This episode on the limits of fiscal policy features highlights from host Gene Tunny’s past conversations with the late Australian economist Professor Tony Makin and former OECD Ambassador Alex Robson. In the discussions, Tony Makin provides a balanced and insightful analysis of Australia’s fiscal response to the COVID-19 pandemic, critiquing programs like JobKeeper while recognizing some justification. He and Alex Robson discuss the importance of considering the open economy impacts of fiscal stimulus and the long-term burdens of debt. The episode looks to validate Makin’s warnings about the limits of discretionary fiscal policy through subsequent evidence and events. Gene summarizes the JobKeeper evaluation results and what happened in the Australian housing market following the pandemic fiscal stimulus.
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What’s covered in EP222
- Fiscal policy limits and its impacts: introduction (0:03)
- Economic stimulus measures during the COVID-19 pandemic. (9:36)
- JobKeeper program design and targeting. (15:44)
- JobKeeper program’s effectiveness and infrastructure spending challenges. (21:31)
- Keynesian economics and infrastructure spending. (27:50)
- Fiscal policy and its impact on the economy. (33:13)
- Fiscal policy and its unintended consequences. (40:12)
- The economic impact of public debt with Tony Makin and Alex Robson. (48:31)
- Fiscal policy and its impact on the economy: wrap up. (53:39)
Takeaways
- Fiscal stimulus packages must be carefully designed and limited in size to avoid unintended consequences.
- The nature of the workforce is important to consider when implementing fiscal policy, as not all workers can easily transfer to different industries.
- The burden of public debt, including interest payments, can have long-term impacts on national income and economic growth.
- The effectiveness of fiscal policy in an open economy is influenced by factors such as capital mobility and exchange rates.
- Tony Makin was a leading advocate for sensible fiscal policy in Australia, and his contributions to the field are greatly missed.
Episodes the highlights are clipped from
EP119: What Tony Makin taught us about macroeconomics – Economics Explored
A Fiscal Vaccine for COVID-19 with Tony Makin – new podcast episode | Queensland Economy Watch
Links relevant to the conversation
Fiscal policy papers by Tony Makin:
The Effectiveness of Federal Fiscal Policy: A Review
(PDF) Australia’s Competitiveness: Reversing the Slide
Treasury analysis of JobKeeper:
Independent Evaluation of the JobKeeper Payment Final Report | Treasury.gov.au
The employment effects of JobKeeper receipt | Treasury.gov.au
News regarding unintended consequences of fiscal stimulus:
Transcript: The Limits of Fiscal Policy: Insights from Tony Makin, Alex Robson & others – EP222
N.B. This is a lightly edited version of a transcript originally created using the AI application otter.ai. It may not be 100 percent accurate, but should be pretty close. If you’d like to quote from it, please check the quoted segment in the recording.
Tony Makin 00:03
For instance, baristas who’ve lost their jobs are not necessarily going to be one want to be out there on the road as a construction worker, financial sector employees and not wanting to be perhaps putting paint bets and ceilings. So the the nature of the workforce is important. We can’t just treat the labour force as this homogenous entity where people can transfer across to any sort of industry at whim.
Gene Tunny 00:39
Welcome to the economics explored podcast, a frank and fearless exploration of important economic issues. I’m your host, Gene Tunny. I’m a professional economist and former Australian Treasury official. The aim of this show is to help you better understand the big economic issues affecting all our lives. We do this by considering the theory evidence and by hearing a wide range of views. I’m delighted that you can join me for this episode, please check out the show notes for relevant information. Now on to the show. Hello, in this episode, I’m going to talk about the limits of fiscal policy. So that’s the use of government spending and taxation to influence the economy. So to try to smooth out the business cycle or to respond to some big shock, like the pandemic or the financial crisis. During the pandemic, in particular, we saw heavy use of fiscal policy by governments around the world. While some stimulus may have been warranted, we’re starting to really see some of the adverse consequences of fiscal stimulus packages in different countries. So you could argue that are a good part of the inflation that we’ve seen in the last couple of years that was due to the, you know, these massive fiscal policy responses that occurred that, that injected all of this additional money into household and business bank accounts, and we ended up with too much money chasing too few goods, which is that that classic explanation of inflation. We’ve also seen high public debts. So big increase in debt worldwide. And then we’ve got the growing burden of interest payments on government budgets. We’ve also seen impacts like what you’d call crowding out, we’ve seen supply side impacts, or constraints really starting to, to bite, particularly in the building industry. So some of these, these unintended consequences, you could say, maybe they should have been foreseen, they’re really starting to have an impact, particularly here in Australia, we’ve seen an impact on the building industry on its costs, and that’s affecting firm viability. So there’s all this extra demand, and there’s only so much supply out there. And, you know, supply can only respond in, it can’t respond automatically or instantly, to to this additional demand. So we’ve seen a big increase in in costs in that sector, and then that’s having all sorts of adverse impacts and you know, builders are closing down and then the people who are getting their houses built, they’re badly impacted, too. So that’s, that’s one of the things we’re seeing here in Australia that I’m going to talk about. Early in the pandemic, Professor Tony Macon of Griffith University in Australia. So Tony was based on the Gold Coast, which is south of Brisbane, where I am so early in the pandemic tiny warned about the adverse consequences of fiscal stimulus in Episode 41 of the podcast. So in one of the earlier episodes of this show, in June 2020, I spoke with Tony about his analysis of Australia’s fiscal response to the pandemic. He prepared that for the Centre for independent studies, which is a think tank in Sydney. So the CIS it’s one that I’m an adjunct Fellow at and I’ve had a lot to do with over the years. I’m gonna play some clips from that conversation I had with Tony, in, you know what turned out to be one of the early Months of the pandemic. So, I mean, things started going, going crazy. And when was it March 2020. So that’s a, it’s just a few months after, after that. We had a big a major fiscal policy response by the end of March in Australia, if I remember. And so we’re starting to see some of the, you know, the less desirable features of that already in in June when I spoke with Tony. Okay, so I’m going to play some clips from that conversation to illustrate some really important points about the limits of fiscal policy. So I’m not saying that activist fiscal policy is everywhere and always bad. I think what I want to say is that you’ve really got to be careful with it, you’ve got to think about, well, what’s going to be the ongoing impact on your interest payments? Could could there be any crowding out? Could there be unintended consequences? Could you actually be destabilising the economy in the future? You may be trying to stabilise it now, but could you actually make things worse than they otherwise would be in in the future? So they’re the types of considerations I think are important with with fiscal policy? Okay, one thing I have to say is that tiny Macon is sadly, no longer with us. He died unexpectedly in November 2021. So, in addition to playing some highlights from my fiscal policy conversation with Tony, I’m also going to play some highlights from my conversation about Tony’s legacy that I had with Alex Robson in Episode 119, from December 2021. So I think they’re worth that’s worth sticking around. For. Alex is a you know, he’s a former collaborator with Tony, he wrote some papers with him. And he’s also Australia’s former ambassador to the OECD in Paris, which is really top job in economics. Yeah, so Alex, Alex is a great person to hear from and he has a lot of excellent observations about about Tony. Okay, let’s play the first clip, which it features Tony’s critique of the massive job keeper, payroll subsidy programme that we have in Australia. I think that much of Tony’s critique has been supported by the facts. So new evidence, or what we’ve learned about how Job keeper rolled out and, you know, the impacts that it had. And also, I think that the review of the programme that my old deputy secretary in the treasury, Nigel Ray, so Nigel did a review of it. Last year, I think that that review that brings out some of these, well, that’s supportive of some of the criticisms that that that Tony made, although, of course, it’s it’s going to be measured. And you know, Nigel, is not someone who’s going to come out and say, Look, this is, you know, this is terrible, you really stuff this up, he’s going to be very measured about it all. There’s also a treasury research paper that’s relevant here. And I’ll have more to say about them after I play the clip. Tony, I’d like to ask about the Australian response, I thought you made some really great observations about the different elements of the response. So there was the job keeper programme, the payroll subsidy programme. And then there were there were cash handouts. And there’s also some bringing forward of infrastructure spending. You made some really insightful remarks regarding the efficacy regarding the merits of the different elements of the Australian Government response. And I think there are lessons that can apply to responses across the world, would you be able to take us through what those those insights and lessons that you made workplace turning?
Tony Makin 09:36
Yeah, well, I made a distinction between fiscal responses that were targeting the aggregate supply side of the economy, and, in the paper, endorse those in principle and in particular, we’re talking about job Keeper which I think is a great innovation. We’ve not seen a scheme like like that, before, it’s not original to Australia, Australia copied what was happening in the UK and New Zealand and one or two other European economies. And the innovation was to see firms as a source of employment. Correct. And to alleviate the pressure on firms and their employees in particular, by providing a direct subsidy to the firm. So it was a supply side initiative, more than a demand side initiative, it was helping aggregate supply, it wasn’t an element that he was sought to increase CRI or it was increasing G, of course, but it was it was it was aimed at the firm’s production. So that was an innovation. And I think there’s a prototype there for future fiscal responses in heaven. Let’s hope we don’t have similar sorts of crises. But it’s it’s a preferred means as opposed to the aggregate demand side response. And a, we’re in the form of two cash transfers or cash handouts, as we saw in response to the GFC trying to in the Keynesian ways stimulate spending, and the purpose of stimulating the spending is to enhance employment. So it’s a roundabout way of trying to enhance employment. I think it has the features of a of a subsidy to retailers in effect, because they’re the ones that they’ve been at most. And in any case, if there is spending and evidence shows that such handouts tend to be largely saved, but if they are spent, they are spent on imports. And they’re funded by borrowing from overseas, which has to be paid in the future. So there were two responses there that were trying to sustain employment one was the direct one to Job keeper. Good marks for that one. And then there was another one on top of that, which was the cash handouts, which was a roundabout way of of sustaining employment when there was another policy in place for that purpose.
Gene Tunny 12:24
Yep. So this job keeper, it was originally costed at one 30 billion, it turns out all it it may only cost 70 billion, there was a forecasting error. But that’s that’s, that’s tangential to our discussion. You did know that while job keeper is more justifiable than other stimulus or emergency measures, there are still concerns with the design of job keeper. Could you take us through some of those please, Tony,
Tony Makin 12:57
our look, the key one is the industry is involved. The questions about casuals being paid more on job teper than they were otherwise earning. So they’re being paid more not to work than to work. I think that’s the key floor with the with the programme. And hopefully that will be fixed when the Treasury completes its review very soon. I guess it’s also questions about eligibility and the the the rule that was there for downturn in, in sales, some of those aspects of it could be possibly fine tuned, but I think it is a useful prototype that can be improved.
Gene Tunny 13:49
Yep. If they if they did it again, I’m sure they would better targeted, and they might target it to the industries that are most affected, such as hospitality, tourism, retail, possibly not professional services, which, you know, appear to be, well not as badly affected as some other sectors. So the the key lesson is that this needs to be better targeted. The problem was from what I can tell this was developed within a week, possibly under a week when at toward the end of March, when they realised that they needed something like this because all of the employer groups were coming to the the government ministers and telling them we need this or we’re going to have to sack millions of people. So I think that’s what drove it. It was done very quickly.
Tony Makin 14:43
Yes. And also the alternative was to put enormous pressure on the on the Employment Benefits Scheme. people queuing up for benefits that would have been a major headache as well. Absolutely.
Gene Tunny 14:56
I think one of the great points you made in the paper was Sir. Regarding the cash handouts, we want to get people out spending, but the public health advice is saying actually stay home, we don’t want you to go out. So I thought that was a really interesting point. And actually, yes, that’s right. So the goal of these emergency measures should be to sustain businesses to keep people in employment during this challenging time. It’s not necessarily, though, and the way to do that is not necessarily to give people money to go out and, and spend on new flat screen TVs, which are imported. So that’s, I think that’s a good point that you’ve made. Okay, so that was Tony on job keeper, which was the payroll subsidy programme we had in Australia. And yep, Tony was, Tony was right about the some of the problems with that programme. Um, overall, I mean, I think that was a very balanced assessment of Tony’s he did recognise that to an extent, it could have been justifiable if it was better targeted. So he wasn’t ruling it out completely. He just had the had some concerns about the design. So I think that was a very, you know, measured, balanced assessment of job keeper from tiny, and another measured and balanced assessment of job caper came from Nigel Ray, who, as I mentioned, was my boss in the treasury. So really, really great public servant, Nigel. And, yep, I think he’s written a great report on job keeper. In the independent evaluation of the job keeper payment final report, he prepared that for the Treasury, I’ll put a link in the show notes. It was broadly supportive of the programme. But Nigel, you know, he had to acknowledge there are some serious issues with it with the design of it. And so what did he conclude? Let’s, let’s go through it. So one of the major conclusions was that a more flexible policy designed during the first phase of job keeper. So I think that was the first six months. A lot of the detail is, it’s hard for me to remember at this stage, but I think that he’s talking about the first six months of the programme. They rolled it out for six months, and then they had another six months of it. A more flexible policy designed during the first phase of job keeper would have enabled an earlier move from prospective to retrospective eligibility thresholds. For example, After three months, this would have allowed better targeting of payments beyond the initial three months and lower the costs of the programme. Okay, so what he’s, what he’s talking about there is that when it was rolled out, basically, you know, accountants would apply for their clients that apply to the ATO, and the accountants would be asking their clients, okay, well, what do you think’s gonna happen to your turnover over the next six months, so when whatever the whatever it was, maybe was quarterly basis, and, you know, you’d think, Oh, well, we’re gonna have this major pandemic. So yeah, we think we’re gonna get smashed. And so there are a lot of, you know, firms that applied for job keeper and got this job keep it like this very generous, turned out wage subsidy, that, you know, they really didn’t end up needing and they didn’t have that turnover reduction that they were forecasting and that they, you know, they’re they advise the ATO that they would, they would have, but there was no way for the ATO to claw that, to claw that back. So, yeah, what Nigel’s getting out there is that you could have designed it in a way that limited the fiscal cost by actually seeing, you know, what happened to the businesses like after a few months and then adjusting the payments after that. So I think that’s what he’s getting out there. It relied a lot on what businesses and their accountants were forecasting would be the impact of the pandemic on their, their turnover. And for many businesses that didn’t actually they didn’t experience the big revenue reductions or the turnover reductions that that they were forecasting, you needed to forecast a particular percentage reduction in in your turnover. I can’t remember off the top my head if I can find it. I’ll put it in the show notes. Righto. So and the second major finding from Nigel regarding job keeper he noted that a tiered payment structure One that is proportionate to previous earnings is better targeted than a flat payment. And this is getting at that concern that Tony had that there were quite a few part time. People, part time employees who may have maybe they were working a couple of days a week in, in a business and they, you know, they were earning an award wage that wasn’t much more than the national minimum wage. Suddenly, because of this payment for a job keeper was that it was more gee, it must have been at sort of trying to approximate a might have been a full time wage for a person roughly on minimum wage or something like that. I can’t remember exactly. But it was much higher, then, you know, some it’ll be more money than someone be would be earning if they’re only working a couple of days a week, part time. And so the idea was, let’s make this simple. Let’s get this out to the people who need it. Let’s not worry too much about trying to make it more targeted, because we don’t have time to do that. And what it meant is that you had and this is the point time he’s making you had many part time people actually earning more with job keeper, then they would have learned otherwise. So yeah, that was a really poorly designed part of job keeper. Also relevant regarding job keeper is a recent Treasury research paper and this came out. So this came out late on Friday, the 22nd of December, okay, so the Friday before Christmas 2023. And Peter Tula, who’s my colleague at the CIS, so Peter is the chief economist at CIS. He tweeted on the Friday that the fact that Treasury releases it late on Friday 22nd December suggests that it embarrasses somebody. So Peter was suggesting that this paper from the Treasury by Natasha Bradshaw, Nathan Deutsche and Lachlan vos, or vas, it’s titled The employment effects of job paper receipt, Peter suggesting it must be embarrassing someone. So what does it what’s embarrassing about it? So the main findings from it. So I’ll put a link in the show notes, you can check out what they’ve done. They’ve done some clever things with a, you know, a data set on businesses that where they can try to infer what’s actually going on, it’s rather clever paper. So check that out. Our findings suggest that at its height in early 2020, job keep it directly preserved between 300,000 to 700,000. Jobs. Right. Okay. So that’s, that’s reasonable. I mean, that’s, you know, if that if it was 700,000. And, you know, that could have pushed the unemployment rate up to near 10% or something, they’ve got an estimate of what then what that would have been, and put that in the show notes. So, you know, that’s a, that’s a big deal. But then if it’s only 300,000, well, okay, is that, you know, how effective was that? So I guess, maybe that’s something you could, you could say, justifies the cost of the programme, which was in the order of $100 billion or so that’s, you know, that’s something you could argue about. So, you know, I’d say somewhere between 300,000 to 700,000 jobs, that compares with around three and a half million employees covered by the scheme at its peak. So I think when the government was rolling it out, initially, it it was suggesting it could save something around, you know, 700,000 jobs or so. If it actually is about 300,000, then well, that makes you wonder, you know, was that good value for money? So maybe that’s something that they’re embarrassed about? I’m not sure. I mean, you could say Oh, well, hundreds of 1000s of jobs, maybe it was worth it. That would be their their argument. What could be the potentially embarrassing bit about the paper is a finding that is in the footnote. It’s a one of the footnotes. And this finding is it’s on page two suggestive evidence. That job keeper receipt made casual workers less likely to be employed over a year later. So they found suggestive evidence that job keeper receipt made casual workers less likely to be employed over a year later. So the effects are far smaller and less statistically significant than the positive effects found during early 2020. But are not implausible they could reflect income effects on labour force participation given job keep a lead to some workers having substantially higher incomes than they otherwise would have. Okay. So this is that point about these, you know, these part time workers getting all of this additional, additional cash so many, many casual workers would only be working part time, they would be, you know, they could be working in a bar or at a cafe, and they’re getting much more money than they would have expected. So they’ve got all this extra money in their bank accounts. And so what they do a year later, is, you know, for many of them, they go, okay, but there’s extra cash, maybe I don’t need to work as many hours at the bar or the cafe, I’m going to spend more time on my studies or, or on a hobby, or I’m going to go overseas. So that’s what they’re, they’re driving out there. So this is really illustrative of how you can have these unintended consequences with fiscal policy. So maybe that’s what’s what’s embarrassing about the paper. So check it out. I think it’s a good paper, it illustrates a neat little econometric technique that I might talk about in a future episode. Okay, so that’s, that’s plenty on job keeper, the payroll subsidy programme and the the challenges or the problems you have when you don’t design a programme properly, of course, they had to do it very quickly. Next time, let’s hope they have a much better design, if there is a next time hope there isn’t a next time. If there is it needs to be better designed. The second clip that I want to play from my chat with Tony is about infrastructure spending. So with job keeping, we were talking about this payroll subsidy and you know, often, often the fiscal stimulus comes in the form of cash payments to households or businesses with the payroll subsidy programme, which then had to be paid to the employees. Some fiscal stimulus comes in the form of infrastructure spending, public works, that sort of thing. And I think Tony’s right there, that can also be problematic, you’ve really got to think about that. And that is the topic of this second clip from tiny, so I will play that now.
Tony Makin 27:50
infrastructure spending can be beneficial. And it has lasting benefits. And what it does not do is deteriorate the government balance sheet, as does the spending on cash handouts and other forms of consumption related government stimulus. What infrastructure does is it creates an asset there on the government’s balance sheet that matches the borrowing, it still has to be funded by borrowing, we started with a budget deficit. So all of his extra spending has to be funded by borrowing. And so there’s an asset there, so the balance sheet won’t deteriorate, to the extent otherwise. But again, it needs to be quality spending, it needs to pass certain tests, the crude Keynesian idea would be again, just to spend on anything. And being holes in the ground, as you mentioned earlier, is a form of crude Keynesianism, which, which could well be sort of portrayed as a form of infrastructure spending if it’s working on the road somewhere. But the point about infrastructure spending is it does have to pass the test where the benefits the present value of the benefits of the project, exceed the costs. And one other point to make about infrastructure spending. And this is one feature of government spending, the Keynes instanced in his work originally right back in the 1930s, but he talked about Public Works, which is effectively what we call infrastructure today. But the difference between then and now when they talk about boosting infrastructure spending is that the nature of the workforce has changed dramatically. I mean, people these days, have certain skills. It’s a highly variegated work workforce, people doing different things. And the assumption in Keynes’s theory was you increase spending on public works, then you have workers easily transferred from jobs that they’ve lost places of employment where they used to be in factories and other areas of unskilled work and they can easily be transferred to, you know, working on the road, so to speak. But these days, that seems far fetched, because for instance, baristas who’ve lost their jobs are not necessarily going to be one want to be out there on the road as a construction worker, financial sector employees, and not wanting to be perhaps putting pink bats in ceilings. So the the nature of the workforce is important. We can’t just treat the labour force as this homogenous entity where people can transfer across to any sort of industry at work. And there’s also I mean, there’s, there’s information costs there. There’s transactions costs, which which make the whole process a little bit trickier than than it sounds in terms of increasing employment.
Gene Tunny 31:08
Yeah, it’s not like it was in the 30s when you could get a whole bunch of unskilled or semi skilled workers, unemployed workers and have them carve out a walking track in the national park or something like that. Exactly. Right. Yeah, yeah. Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 32:06
Now back to the show. Okay, so another really balanced and insightful clip from tiny. And one of the things Tony was talking about in this clip is Keynesianism, so the ideas associated with John Maynard Keynes, the great British economist, and there’s a particular I guess, a school of thought or there’s a crude Keynesianism often in the way that you know, some, some economists or well, not not many economists, I think most economists recognise the the limits of fiscal policies, the problem with too much discretionary policy with Hey, you got to be careful with it. But there are there still are some we could say crude Keynesians and in in politics, too, there are some people with these these crude Keynesian ideas and they become quite popular during times of crises. And you know, Tony was someone in Australia who was always, always pushing back against that crude Keynesian view and trying to explain what are the what are the potential offsetting impacts, you know, how can interest rates respond, exchange rate, what’s the response to fiscal stimulus and particularly in an open economy like Australia’s Okay, so I’ll play the next highlight in which Tony covers that. So,
Tony Makin 33:42
in the open economy, where you introduce capital flows, exports imports, exchange rates, and emphasising in particular the exchange rate, then you can have a counter model to crude Keynesianism and the best known approach is the so called Mundell Fleming model, which is which features in intermediate macro economics textbooks. And it really just builds upon the IS LM model that Hicks invented by introducing capital flows and exchange rates and net exports. So, listeners may well be familiar with with that model, but simply says that if you increase government spending, you’re going to increase the budget deficit there’s going to be more spending in the economy, but that for a given money supply is going to tend to push up domestic interest rates relative to foreign interest rates and that will induce capital inflow foreigners will be flooding into buy these bonds that are paying a slightly higher interest rate than in their own countries, and that capital inflow will appreciate the currencies. And we’re talking about a floating exchange rate here. And that appreciation will worsen competitiveness because in the short run, price levels are fixed. So a nominal appreciation will translate to a real appreciation. And that loss of competitiveness will crowd out net exports. And this is exactly what we saw. Post GFC. And I’ve written written on this. It’s part of the Treasury external paper. But the exchange rate appreciated massively. As the fiscal stimulus was being rolled out and just look at the national accounts, and you’ll see that the swing variable, there was net exports that went down due due to the loss of competitiveness. That’s, that’s one open economy perspective. And I think that model has been borne out empirically, with reference to Australia’s previous experience, post GFC.
Gene Tunny 36:10
Yeah, so I’ll put a link to that paper of yours, which I think was in agenda. And you also wrote a paper for the minerals Council. One thing which was what one thing that’s really interesting, tiny is that your original minerals Council paper was criticised by the Treasury Secretary, Dr. Martin Parkinson, my old boss at the time. But then a couple of years later, you wrote a paper for the Treasury under the new secretary, John Fraser, essentially, almost refuting what Dr. Pockets and wrote in that rather extraordinary refutation of your minerals Council paper.
Tony Makin 36:58
Yes, yes. It’s quite curious and evidence that economists disagree, even heads of treasury disagree and their economic thinking. So yes, Martin Parkinson issued a press release criticising my minerals Council paper, which was mostly about Australia’s competitiveness. It was not focused, essentially on fiscal policy. That was a part of it. But that’s what caught the criticism from Treasury. And then subsequent to that, when John Fraser Parkinson, successor became Treasury head, he commissioned me to write a paper for Treasury, and that is available from their website, Treasury, external paper where I elaborated on the aspects in the minerals Council paper about fiscal policy and and raise some of these issues about accounting models to to crude Keynesianism. Yeah.
Gene Tunny 37:58
It’s interesting, because I mean, we both worked for Treasury it at different times, though. And I remember the traditional Treasury view is that we have to be careful about fiscal policy because it could end up being destabilising is the open economy impacts that you’ve mentioned, there’s also the problem that you don’t know whether you’re intervening at the right time. The problem that, you know, the stimulus might come on when the economy is recovering anyway. And then it’s, you know, it’s not really necessary. So there are these lags involved. What happened, I think, during the GFC, or the global financial crisis, was that the Treasury people thought, and you know, the, the politicians Kevin Rudd, the Prime Minister, Wayne Swan, the Treasurer, they thought, well, we’ve got this huge shock coming from overseas, we’ve got to do something. So we’re just going to throw as much money at the problem as we can to save the economy. That seems to be the logic and know all of those old concerns about discretionary fiscal policy, what we call discretionary fiscal policy, as distinct from automatic stabilisers such as unemployment benefits, which increase during recessions or the fact that your tax revenues fall during recessions. That all view that discretionary fiscal policy is insensible. That was just thrown out the window. And we’re seeing it again now. So what do you do you have any views on why treasury? The Treasury line on fiscal policy has changed, Tony?
Tony Makin 39:35
Well, I think it’s become crude, Keynesian. And there’s another example that you hadn’t mentioned, and it was the response to the Asian financial crisis, which was also a major, a cataclysmic event at the time in terms of what happened to asset prices and, and we by then had been heavily dependent on the Asia Pacific For our for our trade, not so with the GFC. Because our trade with North North America, the North Atlantic region was minimal compared to Asia. And yet the responses were completely different. In the first instance, there was virtually no fiscal response, there was a strong monetary response, which allowed the exchange rate to stay at a highly depreciated level, which, which soars through that crisis, we didn’t experience a recession that time. And that was what was happening with the global financial crisis, the exchange rate collapse, not as much as it did during the Asian financial crisis. But the government of the day then panicked, reflecting the panic in the US, and by that time, interestingly, the International Monetary Fund had a change course. And it’s thinking it has traditionally been influenced by Chicago economists and had always highlighted in my time working there highlighted problems with activist fiscal policy, including the lags problem that you’ve you’ve mentioned, but there had been this major reversal of thinking at those levels. And the Australian government here, panicked as a consequence of the crisis where we did not where it should not have given that the banking system here didn’t collapse in the same way as it did. In the United States. I fully endorse the the underwriting of the system or the banking system at the time, but the fiscal stimulus was, was completely over the top in my view.
Gene Tunny 41:46
Okay, I really loved that clip of my chat with Tony about fiscal stimulus, I think the comparison he makes or the contrast he makes between how Australia responded to the Asian financial crisis, which as he knows, was a huge deal. Particularly in in Southeast Asia. I mean, it had huge impacts on a major Well, an important economy to the north of us, Indonesia, which, you know, country I’ve had a little bit to do with, particularly with their finance ministry. And it led to effectively to the overthrow of the Suharto regime that they had there. So huge, huge impacts in that region. And yet, Australia responded differently, as Tony was explaining, but by the time of the financial crisis, the thinking in in Treasury, and and also it was a government of a different political persuasion, too. So that may have had something to do with the response. Right. Okay. So we’ve talked about crude Keynesianism. The other thing? Oh, yes, one. One thing I want to mention here is that I’ve been talking about how there are these unintended consequences of fiscal policy that that we can see. And I think that was particularly the case with, with one of the packages that was part of the pandemic response here, which was home builder, which was this home builder grant to two people who were, you know, building or renovating a home. So they had a home builder grant there was about, I think it was two and a half billion dollars. I’ve got that in my notes. And it’s ended up having these, you know, a really adverse impact on the building sector now. So there was a really crisp report from this was on news.com.au. This was on Christmas Eve, Kassar building group collapses into liquidation receivership owing $3.7 million, Guzman and Gomez. So jiwaji sites impacted. And so it’s a nice little as well, you know, it’s not nice, but it’s a good illustration of these unintended consequences. So I’ll just read some, I’ll put it in the show notes. And I’ll just read. I’ll just read some of the main points because I think it does illustrate, you know, what can go wrong if you’re not thinking through what the consequences of your policies can be. So ASIC is the Australian Securities and Investments Commission. So that regulates companies here in Australia. So ASIC insolvencies, statistics show 2213 building companies collapsed during the 20 to 23. financial year, there was a 72% increase on the previous 12 months. The alarming trend has been blamed on a perfect storm of factors including fixed price contracts, escalating costs, supply chain disruptions and tradie shortages. So tradie that’s the what we call tradespersons here in Australia. I’m not sure if you use that term in other countries, if you’re in the state So the UK, for example, the previous Morison government’s home builder grant, which was introduced in June 2020, handed out $2.52 billion to owner occupiers who wanted to build a substantially renovated home it turbocharged the sector, more than 130,000 Customers signed on to the programme with many trainees agreeing to the work under fixed price contracts, it soon became unsustainable as prices began to soar. Okay, so there was this crowding out. And you know, the, the builders or the tradies, they were relying on supply, you know, whether, you know, they may, they may have had to subcontract to other trainees, or they may have been, you know, they may need to purchase the supplies, so plumbing supplies or timber, and they may have been thinking, Oh, well, we’ll just quote based on the prices at the moment. And then suddenly, there’s this additional demand a huge amount of additional demand, and their prices increase for all those input costs. And they’ve signed these contracts to do the work at a particular rate. And these jobs are no longer viable for them. And so now what we’re seeing is we’re seeing these these building companies and collapsing, they’re just going into, into receivership liquidation administration. Yep. So bad results from that. So I’ll put a link in the show notes to that really important piece of information there. This is my final clip from Tony, from my conversation with Tony that had in June 2020. It relates to the ongoing burden of the debt. So those interest payments that, you know, that takes money out of your budget, that’s money that you can’t spend on health and education, for example, and this is something that I think it’s not sufficiently appreciated by decision makers during times of crisis. Okay, so I think, you know, there’s, there’s this need to respond, there’s this, there’s this panic, we think this is, this is the big issue we’re going to deal with. Okay. Sure. Except I accept that. But I think decision makers really have to think more about the long term implications. Okay, because, you know, this, this crisis will pass, presumably, I mean, you don’t want to be, too, you know, obviously, we need to be realistic. But generally, these things will pass, we’ll get to the the other side of it. And I suppose we, we probably should have expected that we would get over this pandemic. I mean, it has been, it has been dreadful, and you know, lots of people have died from it. So I’m not willing to downplay it. But we should have thought that yep, there will be life after the pandemic, and there will be this ongoing burden. Okay. So let’s play the next clip, the final clip from Tony on debt. What do you see as the the problem with this is this buildup of debt isn’t there, and there’s the problem, we have to pay for it, or we have to service that debt and a lot of that money is going to go overseas. You’ve also mentioned the impact on economic growth. What evidence is there regarding the impact on economic performance and growth of a buildup of public debt, which is in Australia is easily going to exceed $1 trillion within a few years?
Tony Makin 48:31
Yes, well, there’s certainly going to be the impact on national income because there’ll be a pure drain from national income of the public interest paid abroad, and we’re talking about 10s of billions there that will just be subtracted from national income to service to service the debt that we will have and that that drain will likely exceed. If it’s a trillion dollar debt, it’s likely to be about eight times the foreign aid budget and a multiple of, of what’s spent on the Pharmaceutical Benefits Scheme and, and a host of other other government programmes. So there’s going to be a direct impact there. But there’s been a number of elaborate econometric studies done. And you’ll find them in the literature. I won’t instance all the authors, but the IMF has done work on this. I’ve actually done had a paper published with a PhD student of mine, looking at Asian economies, and there seems to be a consensus empirically, that a 10% increase in public debt. Other things are saying well, contract, GDP growth, that’s conventionally defined GDP by point two of a percent. So that might not sound much but new compound that through it can be quite significant. After a few years.
Gene Tunny 49:55
What would be the mechanism there tiny would it be the fact that too due to service this debt, you might have to have taxes higher than otherwise. And these taxes, haven’t they lead to an efficiency loss. There’s an efficiency loss with taxation, because you’re discouraging people from working or investing. Could that be one of the mechanisms?
Tony Makin 50:15
Yeah, absolutely. The interest rate is going to play a play a role as well. But the there’s going to be a deadweight losses of the future taxes are going to harm future income. There’s no question about that. But also, there’s other studies have shown that the the the interest rate will will increase by seven basis points, or 1% increase in the public debt to GDP ratio tends to in these studies show that the interest rate tends to go up by about five basis points or up to five basis points. But the mechanism through tax is important, but also, through expectations, if you’ve got this big debt overhang, public debt overhang that’s going to affect expectations. And we can invoke Ricardo there in terms of what what he said for for households having to attend to to save more, but also firms and it’s not something that Ricardo instance, I think it’s important that investment investment is likely to be weak due to the uncertainty that business has about future tax liabilities in the face of an enormous public debt. And then lastly, there’s the impact on future generations that Thomas Jefferson, a founding father of the United States instance, and that the the future generations are going to have to pay for the repayment of the massive debt that’s that’s arisen due to the fiscal response. Yep.
Gene Tunny 52:02
Okay, so that was really interesting from tiny there. Now, some of that was the point he was making about expectations and what you call Ricardian equivalence, I think we’ll have to cover that in a future episode, because there’s a big controversy about that, and to what extent that actually, that actually happens. So, yeah, we’ll we’ll cover that in a future episode. The other stuff, you know, the, I think it’s the other points are really undeniable, really about the the interest burden of the debt and what that does the budget. So I think that’s, that’s well said, from tiny Okay, so that’s, that’s it from my conversation with Tony. What I’d like to do now is I like to play some clips from Alex Robson, who I mentioned before, Alex is out of the amazing Korea. He was an economic adviser to former Australian Prime Minister Malcolm Turnbull has been Australia’s ambassador to the OECD in Paris. And like me, he hails from Townsville in North Queensland. So yeah, I was really glad to catch up with Alex. Well, I wasn’t glad because it was a terrible event. But it was good that I could catch up with Alex after Tony’s passing to discuss Tony’s legacy. So here’s Alex on tinies legacy.
Alex Robson 53:38
I mean, in a closed economy, the assumption is you’ve got no capital inflows or outflows. And so the exchange rate then doesn’t really matter. So what Mondale and Fleming showed in the 60s Was that actually, if you just change that assumption, and then allow for the exchange rate to change, and capital inflows and outflows to occur, and that has been impacted by by imports and exports. And so with policy, say, for fiscal policy, you get this leakage into and out of exports and imports. And so if your sales are up, for example, boosting government spending or reducing taxes that will then have effects on interest rates, exchange rates and exports, so and then an open economy like Australia, that obviously matters quite a bit. And so the critical thing lever there that that changes, or you know, a lot of those predictions of the standard sort of pump priming model, we think about your government goes out and spends more money and has these multiplier effects and so on is this assumption of capital mobility and how it affects the exchange rate. And once you have that, you get a completely different predictions about the effectiveness of these different policy instruments. So and and Tony was always really good at just constantly reminding people of this and and I think it’s the tend to be something which was taught. It’s been taught, obviously, in universities for a long time, but it didn’t seem to quite make it into the, into the policymakers sort of calculus in in in Canberra. And so that was just one of Tony’s big things was just to remind people and of that. And I think, you know, I mean, we saw that during the GFC. With respect to exports, we saw it with respect to the exchange rate, there were big changes going on. And the point is that, you know, Australia is affected by everything else that’s going on in the world. And that’s why places like the OECD and IMF are always talking about coordinating fiscal policy, because, you know, otherwise, you get these leakages across across countries, and you may not get the impacts that you’re trying to achieve.
Gene Tunny 55:50
Okay, and here’s the second clip from Alex. So my conversation with Alex, I
Alex Robson 55:56
mean, thinking about, he had a good mix of very good technical economic skills. I mean, he wasn’t a heavily mathematical person, but he did use those tools when he needed them. And, but also very much an applied focus to policy questions of the day that that mattered. And it wasn’t something where he, you know, there’d be a policy issue. And so I’m now going to think about that. It was, you know, he’d been thinking about these things for a long time. And then when they tended to come up again, and again, he was ready with the arguments that he divided, quite a lot of thought to. So it was wasn’t like he was sort of chasing these different policies. She was, I think he just spent a career thinking about the big macro topics. And they just come back again and again, in Australia. And and it was we were fortunate, I think, to have him as a voice during these tumultuous times in the big macro debates of the 90s. And then during the GFC. And then more recently, as well, yeah, I think, yeah, thinking about his career, it was a good mix of contributions to the academic literature, technical skills, but then also translating that into policy commentary and advice that really stood him apart from a lot of economists today.
Gene Tunny 57:10
Okay, so we’ve come to the end of the episode. I think that the experience of many economies over the last couple of years has provided validation for the criticisms of fiscal policy of activist fiscal policy that came from economists such as the late Tony makin. The takeaway from this episode is that fiscal stimulus packages need to be very carefully designed and limited in their size, if you are going to implement them. There’s a legitimate argument that they’re best avoided altogether, but I would reserve the right to use them in some cases. And even Tony did suggest that there may have been justification was something like Job keeper, but a more targeted in better designed version of it. Okay, so, to wrap up, it’s really pleased me to be able to go back into the archives and to to find these great highlights from my conversation with tiny, tiny making. He was the leading advocate for sensible fiscal policy and Australia for for many years, and he is sorely missed. Thanks for listening. rato thanks for listening to this episode of economics explored. If you have any questions, comments or suggestions, please get in touch. I’d love to hear from you. You can send me an email via contact at economics explore.com Or a voicemail via SpeakPipe. You can find the link in the show notes. If you’ve enjoyed the show, I’d be grateful if you could tell anyone you think would be interested about it. Word of mouth is one of the main ways that people learn about the show. Finally, if your podcasting app lets you then please write a review and leave a rating. Thanks for listening. I hope you can join me again next week.
59:20
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Credits
Thanks to Obsidian Productions for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au. Full transcripts are available a few days after the episode is first published at www.economicsexplored.com. Economics Explored is available via Apple Podcasts, Google Podcast, and other podcasting platforms.
