The Rise and Rise of Australia’s Debt

One of ALP’s worst mistakes besides their hopeless Policies was the selection of Wayne Swan and his Keynesian way of  as Treasury Guy.  The sheer brilliance of this guy was made clear when he was named the ‘world’s best treasurer’ on September 21, 2011.

It’s a truism of Keynesian economics that consumer spending drives the economy; if spending slows in a recession, government must make up the difference. In reality, consumer spending merely signals what consumers want; producers may be unable or unwilling to deliver. Government spending may compensate — or make matters worse — depending on the type of spending and whether it’s financed by progressive taxes or by borrowing.

Let’s see if I can explain it:  I go and spend $1 at the shop. The proprietor spends $.80 of that for petrol. The petrol station owner then spends $.80 of that to get their hair cut and so on.  By the logic of what is an infinite series,  my original $1 in spending has created an additional $4 dollars in spending; or a “multiplier” of 4.  And with that additional spending comes another $4 in production.

Now imagine if I leave that $1 in the bank, and the bank doesn’t lend it to someone else to spend, then government must spend a $1 instead to keep the economic machine running. This is the idea behind Keynesian accounting, and it sounds fair doesn’t it?

But, there is a glitch in this philosophy: the assumption that spending automatically leads to production and jobs.( this is where we must remember what it means to Ass u me.)

Consider a small business. It makes wooden widgets. Every month it has to decide how many puzzles to make, and in essence  how many hours to schedule for it’s employees. So what will it consider?:

1. First, it must estimate the next month’s sales from the sales last of the last month as well as the trends of previous months.
2. Therefore it plans how many widgets to produce based on consumer spending. But also considers how much cash is available to pay for plywood and workers’ wages.
3. Small businesses will often operate on lines of credit, borrowing each month for payroll and materials, then paying back loans with cash following sales.
4. If — as happens in a recession — banks reduce the amount of credit and customers delay paying, our widget maker cuts back planned production and lays off it’s workers.

If it were a large profitable conglomerate, an combination of dozens of businesses and thousands of products. This kind of enterprise faces no shortage of cash in a recession.
But management will become very cautious.  It shuts down it’s less profitable business lines and lays off workers, even though there may still be substantial demand.
Equally big banks turn cautious, denying credit even to it’s steady customers like our widget maker.

Therefore when a recession makes cash tight for small business, and confidence low for large business, consumer spending does not necessarily translate into production and jobs.

Can government spending create production and jobs to replace those lost in a recession? That would depend on the type of spending. Military spending is the hardest. First it creates very few jobs per dollar spent; second, it creates limited benefits. Although it is much needed and we cannot afford to make it too lean.  Contrast that with urban services:  street and sewer repairs, garbage collection, schools, police, fire, welfare and health provision — all of which create many jobs per dollar spent. Then add to it Federal safety-net spending – ie. Social Security, & Medicare.  Without these services operating invisibly in the background, neither the Widget maker, the conglomerate, nor their customers would survive.

This is where I believe government should spend more money during a recession, not cut back.  The effectiveness of government spending also depends on how it’s financed. Local government services raise property values; when property owners pay property taxes, they pay for benefits received.  However, the Keynesian method is based on excessive borrowing which undermines the benefits of government spending.  It is really a harmful myth that spending drives the economy.  It makes us think we can rev up the economy by any additional government spending, financed by borrowing. In reality, we need productive, job-creating, service-providing government, supported by sensible taxation that does not take away the incentive to create business in Australia.

In a Fabian essay, Wayne Swan offers a new motto for why the budget needs to quickly get back to surplus: “If we are going to be Keynesians in the downturn, we have to be Keynesians on the way up again.”
Mises Daily: Monday, December 21, 2009 by Robert P. Murphy

Keynes in the 1930s depression suggested paying workers to dig holes and fill them in again. So, in response to the financial crisis, Labor spent $16 billion on low-productivity school halls and a few billion on a home insulation program that burned down houses.  He was so intent on an analysis of the failed Scullen Government in 1929 through to the 1940′s as proof of the success of the Keynesian approach.  He even failed to take account of “Krugman Falls into the Keynesian Accounting Trap”  Krugman is arguably is the world’s most famous living Keynesian, and he won the Nobel (Memorial) Prize for his work on trade theory, accusing him of a basic error on this score would be akin to telling Madonna she knows nothing of pop music, however, it remains that there are large holes in this theory and a fallacy in the “national accounting identity” equation [Y = C + I + G + (X − M)] .

The Keynesian view says that one way to measure total economic output (Y) is to add up total spending on consumption (C), investment (I), government purchases (G), and net exports (X − M). This leads to the equation:

Y = C + I + G + (X − M)

this is not a “theory” of the macroeconomy, it is a truism of accounting. Because goods are diverse, the only way to aggregate them in order to come up with a figure like “total output” is to add up their money prices. So if “total output” is just the total amount of money that producers are receiving, then this number must be the same as the total amount of money that purchasers are spending. That’s why the left side of the equation must equal the right side.

Therefore, if foreigners are spending money on consumption or investment goods produced within the United States, then this spending on US exports (X) needs to be added, because the first three components (C, I, and G) wouldn’t have already captured it since they only look at domestic expenditures.

In our present context, Krugman has argued that lowering trade barriers will (in general) raise X and M equally, and so this can’t possibly change the left side of the equation.  But that is wrong; it assumes that domestic consumption and investment spending will not themselves be influenced by the reduced trade barriers. Since the standard case for free trade rests on the demonstration that it will increase per capita income, it is simply amazing that Krugman failed to realize this before firing off his blog post. But this has shown the inefficiencies of the Keynes method.  It is not designed for the changing world of the 21^st Century.

I am not as smart as Mr. Swan obviously, but I have always believed you don’t compare chalk with cheese.  I would be interested in a more modern approach to suit the 21^st Century, and look for successes in this era, why wasn’t this done, maybe because the world of accounting has evolved, unfortunately Mr Swan seems to have remained as a ‘Hobbit’.

Wayne Swan ‘s Keynesian Accounting has cost us $232 billion debt at a time when we should have been building business confidence in Australia.  He needed to have budgeted closely with revenue rather than borrow whatever the Policies wanted, and he needed to be on the backbench instead of ruining Australia’s finances.