Turnbull’s signature economic reform of the past year is dead.
It caps a terrible record of under-achievement for a Prime Minister whose CV sparkled with private sector success as a lawyer, a banker and an investor.
After a string of career politicians leading the country, (Keating, Howard, Rudd, Gillard, Rudd (again), and Abbott), Turnbull was seen as a welcome break – holding out the promise of a practical and results-driven politician just keen to ‘get things done’.
Instead, it is Turnbull who got ‘done’. The rot set in in the earliest stages of his leadership when he caved to the demands of haters and extremists on the Right, rather than staring them down. Having just won the endorsement of his Liberal colleagues by a convincing majority, his political power was at its zenith and the likes of George Christensen, Corey Bernardi, Jim Molan and Craig Kelly could have been marginalised.
Instead, by pandering to their ever-more-strident demands, Turnbull fed the beast of dissent, and is now set to pay the ultimate price.
Having failed miserably to deliver the tax cuts he argues the country needs, and having failed to erase the fog of uncertainty shrouding the nation’s energy and climate change polices, Turnbull’s economic legacy is exceptional only in its mediocrity.
But if you think that’s bad, his potential replacement could well be even worse.
Peter Dutton, a man who rose without trace after being plucked from backbench obscurity by an increasingly embattled John Howard as a sort of electoral talisman, is not a deep thinker.
That by itself is not necessarily a deal-breaker when it comes to being PM, but its opposite should be.
Throughout his career, Dutton has shown himself to be a narrow and unimaginative politician. He has adhered like araldite to a constellation of received attitudes and prejudices that hark back to an Australia that has long since departed from most corners of the country.
Think this is harsh? Consider his response when asked on Sky TV, in the aftermath of his failed leadership bid, what he thinks of the Coalition’s prospects: “I believe strongly that we can win the election if we get the policies and the message right about lowering electricity prices, about … We need to invest record amounts into health and education, aged care and …”.
It’s a shopping list of platitudes, not a manifesto for leadership. Dutton might say he is merely reciting the priorities of the Government of which he remains a member.
But for someone who has long harboured ambitions to reach the top job, it seems like a very thin resume of ideas.
Aside from a determination to ignore the policy challenges of a rapidly changing climate, Dutton’s grab bag of priorities betrays sloppy economic and fiscal thinking.
First the fiscal. Just by virtue of holding its spending steady as a proportion of GDP, governments each year invest “record amounts” in areas like health, education and aged care.
Economic naivety could be much more serious and potentially damaging.
If, by “lowering electricity prices”, Dutton is simply using shorthand to refer to policies that might help contain the extent of price rises, that might not be so egregious. Governments already interfere in market pricing, such as by limiting annual residential rent increases. While this distorts the property market, the potential discouragement of investors is balanced against the financial certainty it provides to renters.
But if he is delving into the agrarian socialist playbook of his fellow-travellers in the National Party like Christensen and Barnaby Joyce to introduce price controls, that is much more concerning.
Because of the modest size of its economy, Australia relies heavily on foreign investment for development.
But every measure taken to prop up farmers and rural industries, to block offshore investors, and to control prices, comes with a cost.
In the aftermath of the GFC, Australia has been a popular destination for foreign investors. But as the US and other economies strengthen, that advantage is waning.
Markets hate uncertainty, so the latest bout of instability surrounding Australia’s highest political office is unhelpful.
Add to that the prospect of a change to a leader even more deeply beholden to vested interests and a Trumpian understanding of the economy and trade (ie. not much), and even the modest growth of recent times might seem like a golden time of prosperity and stability.
As Coalition MPs consider how they will vote in the next leadership ballot, let’s hope they consider what’s best for the country, rather than just what’s best for them.
WHILE the Brits turn themselves inside-out trying to work out if they should go for a hard, soft or slightly runny Brexit, the EU is keeping its trade negotiation machine running at high gear.
In recent years the Europeans have been busy stitching together a web of regional and bilateral trade deals that span the globe. Of the 164 countries that are members of the World Trade Organisation, just six do not have preferential access to the EU.
Currently, Australia is one of them. But that could soon change after the European Parliament on 26 October authorised the EU to begin talks on a Europe-Australia Free Trade Agreement (FTA).
This authorisation comes at the end of a long process of sounding each other out and assessing whether such a deal is desirable and worth the effort, so it is a big deal.
It means that a Europe-Australia FTA of some kind is virtually inevitable.
Politically, this is soc in the eye for Theresa May’s Government.
One of the conceits of Brexiteers is that, freed from the shackles of the EU, Britain may once again rise to global eminence as a champion of free trade. Some even hope that the Commonwealth can be transformed into a sort of ‘Empire 2.0’. In their imaginings they hope/believe that former colonies like Australia, New Zealand, Canada and India will fall over themselves at the opportunity to resume the trade links that were severed or downgraded when Britain joined the Common Market in the early 1970s.
Put aside the fact that the days of Empire are remembered far from fondly in much of the Commonwealth, the idea has little grounding in the economic reality of today.
In the days of Empire, Britain was a major manufacturer with a huge appetite for raw materials it was an obvious market for commodities produced by its colonies.
But after 40 years of integration with the EU, the British economy is vastly different. Most of its manufactures are intermediate goods that are part of supply chains that crisscross Europe like a web, and services like finance, education and tourism support much of its wealth.
Meanwhile, the former colonies have well and truly moved on.
Canada is closely dies in economically with its giant US neighbour, Australia and New Zealand look much more to China and Asia for their markets, India is developing into a major economic power in its own right and the former African colonies have more extensive trade arrangements with Europe than Britain.
Europe, the land of opportunity?
It is fair to ask whether Australia needs a trade deal with Europe, given that the EU is already our third largest trading partner (bilateral trade was worth A$68.7 billion in 2015), and a major source of foreign investment (worth A$220.3 billion in 2015).
But there are frictions in the trade relationship.
European agricultural markets such as beef, sugar, dairy and cereals remain heavily protected from Australian exports, contributing to a lopsided trade flow.
In 2015, the EU sold almost A$30 billion more of goods and services to us than we did to them.
The question is whether the Europeans will be able to offer better access to their markets for Australian farmers.
In its statement on the negotiating mandate, the EU has stressed that “the European agricultural sector and certain agricultural products, such as beef, lamb, dairy products, cereals and sugar…are particularly sensitive issues in these negotiations”.
Given that Australia is the world’s third largest beef and sugar producer, and is a major player on global cereal and dairy product markets, Europe’s notoriously bolshie farmers are unlikely to meekly accept increased market access for their Australian competitors without a fight.
The EU trading mandate also calls for meaningful commitments from both parties to protect fisheries against illegal and unregulated fishing, which is significant given concerns about the rapacious fishing practices of fishing fleets operating out of Spain, France and other EU countries.
It appears this might be a fight the EU does not have the stomach for in the current fractious political climate prevailing in Europe, where populist and nationalist movements command significant electoral support.
In careful language, the EU negotiating mandate stipulates that a “balanced and ambitious outcome” on agriculture and fisheries is only feasible if it “gives due consideration to the interests of all European producers and consumers”.
Tellingly, this “consideration” includes the possibility of tariff-rate quotas or unspecified “transition periods”, and even holds out the possibility of so-called safeguard clauses to allow preferences to be suspended temporarily, or even excluding the most sensitive sectors (beef, sugar, cereals, dairy) from negotiations altogether.
Australian negotiators might talk tough if the EU tried to block improved access for farm products altogether, but the Europeans would remember how Australia caved to the US when it refused to include sugar as part of the Australia-US Free Trade Agreement.
Whatever happens on agriculture, the EU wants the FTA with Australia to include “significant concessions on public procurement at all levels of government, including state-owned enterprises”, and is also looking for commitments on anti-dumping and countervailing measures that go beyond WTO rules.
Other provisions the EU is seeking include:
Brexit dangles like an unanswered question over the Australia-EU trade talks.
The final terms of Britain’s exit from the EU will resound globally. But by pushing ahead with its trade negotiation agenda, the EU is staying faithful to its ambition as the world’s foremost transnational economic community.
[This is a copy of a story I wrote that has been published in the August edition of In The Black. The story as it appeared in the magazine can be found here: https://www.intheblack.com/articles/2017/08/01/cutting-company-taxes]
Cutting taxes is an expensive business, so it seems odd that debt-laden governments are rushing to lower corporate tax rates.
A budget deficit of US$588 billion has not deterred Donald Trump from announcing plans to slash America’s nominal corporate income tax rate from 35 to 15 per cent at an estimated cost of US$190 billion. Despite uncertainty about the long-term economic impact of Brexit, the United Kingdom has just reduced its corporate profits tax to 19 per cent, and will lower it to 17 per cent in 2020.
In Australia, the Turnbull government has secured support for a phased reduction in its company tax rate from 30 to 27.5 per cent for businesses with a turnover of up to $A50 million at a cost of $29.8 billion, and eventually wants an across-the-board rate of 25 per cent, which in total will cost $65.4 billion in foregone revenue – this at a time when the deficit sits above 2 per cent of GDP and no surplus is in prospect until at least 2020-21. Even Hong Kong, which has lower company tax rates than most, is feeling the pressure to continue cutting, announcing that 75 per cent of its 16.5 per cent profits tax will be waived up to a ceiling of $HK20,000.
These governments, and others like them, are betting that the benefits expected to flow from cutting company taxes – increased investment, improved productivity, higher wages and a bigger economy – will eventually overshadow the short-term cost to both taxpayers and government coffers.
In this, they can expect some assistance from improving international conditions. The International Monetary Fund reckons the global economy is finally gaining momentum and will expand by 3.5 percent this year and 3.6 percent in 2018, with indicators for investment, production and trade all pointing up.
But much rests on how investors, particularly those from offshore, will respond.
Can less be more?
Foreign investment has long been the lifeblood of growth for Australia – current account deficits have for decades been a permanent feature of the economy.
The Australian Government expects that cutting the corporate tax rate will attract more international capital to the country, spurring investment in technology, equipment and skills and generating more jobs and higher incomes.
Modelling and analysis by economists such as former Treasury Secretary Ken Henry suggests they are right.
In 2009, Henry recommended a cut in the company tax to 25 per cent on the grounds that “reducing taxes on investment, particularly company income tax, would…encourage innovation and entrepreneurial activity…[and] increase income by building a larger and more productive capital stock, and by generating technology and knowledge spill-overs that boost the productivity of Australian businesses”.
Treasury officials have put some numbers on the likely benefit, estimating that a cut in the company tax rate to 25 per cent would deliver a permanent 0.6 to 0.8 percentage point lift in real gross national income, underpinned by an increase in investment of almost 3 per cent, a 0.4 per cent boost to employment and a 1.2 per cent rise in before-tax wages.
The tax changes agreed to so far by Australia’s Parliament fall well short of this lofty goal but the Government is undeterred, and has introduced legislation seeking approval for a cut to 25 per cent.
Observers like Melbourne University professor of economics John Freebairn and Jim Minifie, Productivity Growth Program Director at the Grattan Institute think-tank, think Government policy is right to push for corporate tax cuts.
“If we were to reduce our corporate tax rate, that would reduce the tax burden on non-resident investors, so they pour a little more money into Australia,” Freebairn says. “That means slightly better, more sophisticated machinery and equipment, they might bring some extra technology and managerial expertise with their investment and, with people working with better machinery and technology, their productivity goes up and that pushes them into higher wages.
“That is the story in the Henry Review, and that has been backed up by modelling by Treasury and the Centre for Policy Studies.”
Minifie calculates that the Government’s eventual goal of an across-the-board reduction to 25 per cent could deliver a 15 per cent rate of return over 10 years – “not bad for a government that can borrow at 3 per cent”.
Freebairn is more cautious about estimating the long-term benefit of such a tax cut.
“Whether Australia in general wins or loses depends on how much bigger the Australian economy grows as a result of the extra investment,” he says. “Treasury modelling is saying you are going to recoup about half of it, but it could quite easily be 20 or 30 per cent plus or minus that.”
A hard sell
It is no surprise that governments are keen to talk up the potential for wages to rise on the back of corporate tax cuts, and to claim that they will effectively pay for themselves in stronger economic growth.
The idea that investors, many of them foreign, should get a hefty tax break in return for uncertain and delayed gains would be a hard sell at any time, but particularly so when budgets are constrained and wages are stagnant.
The Trump administration, which will have to win congressional approval for its tax plan, argues that the massive cost of its proposed corporate tax cut will be covered by a sustained increase in economic activity.
Though the claim has been dismissed as “fanciful” by The Economist, the cut is part of a package of reforms that in aggregate could boost US corporate tax collections.
America’s labyrinthine tax laws are riddled with loopholes and exemptions that mean the effective tax rate is more like 20 to 25 per cent, well below the nominal 35 per cent rate. The system is further distorted by arcane rules that discourage companies from repatriating profits (it is estimated they have up to US$2.5 trillion stashed abroad) and encourage them to adopt exotic legal structures and take on debt rather than raise equity.
US Treasury Secretary Steve Mnuchin wants to reform the system, including allowing company profits to be taxed by the country where they are earned and offering a one-off tax rate (rumoured to be set at 10 per cent) on repatriated profits in order to lure much of this money back home. Some estimate the change could tip an extra US$250 billion into federal government coffers.
Unfortunately for the Australian Government, it does not have a similar pot of potential revenue to draw upon to help pay for its corporate tax cuts.
Instead, it is banking on increased domestic growth, a stronger global economy and extra taxes and charges on income earners, banks and employers to help offset the cost and put its finances on a path to recovery.
But a soft employment market and slowing wage growth has forced the Australian government to downgrade its anticipated tax take from workers and shoppers. It has trimmed $6.3 billion from its four-year forecast for individual and other withholding tax revenue in its 2017-18 budget, and expects to receive $2.5 billion less from the goods and services tax than it originally thought.
Instead, it predicts in the short-term that corporate tax revenue will pick up on the back of stronger global commodity prices, tipping an extra $6.9 billion into its coffers, while a 0.5 percentage increase in the Medicare levy combined with a levy on the major banks and a charge on businesses employing foreign skilled workers it expected to raise an extra $14.9 billion over four years.
This, in tandem with a swathe of cuts to higher education spending, welfare payments and price cuts for subsidised medicines, is expected to help drive a return to budget surplus in 2020-21, even accounting for the cut in the corporate tax rate to 27.5 per cent.
Some, such as CPA Australia chief executive Alex Malley, have questioned the Government’s forecast for GDP growth to accelerate to 3 per cent by 2018-19, and ANZ Banking Group economist David Plank says that although the budget’s numbers looked plausible, they were “at the optimistic end of what is likely to happen”.
Malley worries that the country is riding its luck on improved international conditions rather than undertaking the difficult reforms that are needed.
“We’re concerned we may be falling back on our ‘lucky country’ mentality and hoping that world growth will be sufficient to see us through,” Malley says. “There are still underlying structural issues in our economy that have not been effectively addressed in this budget.”
He says the government is over-reliant on individual and company income tax revenue, and will eventually have to confront difficult choices regarding the nation’s tax mix.
If the global economy falters again, or corporate tax cuts fail to deliver on hopes for an increase in investment, productivity and wages, that moment may come sooner than it expects.
 https://www.theatlantic.com/business/archive/2017/01/trump-corporate-tax-cut/514148/; “Cutting the tangle”, The Economist, 29 April, pp50-1.
 The Economist estimates the tax cut would cost about 1 per cent of GDP: “Cutting the tangle”, The Economist, 29 April, pp51.
 “Under audit”, The Economist, April 29, p8.
At least holidays to the US will be cheap for a while.
It is hard to know where to start with a Trump presidency.
Will he really rip up NAFTA, start building a wall on the Mexican border, toss out ‘illegals’ and block Muslim immigrants?
Or will wiser heads prevail once he grabs the reins of power and the full implications of his various outrageous and incoherent policy announcements become apparent?
The terrifying thing is that no-one knows.
Who knows how a bullying, narcissistic and misogynistic demagogue is going to behave in the White House.
But if he lives up to even a bit of his rhetoric, both the US and the world are in form some very ugly times.
Here’s just a sampling of the changes a Trump presidency may usher in, and how they would affect the world, and Australia.
In line with his much less internationalist view of America’s role, Trump is likely to oversee a reversal of Obama’s pivot to Asia.
Asia Pacific allies like Australia, Japan, South Korea, the Philippines and Thailand will be left to do more of the heavy lifting in regarding regional security. Some might be tempted to move closer to China.
China itself faces great uncertainty.
Trump has indicated he wants to throw up the tariff barriers to Chinese imports. It is a move that will not only impoverish many who voted for him in the first place, by denying them access to the cheap goods that have softened the impact of stagnant wage, but could be very destabilising for the Chinese Government.
Though China has been trying to engineer a change in the economy toward consumption-driven growth, it is still a work in progress, and much of its prosperity is still tied to exports. If Trump was to pull up the shutters on China’s biggest market, the consequences would be dire – not just for China, but also Australia, which depends on Chinese demand for much of its export sales.
If Trump sparks a trade war of the kind that preceded World War Two, when trade barriers went up around the world, the political and economic damage will be huge. The post-war world order that has driven unprecedented prosperity – billions propelled from poverty, disease and malnutrition abating – could be shattered. We would all be the much poorer for it.
The fissures within the US itself that have been exposed by the hate-filled campaign of the last 12 months may widen, instead of narrow, particularly as the fortunes of the have-nots deteriorate further.
Then there is the worry that comes with a nuclear arsenal capable of killing us all many times over being in the hands of one that seems so volatile and unstable.
It is a grim outlook.
But there are at least two threads of hope.
One is that this becomes the high water mark for the craziness that has gripped the world this year. The so-called anti-establishment crowd (who seem very disparate except, maybe to themselves) have had their Brexit, and they have populated the Australian Senate with fringe-dwelling nutters.
But under the pressure of actually trying to do something, and reconciling interests that are increasingly at odds, the coalitions of resentment and anger that have propelled such outcomes may evaporate, and the promises of better times that they sold will be seen as the flimsy soundbites they were.
The second hope is that Europe will cleave to its moderate sensible course and thrive as smart money exits the US and China sees it as an increasingly attractive place for investment.
It may become a salutary lesson for the naysayers in the US and Britain of what they gave up for their collective fit of pique.
In the meantime, can someone please keep Trump away from that button!
The world’s major central banks have thrown just about everything at trying the limit the effects of the global financial crisis and support the subsequent recovery.
In their efforts to prevent what the northern hemisphere calls the Great Recession turning into another Great Depression, they have not only slashed official interest rates to extraordinarily low levels, but have been printing enormous sums of money and even, in some cases, setting negative rates – measures that only a few years ago were barely thinkable.
The concerted actions of central banks and national governments in the immediate aftermath of the Lehman Brothers collapse in September 2008 succeeded in preventing the economic downturn turning into something far worse.
But almost eight years later the recovery is still struggling to find traction. The World Bank recently downgraded its 2016 growth forecast to just 2.4 per cent, and the crunch on revenue is making it harder for many governments to wean themselves off debt and deficit. In the United States, public debt as a proportion of GDP is almost 105 per cent, while in Britain and France it is touching 100 per cent and in Japan it has topped 250 per cent.
Major central banks, meanwhile, are grappling with the legacy of ultra-low interest rates and ballooning balance sheets. The official interest rates of most are close to (and in Japan’s case, below) zero, and total assets held (excluding the People’s Bank of China) has reached US$11.8 trillion.
It is little wonder the International Monetary Fund recently warned that if there is another severe global downturn, “the needs could exceed the collective resources available”.
And the risks are not small.
A febrile world
The World Bank warns that the global economy is facing “mounting risks” from slow growth in advanced economies, stubbornly low commodity prices, weak global trade and diminishing capital flows – concerns echoed by IMF Managing Director Christine Lagarde.
Even US Federal Reserve Chair Janet Yellen, who has generally adopted an optimistic tone about the outlook for the US and global economies, sees risks aplenty, including Europe or China “taking a turn for the worse”, a spike in oil prices, a resumption of the slide in commodity prices or a non-economic shock.
“In the current environment of sluggish growth, low inflation and already very accommodative monetary policy in many advanced economies, investor perception of, and appetite for, risk, can change abruptly,” Yellen says – underlining Yale University economist Robert Shiller’s point that it is how people perceive, and respond to, such events that will be crucial in transforming something like an oil price hike into “a truly virulent economic disruption”.
What are the chances?
Former US Treasury Secretary Larry Summers puts the odds of the United States sliding into recession in the next year at one in three, and believes it is a better-than-even bet in the next two years.
The United Kingdom-based Resolution Foundation is similarly downbeat. It reckons that, based on the pattern of past business cycles, Britain has a one-in-three chance of enduring a downturn in the next five years, increasing to an 80 per cent chance by 2025.
This may be too pessimistic, but economists reckon there are several good reasons to expect that, sooner or later, there will be another downturn.
What to do?
Given how much central banks are already doing to support activity, worried policymakers are thinking hard about what else they can do.
One answer is to do more of what they are already doing – holding interests rates very low, expanding their quantitative easing programs, and providing forward guidance on the direction of interest rates.
But former US Federal Reserve chair Ben Bernanke warns there are limits to how low interest rates can be pushed, and the effectiveness of such a policy is likely to diminish over time, while the risks it brings with, such as property bubbles, are likely to increase.
There has been discussion of whether inflation-targeting central banks should raise their aim, lifting their goal from 2 per cent (in the case of the Bank of England) to create additional rate setting room. However, not only does this run the risk of cutting loose inflation expectations and undermining the hard-won credibility of central banks, it is not obvious how this would help stimulate the demand necessary to lift prices.
For almost 50 years the idea of ‘helicopter money’ has been kept in a box labelled ‘only open in case of emergency’.
Now, it is being dusted off and talked about seriously by influential economists including Bernanke and former UK Financial Services Authority chair Adair Turner.
The idea, first articulated by Milton Friedman in 1969, is to fund expansionary fiscal policy, such as a personal tax cut or government investment in infrastructure, from the balance sheet of the central bank, rather than by issuing interest-bearing bonds, as would normally be the case.
For Bernanke, the idea is appealing because the stimulus can be directed through multiple channels at once – funding public works, increasing household income and boosting inflation – without adding to the future tax burden.
“It is extremely likely to be effective, even if existing government debt is already high, and/or interest rates are zero or negative,” he says.
The fear has always been that, once helicopter money starts flowing, it will be hard to make it stop. If politicians get the whiff that they can fund pet policies without driving up taxes, the thinking goes, governments and central banks will struggle to ever turn off the tap.
But Turner says dividing responsibility between governments and central banks should help ensure it is only used in moderation, and in a way that is safer, and with fewer side effects, than running negative interest rates and huge quantitative easing programs.
Missing in action
Helicopter money is often talked of in terms of what more central banks can do, but in reality it is a cross-over policy that requires monetary and fiscal policy to work in concert – something that has rarely happened since the GFC struck in late 2008.
In the ensuing eight years, governments have left most of the work of rescuing economic activity to central bankers.
In the US, Europe, Australia, Canada and elsewhere governments, spooked by ballooning levels of public debt, have been intent on holding spending down rather than loosening the purse strings to help stimulate demand.
In more normal times, bodies like the IMF and the OECD would laud such restraint.
But the weight of economic advice is shifting and government austerity is out. In its place, governments are being urged to consider tax cuts, handouts, investments and structural reforms.
The fear is that if they do not, the world will become locked in a low-growth, low-inflation trap such as has ensnared Japan for the past 25 years.
Open the taps
Summers believes the major economies, particularly the US, Europe and Japan, are already experiencing what he calls secular stagnation, characterised by persistent shortfalls in demand due to long-term developments, particularly an aging population. As population growth slows, businesses and governments scale back investment, holding down employment and wages which, in turn, restrains consumption.
To break out of the cycle, he says, governments need to act.
“Fiscal policy is now important as a stabilisation policy tool in a way that has not been the case since the Depression,” Summers says.
As chief economic adviser at Allianz, Mohamed El-Erian put it, “central banks can’t go it alone anymore”.
“Officials of advanced countries increasingly are acknowledging that the problems facing their economies require a new response to take over from the overlong use of narrow, short-term tools,” El-Erian says.
The change in mood has been reflected in the acceptance by European creditors that Greece needs debt relief, as well as Germany’s warning against over-reliance on central banks, and policy prescriptions from the IMF and the OECD that urge governments to take on much more of the burden of supporting economic activity.
The IMF’s Lagarde says monetary policy needs support. While accepting that countries with high debt and low public sector savings need to work on consolidating their finances, “those with fiscal space should commit to ease fiscal policy further,” she says. Even those with tight finances could aim for a more “growth-friendly” mix of taxes and spending, particularly increased investment in infrastructure.
The OECD sounds an even more urgent note.
The global economy is stuck in a low-growth trap and “comprehensive policy action is urgently needed”, according to OECD Secretary-General Angel Gurria. “Reliance on monetary policy alone cannot deliver satisfactory growth and inflation”.
“Almost all” countries have scope to redirect public spending to more growth-friendly projects, he adds.
Money well spent
But it is not simply a matter of shoving money out the door.
Governments need to work out ways to ensure the funds they pump out are used here and now, when the economy needs it most, rather than being stockpiled and used in sunnier times, when they could amplify inflation risks.
They need to overcome the propensity of consumers and businesses to cut back on their spending when uncertainty reigns.
Households nervous about the economy and fearful for their jobs tend to save rather than shop. And without a lift in demand, businesses have no incentive to hire and invest.
There are also more traditional objections to government stimulus measures – that they crowd out private sector investment, often take too long to take effect (and becomes pro-cyclical), and that much spending is unproductive, swallowed up by bloated bureaucracies and diverted into political pet projects.
But Princeton University economist Alan Blinder, a former Federal Reserve Board member and Presidential economic adviser, finds none of these are insurmountable.
When an economy is weak, he says, the risk of government crowding out private sector activity is implausible.
Some argue that fiscal stimulus merely brings forward demand and does nothing to increase aggregate supply.
Blinder questions whether this is the case, pointing out that if it pulls more people into the workforce or results in productivity-enhancing innovation or investment, it deliver a permanent boost to capacity.
A thornier issue is what form government stimulus should take if it is to be effective.
Blinder says recent US experience gives some good pointers to what works and what doesn’t.
Tax cuts often top the list when politicians think of ways to stimulate growth, but Blinder’s research shows striking differences in their impact.
Tax relief aimed at consumers, particularly lower income households, like child tax credits, payroll tax holidays for employees and earned income tax credits added between US$1.24 and US$1.38 to GDP for each US$1 of tax cut during the depths of the recession in 2009, compared with just 32 cents for every US$1 from a permanent cut in the corporate tax rate.
Even more effective were transfers and payments like food stamps and the Cash for Clunkers program. The temporary boost in food stamps, directed at low income households, delivered an extra US$1.74 to GDP for every US$1 outlaid, and Cash for Clunkers (under which owners of old gas guzzlers were paid a subsidy to trade their car in for a new vehicle) was almost as effective – US$1.69 for every US$1.
The lesson, says Blinder, is that temporary measures targeted at liquidity-constrained consumers can deliver a big bang for the stimulus dollar.
This is not just a US phenomenon. Between October 2008 and May 2009 the Australian Government directed almost $21 billion in welfare payments and tax bonuses to low and middle income households.
It has been estimated around 40 per cent of households spent the money, and Australian Treasury estimated the handouts added more than 0.3 of a percentage point to GDP in the last three months of 2008 and 0.8 of a percentage point to growth in the first three months of 2009.
Well-targeted tax breaks and transfers, Blinder says, can help an economy strongly and quickly.
But, he adds, the longer a recession continues the more governments must look to other measures, like infrastructure investment.
Capital spending is typically viewed warily as a stimulus measure. Infrastructure projects can take a long time to get going, often a chunk of the funds is absorbed by intermediaries like state and local governments, and the money is spent slowly.
But Blinder says the longer a downturn persists, the more such support for activity comes into its own.
It has led some to suggest that governments maintain a list of infrastructure projects ready to go at a moment’s notice.
Breaking the chains
Governments are being urged to put their shoulders to the wheel not only through well-targeted spending, but also undertaking much-needed structural reforms.
In downturns, the instinct of politicians is often to try to save jobs by putting up tariffs, manipulating the currency and erecting other barriers to international competition.
But economists warn the benefits of such policies are illusory. By pushing up the cost of imports and slowing the transfer of skills and technology, the undermine competitiveness and productivity.
Instead, organisations like the IMF, OECD and the Resolution Foundation advise governments to resist intervening in exchange markets, foster competition in domestic markets, combat the effects of aging by boosting workforce participation and increase investment in productivity-enhancing infrastructure.
Bank of Queensland chief economist Peter Munckton says European governments, in particular, “should be working very hard in cleaning up their banking system”, which still labours under a huge overhang of debt.
El-Erian warns the longer politicians prevaricate, the worse the situation becomes.
“Today’s growth shortfalls become harder to reclaim even as tomorrow’s growth potential is undermined,” he says. “Every quarter [governments] wait to enact credible and comprehensive measures adds to the difficulty of removing the impediments to inclusive growth, and makes the political context even more complicated”.
Muckton says that, in the name of prudence, governments should act now: “We should be doing the backburning before the next firestorm arrives”.
* An edited version of this post was published in the August edition of In The Black. It can be viewed at: https://intheblack.com/articles/2016/08/01/is-the-world-prepared-for-the-next-economic-downturn
On the face of it, the idea that you can increase employment and pump up economic activity by reducing corporate taxation sounds straight forward and uncontroversial. After all, the less company revenue that goes to the tax man, the more should be on hand for things like hiring more staff, buying new equipment and the like.
Ultimately, the thinking goes, the boost to employment and growth will make everyone a winner.
It is the deceptively simple idea that lies at the heart of the Coalition’s economic plan to boost jobs and growth by implementing $48 billion worth of business tax cuts over the next 10 years.
It also happens to be wrong.
Many have already pointed out that the benefits of stronger growth and increasingly profitable businesses don’t necessarily “trickle down” through more and better-paid jobs, as some naively believe.
The widening gulf between a small group of high-income “haves” and the rest of society is evidence of that. In Australia in 2013-14, 62 per cent of all household wealth was concentrated in the top 20 per cent, while the bottom 20 per cent held just 1 per cent of all wealth. Ten years earlier, the wealthiest 20 per cent owned 59 per cent of all wealth.
As The Economist reported this week, the proportion of working poor in the UK is increasing – 10 years ago about 40 per cent of those in absolute poverty (income less than 60 per cent of the national median, after housing costs) lived in households where people were in some sort of employment. Today, that proportion has risen to more than 50 per cent.
Try telling workers whose wages have yet to recover to pre-GFC levels even while house prices soar, and it is little wonder that an election pitch centred on business tax cuts is a hard political sell job.
But added to well-founded scepticism about who will actually benefit from business tax cuts is an even deeper problem that makes them a poor prescription for jobs and growth.
The searing experience of the GFC and its aftermath has provide a wealth of information to digest about what works and what doesn’t in trying to support economic activity and employment at times of low or stagnant growth.
Among those who have taken a close look at the effectiveness of government stimulus measures is Princeton University economist Alan Blinder.
Blinder, who is a former Vice Chairman of the US Federal Reserve’s Board of Governors and served on Bill Clinton’s Council of Economic Advisers, has run the ruler over the various actions taken by the US Government in the wake of the Lehman Brothers collapse, from welfare handouts and the Cash for Clunkers program to infrastructure and defence spending and business tax cuts.
His findings (http://www.hamiltonproject.org/papers/fiscal_policy_reconsidered) will hearten Keynesians and should give those who spruik business tax relief as the first and best policy response to a downturn pause for thought.
What Blinder found was that the most effective action taken by the US Government was to target temporary handouts to low income households through the Supplemental Nutrition Assistance Program (formerly known as food stamps).
In the first three months of 2009, for every $1 directed by the government through SNAP, $1.74 worth of economic activity was generated.
Extending unemployment insurance benefits had a 1.61 multiplier effect over the same period, while a temporary boost to work-share programs had a 1.69 multiplier effect.
Even increasing infrastructure spending was found to have a significant multiplier effect, though Blinder said the time lags involved in commissioning and undertaking capital projects meant that it was a stimulus measure more appropriate for prolonged downturns rather than shorter ones.
But, effective as some of these spending measures proved to be, there was great clamour from more conservative members of Congress for tax cuts as the tonic the ailing economy needed.
Here, Blinder found the evidence was mixed.
While temporary tax cuts and credits targeted at “liquidity constrained” (read, hand-to-mouth) households had appreciable multiplier effects (like Child Tax Credits, 1.38 times; Earned Income Tax Credits, 1.24 times), permanent tax cuts were much less impressive in their effectiveness.
The multiplier effect of permanent cuts to dividend and capital gains taxes was 0.39, and for a permanent cut in the corporate tax rate, it was just 0.32.
Not only were corporate tax cuts much less impressive as a stimulus measure, but they were prone to getting hijacked by the business lobby and turned into something whose prime purpose was to plump profits rather than fuel economic activity.
As evidence, Blinder cites the experience of an accelerated (“bonus”) depreciation measure included in a 2002 tax cut bill.
The change, which had the effect of putting investment goods “on sale” for a limited period of time, was originally due to expire after 18 months. This short duration was considered key to its effectiveness as a stimulus measure.
Instead, business lobbied hard to have the bonus depreciation extended…and extended… and extended…so much so that last year legislation was passed to keep it going until 2019.
“Ironically, we may have destroyed the usefulness of bonus depreciation as a countercyclical tool by making it permanent,” Blinder says, and advances what he calls a general theorem of political economy: “Business tax cuts artfully designed by economists for maximum bang for the buck will be altered by lobbyists to achieve maximum revenue loss instead”.
The reason is that “business lobbyists don’t care about ‘bang’, but care deeply about getting more ‘bucks’ for their clients, and lobbying almost always overpowers economic logic”.
The lesson, says Blinder, is to be wary of using investment incentives as a stimulus measure.
Many might object that American business and politics is a lot different to that in Australia and, anyway, we are a long way from the dire economic circumstances that confronted policymakers in late 2008 and early 2009, so Blinder’s analysis has little to tell us.
But the real question is, is a company tax rate of 30 per cent stifling activity, and would cutting it to 25 per cent over the next 10 years unleash a wave of investment and jobs growth?
The evidence suggests the answer to both questions is no.
As the Reserve Bank of Australia has observed, what has been holding growth down in Australia has been the plunge in global commodity prices and the fall in resources investment.
This has been partially offset by the effects of low interest rates and a weaker currency, which has encouraged growth in services exports and housing investment – both oif which have helped support an improvement in consumption to around its decade-long average of 3 per cent.
Arguably, what has been weighing on hiring and non-mining investment for the last few years has been soft demand and uncertainty about the outlook.
A $48 billion company tax cut might help firms capitalise on the improvement in consumption, but it is hard to see how it would drive it. Unless there is a compelling reason to hire and invest (read: an opportunity to make money), businesses are unlikely to make an outlay, regardless of whether the tax rate is 30 per cent or 25 per cent.
Instead, much of it could find its way into the bank accounts of lawyers and bankers devising M&A activities or pumping up shareholder dividends.