Corporations such as Google, Amazon, and Live Nation are allegedly taking advantage of chokepoints in the economy, earning excessive profits. That’s the thesis of a new book, Chokepoint Capitalism: how big tech and big content captured creative labour markets, and how we’ll win them back. The authors are Uni. of Melbourne Law Professor Rebecca Giblin and writer and activist Cory Doctorow. Show host Gene Tunny speaks with Prof. Giblin about Chokepoint Capitalism in this episode.
Rebecca Giblin is an ARC Future Fellow and Professor at Melbourne Law School, and the Director of the Intellectual Property Research Institute of Australia. Her work sits at the intersection of law and culture, focusing on creators’ rights, access to knowledge and culture, technology regulation and copyright. Using quantitative, qualitative, doctrinal and comparative methods, she leads interdisciplinary teams with expertise across data science, cultural economics, literary sociology, information research and law to better understand how law impacts the creation and dissemination of creative works.
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.
Gene Tunny 00:00
Coming up on Economics Explored.
Rebecca Giblin 00:03
We’re sharing less and less in the value that’s that’s created by our work. And that’s happening because we’ve got these increasingly powerful corporations, creating choke points that allow them to extract more than their fair share.
Gene Tunny 00:18
Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny broadcasting from Brisbane Australia. This is episode 169 on choke point capitalism. That’s the name of the new book from University of Melbourne law professor Rebecca Giblin and from writer and activist Cory Doctorow. Professor Giblin joins me this episode to discuss the book. Please check out the show notes, relevant links and information and for details where you can get in touch with any questions or comments. Let me know what you think about what either Rebecca I have to say in this episode. I’d love to hear from you. Right now. It’s my conversation with Rebecca Giblin on a new book with Cory Doctorow chokepoint capitalism, thanks to the publisher scribe for sending me a copy of the book. And finally, thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Rebecca Gibson, welcome to the programme.
Rebecca Giblin 01:00
Gene Tunny 01:01
Yes, good to have you on Rebecca keen to chat with you about your new book, Choke Point Capitalism: how big tech and big content captured creative labour markets and how we’ll win them back. So to begin with, Rebecca, could you explain what’s the meaning of a choke point? And why do you think capitalism can be labelled in this way? Or there’s a form of capitalism that is chokepoint capitalism?
Rebecca Giblin 01:40
Well, competition is supposed to be fundamental to capitalism. It is supposedly about the free exchange of goods and services. But you have this new orthodoxy that’s come out in the last 30 or 40 years. When you have Peter Thiel say competition is for losers. You have Warren Buffett salivating over companies that have what he calls wide, sustainable moats, which are barriers to competition that stop that, you know, lock in customers and lock in suppliers, and stop that free exchange. And once and this is now the orthodoxy that’s been taught in business schools, people are told that if you want to make a fortune, you don’t make something, don’t provide a service, but find a way to scrape off the value of other people’s labour. And these are the choke points. So it’s where you manage to lock people in. So you lock in customers, you lock in suppliers, you use, the power you get from that. And those increased margins you get from that to do a scorched earth approach where anybody in your kill zone gets eliminated so that there are fewer and fewer choices for those locked in customers and suppliers. And then ultimately, you shake everybody down for more than your fair share. And we see these choke pointed markets in throughout the culture industries in particular, that’s what we talk about in the book to demonstrate this problem. But they’re everywhere. We’ve started seeing the term getting used in the context of all different kinds of businesses. We’ve had people talking about on social media emailing us to tell us about it. One of the more interesting ones and somebody saying this is exactly what’s happening in the global ornamental plant industry is a big plant is a problem as well.
Gene Tunny 03:28
Ornamental what? Sorry?
Rebecca Giblin 03:30
Plants, Yes. Yeah, it’s a big problem in the plant market, we discovered. And, and what we’re really trying to demonstrate here is the danger of this. And the reason why so many of us are feeling squeezed right now. It’s not our imaginations, it’s that we are being and that we need to become really aware of it if we want to change the material conditions in which we live and work.
Gene Tunny 03:54
Okay, so by many of us, are you talking about creative professionals?
Rebecca Giblin 03:59
But it goes much beyond that as well. If you’re working, or if you’re a supplier to Coles and Woollies, for example, you are dealing with a similar kind of buyer power as what we talked about in the book. And so let me mention this. This book, we talk about monopoly a bit, which is, you know, we’re all familiar with that concept, because we got a board game for that one. It’s where you’ve got a seller, that’s really powerful. So Amazon, for example, is a really powerful seller. And its relationship with consumers because it controls so many consumer markets, including the market for books, but it’s also an incredibly powerful buyer. So if you’re a publisher or an author, you you you need to go through Amazon to reach those customers. And so it’s, it’s it’s got monopsony power as well, which is where you’ve got a powerful buyer. So if you’re a supplier to Coles and Woollies, you’re dealing with people. I have to say this word monopsony, it does turn a lot of people off. It did appear a lot more often in the book in the first draft and people begged us to take it out, but we do think we can make it sexy. Technically what we’re talking about here is oligopoly, which is probably even worse, which is where you’ve got a couple of very powerful buyers. But I’m going to use monopsony just for simplicity. But that’s what you’re dealing with if you’re a supplier to Coles and Woollies, in Australia or so many other companies that have increasingly come to control their markets. And the reason why we’ve got this increased corporate concentration throughout the world is largely due to the emergence of what we call Chicago School of Economics reasoning, this, it gets a little bit wonky at this point, but this consumer welfare theory, that suggests that we should only be concerned about corporate concentration, not just because it exists, but where it has the effect of, of harming consumer welfare, which is often treated as just looking at the prices people pay. There’s many problems with that standard. And we’ve seen them the consequences of that really starting to play out now. But one of the consequences is that it really ignores the fact that when you’ve got a powerful buyer, right, it may be that the prices that the consumer pays are not affected. But that buyer has its hand in the pockets of its workers and its suppliers. And you’re it’s a little bit of a stage magic, sleight of hand misdirection where you’re looking over there at the Consumer Price, and not noticing that you’ve got somebody picking your pocket on the other. And we think I mean, it’s exactly the same end result. If you’re if you’re having downward pressure on your wages, the salary that you bring, bring in the what you get paid for your goods and your services, it has the exact same end result as higher prices at the checkout, which is that you’ve got less and less capacity to pay for what you need. And what we’re really seeing now in the current environment. And a lot of these prices, we are seeing big price increases at the checkout. And partly those are inflationary pressures. But we are seeing as well, there’s a lot of evidence of companies, these powerful concentrated industries, hiking up their profit margins and using inflation as an excuse for that. So we’re seeing higher prices at one end, and also these companies having their hands in our pockets at the other. And so it’s no wonder that everybody’s feeling squeezed.
Gene Tunny 07:30
Right. Okay, so you mentioned a few things there. You talked about antitrust, and I’ve chatted with Danielle Wood from Gratton about this, this issue of you know, there was this consumer welfare standard. And that meant that there may be, there wasn’t as much antitrust enforcement. But now there’s been a change, you’ve mentioned, is it Lina Khan in the States? So there’s more of a, a willingness to look at antitrust as a tool. And can we, Rebecca can ask about what mean, what companies you’re talking about? I mean, are you talking, you mentioned. Well, it’s could, though, there could be companies in the sort of more traditional economy, but it’s, is it mainly big tech? Are they these are the companies that are exhibiting the characteristics of being a choke point, capitalist, what are some of these companies?
Rebecca Giblin 08:23
Okay, so the ones that we talk about in the context of the creative industries, they go all the way through the chain. So if we think about just music to begin with, musician has to deal with the big three record labels, who control almost 70% of global recorded music rights. They own the big three records, the big three music publishers, which control almost 60% of global song rights, they structure the deals in ways that benefit their executives and shareholders, and work to the detriment of these creative workers. Then the streaming industry, which is where most of the increasingly most of the money from recorded music is generated, the streaming we lots of people know that music streaming really doesn’t pay very well. But fewer people are aware that the reason that works, the way that it does is because this is the way those big three record labels, arranged things, the streaming platforms had to have to go through those records, those record companies in order to get permission to play the songs. And in order to clear those rights, they have to enter into these deals that again, favour those record labels, again, to the detriment of the artists, and that give those those those major labels who should be far less relevant and indeed are far less relevant today than they were 30 or 40 years ago because they no longer control all of the avenues to distribution, but because they’ve got these huge reservoirs of copyrights that they’ve acquired often through buying up distressed companies very, very cheaply, that’s given them outsized power to control the future of music. And so you can see that those, the copyrights themselves create a choke point, at one point, the incredible complexity of the licencing systems that we have in music, create other choke points, because it is only Spotify and the big tech music offerings that can afford to go through the, you know, these hoops to pay that what’s demanded by the record labels and also to comply with these complex regulatory rules and that keeps lots of other companies that that could be started by people who love music and want to support artists and passionately believe in alternative ways of getting music out there. It stops them from being able to start up any kind of meaningful competition. And then if you look, and you say, Well, that’s all right, people don’t really need to make money from recorded music. No one’s really made money from recorded music except a few outliers. People make money from touring. Well, then we start looking at Live Nation, which is the behemoth in that space. It controls nearly all of the world’s largest and most prestigious music venues. It also has a music management and promotion business. And it bought Ticketmaster a few years ago to, you know, in the face of many, many warnings that what has happened would happen, the Department of Justice in the United States still permitted this merger to go ahead. Now, just think about this for a moment. Imagine you are a company. So you’re a music venue, right? And you want to book acts, you will have Live Nation tell you well, if you don’t use us for your ticketing, you won’t be able to book our biggest acts that we control through our management, business and promotion business, or, or any other kind of incredible threat that they’ve made. In the book, we talk about this we are in, we looked in an incredible range of creative industries in our research for this book. And we always gave people the opportunity to be synonymous or anonymous if they wanted to. And I think nobody took us up on that. Even when they were talking about these other really big, really scary giants like Amazon, who’s also known for not playing fair, except the people we spoke to about Live Nation. Almost all of those said that they could not be named. And they were really genuinely terrified about what kind of retribution could come if it got out that they’d spoken to us about this company. But it has a voyeurs, voyeurs view at the businesses of all of its competitors, right? If you’ve got to use Ticketmaster or if you’re a venue, or you face all of these other consequences, all of these other things that you miss out on. But that gives Ticketmaster the ability to see, well, okay, so which other acts that you are hosting are doing well, who are the artists that look like based on the ticket sales, they’re about to break out, and maybe Ticketmaster, Live Nation can jump in with its promotion and management business and snag up those acts. Now, even though they didn’t do the early investment, they can just sneak in and grab them now that they’re about to start making lots of money. And, you know, all kinds of other, you know, extraordinary advantages this gives them and we’re really seeing this play out at the moment with anyone who’s listening. Is there is there much crossover? Do you think Gene in the economics explained audience and the people who are big fans of Taylor Swift, and been waiting in a queue for days in order to get tickets to her concert? You have
Gene Tunny 13:47
Look, I have no idea. I mean, I quite like Taylor Swift. I wouldn’t line up for days to get tickets. But yeah, who knows? Tell me more.
Rebecca Giblin 13:55
Look, the Department of Justice is investigating again, they did do an investigation a couple of years ago that we talked about in the book, where a bunch of venues who all had to be assured of anonymity in order to speak, we’re talking about Live Nation’s mob tactics and ways in which it was using its power to crush other people’s businesses. It got a fine that was just really a slap on the wrist and told really sternly not to do it again. But in this kind of context of fine is a price. The Live Nation is quite happy to pay that kind of fine in, you know, in order to get to continue its predatory behaviour. It will only be stopped if there is sort of meaningful enforcement. And the DOJ hadn’t done anything since until this Taylor Swift controversy came up. And and and we are seeing now there’s going to be another investigation. So hopefully, there’ll be some kind of more meaningful enforcement here and what we really need to see is Ticket Master broken up. That’s one of the main domain remedies were there. antitrust breaches. You can have structural remedies, which is where you break a company up or conduct remedies, which is where you sort of get them to pinky swear they won’t do anything bad. Now, unfortunately, those remedies are not particularly easy to enforce. Right. It took literally decades to break up AT&T In the United States. I was it was a Bell. I think it was Bell before it became AT&T. So there’s so many, the Bell System we concentrated. Yeah, concentrated firms the sometimes I get mixed up. And it can be incredibly expensive and lasts for decades to take these actions and we don’t have decades. And the other problem with those antitrust remedies or competition law remedies is that they work even less well when you’re dealing with monopsony rather than monopoly for various reasons. And so what we argue for in the book is remedies that we know do work in response to monopsony power. And that’s things like encouraging new entrants into the market, directly regulating excessive buyer power by limiting what they can do and by taking measures to build countervailing power in workers and suppliers.
Gene Tunny 16:21
Okay, well, I want to come back to that that point about the monopsony you said, it’s harder for antitrust act on monopsony if you meant I think you said that I’d be interested in that if you can explain why or, and also the, I guess, I’d like to ask about, I mean, is this really so bad? I mean, you mentioned that it’s, it’s captured creative labour markets. I mean, okay, I’m, I’m against a lot of the surveillance capitalism. And I think you know, where to the extent there are choke points, and they’re really bad business practices, or they’re they are, they’re relying on some. Yeah, I guess it’s IP, they’re relying on these relationships they have and they’re, they’re preventing competition from, from coming into the market. Yeah, I can see the problem with Ticketmaster. At the same time, I mean, I think a lot of these platforms have enabled a lot of people to make a living out of content creation, haven’t they? I mean, if you look at YouTube, and you look at all the podcasting platforms, I mean, there are many more people that are able to, you know, quit their jobs and become full time content creators, aren’t there. So, I mean, is there a risk that we, we, we undermine this system that has actually created a lot of benefits? I mean, how do you see it, Rebecca?
Rebecca Giblin 17:48
Let me answer that second part. The second part first, I think we are constantly being sold the idea that we can’t have the good things without the bad things, right. So Amazon is constantly telling us that we can’t have a good search engine without surveillance. But we can have a great search engine without surveillance. Google didn’t surveil us for the first several years of its existence, right. And it was a terrific search engine. We, with the access to digital technologies and the Internet, we absolutely can have global virtually instantaneous gloop at virtually costless, like zero marginal cost of distribution, supply of many kinds of creative work. So we’ve got this potential for the good things anyway, what we don’t have to have is the bad parts, the lock ins, right, these strategies that are used to create these hourglass shaped markets, so that you’ve got audiences at one end, and creators, the other and these predatory companies squatting at the NEC, were they using that power that they’ve artificially created by locking everybody in to extract more than their fair share? So that’s what I say in response to that. And getting, I’m so glad you asked me more about monopsony. Most people run away screaming from that pot. So some of the reasons suddenly tell you a couple of things about it. One reason why monopsony is so dangerous is that it accrues at far lower market concentrations than monopoly power does. So you know, when monopsony when when when a buyer controls even eight or 10% of the market, that already gives it quite outsized power over its suppliers. And that says that’s assuming that there’s no alternative buyer for that. And we saw that when Amazon started out one of its one of its as soon as it got power over the physical book market. It started exerting that to try and squeeze margin out of everybody else. And, you know, this is a famous Bezos aphorism. Your margin is my opportunity. He’s very clear about what he’s trying to do. But sometimes when you look at how the sausage gets made, it can be a little bit frightening. They created something called the gazelle project, which is exactly what it sounds like the way that a cheetah cuts out the weakest Gazelle from the herd, they went after the smaller and more vulnerable publishers to squeeze margin from them. One of them was Melville House, who lots of people have read books from. And the publisher they resisted, he said, look, if you I cannot, we cannot afford to give you what you’re asking for our business won’t be sustainable on that basis, we just won’t do it. And Amazon instantly retaliated by removing the buy buttons for all the Melville House books on its platform. Okay and now at that, at that time, I think Amazon only controlled about 8% of the market for those books. But nonetheless, Melville House was forced to instantly get virtually instantly given because without that, that eight or 10% of sales, it was just no longer sustainable. And so if you look at how much power Amazon had, when it had such a small market share relative to what it has got now, you can see how dangerous that’s become. And then if we look at other industries, in so many of them, you’ve only got, you know, one or two or three buyers that are available. And coincidentally, they often seem to have very, very similar policies and very, very similar abuses. And this is what this is what puts them in that position where they can extract so much from the people that they’re dealing with. Yeah, the other. The other thing about monopsony that I think is relevant here to why the remedies are not particularly effective, is that there’s real concern that when you regulate a powerful buyer, that maybe the reason why it’s so powerful is because it’s very efficient. And this is what Amazon argues it argues that it has this highly efficient structure, that it has these lower costs, which leads to attracts customers, which then attracts suppliers. And then there’s a better customer experience, which brings more in and sort of feeds this loop which Amazon calls its virtuous cycle, right. But what we see when we look at Amazon, and my co author, Cory Doctorow just did a terrific thread, or blog post on his pluralistic website about this a day or two ago, is Amazon increasingly is a shitty place to buy from, because most of it has been taken up by advertising. People, people know that Google and Facebook have big online advertising businesses, but not many people know that Amazon is a close third now. It shakes down the people that sell on it. For placement fees, and for the right to be shown first and for the right to be earlier in the search listings. And that means that you know, rather than getting the best search experience, the best customer experience, you’re just being inundated with ads all the time. They’re making billions upon billions of dollars from this. So the evidence is that in practice, it’s probably not from efficiency, but regulators are concerned that they might not be able to tell the difference. And that makes them hesitant, even more hesitant to intervene in cases of monopsony than monopoly.
Gene Tunny 23:24
And Rebecca, how do you respond to the argument that these companies are simply being rewarded for the innovation, they’re being compensated for the innovation, that they’ve undertaken to deliver new services to consumers, because a lot of these platforms are delivering value or consumer surplus to a lot of consumers. And, you know, providing opportunities for content creators. I’m just wondering how you respond to that argument, because as economists, I mean, we’re very much a lot of economists are sympathetic to that Schumpeterian idea of creative destruction, that wherever there are these, you know, the opportunities for profits that encourages innovation. And I mean, who knows? I mean, will these companies survive? Or will there be new innovative innovators who take over?
Rebecca Giblin 24:10
Let’s see, that’s the thing. This is another thing that we’re constantly being sold this idea, but look at Google, how much innovation does it actually manage? Alright, it made a great search engine, and a pretty good Hotmail clone, right? And nearly everything else that it’s ever provided that’s had any kind of success. It’s bought from other people who did actually innovate with its monopoly profits that it’s making on from these choke points. Right. And so, you know, Google tried really hard, and we talked about it in the book to create a Google video service, right? Absolutely failed with all of its resources and all of its smart people it could not, it’s almost ludicrous, how hard and how many ways it failed on that. And so it had to buy YouTube, right, which scrappy people above a pizza shop where they were actually doing innovation. And we see this time and time and time again, you know Facebook came to control the messaging market, and to control the way you communicate with your community and your family and your friends, not by innovating and creating the products that we want. But by buying up what’s happened Instagram for billions of dollars each when they had, you know, virtually no employees, because these tiny companies were the ones who actually doing the innovation, okay, so we don’t need not only do we not need these, these massive companies in their massive war chest to be innovating, they’re actually getting in the way of other people innovating. Because everybody knows what happens if you get in the kill zone, right? So it’s a risk, you either get bought up. And that’s like, that’s what many, many people are aiming to do. If they’re trying to innovate in this area, they know that the only exit is to get acquired by these companies, or crushed by them. And so it’s called the kill zone. And if you and venture capitalists know, we know that there is less VC investment in territories that are controlled by big tech and other powerful corporations, because of these kill zones. So Amazon, for example, burned, I think it was 200 million US dollars in a single month, undercutting and going directly up against diapers.com, in order to control the nappy market in the US. And that’s an extraordinary amount of money drove this innovative competitor absolutely under because it had access to these, these war chests from its monopoly profits and access to capital markets that this scrappy little innovator didn’t have. Now $200 million in a month to control the diaper market might sound like a lot of money. But it’s actually incredible value, because it didn’t just get rid of diapers.com it sent an incredibly clear signal to anyone else that was thinking of entering any space that Amazon has marked that you will be absolutely burnt out if you even attempt it.
Gene Tunny 27:04
Yeah, it’s a real gangster move, as they’d say, isn’t it? I mean, really?
Rebecca Giblin 27:08
Yeah, they would say no, no, it’s just it’s just it’s good, hard. It’s good fair competition. But it’s not is it? Right. And all of that. There’s extensive research on this, we see that there’s less investment, less innovation in areas where you’ve got choke points.
Gene Tunny 27:26
Okay. Rebecca, I think I should have booked you for longer. There’s been fascinating, and I’m enjoying the conversation. But yes, if, if there’s anything else? Yeah, I’d love to if you had any final points, you know, feel free to make them otherwise. We might have to, we can wrap up. And yeah, I’ll, I’ll try and connect with you sometime in the future. Because I’m sure there’ll be a lot of discussion about your book and this debate will continue on into the future.
Rebecca Giblin 27:55
Yeah, I guess the final thing I would say just to sort of sum up the ultimate message is that you know, creators, but also the rest of us are getting choked, that we’re sharing less and less than the value that’s that’s created by our work. And that’s happening because we’ve got these increasingly powerful corporations, creating choke points that allow them to extract more than their fair share. But we don’t have to put up with it. There’s lots of things that we can do to widen these choke points out once we see them for what they are.
Gene Tunny 28:25
Okay. Rebecca Giblin. Thanks so much for your time. I really enjoyed the conversation. Thank you so much.
Female speaker 28:33
If you need to crunch the numbers, then get in touch with Adept Economics. We offer you Frank and fearless economic analysis and advice. We can help you with funding submissions, cost benefit analysis studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world. You can get in touch via our website, http://www.adepteconomics.com.au. We’d love to hear from you.
Gene Tunny 29:03
Okay, I hope you enjoyed that conversation I had with Rebecca. Overall, I think Choke Point Capitalism is a book worth reading, although I disagree with some of its assertions. Regrettably, I didn’t book Rebecca Long enough to ask her all the questions that occurred to me from reading the book, so I’ll aim to get her back on the show next year for another conversation. The book includes many compelling examples of dubious business practices by big companies. So I must admit I am somewhat sympathetic to the choke point capitalism thesis. And if you’re a regular listener, you will know that I’ve covered surveillance capitalism and problems with big tech in the past. There does appear to be scope for some antitrust action against some of the badly behaved big tech companies for sure. That said, one reservation that I have about the book is that it appears to have a wider ambition than simply acting against the market abuses of big tech. In parts, it reads like a polemic against capitalism in general. For instance, the book concludes, we’ve organised our societies to make rich people richer at everyone else’s expense. I think that sweeping statement goes too far. Like some other popular economics books I’ve read in recent years, choke point capitalism adopts to negative view of our economic system. Capitalism, after all, has lifted hundreds of millions of people out of extreme poverty in recent decades. And it has fostered a bewildering array of innovative new services that have benefited billions of people. And we still have progressive tax systems in which the wealthy generally pay much more tax than the less wealthy. Of course, many wealthy people avoid paying tax I know. But I think it’s broadly true that we still have a highly progressive tax system, at least in Australia and European countries, possibly less so in the US. Okay. Despite some reservations, I’d still recommend the book for its vivid examples of so called choke point capitalism. The book makes a useful and stimulating contribution to the important debate over the regulation of big tech. So I’ve included a link to the Amazon page for the book in the show notes, so please consider buying a copy. Thank you. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to firstname.lastname@example.org And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.
Professor Jon Erickson is an ecological economist and advisor to policymakers including Senator Bernie Sanders. In his new book The Progress Illusion, he criticizes what he calls “the fairytale of economics” and argues we are failing “to design an economy that is socially just and ecologically balanced.” Show host Gene Tunny discusses Prof. Erickson’s new book with him in this episode of Economics Explored.
Jon D. Erickson is the Blittersdorf Professor of Sustainability Science and Policy at the University of Vermont, faculty member of the Rubenstein School of Environment and Natural Resources, and Fellow of the Gund Institute for Environment. His previous co-authored and edited books include Sustainable Wellbeing Futures, The Great Experiment in Conservation, Ecological Economics of Sustainable Watershed Management, Frontiers in Ecological Economic Theory and Application, and Ecological Economics: a Workbook for Problem-Based Learning. He is also Adjunct Professor at the University of Iceland, and has been a Fulbright Scholar in Tanzania, Assistant Professor of Economics at Rensselaer Polytechnic Institute, and visiting professor in the Dominican Republic, Norway, Germany, and Slovakia. Outside of the university, he is an Emmy-award winning producer and director of documentary films, co-founder and board member of numerous non-profit organizations, past-President of the US Society for Ecological Economics, and advisor to state and national policymakers. Jon lives in Ferrisburgh, Vermont with his wife Pat, their occasionally visiting sons Louis and Jon, and a menagerie of dogs, cats, horses, chickens, and donkeys.
Links relevant to the conversation
You can buy The Progress Illusion and if you listen to the episode Jon will reveal a discount code:
Transcript: The Progress Illusion w/ Jon Erickson – EP166
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.
Gene Tunny 00:00
Coming up on Economics Explored.
Jon Erickson 00:03
Since at least the night, late 1970s. For a country like the United States, we’ve been in a progress recession, the GDP has grown, grown, grown, grown. But these alternative metrics, whether it be GPI, or surveys on quality of life, or the ecological footprint, these things have not improved. They have not kept up with the pace of growth, right.
Gene Tunny 00:25
Welcome to the Economics Explored podcast a frank and fearless exploration of important economic issues. I’m your host Gene Tunny broadcasting from Brisbane, Australia. This is episode 166 on the progress illusion, a new book from Jon Erickson, Professor of sustainability science and policy at the University of Vermont. Professor Erickson is past president of the US society for Ecological Economics. And he’s an adviser to state and national policymakers, including Senator Bernie Sanders. Please check out the shownotes for relevant links and information and for details where you can get in touch with any questions or comments. Let me know what you think about what either Jon or I have to say in this episode. I’d love to hear from you. Right oh, now for my conversation with Professor Jon Erickson on his new book The Progress illusion. Thanks to my audio engineer Josh Crotts assistance in producing this episode. I hope you enjoy it. Professor Jon Erickson, welcome to the programme.
Gene Tunny 01:00
Thank you so much.
Jon Erickson 01:03
It’s a pleasure, Jon to have you on. I’ve read your new book, progress, the progress illusion, reclaiming our future from the fairy tale of economics. So given this as an economics podcast, there’s definitely a lot to talk about with your new book. Yes, yes. So can I ask you first? Why do you think progress is an illusion? What are you trying to communicate in this book, please?
Jon Erickson 01:56
Sure. Sure. Yeah. So the progress illusion is really a reference to a fairy tale of humanity’s place and purpose in the world. Certainly, economics isn’t the only discipline that is subject to the solution, but it’s the one that I’m trained in. It’s a story that economists like myself have been teaching and practising for decades, decades that, you know, every time we see the size of the global economy double, which doubles every 25-30 years at current growth rates, that we erode the very foundations of life and human societies in the process. So, in this book, I questioned that, that reigning logic, that reigning story, I unpacked various dimensions of this grand illusion of economics, you know, which I see as an illusion of history and a lot of economics programmes, mine included, we don’t teach the history of economic thought we don’t discuss the debates of, of economists of the past. It’s an illusion of the individual, me, so much of the focus of economics is on the individual and what’s best for the individual in the assumption that whatever’s best for the individual is best for society. So I unpack that and think about the debates over that question. It’s an illusion of choice. I mean, economics sort of sets itself up as the science of choice. But it’s always framed this choice at the margin, right, the choice of the next incremental decision. Yet, when you add up all those decisions together, we very often get into situations that the original decision makers never would have voted for. Right. And ultimately, it’s an illusion of growth and illusion of, you know, a sort of fairy tale or dream of infinite economic growth on a finite planet.
Gene Tunny 03:52
Gotcha. I think it’s interesting. You mentioned that there were these debates, and they’re not always well covered in economics. I remember. I remember learning at least about Malthus, and there was the Malthusian prediction or his his view that, well, we’re in trouble because any economic growth we had, we just ended up having more children, and we’d be back to subsistence. Whereas I think the way that economists started to view that was all well, we solved that problem with technological progress. And, but I mean, look, I understand the point that that’s in a few 100 years or over the last couple 100 years say we’ll be able to do that. Who knows if that can continue indefinitely? I mean, who knows what shocks are coming? So, I mean, maybe, is that what you’re arguing? We could be we could be too optimistic based on recent history.
Jon Erickson 04:48
Well, look, I mean, we’re recording this in the second week of November during that latest Conference of Parties for the UN Framework Convention on Climate Change. And there’s ample evidence to show that this economic system we’ve created is putting dangerous strains on the global climate system, right? A climate system that is, is increasingly called as chaos as in danger of, you know, collapsing the whole experiment of the economy. So, you know, we can go back to Malthus if you’d like. But we’ve always seen that a growing economy creates benefits, and costs. And what we’ve seen, particularly over the last three or four decades is as those benefits have become super, super concentrated. And the costs have been spread out on more and more people, and especially on future generations. So we’re in kind of, you know, yet again, a kind of Malthusian tragedy.
Gene Tunny 05:51
Right. And so is that your biggest concern at the moment, climate change, or other other concerns,
Jon Erickson 05:58
tThere are plenty of concerns to go around. But having a habitable planet is a big one. It’s a big one that fellow economists are concerned about. You know, economists have been part of various signatures, signatories to various pledges of action. It’s a concern that’s related to mass extinction. It’s a concern that’s related to growing inequality and persistent poverty and declining quality of life, even in the richest countries. You know, I think it was, I think it was Alcoholics Anonymous, right, that said, you know, when you do the same thing over and over again, expect something different. You know, that’s the kind of insanity. And that’s what this book is about.
Gene Tunny 06:39
Right? Now, you mentioned, well, you talk about the fairy tale of economics, you mentioned you were trained in economics, do you still consider yourself an economist?
Jon Erickson 06:50
I mean, I often describe myself as an ecological economist, because I’m really trying to understand interdependencies between the economic system, and society and culture and the social system and the environment. I see this work as reforming economics for sure. I’d love someday, where we didn’t have to have all these kind of competing camps and different flavours of economics, we could just call it economics. But since I really don’t identify with the mainstream of economics, I tend to call myself an ecological economist.
Gene Tunny 07:22
Right? And you tell a story in the book about how just something like that was it the JEL, the Journal of Economic Literature codes, and you were stunned? Yeah, the way that Yeah, could you tell that story because of those fascinating, I’d never thought the JEL. Yeah, would be so controversial, or yeah, but please tell the story. I thought it was a good one.
Jon Erickson 07:47
I don’t know that they were controversial it just it just gave me pause. When I saw that ecological economics was given its own code, and treated as a sub discipline of a field that we were trying to overturn or be the alternative to. And this really is, you know, this, this is, you know, reflect on kind of why I wrote this book. You know, it’s a reflection on my career in Ecological Economics, when ecological economics was formalised in the late 80s and early 90s, before it got to JEL code, books and journals and organisations and degree programmes, and folks like me were supposed to be created to try to question the mainstream and reform it. So in many respects, this book is kind of my midlife crisis book, where I take a critical look at the history state and fate of this movement of ecological economics as an alternative to the mainstream. Funny story about 10 years ago, I was the president of the US society for Ecological Economics, and one of these professional societies that have emerged to support this field. And I was at our conference at Michigan State University, and I had thrown my back out. So I was like, during most of the meeting, I was horizontal in my hotel room, just miserable, just really grumpy. I was laying on my back, trying to write notes for my presidential address right, to the society’s membership. And I just was so grumpy, so grumpy, so grumpy. And it really got me thinking about the state and fate of ecological economics, and made me think about like this code, Q 57. Right, the seven hundreds plus subject areas of economics, and how ecological economics was increasingly being absorbed by the mainstream, including by folks who call themselves ecological economists. In fact, at that meeting, there were just, you know, all of these sessions on monetary valuation of ecosystem services, which I saw as, you know, a real slippery slope, you know, can we sort of challenge the mainstream with the logic of the mainstream and commodify nature. So, in a lot of ways that kind of grumpy week in Michigan, set the stage for this book, and, and my desire to really critique my own field.
Gene Tunny 10:16
Right. Okay. So I probably should provide some background on so these JEL codes, they’re the codes that you would put at the bottom of an abstract for a journal paper or a conference paper to signal this is the field or that the field of economics are the sub discipline of economics that it’s in. And so that helps them identify where it should go in conferences, for example, which session. Now, it’s interesting you mentioned how environmental economists have come to start valuing nature or to quantify environment, environmental damage, or to value what a wetlands are worth or in I mean, as a, as an economist, I’ve done various exercises like that in the past. I just want to understand where you’re coming from, do you think that’s the wrong way to go about it, to think about the the economy or the environment to think about? Well, we’re doing this many dollar dollars of damage to the environment, and therefore we need to impose this, this cost this charge on people who are damaging it, and to make sure we have, you know, where I’m going, what we’re trying to get ya get some sort of, we’re getting some solution by having the right taxes and charges in place or Pigovian tax, for example, what do you what are your thoughts on that, Jon?
Jon Erickson 11:43
Yeah, that the field of environmental economics and and before that natural resources, economics, really preceded this field that I’m describing of ecological economics, really treating the economy as an ecosystem, and environmental economics has its roots in the late 1960s, early 70s. And, you know, reaching back to Pergo, in the 20s, and 30s. And fitting the environment inside the marketplace, right, using prices to correct the so called market failures of what were framed as environmental externalities. So that’s how I was trained at Cornell University, I was in an agricultural economics department, learning natural resource, environmental economics, and kind of, you know, buying into that logic of, of the environment is just a failure of the marketplace. Ecological Economics. So that’s valuable. And that’s pragmatic. And I’ve done my share of work that is trying to make the case the economic case for environmental protection. The challenges is when that tool when that approach, when the sort of expansion of cost benefit analysis to environmental concerns, when that rises to a worldview, right? When you commodify all of nature and when you reduce all social relations of humanity to market logic, we start to run into what economic historians or people in the 40s and 50s The Economist name is escaping me right now, the fellow who wrote The Great Transformation, Karl Polanyi. Yeah, the Karl Karl Polanyi warned of the merging market society, right. Whereas the rules and priorities of a market system that envelop the democratic system, that envelop our social and environmental values. So I’m okay using economics as a tool and treating economists as mechanics or janitors to sort of tune the market system. But when economists are sort of framed as overlords of the social environmental system, right, or conveyors of a master worldview, that’s where my hairs go up. And that’s, that’s largely what this book is about, and thinking about the progress solution of economics.
Gene Tunny 14:08
Right? Is the problem that we have this objective of maximising economic growth where we’re concerned about GDP, are you arguing? We’re not as concerned about these environmental measures? How do you what do you think we should be concerned about? Or how should we be making decisions as a society?
Jon Erickson 14:30
I’m making the case that 21st century economics should reflect 21st century problems and values. I think when the mainstream of economics or what we often call neoclassical economics was formed in the late 1800s, early 1900s. Maybe the focus was well placed on growing an economy of the efficiency of market system right, of taking power away from the church and state and putting it into the hands of the consumer. and producer. You know, it’s much like thinking about an ecosystem at the early stages of any ecosystem. It’s the pioneering species that are prioritise its growth and competition and resource exploitation, that is prioritised. But as the system matures, as the system grows into a fixed, fixed environment, the goal should change, right, the goal should move away from growth and towards maintenance, bitterness, towards durability, towards resilience, away from competition and towards cooperation right away from sort of thinking about the number one priority is to grow our way out of problems, to realising that growth itself creates problems that growth can’t fix. So Ecological Economics reflects a maturing of economic thinking, that reflects the challenges of the 21st century.
Gene Tunny 15:59
Right. Okay. So it seems you’re, you’re concerned about the problems that growth can’t fix. Okay. You don’t think regulations can help? I mean, because we’ve got cleaner air?
Jon Erickson 16:12
Not exactly. I mean, I think we need to move beyond just economic instruments to fix things using the market to fix market failures, right. But really trying to find that balancing act between market mechanisms and government regulation between improving and making government work better, instead of the opposite narrative of, you know, government is the problem, not the solution. No, in this book, I reflect on kind of my own upbringing in the United States, and my parents generation, you know, and growing up in the Kennedy years, where the narrative was, you know, you know, ask not what your, what you can, what your country can do for you ask what you can do for your country. And I grew up in the Reagan Thatcher generation, right. And the Reagan narrative was, you know, it’s all about the individual, it’s greed is good. Don’t ask what you can do, you know, do for your country, get government off our backs, you know, that’s what we need to do. So, I think in an age of climate chaos, in an age of the sixth mass extinction, and an age of growing inequality, the narrative has to change, the story has to change, we have to recognise that a system and an economics that was created in the context of a 1940s 1950s expansion out of the Great Depression had its day. And now, the realities of our time, need to need to start to shape a new reality.
Gene Tunny 17:44
Okay. And so what does that? What does that mean, Jon? Does that mean, we need? Do we need redistribution policies? Is that what you’re arguing for to address inequality? We need greater environmental? Well, we need to prioritise the environment. I mean, that’s gonna be I mean, obviously, the environments important, I’m not denying that. I’m just thinking in in Australia here. I mean, it’s we’ve got very stringent environmental regulations already. And if we have more stringent environmental regulations, it’d be very difficult to develop anything. So I’m just wondering what it all means is it? Does it mean, we have to accept a lower standard of living in the future? are you pessimistic about technological change or ability to to innovate our way out of these constraints? Could you talk about that, please?
Jon Erickson 18:38
Yeah, I think that’s too narrow of a frame. When you think about economy environment, and what I’m concerned about, there is reams of evidence show that so called advanced economies, such as the United States and Australia, built on hyper individualism, built on the legacy of a social disease that sociologists call affluenza, right, or this addiction to consumerism, that this model of progress has leaves a little lot to be desired. And that in fact, maybe we’ve been in a progress recession for some time now. Scholars in the United States and Australia and dozens of other countries around the world have been estimating for years now. What’s called the genuine progress indicator, something that is meant to be compared to the more common gross domestic product. And what this indicator does is it recognises that a growing economy has benefits and has costs. In fact, I first discovered the GPI when I was in grad school in the early 1990s. And in the US, we were in in the the bush one recession. And there was a beautiful article written in the in the Atlantic and it had the title of something like if GDP is up. Why is America so down? Right? We were kind of in this recovery state. And people were, you know, economists are saying, hey, the economy’s growing, we’re all good again. And the average American, I’m not good, I can’t make ends meet. I’m miserable. And the same narrative has popped up at the tail end of every recession ever since ever since. In fact, it started working on this book at the tail end of the so called Great Recession. And the same thing was happening, we were using the instruments of economics using mainstream thinking to grow our way out of problems. And the average person was saying, who is benefiting? And who does who? Who’s paying the cost? Yeah. So the GPIO through this series of 26, some odd calculations and says, What are the true benefits of a growing economy? And what are the costs? What are the environmental costs? What are the social costs, and have shown quite convincingly that since at least the night, late 1970s, for a country like the United States, we’ve been in a progress recession, the GDP has grown, grown, grown grown. But these alternative metrics, whether it be GPI or surveys on quality of life, or the ecological footprint, these things have not improved, they have not kept up with the pace of growth, right. So we have to start asking at these kind of higher levels. What do we do with this for right? What’s, what’s the new balancing act in a maturing economy? How should we reprioritize what is the good life? And how should we I mean, you frame it as accept the lower standard of life, the standard of living the material standard of living, I frame it as as asking the question, how do we live better? How do we how do we live well, within our means?
Gene Tunny 21:47
Yeah, sure. I can, I can understand that. I guess what I’m thinking, Jon, is that at the moment, in Australia, one of the big issues is, well, the rising cost of living, high inflation relative to wages, and the lack of housing, I mean, we’ve got a dire shortage of housing here in Australia. Now. I mean, look, there are a variety of reasons for that, possibly. But I mean, at the moment, when I’m looking at things, I’m thinking a bit more economic activity to construct houses would have been good over the last 10 to 20 years. And, and we’ve got rising cost of energy. So yeah, I take your point, I think I think a lot of people out there would be concerned though, about this. Yeah, that they that, yeah, I’m not I’m not necessarily wanting to criticise what you’re saying, I understand where you’re coming from. I’m just yeah, that’s where I’m coming from, if that makes sense.
Jon Erickson 22:51
Yeah, that makes perfect sense. And that’s the big question, right? Like, can the same kind of thinking that got us into these current messes? That is making the billionaire class hugely, hugely more material well off, while the rest of us feel like we’re on a treadmill, just barely getting by? Can the same kind of system, right? That has privatised the benefit of growth and socialise, the costs? Can that continue? Or should it continue? Right? Should we sort of create a social movement and start to ask, what is the economy’s purpose? Who is the economy? And growth for whom and for what? Now, you know, when I debate economists, they always say, like, come on, come on, you know, you’re not being fair economics is just a model. It’s a model of progress. All models are wrong, some are useful, right? They quote George George Box. Right? All models are wrong, some are useful. And I said, Yeah, I, I agree, all models are wrong, some are useful. But what box didn’t ask is useful for? Right. So in the US, we’re seeing these energy prices, and we’re seeing record profits to oil companies. In the US, we’re seeing housing shortages, right? Yet we’re seeing record rents to the ownership class. In the US, we’re seeing families, you know, struggle to get by in these kinds of post pandemic months and year. And kind of returning to, you know, try and train as quickly as we can to get back to normal, right? Pre pandemic years. And a lot of us, and a lot of folks that are most vulnerable in this current system, are saying we don’t want to go back to normal normal was already in crisis.
Gene Tunny 24:47
Yeah, yeah. Okay, we’ll take a short break here for a word from our sponsor.
Female speaker 24:55
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Gene Tunny 25:24
Now back to the show. Okay, can I ask about that genuine progress indicator? Who’s producing it? And can I ask him about what, what some of the the variables that go into? It are? Please, you’re really interested in that? Because look, I understand the criticisms of GDP. And I mean, at least if we’re destroying, or we’re subtracting from the environment, or we’re, we’re damaging the environment that you probably should recognise that as some sort of disinvestment or a loss of capital stock. So yeah, would you be able to explain the genuine progress indicator, please?
Jon Erickson 26:04
Sure. I mean, it starts with the basic premise, right, that the economy is subsystem of the environment, and that when the economy grows, it has opportunity cost. So I mean, it’s a basic, it’s built on basic economic system has benefits and has opportunity costs. So with GPI, we start with consumption, the biggest part of GDP, and we say, Okay, let’s take consumption, and then let’s correct it for income inequality, to recognise which what Pergo recognised in the 1920s and 30s, right, that growing incomes grow and give diminishing returns, right, that the next unit of of income to a rich person creates far less welfare society than the next income, a next unit of income to a low income family or a low income person. So we correct for income inequality. We then go through a series of calculations that for example, take consumer durables and GDP and say, you know, a society a GDP benefits by building a throwaway society. With durables, washing machines, automobiles, long lasting expenditures, if they were out often have to be replaced. That’s great for GDP. Right. But is it good for progress? So we say, Okay, here’s the expenditure of durables, and here’s the benefits of durables, right? Over time, these things are supposed to last more than a year or two or three years. So there’s economic adjustments, there’s an adjustment for over for underemployment, right. Idle work, people who wish they could work more. So it’s got that kind of basic economic logic built into it. But then there’s a whole category of depletion and pollution costs, right? We shouldn’t be treating depletion of our soils, our water, our air, as income. In fact, any business that treated depreciation of capital assets as as income instead of costs wouldn’t be in business very long. But that’s exactly what we do in our economic book keeping for nation states. Then there’s a whole series of interesting calculations on the social side of thing, right, we have to recognise that the GDP only recognises the value of your time in a market, earning income, earning wages earning profits. And so what the GPI the genuine progress indicator says is that there’s, um, use trade offs, right? Every hour extra hour work, the opportunity cost of that is an hour, not with your family, an hour, not in your community. And now we’re not leisure. So rather than feeding every single hour at work as a benefit with no costs, GPI goes through and says, let’s be honest here, right? Work is good, up to a point, income is good, up to a point consumption is good, up to a point. But we have to recognise that consumption and income and growth have diminishing returns. And at some point, at some point, the growth of an economy creates more costs than benefits. What Herman Daly, one of the founders of ecological economics, who, unfortunately passed away a couple of weeks ago, called an economic growth, right, a growing economy that creates more cost and benefits. Okay, we could do a whole podcast just on GPI, so don’t get me going.
Gene Tunny 29:40
Yeah, that’s fine. I might. I’ll have another look at it. Because, I mean, it’s one thing that comes up in various conversations I have, and I’ve been looking at the national accounts recently, I’ve had people on talking about that and their conceptual foundations and we’ve, we’ve we’ve mentioned that every
Jon Erickson 29:58
time we have a recession Yeah, the critique of GDP comes up, right? Yeah. Like, hey, wait a second growth isn’t providing what’s going on here. And every time coming out of recession, we question the metric. And then we kind of start growing again and says, Okay, let’s go back to normal. Yeah. But we have to kind of keep revisiting these alternatives. You know, the original architect architects of GDP back in the 30s, and 40s. Were very careful to say this is not a measure of human progress, human welfare. This is a measure of economic activity, which contributes to human welfare, but is not in and of itself. human welfare.
Gene Tunny 30:40
Yeah. Yeah. I agree there. Now, what about what can be done? Do you have a set of policy recommendations? Jon, are there? What would What do you think needs to be done? Are there things that there will be things that need to be done by governments? Are there things that need to be done by individuals? I mean, it sounds like, Well, okay, maybe you tell me if I’m wrong here. But when I read your book, and I heard about the progress, I was reading about the progress illusion that concerns about how we were consuming too much, I mean, do we need to show that we as individuals be consuming less Is that is that part of your argument? We should we shouldn’t be going on as many overseas trips, we shouldn’t be using the car as often we should think about our purchasing decisions, not get a new washing machine or get a I only get one, when it breaks down, try to repair things. What are you arguing in this book? Is the solution?
Jon Erickson 31:40
Well, what would an economy look like? That was built on maintenance resilience and cooperation is that growth, efficiency and competition, right, a late stage maturing economy like yours in the Australian ours in the US? That’s, that’s what I’m asking, you know, an economy, a mature economy should have different goals than an economy at pioneering stages. So it really is about a reprioritization of our goals, especially on consumption, right? Because there’s ample evidence to show that we in the West are over consumers, and our kind of addiction to consumption is creating psychological problems, social problems, that consumption has been kind of become a cure for social ills, right? Like, it’s a distraction. I mean, the whole advertising industry is designed around the idea of kind of making you and I feel bad about ourselves, right. And to sort of fill the void with more consumption. And I actually think this is one of the lessons coming out of COVID. Right, as sort of people were, especially, you know, high income people who, who could weather the storm, better than most, were forced to slow down, were forced to pee at home, were forced to kind of reevaluate life’s priorities, and found out that, you know, this kind of ever, burning hamster wheel of economic growth isn’t all that it’s cut out to be. So it’s the reprioritization of goals, which is going to have to reprioritize policy instruments. Daily Herma, daily use the analogy of a plinth Plimsoll line, I’m not sure I’m pronouncing that right, of a cargo ship. Right. So this is the line that’s painted on a ship, very easy technology. And as the as the cargoes ship is loaded, it sinks into the water. And when it gets to the line, you’re supposed to stop, right, because you’re in, you’re in danger of overloading the ship. So if we sort of reprioritize and think about the principle line of an economy, we can’t just more equally or equitably distribute the cargo of an overloaded ship and expect it to be resilient. We can’t just more efficiently load an overloaded ship and expect it to weather the storm. As the pump, some land goes underwater, right. And there’s ample evidence to say that we are kind of in an overshoot on a lot of environmental parameters. You’re in danger of sinking the ship, especially in stormy waters. So this analogy implies that as we run up against planetary boundaries, planetary limits to growth, the scale of the economic system is way more important to stress than distribution or efficiency. And if we can’t count on a growing system to solve distribution problems, then we’re gonna have to quickly think about the fairness of this distribution of benefits and costs of that system. And then it only then can we get to efficiency, which is the priority of economics. So this means that you know, new policy instruments stuff that focused on scale distribution, then efficiency is the way to go. And I talk a lot about this in the last chapter book, as I kind of wrestled with the idea of how did I put it radical pragmatism? Right? Yeah, that’s a pragmatic things that we can do now, for example, to wean ourselves from fossil fuels, you know, home weatherization, and carbon taxation, and, you know, maintenance of our systems, electrification of transportation, transition to renewable energy. But all of these are really hard to do in an economy that continues to bloat an economy that continues to grow. So we have to be thinking about the scale of a system. And that’s probably the radical part of radical pragmatism, right? What’s it going to take to rein power away from the status quo, that part of the system that’s benefiting from this growth model, and create an economy that works for all?
Gene Tunny 36:05
Okay, so I’m just wondering what exactly that involves? And is this part of this whole idea of D growth? Is that what you’re arguing for? I’ve heard about this concept of D growth, that that’s coming up, and there was an article in the FT about it the other day. So you’re just wondering, what needs to be done? I mean, do how do we, how do we have that, though? How do we recognise those constraints? I mean, you mentioned carbon tax. I mean, that’s something that, but you’re also saying that that’s not going to be enough and mean, given current magic
Jon Erickson 36:41
bullet, but it changes that changes the system? Yeah. Yeah. I mean, degrowth is the sort of social movement side of ecological economics, if you will. It’s a question of, how do we orchestrate a just transition to a right sized economy. Now in some parts of the world, and for some people in the world, you know, growth still creates more benefits and costs. But there are plenty of parts of the world and plenty people in the world where growth, Grace, more cost and benefits, right. So we have to orchestrate a kind of Race to the middle. And in fact, if you plot something like the HDI, the Human Development Index, which is a UN level index, this used to sort of monitor, you know, the benefits of development. If you plot HDI at national levels against energy per capita, you get this curve, right that the initial development improves considerably, with just a little bit more energy use per capita a little bit more than final impact per capita, Right. but only to a point that we get into this kind of club of countries, where continuing use of energy continuing depletion of the environment, continuing materialisation of the economy, doesn’t improve development doesn’t improve the HDI. And you get this long tail with countries with the same HDI of countries that that consume 20 or 30, or 40, or even some cases 80% less energy and material. So countries like mine, the US were way out on this tail, where we’re not getting improvements in human development. Yet, we’re consuming way, way, way more energy than the average human right. And way more energy in the countries that have similar levels of development, similar qualities of life. So what are we doing? Right? We’ve got to orchestrate a race to the middle and whether you call that d growth for the rich countries, and to be more agnostic about growth for everyone else, like grow, where it makes sense and shrink where it doesn’t. That’s the kind of century that we’re in. That’s the biophysical reality of the new economy.
Gene Tunny 38:57
So Jon, do you need a command economy to actually to orchestrate this transition to a right sized economy? I’m just trying to think about how this would happen. Because I mean, people, a lot of people out there, just, you know, they’re trying to live their lives and do the best they can. And a lot of people have to a lot of families, the couple have to work two jobs. They’re trying to make ends meet. I mean, they Yeah, they probably wouldn’t see themselves as as living a hugely materialistic lifestyle, but then compared with other parts of the world. Yeah, sure. It probably is. Yeah, I’m just wondering how we how we can do that. I mean, I’ll
Jon Erickson 39:37
yeah, yeah. My trainer has economists. I assume you’re trained economists. We were sort of taught these, these two different DS, roughly two different models, market economy and a command and control economy. And we were taught that this command and control thing is inefficient and unfair and results in a kind of an over regulated world and we need to the market economy is not perfect, but may Is it better than command and control? I’ve come to realise that that’s a load of BS. The market economy is also a command and control economy, right? Markets are designed by those and power markets are social constructs, especially the last three or four decades of neoliberalism has created a kind of free market experiment, right? That is concentrating the benefits and widely distributing the costs. So talk to the average guy or gal on the street and ask them, Is this economic system working for them? And if they say no, do you say, well, let’s double down on the logic of the system? Or do we try something different, right. So we’re finding that more cooperative forms of of economies are resulting in more shared benefits and shared costs. Were working with a group called the next systems project that has been sort of systematically cataloguing different political economics systems, local skills, community skills, United States that have dramatically different outcomes and dramatically different structures. It’s not just either or of command and control of free markets. It’s blending things in between, it’s the continuum in between, that is the secret sauce. So I don’t buy that we immediately just have to go to command and control. Although in crisis, what we learned from COVID is what happened is the world’s government goes goes to command and control, right? If climate is a crisis, if, if environmental depletion is a crisis, we might be using the very system of free market thinking, to push us into a state where the only option is going to be command and control. And I don’t want that you don’t want that. People don’t want that. We want our basic liberties and freedoms. But we want to do it in a way that creates an economy for all for children and for for future. I also kind of reject the the narrative of economic freedom, right? Because that’s awesome. That’s also painted as freedom to do things. And instead of freedom from tyranny, right, freedom from the impacts of, of the environmental costs of a growing system, freedom from the social inequalities, of a system that’s geared towards making the billionaire class even richer. Freedom from the costs of growing economies, what we should be thinking about, not freedom to do things to our neighbours, to our environment, and to future generations that ultimately are going to come back and bite us in the tail. Yeah, a buy in any of this.
Gene Tunny 42:58
Well, I’m interested in the new systems project. I’ll have to make system next systems project. I’ll have to look into that. I mean, do you have any examples of those communities you’re talking about?
Jon Erickson 43:10
Well, it’s examples of of. So you take the US and you think that we’re this kind of, you know, outside looking in and the narrative on the mainstream news channels is that, you know, we’re this free market, capitalistic system. It’s actually not true. So much of what makes the US economy work is cooperative ownership, collective ownership, state run, companies, state state run banking systems, state state runs systems of have that make the the economic system work. Take the banking sectors, trillions of dollars and coops where the depositors get votes on the matters of their banks. Take agriculture and education, and even energy and electric utilities. So much of those industries are run by cooperatives. In fact, electricity cooperatives deliver electricity, the United States, to a well over half of the geography of the high states, to rural communities, where the sort of economics doesn’t work for for industrial companies. There’s experiment after experiment, after experiment of different kinds of political economic institutions that have that we have lots of lessons to learn from. And this is what I meant in the beginning, when I talked about you know, economics, part of the Progress illusion is this kind of illusion of history right. To think that the current economic system, the neoliberal system, the free market, system, is is is the only one is has been perfected, right? Is the kind of logical inclusion of everything along the way, and that we don’t have to learn from our history. We don’t have to revisit the debates. We don’t have to consider the morality of our economic choices, or their biophysical consequences. And yeah, there’s a lot. I mean, I speaking mostly as a, you know, from the perspective of an American, maybe it’s different in Australia. But man, we have this sort of US centric view of the world, that everything we do is right. And every thing that we do is the best that ever was. And we don’t need to learn from our history. And we don’t have to need to learn from other other experiments around the world. And where I land is, that’s some pretty insular thinking,
Gene Tunny 45:45
huh? Yeah. Yeah. Okay. We’ll start wrapping up soon, Jon, this has been Yeah, really thought provoking. So it’s good to have you on the show. could ask you about neuro neuro economics. So you talk about that in the book. This is a new field, I’ve only learned about recently, what what’s that? What’s your interest in that field? And what’s it broadly trying to tell us? Or what’s it found?
Jon Erickson 46:11
Yeah, sure. Well, so this is where, you know, I’m kind of researching the book, like, what are some alternative ways to think about the human agent and our economic models? Because the economics, we’re taught a very, very, very narrow version of humanity, right, which is sometimes called like a subspecies of human homo economic is, yeah, isolated individual at a point in time, right, who
Gene Tunny 46:36
just wants more? The rational utility Maximizer? Yeah,
Jon Erickson 46:40
exactly. Exactly. And both within economics and outside of economics, you know, we’re learning that when we test our theories, with real data, and not just abstract mathematics, that this sort of foundations of this rational actor model, unravel. So what I do in the book is I explore what you might call borderline disciplines, right? Where economists have cooperated with other disciplines, especially other natural science disciplines. And so neuro neuro economics is one of those examples where economists have collaborated with neurosciences to ask questions of proximate cause. Right. So in science, we think of proximate cause and ultimate cause. And then the case of economic decision making proximate causes asking how we make decisions, whereas ultimate causes more a question of why do we make decisions that we do? Neuro economics is an example of a borderline disciplined, proximate cause where, literally economists are taking tests objects, with their neuroscience colleagues, asking people to solve economic puzzles, or make economic choices that are watching their brain light up, right, and trying to understand where and when do the kind of precepts of the rational actor model hold up? And where don’t they? So it’s one of these Borderlands this was, such as neural economics is an example. But also behavioural economics, experimental economics, where we’re trying to kind of understand the brain in the case of economics, the whole human case of behavioural economics, groups of humans in the case of experimental economics, groups of groups in the case of institutional economics. And then there are entirely evolutionary history as a species in the case of evolutionary economics. So these are all examples of, of the isolated discipline of economics, starting to cooperate with other fields, and building what I call in the book, borrowing from the biologist, EO Wilson, a more conciliate form of economics, where we find the jumping together of knowledge to really watch it watch the 21st century version of this field.
Gene Tunny 49:13
Right now. Okay. Well, yeah, oh, it’s something I want to have a closer look at, because I definitely recognise the limitations of that. That standard economic model. I mean, for years, economists were saying, Well, it’s, we recognise that all the assumptions are a bit unbelievable. But as long as it makes good predictions, and it’s, then it’s fine, but it turns out, it may not actually make good predictions. So,
Jon Erickson 49:39
I mean, I gotta go through the history of you know, the running joke, of course, right is that economists have successfully predicted seven of the last three recessions. So it’s, this this model of the rational actor model turns out to be not a very predictive model, or a model. Again, all models are wrong, some are useful. But we should start asking useful for whom? And it turns out this this isolated model is useful for the billionaire class but not useful for the rest of us.
Gene Tunny 50:10
Right I so we might start wrapping up, I’m keen to just learn about, what are you hoping this book we’ll achieve? Jon, what’s your What are your hopes for this, this book,
Jon Erickson 50:22
my generation, I’m 50 birthday this month, I’m 52 going on 53 My generation was inspired by the works of a number of like, you might call a renegade economist, right? Who sort of solid different path. Folks like Herman Daly, who I mentioned to, we just recently lost that 84 years old. I mean, Herman was on a similar journey that I was he started out with aspirations to be a growth economist, he thought that the logic and approach of market fundamentalism could be sort of bred when he was training to be an economist in the 50s and 60s, to solve problems, particularly problems of poverty, right to grow the economy, lift people out of poverty, but in his own educational journey, set against the aspirations of the Great Society in the US in 1960s, the civil rights and environmental movements of the 60s and 70s You know, he was inspired by inspired, inspired by the work of earlier group of renegades folks like Nicholas Dzerzhinsky regime who wrote on energy and the economic problem, bringing the principles of physics into economics, Kenneth Boulding, who wrote the infamous article, the economics for the coming Spaceship Earth that was really coming to terms with the opportunity costs of a growing economy inside of a fixed ecosystem. John Kenneth Galbraith, who, whose social critique in the affluent society really sort of, you know, early on question a society built around, creating more and more affluence into an affluent class. And, of course, the 1962 book by Rachel Carson’s Silent Spring, which was really impactful on Herman’s thinking, and design of an economic study of economy inside environment. So, you know, these sorts of scholars were also inspired by long standing debates about the function and purpose of the economy, you know, really going back to the classical era of economics, when economics was seen as as a branch of moral philosophy, right. Not not a pseudo science hiding behind abstract mathematics. So Herman’s work was another kind of link in the chain. His work on economics, the life sciences, first big published article, his work on steady state economics in 1977. Book, his work on for the common good that he wrote in 1989, with a theologian, John, John Cobb, you know, he was created another link in the chain that was trying to build a study of economics as if people and planet mattered. So I hope, you know, this book is yet another link in this chain of link that comes from my generation, that can continues to build a kind of more modest, more humble economics that can contribute to social well being and environmental, environmental protection, and not just simply,
Gene Tunny 53:39
okay, well, I’ll put a link in the show notes. So if you’re in the audience, and you’re interested in, in the in the progress, illusion, and look, it’s got a lot of, it’s got a lot of great information in it. Lots of lots of great analysis, and it’s very thought provoking. So I certainly enjoyed or I learned a lot reading it. I thought it was good. I liked how you went through the evolution of of economic thought and all the debates and even what I was struck by was, I didn’t realise that was Tinbergen, the famous Dutch economist. Yeah, he had a bit of a Nobel Prize winner. Yeah, he ended up he started to question the whole the the economic growth narrative in the was it the 80s or 90s? Are some of the you tell the story along those lines, I thought was interesting. Yeah. Yeah. So I think there’s a lot of good stuff in there. Okay, Jon, any final thoughts before we wrap up?
Jon Erickson 54:42
Look, I really appreciate this. Thanks so much for your podcast. I was listening to a bunch of your past thoughts in preparation for this and this is such a great show. Very valuable show. And yeah, folks are interested in this book. It’s, it’s been published by Ireland press which is One of the bigger nonprofit publishers of environmental books in the US and give your listeners the secret code. If they order a book from Island Press they get 20% off if they answer the enter the code illusion so but on my capitalism have there for a second
Gene Tunny 55:17
okay, is that all is that this capitalization matter is what did you just tell me that and I missed it sorry was
Jon Erickson 55:24
no I don’t know that it needs to be capitalised. But it’s the word illusion is the code for 20% off.
Gene Tunny 55:30
Okay, good one. Well, I guess people try it and if, yeah, hopefully it doesn’t matter whether you capitalise it or not, or try and capitalise that, that doesn’t work. Without caps. Okay. Very good. Okay. Jon Erickson. Thanks so much for your time. I really enjoyed the conversation and really appreciated your insights. So that’s been terrific. Thank you. Okay, that’s the end of this episode of economics explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to contact at economics explored.com And we’ll aim to address them in a future episode. Thanks for listening. Till next week, goodbye.
Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.
he governments of many countries have structural budget deficits, so even as their economies recover from the COVID-recession they are still running deficits. In many countries, the fundamental structure of the budget is bad. There is too much spending relative to revenue, even in normal or good times, not just in recession. In this episode we explore how economists can calculate structural budget balances. We look specifically at what the Australian Treasury does, given that a new Australian Budget came out last week.
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.
Gene Tunny 00:00
Coming up on Economics Explored.
So I think this is a really neat methodology that the treasurer is trying to break down the different influences on the budget to see what’s really going on. And what it reveals is that there’s this structural problem with the budget.
Welcome to the Economics Explored podcast, a frank and fearless exploration of important economic issues. I’m your host Gene Tunny broadcasting from Brisbane, Australia. This is episode 164 on structural budget balances, government budgets around the world was smashed by COVID-19. With countries recording huge deficits and big increases in debt. The governments of many countries have structural budget deficits. So even as their economies recover, they are still running deficits. In many countries, the fundamental structure of the budget is bad. There is too much spending relative to revenue, even in normal times, not just in recession. For example, the IMF estimates the United States will have a structural or cyclically adjusted government budget deficit of five to 7% of GDP over 2023 to 2027. In this episode, we explore how economists can calculate structural budget balances, we consider the different components of budgets, the structural, cyclical and temporary. We look specifically at what the Australian Treasury does, given that a new Australian budget came out last week. Joining me for the conversation is my Adept Economics colleague, Arturo Espinoza. Please check out the show notes relevant links and clarifications and for details where he can get in touch with any questions or comments. I’d love to hear from you. Righto, now for my conversation with Arturo on structural budget balances, thanks for my audio engineer Josh Crotts assistance in producing this episode. I hope you enjoy it. Arturo, good to be with you again.
Arturo Espinoza Bocangel 01:49
Hi Gene. My pleasure to be here.
Gene Tunny 01:51
Excellent. Arturo, so I thought today we could have a good chat about this concept of a structural budget balance. So we had our federal budget, the Australian government budget was released last week. So for 2023, the financial year. And this was because we have a new government. So there was an election in May. And there was a change of government, we now have a Labour government. So a more left wing government than the previous government, which was the Liberal National Government, the coalition government, and in Australia, a Liberal government is actually a conservative government. It’s all very confusing. Right, so we had a change of government and there was some improvement in the current year budget balance because of higher commodity prices, which flow through to, to earnings to and to tax revenue, that the federal government pulls in, particularly from the big mining companies. So there was an improvement in that underlying what they call the underlying cash balance. But this federal government is still running quite significant deficits. So it’s still running a deficit of some $37 billion, this financial year, the previous government did its budget back in May, I think they were projecting that up around must have been nearly 80 billion, I can’t remember exactly. But it was an improvement on that. But it’s still one and a half percent of GDP at $37 billion. And then over what they call the forward estimates, which is out to 25-26. We’ve still got deficits in the range of 40 to $50 billion, approximately, and, you know, up to 2% of GDP is in 24-25. So we’ve still got significant deficits. And the problem that we’re seeing in Australia, and this is similar to in other countries, too, is that governments are just spending much more than they’re bringing in in revenue. I mean, I guess that’s what a deficit is, right? I mean, that’s, but but there’s a problem that, that because of politics, because no one wants to pay taxes, politicians don’t want to put up taxes, and they want to deliver the goodies, they want to fund a high level of services for the population, and that helps them get elected. And so we’ve got this, this problem, this imbalance between what they’re spending and what they’re bringing in in taxes. And this is where I think this structural budget balance concept is of great use. And I just want to talk about that. So does that make sense Arturo, what we’re going to cover today?
Arturo Espinoza Bocangel 04:45
Yeah, that makes sense. It also is a very interesting topic related to government debts and this structural budget.
Gene Tunny 04:58
Yeah, yeah. So It’s always a concept that’s fascinated me. So I used to work in the Treasury in the budget policy area. And when I was there, we didn’t produce this structural budget balance estimate, and there was a big debate about whether Australia should have one and whether it’s feasible to develop one because as we’ll discover, you have to make all sorts of assumptions to generate it. It’s it, there’s a there’s a bit of, you know, there’s there, there’s a bit of number crunching that goes into it. And you have to make all sorts of assumptions regarding, well, what’s the normal state of affairs, because one way of thinking about this structural budget balance is that it’s what the budget would be if you took away the cyclical or cyclical factors. So if you if you’re able to abstract or control for the business cycle, so whether the economy is booming, or whether it’s slumping, then it gives you the budget balance that you would get in that situation, because one of the problems with the standard budget balance as a, as a measure of how the gut of the government is performing in a fiscal sense is that it is what economists call endogenous, it’s determined, partly, it’s determined or largely as determined by the state of the economy is determined within the system, it’s endogenous. It’s not something that the government can, can totally set, exogenously or it doesn’t have full control over it. Because your level of taxes depend on the state of the economy and commodity prices in Australia, if the iron ore prices is really high, or the coal price is high, then BHP, Rio Tinto, et cetera, the big mining companies, they’re only more profits and the federal government, it gets a share that it gets about 30% of their profits. So yeah, that can have a, you know, that can mean billions of dollars to the budget bottom line. And so that’s why we see the budget balance, it’s, it moves with the economic cycle, and so your government could be running a deficit. But that could be understandable, given the state of the economy. And so the underlying budget is okay, the structural part of the budget is okay, that’s not the case with Australia, but I’m just using that as an illustration. So it may be useful. Well, I think it is very useful to adjust for those cyclical factors. And that’s what the Australian Treasury has done in what I think is one of the most useful charts in the budget, which is in their statement on the fiscal outlook chart 320, the structural budget balance. And that really tells a story, it tells a story about how within the federal budget, because of this, this gap between what the government is spending money on and what we’re paying in taxes. So if government spending is at a level of around 26% of GDP. And revenue is under 24% of GDP. Or maybe it’s 25. And 23. It’s sort of that sort of order of magnitude, or it’s those are approximate figures, I’ll put the right figures in the show notes, we’ve got this gap. And this is a permanent gap. It’s a structural gap. And this is what this chart shows of two percentage points of, or 2% of GDP. And this is baked into the budget. And this is what this structural budget balance chart shows. So what they’ve, what they’ve done is the they’ve worked out that structural factors, leading to a deficit of about 2% of GDP, cyclical factors, so the state of the economy, the state of commodity prices, the fact that the iron ore price is super high, the fact that the economy has been booming. What that’s doing is pushing up, or that’s improving the budget balance by looks like 1.8 or 1.9%. If you look at the chart, and what that is telling me and what that is, this is for the current financial year 22-23. What it’s telling me is that, well, if we didn’t have that, that structural problem in the budget where we’re just spending more than we’re, we’re bringing in, and that’s the case and that would be the case in a normal year, in an average year. If we just control the economic cycle. If we didn’t have that structural problem. And if we looked at what the strength of the economy is commodity prices, and the government should be running a budget surplus of nearly 2% of GDP, and in actual fact, it’s running a budget, a budget deficit of what is it, one and a half percent of GDP. So there’s this big, there’s this big gap, which, in a way, represents the additional demand that the government is generating in the economy that isn’t warranted, given the economic circumstances. So the government budget is highly stimulatory to the economy and that is arguably a problem for Well, I think it is a problem, it’s contributing to the inflationary situation that we have in the Australian economy at the moment. And likewise, governments around the world that are running large budget deficits, such as the US government, such as the UK Government are contributing to the inflationary situations in in those countries, because if you looked at what the budget should be, given the state of the economy, it should be in a lot better state than than it is now than then those budgets are now and that’s what this cyclically adjusted budget balance or structural budget balances is approximating. Okay, one of the other fascinating things in that chart, I should note, the Treasurer is prepared on the structural budget balance for Australia, is that in 22-23, there’s still a sizable impact over 1% of GDP coming from temporary fiscal measures. So these are things that are related to COVID 19, to the pandemic response. So even though, I mean, look, I know that COVID COVID is still around, and apparently we’ve got another wave coming. I mean, the worst part of the pandemic is over, but still there is a, we do have these temporary fiscal measures occurring. And so what that means is, yeah, so that’s, that’s something that’s contributing to the, the deficit here in Australia. So what that chart is telling us is that, look, the structural budget, the structural problem in the budget is around two percentage points, or 2% of GDP. The cyclical, the benefit to the budget from the improvement in the economic cycle and higher commodity prices is, is just under 2% of GDP. So what that would suggest is that, that would mean we’d have a budget deficit of just a fraction of GDP, like maybe point one or point 2% of GDP. But then we’ve got these. Actually, it might be point three or point four, I’ll have to check the numbers that don’t put the exact numbers in the charts. I’m just trying to eyeball and I’m not wearing my glasses. But then we’ve got this temporary fiscal measures, which is, which is worsening the budget by over 1% of GDP. And how these all sort of add up is that we end up with a budget deficit in 22-23. Of what was it, one and a half percent. So I think this is a really neat methodology that the treasurer is trying to break down the different influences on the budget to see what’s really going on. And what it reveals is that there’s this structural problem with the budget. And, you know, this is something that all treasuries and finance ministers should do, in my opinion. There are some IMF estimates for other countries we’ll talk about later, the Australian Treasury seems to be doing a really good job at its estimates, and it’s discovered this structural problem, this big hole in the budget. Okay, so does that all make sense Arturo?
Arturo Espinoza Bocangel 14:01
Yeah, that makes sense. That was very clear. This is incredible how Australia is spending around this, because you, you mentioned around two or 3% is spending more than what they receive in terms of revenue. But let’s explore what are the main components of that structure, structural deficit?
Gene Tunny 14:33
Yes, well, a big component, or one of the major contributors to it in recent years, has been the National Disability Insurance Scheme. So it’s this expansion of the welfare state. Now I’m not making any judgement about whether that’s a good idea or not, because it’s very popular, and it’s well intentioned and there are clearly a lot of people out there in need. One of the challenges with it, though, is that it is growing at a very high rate. So it’s not the total structural deficit, because it’s at the moment, I think it’s around $30 billion. So it’s not just the NDIS. It’s other things. And then we have, we’ve had various tax cuts in the past, there’s a stage three tax cut that’s programmed in. So there’s going to be a tax cut in 2024-25, which aims to get rid of one of the tax brackets and to flatten the progressivity of the tax system. And that’s going to cost the budget revenue. So it’s a combination of spending new spending programmes and spending programmes that are costing more money than were expected. Also, we’ve got rising interest, a rising interest bill at the moment because of higher interest rates. And then people on the left of politics would argue, Well, look, the the problem is, we’re just not raising enough in taxation, if you’re going to spend this and that, look, that’s one legitimate perspective. If the government is going to spend this much on a permanent basis, if we are committed to an NDIS, National Disability Insurance Scheme, then we will have to have higher taxes to make the budget sustainable in the long term. I mean, personally, I’d prefer that we’d have lower taxes, we would, we would, we would get spending under control. But look, if we can’t get spending under control, then we may have to, we may have to put up with that. So because ultimately, we do need a sustainable budget, we’ve got to keep that debt to GDP ratio under control. At the moment, the projections are that for Australia, it’s not looking catastrophic yet, luckily, I mean, it’s on the current budget projections, it’s going to get up to around 48% of GDP. So it’s going to plateau around that, by the What is it 2030 to 2033. There’s another chart where they’re projecting that in how that’s going to perform. So this is the debt to GDP, which is one of the critical ratios that commentators, economists, ratings agencies, like S&P and Fitch and Moody’s, what they look at. And I mean, Australia’s lucky we started off with so what we started off with no debt to begin with, in 2008, we had, we had negative net debt, and we only had $50 billion of bonds on issue. So we’re in a good position to start with, so we’re at, we’re only gonna get up to about 50% of GDP at the moment compared with you look at the states, which is the US it’s over. We had a look the other day, didn’t we? I mean, it’s up 120 to 130% of GDP or something. Yeah. Okay. It’s very high if you look at projections for actual data and projections for the US. So we’re, we’re nowhere near that what’s happening is that the outlook is worsening. So if you look at that Treasury chart and the budget, compared with where we were back in May, or back in April, when the government released its last budget, that’s right before the election, and then the Treasury put out the pre election, fiscal, economic and fiscal outlook, the instead of the gross debt to GDP ratio, peaking around 24-25 and then falling as the economy grows, and the debt doesn’t, doesn’t grow as fast, which was what they were previously forecasting back in April. And they had the gross debt to GDP ratio going to 40%. Instead, it’s going to continue to grow over this decade, and then start to flatten out around 2032 to 33 at around 48%. And I mean, who knows that could get worse. I mean, this out. So much depends on what happens with interest rates and a big part of this change, why things are worse now than they were back in April is one, it’s because this NDIS is growing, the cost of that is growing faster than expected. And also because of the higher interest burden. I think that’s really shocked people and this is something I’ve been calling out for a while I’ve been identifying for a while that this as interest rates rise, that’s going to have a big impact on the budget, because we’ve got so much debt already not as much as other countries but still more than we’ve had in the past. So well in the last few decades, okay, so does that answer your question Arturo? You’re asking about where’s it come from? And yeah, where’s that structural deficit come from? And look, it’s a, it’s a variety of things. It’s just our willingness to bear the taxes. It’s either you can either look at it as our unwillingness to pay the taxes that we need to to fund the level of services. That’s one perspective. That’s the perspective of people like The Australia Institute, they would argue that all these things we’re spending money on. So from a left wing perspective, I’m not making any judgments at the moment about, I mean, I’ve got my own personal judgement, but I’ll just present both sides of the story, they would argue we’re not, we’re not raising revenue. And then the people on the other side, they would like the IPA or whoever the right, they would argue, well, we’re actually spending too much relative to what we’re paying in taxes, the level of taxation is fine or should be cut even further, let’s cut expenditure. And the government itself is very conscious it, it doesn’t want to raise taxes, right, because raising taxes is politically unpopular. No one wants to buy any more tax. So it looks like the government itself recognises that it will have to cut spending. I mean, maybe it’ll try and tweaks and tax policy settings or, or cuts in tax concessions. Jim Chalmers, the Treasurer here who he’s talking about taking a forensic approach to tax concessions. There was a story in the Australian today, so it looks like they’re gonna have a look at some of those tax concessions, so who knows they could look at tax concessions for superannuation, and they could look at our concessional taxation of capital gains, things like that. So we’ll have to wait and see what happens there. But look in the IRS is the one that they really need to look at because it’s just growing at a very high rate. So let me try to illustrate that with some figures. So last week’s federal budget so I’m quoting from a report in the Australian day today revealed the NDIS which will cost the federal and state governments $35.5 billion this financial year is on track to hit 52 billion by 2025 26, dwarfing the costs of both Medicare and aged care. So long term Treasury forecasts suggests the federal government’s contribution to the scheme will grow by almost 14% a year for the next decade, with total scheme costs approaching 100 billion by 2030 to 33. It became operational in 2013. It currently has 555,000 participants. Its annual financial sustainability reports suggest numbers will reach almost 860,000 by 2030. More young people with diagnoses of autism and psychosocial disorders are entering the scheme. Almost a third of current participants have an autism diagnosis. And four and 10 are age 14 and under. So this is an illustration of one of the challenges of public services. I think because there is a lot of need out there are a lot of people who are doing it tough or there’s a lot of need in the community. And as soon as the government gets involved, there are a lot of pressures on the government to expand the level of service to increase the level of service. This is a great challenge for the government. I remember when I was in workplace health and safety here in Queensland, it’s nearly 20 years ago now. I remember the policy discussions around the need to look after people who are catastrophically injured. This NDIS has come out of a need to at least look after people who fell through the cracks of the previous system. What happened years ago was if you were catastrophically injured say you had a diving accident. And it was recreational diving. You weren’t covered by any insurance. Okay, there’s, it’s it wasn’t a motor vehicle accident. It wasn’t a workplace accident. And there would be very high costs of care if you were made quadriplegic, for example, but there’s no insurance to cover you. And so there was this concern that there are these people who are missing out. And so there’s clearly some sort of there was a need definitely to do something to help those people out. And this whole NDIS from what I can tell grew out of that conversation that was occurring around the early 2000s because I remember being part of the conversation at the Queensland Government level and some of the policy development there and then it came out of this 2008, the 2020 summit that Kevin Rudd organised his ideas fest that they had in the talk fest that they had at Parliament House and, and they invited 1000 of the best and brightest from around Australia. And this was one of the ideas that was advanced at the summit. And, this was one of the ones that progressed and then the Gilad government introduced that I think in 2013. And look, it’s a really valid thing. There is certainly cases, people that needed assistance. The problem is where do you draw the line, and this is a problem that governments often have. And here, the line has become, the circle has expanded even more. And I mean, people or families with autism, and with developmental delay, certainly need assistance. And I’m on the board of a non-for-profit that advocates for families where a child has a developmental delay, so I fully understand the concerns. And the need. The issue is that there’s a big cost to the budget from having this expansive definition. And the government is currently I mean, we’ll have to wait and see what it what it does about it all. Okay, we’ll take a short break here for a word from our sponsor.
Female speaker 26:23
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Gene Tunny 26:52
Now back to the show. So any questions or any thoughts on that Arturo?
Arturo Espinoza Bocangel 27:01
No, at the moment..
Gene Tunny 27:02
Good. So yeah, that’s essentially where we’ve got this structural budget balance problem coming from Australia. And I thought it might be good just to go over quickly, what the different sources or the different ways that they adjust for the state of the economy. And what it comes down to is coming up with estimates of how the economy would have performed, what it would do in the absence of a business cycle. So you have to work out what a trend level of GDP is. So the if you think about macro economics, one way of thinking about how the economy evolves over time is a cycle and trend. There’s the economy. Over time, we know that the economy expands. So the economy today is much larger than it was 10 years ago, it’s much larger than it was 20 years ago, 30 years ago. So over time it grows, there’s trend growth, it’s on an upward trajectory. But it will cycle around that trend. So you can have periods where you’re well above that trend when the economy’s booming. And then you can have periods when you’re, you’re well below you’re in a recession, for example. And so what these structural budget balance estimates, what they do, is they will they based on an estimate of what that trend level of GDP would be. And so what they will do, what the Treasury will do, if they will look at, well, what’s the underlying population growing at? What’s productivity, on average growing at? And are there any trends in labour force participation that we need to take into account? And this is this supply side model, underpinning these trend GDP estimates? So these are what you would expect in the absence of a business cycle. And so that’s one of the core parts of it, they’re trying to control the business cycle. And then they also have to control commodity prices. So they’ll look at well, how much higher than we normally are commodity prices, the iron ore price or coal price, how much higher are they than we normally expect them to be? And let’s discount that, let’s, let’s, let’s assume that they’re not so high. And so the Treasury will have these parameters. They’ll have these sensitivities of different types of these revenue, items of income tax and company income tax, two different commodity prices they’ll have, and they’ll have an estimate of how sensitive the unemployment benefits that are paid are to the state of the economy to where GDP is relative to its trend. And I think that’s the one item that the Treasury adjusts. So it tweaks it adjust revenue on the revenue side and adjusts income tax and company tax. And I think capital gains tax, if I remember correctly on the expenditure side, it just adjusts unemployment benefits. We know that unemployment benefit payments are going to be higher if the economy’s in recession, lower if it’s, if it’s booming. And so there’s an adjustment that’s made there. And there’s a whole bunch of assumptions that go into these estimates. Does that all make sense Arturo?
Arturo Espinoza Bocangel 30:39
Yes, it’s all clear.
Gene Tunny 30:42
Okay, so what I’ll do is I’ll put a link in the show notes to a paper estimating the structural budget balance of the Australian government that was by three of my old colleagues. So Tony McDonald, Yong Hong Yan, who I don’t know, Blake Ford and David Stephan, I worked with Tony, Blake and David. So all good people. So that’s a great paper. I’ll link to that in the show notes. And I’ve noticed that the IMF also produces some estimates of these structural budget balances, although they call them, they use the other, the other name for them cyclically adjusted balance, and you can find these at the back of what’s called the IMF fiscal monitor. And I’m looking at the one from October 2022. So check that out. There’s a whole range of interesting estimates there. So if for example, you look at table A3 for advanced economies, general governments cyclically adjusted balance 2013, to 27. So it’s got historical data, it’s got forecasts in it. For Australia, they’ve got their own estimates of what the structural budget deficit is, they’ve got estimates that go from around, or three and a half percent in 2022. So that’s a calendar year 3.1%, deficit and 2324 to 2.6%. And it gets down to about .7%, deficit in 2027. So not as bad as the Australian Treasury’s estimates, which are, which have the structural deficit maintaining around 2%. There are reasons why the IMF figures are different from the Australian Government’s because the IMF, the IMF doesn’t take into account as many factors. It’s on a calendar year basis, the Treasury and I think in one of its papers, it goes through why it’s estimates are different from say, the IMF or the OECD, I think for Australia, the Treasury are probably doing a better job at it just because the IMF and and the other agency, international agencies, they have to do it for all the countries and they’re not experts in any particular country. I think the Australian Treasury’s estimates are probably better for getting a sense of the structural problem in the budget, the Treasury has got access to, to much better info, much better data on Australia, then the IMF, it’s got much better insights, I should say, into what’s going on. And its model for the structural budget balance for Australia is much more precise. It goes into more detail than the IMF. So all I’m saying is I think the, I think the Australian Treasury numbers are better than what the IMF is, is estimating there. And I tend to agree that there is that structural budget balance of, of 2% of GDP, which is a challenge for this current government, and will probably be a challenge for future governments. And it’s going to require either large cuts in spending. So getting the NDIS under control, which is going to be hugely unpopular, because it’s a very popular programme and well intentioned. And I know people are benefiting from it. And you know, it’s, it’s, it’s giving people a sense of dignity and improving people’s quality of life. So look, who knows, I mean, this government, because it’s a government from the sort of left wing I mean, it’s not as left wing as some other governments you’d see around the world. It’s not left if you think about what left, left wing governments are in South America, for example. But it’s not. It’s going to find it difficult because it is more left wing than right wing. So the Liberal National Government is going to find it difficult to cut something like NDIS or cut welfare benefits, and hence maybe it does have to look at some tax measures. Maybe it does have to cut it tax concessions heavily. Maybe it does have to adjust that stage three tax cut that’s programmed in, maybe not give us much of much, maybe not have such a big tax cut. We’ll have to wait and see. Okay. Anything else Arturo, that we should cover before we wrap up?
Arturo Espinoza Bocangel 35:21
Yes, I think I wanted to highlight that it should be a good discussion was a good topic to see which of those programmes social programmes are working? Good in terms of indicators. So in terms of the results on population, you’re in to see if there is any problem there. But because we know that not all the things are all the social programmes are working well. Perhaps that will be a good topic to discuss, to discuss in other episodes.
Gene Tunny 36:04
Yeah, look, I think you’re right there. And what this is highlighting I think, Arturo is yes, the need to, to really delve into whether these programmes are working or not, because we’ve got these programmes that are well intentioned, that governments they hope to do some good to achieve outcomes, but how do we know that they are actually achieving outcomes? Are they doing it in the most cost effective way? And that’s why something like this evaluate a general concept could be so valuable. This is an idea that the first person I remember proposing it was Nicolas Gruen. And so Nick’s been on the show before, well known Australian economist, CEO of lateral economics, I do some work with Nick from time to time. And, you know, he’s been involved in public policy for decades, he was involved with the button car plan back in the 80s. He was involved with your work for the treasurer in the 90s, very lateral thinker, and he came up with this idea of the evaluator general, which would have a, it would have a brief of going across the Australian Government and figuring out which programmes work, which don’t, are there other ways we do things, other innovative ways we can do things to, to solve problems. And it looks like this government is going to go ahead with some sort of evaluator general. So Jim Chalmers has pledged to put in place an effective and rigorous evaluator general and new offers based within treasury and flagged by Labour before the 2019 election, which could work with other departments to access to assess the effectiveness of government programmes. Okay, great stuff. So this is in an article by Joe Kelly in the Australian, I’ll put a link in the show notes that I was quoting from there. I think one of the issues Nick has with that proposal, though, is that it’s located within the Treasury, I think he would prefer that it has its own life, it’s outside of the Treasury. It’s a statutory authority, it has some degree of independence granted by the parliament. So yeah, I don’t think Nick’s actually I can’t speak for him. I should have him on the show to talk about that. But I’m guessing he’s probably thinks that that’s not exactly what we need. But look, I should let him. Let him speak about that in the future. So that’s the evaluator general. So I think that’s the sort of thing you’re driving at is it Arturo? That we, because we need to evaluate these programmes. The evaluator General’s one way of doing that. Exactly. So one thing I thought I should cover before we wrap up, is just what happened with the UK earlier. When was it last month? Or remember, they had their mini budget, maybe it was in September now? They had the mini budget, Liz Truss the new PM, no longer PM, shortest reigning PM in British history. And the chancellor Kwasi kwarteng, I think it was, and they released that mini budget with a big tax cut, and the markets just absolutely went nuts. The pound crashed. We had yields on UK bonds spike, because everyone there and this is the recognition that there was a structural problem already with the UK budget, the UK couldn’t afford to have a tax cut, who was going to spend, go on spending what it was spending, and it’s just quite extraordinary the way that the Institute of Fiscal Studies describe that and I’ll put a link to this in the show notes, I think it’s a great note and some really good take on it. The way they describe that mini budget, which has been reversed because the current, there’s a recognition that it was unsustainable, so we’ve got a new PM now and a new chancellor, and they’re, and they’re, they’ve reversed that. I think Liz truss, had even reversed it. And she had sacked her Chancellor, but okay, so it’s gone. But for a short time it was in place and the markets absolutely freaked out. And yeah, this is the IFS take, which I think is great, which was made at the time the chancellor announced the biggest package of tax cuts in 50 years without even a semblance of an effort to make the public finance numbers add up. That is just brutal. Goes to show just how important it is to actually care about this stuff. And I mean, I’ve been saying this for years, I used to work in the Treasury in the budget area, and I know how important it is to get this stuff right and not to go and do silly things. And so I understand where IFS is coming from and understand why the markets really just hated that mini budget. And there’s a great, there’s a great chart and that IFS analysis, which showed that if you look at what was happening to the, to the national debt or the the UK public debt, if you compare that mini budget, what would have happened with the mini budget was what was expected before so instead of the debt as a percent of national income, staying in the range from 80 to 85%, of GDP going down gradually, over the next five years, from around 85 to 80. Instead, it was going to end up going from a bit under 85% to nearly 95%. So it’s just a really bad policy. So understandably, that mini budget was absolutely. Yeah, I mean, the markets just reacted very badly and essentially brought down the Prime Minister and the Chancellor, just because, yeah, it was just very irresponsible fiscal policy. And that’s what we’ve always got to guard against now. We’re not there yet in Australia because we started off in such a good position, debt to GDP is still relatively low compared with other countries. We’ve got a bit of room, still we’ve got time, we’ve got time to turn it around. But we’ve got to start doing something because we just can’t be in a situation where we keep accumulating debt. And we know, we know there’ll be another crisis of some kind, there’ll be a downturn, hopefully, we don’t have another pandemic, but there’s going to be another crisis, there’ll be a period when we end up adding lots of debt in a short period of time or a few years. And that will mean a higher interest burden, these projections of our debt to GDP, starting to flatten out around 2032 to 33 at 48% of GDP. Okay, that could give us some comfort, but we just don’t know what’s coming down the track. My worry is that interest rates could go higher. There could be another downturn or a crisis and then we add more debt on and then that gross debt to GDP, instead of flattening out it goes on an upward trajectory. That’s a risk I worry about and why it’s so important to get the budget under control. Okay. Final thoughts, Arturo?
Arturo Espinoza Bocangel 43:39
No, thank you for all your explanation Gene.
Gene Tunny 43:43
Very good. Well, it’s been great chatting with you, Arturo. And I’ll look forward to chatting again. And if you’re listening in the audience, if you want to look at any of these, these articles I’ve mentioned, I’ll put links in the show notes. Please get in touch with any questions or comments. Let me know whether you agree or disagree. Let me know if they’re things you want to know more about, and I’ll do my best to cover them in a future episode. So thanks for listening. And Arturo, thanks for joining me.
Arturo Espinoza Bocangel 44:14
Thank you for having me, Gene. Bye.
Gene Tunny 44:17
Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to email@example.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye
Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.
Slouching Towards Utopia is the new book from Brad DeLong, Professor of Economics at University of California, Berkeley. Professor DeLong joins show host Gene Tunny to discuss the long twentieth century from 1870 to 2010. The conversation considers the three factors which came together to massively raise living standards post-1870, and how nonetheless we’ve struggled to achieve the Utopia that once appeared possible. The “neoliberal turn” beginning in the 1970s and 1980s is considered, and DeLong explains why he writes that “Hayek and his followers were not only Dr. Jekyll–side geniuses but also Mr. Hyde–side idiots.”
You can buy Slouching Towards Utopia via this link and help support the show:
Brad DeLong is a professor of economics at U.C. Berkeley, a research associate of the National Bureau of Economic Research, a weblogger at the Washington Center for Equitable Growth, and a fellow of the Institute for New Economic Thinking. He received his B.A. and Ph.D. from Harvard University in 1982 and 1987. He joined UC Berkeley as an associate professor in 1993 and became a full professor in 1997.
Professor DeLong also served in the U.S. government as Deputy Assistant Secretary of the Treasury for Economic Policy from 1993 to 1995. He worked on the Clinton Administration’s 1993 budget, on the Uruguay Round of the General Agreement on Tariffs and Trade, on the North American Free Trade Agreement, on macroeconomic policy, and on the unsuccessful health care reform effort.
Before joining the Treasury Department, Professor DeLong was Danziger Associate Professor in the Department of Economics at Harvard University. He has also been a John M. Olin Fellow at the National Bureau of Economic Research, an Assistant Professor of Economics at Boston University, and a Lecturer in the Department of Economics at M.I.T.
Transcript: Slouching Towards Utopia w/ Brad DeLong – EP163
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.
Gene Tunny 00:00
Coming up on Economics Explored.
Brad DeLong 00:02
2008 you seemed to see the engine of technological progress itself drop into a lower gear slow down by half or more. Starting in 2012-2013, we see the rise of anti democratic movements all over the world.
Gene Tunny 00:23
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 based in Brisbane, Australia, and I’m a former Australian Treasury official. This is Episode 163, on Slouching Towards Utopia, the new book from the renowned US economist, Brad DeLong. He joins me this episode. Brad DeLong, is professor of economics at the University of California Berkeley. From 1993 to 95. He was deputy assistant secretary of the US Treasury for economic policy, and slashing towards utopia. Professor DeLonge explores why, despite the incredible increase in our productivity since 1870, we have failed to achieve a utopia. DeLong argues that what he calls the long 20th century began in 1870 mended by 2010, after which a productivity slowdown and stagnant wages have contributed to political discontent around the world. Please check out the show notes, relevant links and details of how you can get in touch with any comments or suggestions. I’d love to hear from you. If you’d like to buy Professor Long’s book, very grateful if you could do so via the Amazon page link in the show notes. By doing so you’ll help support the show. Right oh, now it’s my conversation with Professor Brad DeLong on Slouching Towards Utopia. Thanks to Nicholas Gruen for connecting us and to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Professor Brad DeLong thanks for appearing on the programme.
Brad DeLong 02:02
It’s wonderful for me to be here. Right. Might help me sell some books. Excellent. Something I’m very, very interested in right now.
Gene Tunny 02:09
Excellent. Yes, yes. I hope to help you do that. And hopefully if people in the audience if they enjoy the conversation, and I’m sure they will, I’ll put a link in the show notes for sure for to your book. So I’ve been I’ve been reading your book and enjoying it.
Brad DeLong 02:20
Thank you very much.
Gene Tunny 02:23
Yes, I’m the Kindle. Nicholas Gruen put me on to it. So Nick’s a big fan, too.
Brad DeLong 02:33
Yes. Yeah. So I’m very grateful to him for spreading the word.
Gene Tunny 02:37
Yes, yes. And it’s Slouching Towards Utopia in economic history of the 20th century. Brad, I’d like to kick off by asking, What motivated you to write the book? And what message are you trying to convey with the title, please?
Brad DeLong 02:53
Well, I suppose I started. I guess it really was reading Eric Hobsbawm’s, Age of Extremes, you know, back in 1994. And thinking that the story he was telling wasn’t the big story, that what he was telling was only a relatively small part of the big story. And that someone should write a book that told the other big story of history after 1870. And so I grossed about that for a couple of years. And in 1998, I thought, since no one else was writing it, maybe I should write the big story. And so I wrote a chapter to kind of put a stake in the ground and started showing it around, but you didn’t do anything else. And then maybe a decade, a decade and a half later, an editor from basic Tim Sullivan came around and said, You know, someone should write this, that someone should be you, you’re clearly not, why don’t we put you under contract. So I can call you once a year and yell at you about where the manuscript is. Um, and, you know, he did that. And to get into that once a year, that was a call and so forth. And then eventually, I just kind of buckled down and wrote the thing. Then, after writing the first draft, I had to take the chainsaw to it, because it was twice as big as the book that was published. And then after that, we had to polish it, and was out there in the world, you know, spiffy and polished and shrunken down considerably from the project I originally attempted. But it’s out there in the world. And I’m, I actually like it a lot, which I didn’t expect to at this point. At this point. I expected to be sick of it and thinking there was a lot wrong with it, then I find but I’m not thinking that way.
Gene Tunny 04:45
Okay. Yes. Well, that’s good. I mean, I think it’s, I think it’s terrific. And, I mean, it’s still a big book, it’s still 600 pages or so. So it’s still very, very meaty. I was impressed by all of the examples. In history, I didn’t know things that I found fascinating. So thank you. Yes. One thing I didn’t appreciate until I read your book. And maybe I’ve just missed this in other places, but the role of the Saudis in ending the Soviet Union, I didn’t appreciate how much when they increased oil output in the 80s. I think that’s the story, isn’t it? That meant the Russians or the Soviets weren’t earning as much income from their own production and that effect. Yeah. Yeah. I thought that was.
Brad DeLong 05:32
This was this was what the late Yegor Gaidar always insisted on, you know, that as long as the Soviet Union could trade oil for grain, the fact that the system was so sclerotic, they were unable to figure out a way to grow more grain at all was, you know, a problem, but not a crisis. But then the price of oil falls by two thirds and 1986, you know, as the Saudis react to with current, what’s currently going on in the Iran, Iraq War, and other things, and all of a sudden, the Soviet Union has to start borrowing if it wants to import its grain, and it starts borrowing from banks. And then the banks begin to say no. And then it goes and starts borrowing, starts asking for loan guarantees from Western governments. And then the demands come for well, we’ll guarantee these loans, but we want you to kind of be cooperative and open with respect to politics and democracy and things. And then the whole system simply collapses. It’s really quite an interesting story. Yegor Gaidar, Gaidar has a short speech he gave, I think, at the American Enterprise Institute called something like grain and oil. It’s very much worth reading,
Gene Tunny 06:50
RIght. Okay. Well, that’s good. I’ll see if I can track it down and put a link in the show notes. I mean, that’s one of many examples of, of good stories in the book, I look, I’d like to go back to what you mentioned about Eric Hobsbawm, who’s a Marxist historian, if I remember correctly, and you’re saying that you think he got the he missed the big story of what happened after 1870? Could you please explain what was he saying? And how is what you’re saying? What what do you think the big story is, please,
Brad DeLong 07:19
Eric’s big story is that you know once upon a time, there was Vladimir Lenin, there was the Bolshevik Revolution. And it created world communism, which was the world’s only hope for utopia. And in the end, world communism was betrayed by exterior enemies outside it, and by interior enemies inside of it, and it expired. But before it expired, I managed to defeat the worst tyranny in human history, the Nazis, because without the Soviet Union, the Nazis would probably still be ruling Europe. And when it expired, that brought the end of human hopes for a really good society. And, you know, from my perspective, this is a story. It’s kind of the story of the Soviet Union as tragic hero betrayed internally and externally is, you know, it’s a story that is, in some ways, simply total bonkers. Unless you’re a strong believer in world communism, as it was formed in the middle of the 20th century, you know, and Eric was right, Eric was, you know, a young Jewish teenager in Berlin in the early 1930s. You’re watching The Nazis marched past calling for the immediate death of himself and all of his family in a time when everyone else was pussyfooting with the Nazis. And you know, only the Soviet Union and the Soviet Communist Party, Soviet led German Communist Party was willing to say, these are horrible people, we need to fight them. And so he made that political commitment as a teenager and you know, was never really able to outgrow it. I’m told that even at the end of his life, if you got a couple of drinks into him, you could get him to say that, you know, Stalin had been too harshly judged by history. And a very smart guy, you know, very learned historian, desperately trying to get it right. Yeah. And the fact that someone like me thinks he could still get it so wrong is very much a cautionary tale about how I should not be proud. And be aware that other people are likely to judge me in the future the way I judge Eric.
Gene Tunny 09:30
Right. And so what do you think is the big story after 1870? So you’ve got to, you’ve got a more optimistic view of history, obviously.
Brad DeLong 09:39
Yeah. Yeah. Well, maybe that 1870 really is the hinge of history. Right. But, you know, before 1870, your technological progress is slow. And you know about infant mortality is extremely high. You’re going to see half your babies die before you’re five. And do something like 1/3 of women are going to wind up without surviving sons, should they be lucky enough to reach 50? themselves? And do you know when the pre 1870 high patriarchy world you reach 50 without a surviving son, you have no social power whatsoever, you know, you have absolutely no account, you have no one to advocate for you. And so before 1870, pretty much whenever there was an improvement in human technology, the response was, oh, great, now I can try to have more kids and raise the chances I’ll have surviving sons above two thirds. And so you’ll from minus 6000, BC, on up to 1870. There is a lot of improvement in technology. Yes, and the upper class lives better, yes. But for most people, you know, you simply have 100, and you simply have a farm size only 102 50th as large potentially at 1870, as your ancestors had back in minus 6000. And you know, you’re still living at something like $3 a day, you’re spending 60% of your income on just getting your 2000 calories plus essential nutrients. And there are a lot of days when you can’t think about much other than you’re very hungry. And that’s the state of the world before 1870. And that means that unless you’re in an extremely lucky place, or like Australia, or an extremely lucky class, that life is going to be kind of brutal, short, and without very many options, which means that in most times in most places, governance is going to be how does an elite figure out how to grab enough for itself and maintain its rule over society. And after 1870, everything changes, technological progress becomes rapid. The technological competence of the human race globally doubles every generation, you quickly get a world in which people are kind of rich enough that infant mortality falls substantially. And with that falling infant mortality, and with the erosion of patriarchy, all of a sudden, you don’t have to concentrate a lot of effort on having children, to be confident that if you reach the age of 50, you’ll still be able to run your own life. And so you’ll we get the demographic transition, now headed toward a stable world population of 9 billion. So for the first time after 1870, technology wins the race with human fertility. And we begin to look forward to a time when humanity will be able to bake a sufficiently large economic pie so that everyone can have enough. And you know, people back in 1870, and before, you know, they thought most of the problems of society came because incomes were low, and technology was underdeveloped. And you had this elite running a kind of domination and exploitation game on everyone. And once you can bake a sufficiently large economic pie for everyone to have enough, those things should fall away. And the problems of properly slicing and tasting the economic pie, right? Have equitably distributing it and then utilising it so that people can feel safe and secure and live lives in which they’re healthy and happy. Yep, those should be relatively straightforward to solve. And so we today at least we today in the rich countries should be living in a utopia, which we are manifestly not. And so the story of history after 1870 is how we’re well on the way to solving the problem of baking a sufficiently large economic pie. While the problems of slicing and tasting of distributing and utilising it continues to flummoxed us.
Gene Tunny 13:57
So with 1870, that’s several decades after what is traditionally thought of as the start of the Industrial Revolution, is it and in there are a few things that come together. Around that time, would you be able to explain that please?
Brad DeLong 14:13
Well, I’d say that the industrial revolution itself, you know, that steam power and metallurgy and early engineering, you know, they were really really weren’t quite enough that they get the average rate at which technology improves along the world up to about half a percent per year. And of that maybe, maybe a third comes from the fact that you’re concentrating on that you can cut that you’re suddenly concentrating all the manufacturing of the world in the districts, most of them in England where manufacturing is most efficient. And you know, 1/3 of it comes from the underlying engine of science and discovery and engineering. And 1/3 of it comes because we were lucky enough that the last round of glaciers, that they scraped all the rock off of the coal around a huge chunk of Northwest Europe, which left you with a lot of coal at sea level that you could just pick up off the ground and ship it out. But come 1870 you’ve concentrated all the manufacturing and you know, you’re pretty much mining out the really easy coal and you have to go deeper, which is more expensive. But the possibility was that, you know, the industrial revolution would be not completely but largely over, except that in 1870, we got the development of the industrial research labs to rationalise and routinized the discovery and development of new technologies. And then the modern corporation, the modern corporate form to rationalise scrutinise, the development and deployment of technologies plus full globalisation, which provides us enormous incentives to deploy and diffuse technologies. And so all of a sudden, instead of half a percent per year, you had a 2% per year rate of global technological change. And while it was possible for human humanity to be fertile enough to kind of offset the half a percent per year technology growth before 1870 with greater fertility and a population explosion, after 1870, even the population explosion could not keep us poor. Yeah. And then we go through the demographic transition and the population explosion reaches its end.
Gene Tunny 16:35
Yeah. So this is the industrial research lab. So you’re talking about Thomas Edison in Menlo Park.
Brad DeLong 16:41
Yeah, Menlo Park and others. You know, I like Nikola Tesla. Because, you know, Nikola Tesla was, I suppose today, we’d call him neurologically divergent. He’s definitely not neurotypical. Which means that unless you can slot him in exactly the right place, you know, where he has lots of people surrounding him who will tolerate him being in A-hole, and pickup which of the crazy ideas he has that might actually be useful unless you have George Westinghouse to build an industrial research lab, to surround him with and then the Westinghouse corporation to deploy his technologies. While Edison is General Electric, and others are frantically trying to keep up because, you know, Tesla knew how to make electrons get up and dance in the way that nobody else did. Without that Nikola Tesla would have been no use to humanity at all, as it was he personally pushed the entire electrical sector forward in time by a decade. And that’s a wonderful set of things. That’s a wonderful set of meta inventions. You know, that turns the process of technological development from being a difficult one in which you have an idea, but then you need to be a human resource department and a executive, a marketer and impresario, an advertiser you know, a well as an engineer, in order to get anything done to one in which engineers can engineer and find people who are good at the other things, to kind of surround them and do all the things you need to do to actually deploy a technology and make it useful. And that really only falls into place around 1870.
Gene Tunny 18:23
Right, okay, yep. And what about this modern corporation or the modern corporate form? So corporations have existed in some form since well, the first few centuries? I mean, the East India Company, the Dutch East Indies Indies Company, yes, yeah.
Brad DeLong 18:40
No, no, but still, they were relatively, they were relatively small things and they were tight have very special the fact that anyone could kind of organise a form in which us have a special royal charter as well. And the idea that anyone could set up a framework which would be a a large, internal, centrally planned division of labour, which could expand and copy itself, but also which had all of these interfaces with the market economy so that it was focused on producing the things that people wanted or at least that people with money wanted. This is something that allows once you have a good idea, and once you’ve built it in one factory, you know, it’s then very natural for the corporation to say, Okay, let’s build it over in the next town. And let’s expand the factory, let’s licence it, let’s move it to another country. You know, all of that only happens to all of what you know, management. The Business School professor Herbert Simon used to call these red islands of central planning, you know, in mesh to connected with the green lines of market exchange. Those are very characteristic of the modern economy. And we really need to have those islands in there and working very well, you know, in order to be even nearly as productive as we are.
Gene Tunny 20:09
Right, and what would be the exemplars of that modern corporate form Brad, are you thinking of General Electric or DuPont of those sort of companies
Brad DeLong 20:18
In the early days, in the early days, it was things like the great farm machinery producers. Were I think the first because, you know, once you figure out how to make a Reaper or a harvester, or later on a combine, you know, demand for it is absolutely huge. And so you don’t want to have one small workshop, you know, one small workshop in some small town in Illinois or something, you know, making a Reaper when the Reaper can be put into use from the Murray Darling River Valley all the way to Argentina and up there. Yeah. Later on, it was Ford Motor Company and General Motors that were the classics. And now of course, I think it is, you know, Apple Computer, which is simultaneously the most to market economy and capitalist driven thing in the world, but also the orchestrator of this enormously complicated, and centrally planned division of labour all over the world with all of its suppliers, in which a relatively small number of people in Cupertino, California, can conduct an economic division of labour, that dwarfs that of the centrally planned Soviet Union at its most prosperous, in terms of how much money and resources are moved around in a way in which in response to commands and to requests issued by Cupertino, to produce the more than a billion iPhones that currently populate the world.
Gene Tunny 22:01
Yeah, yeah, absolutely. It’s extraordinary for sure.
Brad DeLong 22:04
And, you know, we haven’t even gotten into its role as the pusher forward of electronics technology of modern semiconductor, whereby your Apple Computer pays the Taiwan Semiconductor Manufacturing Corporation $30 billion each year, which it then turns around and uses to invest in pushing semiconductor technology forward to make circuits smaller and chips faster and bigger, which it then sells to Apple, which then puts into iPhones so it can earn the $30 billion it needs for the next round.
Gene Tunny 22:40
Yeah, yeah, for sure. And I mean, Apple is still innovating even though Steve Jobs is no longer around.
Brad DeLong 22:47
Jobs is gone. Yeah, yes.
Gene Tunny 22:51
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Gene Tunny 23:25
Now back to the show. Can I ask you about full globalisation? You talk about that? And then you talk about what happened later in the 90s with what you call re globalisation, I think and then there’s hyperglobalisation. What I think what your book reminded me of was just those the large flows of people, and also capital that occurred in the late 19th century and before World War One, and that’s something I think Polanyi wrote about, could you talk about that please Brad?
Brad DeLong 23:54
Oh, well, one thing is to say that, that kind of from 1870 to 1914, 50 million people leave Europe and also 50 million people leave Asia. The people who leave Europe by and large go to you know, Argentina, Chile, southern Brazil, United States, Canada, Australia, New Zealand. They go there they bring European biotechnology crops and animals and so forth. In Australia, they find at least before the great drought of the 1890s that there is not a better place for European sheep than Australia. And so Australia before the drought of the 1890s becomes the place with by far the highest standard of living in the world. As you know the equivalent of the equivalent of OPEC instead of oil. It’s sheep. And instead of shipping petroleum and container ships, they ship out wool in steam powered ocean going ships and they produce the you know an amazingly rich and prosperous middle class civilization of its day, something that I don’t see know very much about. Except for the things I see are the backgrounds I see on Mrs. Fisher’s murder Mr. Rene Fisher’s Murder Mystery Show, which my wife says the clothes the clothes at does extremely well. And then Australia with its large middle class, you’ll powers the demand for Australian factories and Australia industrialising and becomes and remains an extremely rich and prosperous country. Brazil might have seen the been on the same trajectory. You know, Australia has land that’s wonderful for sheep. You know, Brazil in the second half of the 19th century was the best place for rubber. It was the place rubber came from. And so you know, you have the rubber tappers of Brazil making a good living, you have the growth of the Brazilian economy, you have the construction that European singers like Enrico Caruso or Jenny Lind, when they went on world tours, they would go up to Amazon to Manassas and performing them in Manassas Opera House and things worked very, very well, except that the British arrived and they grabbed some rubber plants from Brazil and they carried them back to Kew Gardens. And then the Belgians got a hold of them and they took them down to the Congo and then King Leopold began cutting off the hands of people who didn’t bring in enough rubber from the villages. And in Malaysia, the British Empire brought down workers from China combined it who were desperate to get out of China, given how small farm sizes were and how poor China was, combined it with British capital, and this Brazilian biotechnologies, so that Malaysia, Malaysia, the Malay Peninsula becomes the world’s biggest rubber producing centre in the world by 1914. And the enormous crash, and the enormous crash of the Brazilian rubber industry as well, because the rubber plant had left all its pests and parasites behind in Brazil. And so it grew like a weed on the Malay Peninsula. And, you know, the Chinese plantation workers brought down from the Pearl River Delta, were extremely happy that the British could pay them a quarter of what the Brazilian rubber tappers were used to getting. And they would still say we’re much better off than they would be back in China. That is, and this transfer of all kinds of tropical goods and plants around the world, right that Yemen finds itself suddenly faced with enormous competition from coffee grown in Indonesia, and in kind of Costa Rica as well. Which means that if you were in the tropics between 1870 and indeed, up until 1950, you’d find that whatever you export, its price was dropping like a stone because there was all of this extra competition from all of these extra sites for production opened up by this Asian migration. Well, the rich first world countries did quite well and did quite well in large part because immigrants from India and China were by and large kept out of Australia and the United States. And so wage levels in Australia and Australia and the United States stayed very high. And they got the middle classes in the middle class demand needed to provide the demand so that they could industrialise you know, while Brazil or Malaysia or Congo really didn’t have a chance to industrialise because, you know, no middle class large enough to buy the manufactured goods and no ability to export given how cheap and how good at manufacturing Britain was back then and how eager Britain was to export.
Gene Tunny 29:09
The story we tell ourselves is that it’s, it’s all about it was all about good governance as well. I mean, in good institutions.
Brad DeLong 29:17
Yeah, no bad governance can make something very country very poor very quickly. That and indeed, Arthur W. Economist, Arthur Lewis, you know, all those used to say, look, Australia and New Zealand are not just cousins of Canada and the United States, but also of Argentina and Chile, and in some ways South Africa. And, indeed, come 1914, Buenos Aires looks a lot like Melbourne. But then governance falls apart in the 1920s and 1930s. And even more so after World War Two. And now, you know, no one thinks of Argentina as being a country that is kind of on the same level of development of the Earth, Australia or Canada, because it simply is not. And yet, it certainly has the land, it certainly had the resources that had the education in 1914 it had the technology base, but bad governance can do terrible things. You know, you see this most with respect to communist, right that when the Iron Curtain failed in 1990, we could actually look, and we could see that those countries that had been ruled by the Communists were only 1/5, as rich as the countries immediately outside, immediately across the border. And you know, where that border was, was principally determined by where the Red Army had managed to march in 1945. Yeah, what’s the difference between Czechoslovakia and Austria? Yeah, yeah. Or Yugoslavia and Italy?
Gene Tunny 30:59
Yeah, very good point. I’d like to ask now about the what you call the is it the long 20th century? You talk about this period from 1870 to 2010? And is that the period where we were Slouching Towards Utopia?
Brad DeLong 31:15
Yeah, where every generation, we were doubling humanity’s technological competence. And it was really clear that we were solving the problem of baking a sufficiently large economic pie. And we were trying to figure out how to slice and tastes how to distribute and utilise it. And that was kind of flummoxed more sometimes than others. And people were trying various things. Some of them reasonable, and some of them absolutely horrible and genocidally destructive. Yeah, yeah. I’d say that’s what gives 1870 to 2010 its unit, you know, that we’re solving the what people thought was the big problem, but not at all solving what people thought were, but people back before 1870 had thought would be smaller problems.
Gene Tunny 32:03
Okay, and so 2010, that’s in the aftermath of the financial crisis. So that’s a pivotal event, in your view.
Brad DeLong 32:13
Except it’s not really a pivotal event, okay. It’s more like a pivotal 20 years. Maybe it starts on September 11 2001, when all of a sudden, a willingness to kill people because they worship God differently that we thought was over in 1648, at the end of the 30 Years War in Central Europe, after which people said, let’s not do that, again. We’re back. Maybe it continues in 2003, you know, when the United States stops acting like a relatively cooperative leader of the world, and instead says, We’re another great power, and we’re going to act like great powers do, maybe it’s 2007, when it becomes very clear that in the attack that an ideological attachment to the view that I’m rich, because the market has rewarded me, therefore the market must be a good thing. Had that that idea had hobbled the regulation of finance, and then come 2010 It’s clear, that same idea keeps people from responding to the Great Recession, by saying we need to get back to full employment rapidly instead, all over the globe, people are saying, well, you know, the market is a good thing. And the market has been doing this for a reason. And so you know, we shouldn’t artificially we shouldn’t artificially stimulate the economy. 2008, seemed to see the engine of technological progress itself to drop into a lower gear slow down by half or more. Starting in 2012-2013, we see the rise of anti democratic movements all over the world from you know, Modi’s version of national Hinduism to Viktor Orban and many, many others. And last, I’d say, come 2022, we have the return of major power war. Right, the idea that big wars rather than wars that are kind of a civil war component are a way to solve things. You know, even though if I wanted to convince the Ukrainians that they weren’t a separate nation, but only a Russian ethnicity, you know, I would send the Bolshoi Ballet and I would send orchestras to play the works of Tchaikovsky and I would send poets to read the poems of Pushkin in the general streets of Ukraine. I would not say send killer robots flying overboard to drop overhead to drop bombs and kill but you know the return of a major power war. Add to that global warming is now We’ll go not a distant threat. But lots of people were underwater in Pakistan early this summer and lots of people saying, Why is the Yangtze River five metres below where it’s supposed to be? It’s now a thing. And a thing for the three and a half billion people of Asia who live in the great river valleys and the monsoons and some with the coming of global warming. We have a different and more complicated and I don’t think we yet understand what the post 2010 story is. But it isn’t the technological progress is pulling ahead extraordinarily rapidly making us potentially all prosperous, and we only need to figure out how to distribute and utilise our wealth. Instead, the world faces other and probably bigger problems, and certainly more of them. So that’s why I bring it to an end in 2010.
Gene Tunny 35:56
Okay, okay. I’d like to ask you about what you call the I think it’s the neoliberal turn in your book. So you talk about how we changed or the philosophy the I don’t know, the dominant philosophy and government and politics change from social this, we’re talking about advanced economies change from social democratic, or whatever you want to call it to, starting in the 70s, and 80s, with Thatcher and Reagan. And we also had a variant of it here in Australia. You call it this neoliberal turn and would you be able to be good if you could explain what you mean by that? And also, I’d like to ask you about your this is great, one of my favourite quotes in your book, you wrote that Hyack. So Frederick Hayek, the Austrian economist Hayek, and his followers were not only Dr. Jekyll, side geniuses, but also Mr. Hyde side idiots, I love that. So if you could explain what you’re driving out there, please, that’d be great.
Brad DeLong 36:56
1945 to 1975 or so are absolutely wonderful years. peace, prosperity, the most rapid growth, at least in the Global North that has ever been seen before. Middle class society, everything seems to be going right. But come and after 1975, you know, there’s inflation, which leads to the general consensus that there’s something wrong with social democracy, that it’s handing out too many tickets to things more tickets to things than the economy and society can produce. And when you hand out more tickets, and there are seats, the result is going to be the tickets get the value that is also going to be inflation. And so social democracy needs to get a grip, and become, you know, more responsible and less willing to simply hand out tickets to anyone who asks, add to that the idea that it’s greatly over bureaucratized that the government is doing too much, and there are too many forms to fill out. Add to that, the idea that too many people have taken advantage of the social democratic system, you know, to grab benefits to which there were not in title. I remember in the late 1970s, as a young teenager, there were people who would come around with maps of where the people in Australia drawing unemployment benefits were. And the claim was that they were on the beaches. Yeah, you know, that you get unemployment benefit. And you say, Okay, I won’t look for another job for two months, I’ll go to the beach for two months, and then I’ll look for a job. That all kinds of things in which too many people were saying too many union members and welfare recipients were getting away with too much and not working hard enough. Yeah, that benefits for the slackers were too great than the taxes on the actual productive members of society were too high. And that the tax system was greatly discouraging investment. And thus, economic growth. And thus, the inflation and the slowdown of economic growth that we saw in the late 1970s. Were a result of the fact that social democracy had tapped out and it needed very much to be a rethink. And the rethink takes the form of Thatcher in the United Kingdom and Reagan in the United States. You know, the idea that taxes need to be lower, that the job creators need to be properly incentivized that, you know, the non rich need to be a little bit poor, so they’re a little bit hungrier and work harder. That sources of rent seeking, you know, people who have claims to income but who are not productive, need to have those claims erased , especially if they’re welfare recipients on the one hand, who haven’t been able to maintain a stable family, or if they happen to have lucked into a particular union that manages to have its kind of hands around the throat of some important part of the distribution system. You know, Ronald Reagan’s saying, I’m going to destroy the, Jimmy Carter in fact, Jimmy Carter was, in fact, launched the Airline deregulation effort in the 1970s. One big purpose of which was to make the lives of airline pilots a little less cushy. And Ronald Reagan followed that up by breaking the strike of the air traffic controllers. It was Jimmy Carter, who by deregulating trucking in the United States, you know, applied the same medicine to the then powerful teamsters union, saying, once deregulated trucking, you’re going to be exposed to all kinds of rail and non union competition as well, you know, in your ability to extract an extremely cushy life go. And the ability of the collected organised crime gangs of the United States to draw on the teamsters pension fund is going to be sufficiently reduced. So you have this great wheel around 1980. So much so that in 1994, Bill, Bill Clinton, who really is a Social Democrat at heart, wants to win another term, he feels he has to go out there and say that the era of big government is over. That just as Dwight Eisenhower, a very conservative person could only govern in the 1950s. By saying the New Deal, social democracy is a good thing, but I’m going to be a much better manager. Because I can say no to interest groups that are demanding too much while the Democrats are relying on those interest groups to turn out the vote. So you should elect me to be the president to run the new deal rather than let a Democrat. Yeah, so Bill Clinton was having to say that I’m going to be because I understand how valuable government can be, I’m actually the one who will do the best job of cutting it. So it’s so to do the most good. And that kind of lasted that kind of era in which neoliberal, this neoliberal view, that the market should be doing more, and the government should be doing less? You know, it really lasted up until the great recession since then, since then, we’ve had a time of confusion.
Gene Tunny 42:28
Yeah, yeah. Yeah, for sure. I’m just interested. I’m interested in your thoughts on the that neoliberal term? Because I mean, you’re someone you’ve got, you know, people who are very prominent in our time, and you worked with Larry Summers you’ve written and you’ve done research with, with Larry Summers, who was US Treasury secretary. I mean, how do you feel about all because Would you say there was some benefits to it? Because, I mean, Airline Deregulation, and I mean, that was good for consumers. How do you think about it now?
Brad DeLong 42:58
As they say, you know, in some ways Friedrich von Hayek really was Dr. Jekyll. Yeah, in that if you have a, you know, if you have a command and control system, you know, there’s somebody at the top, who’s issuing orders and everyone else is kind of not really using their mind that they’re kind of robots doing what the person at the top orders. And, you know, if you’ve ever worked in any large organisation, you know that the person at the top has very little idea of what’s actually going on down at the bottom. And will often be issuing commands about what you should do next that are best nonsensical, and that are worst highly destructive. You try to have a committee solve that problem of central command by establishing it by writing a rulebook. And then you have a bureaucracy because God knows the rulebook only covers about a third of the cases, it’s simply not possible for any small group to think about. But um, assign people private property and let them trade and exchange in a market. And all of a sudden, the people who are actually on the ground in the situation, you’ll have the ability to do things because the property is theirs. And also, as long as market prices are in accord with social values, they have a very strong personal incentive to do the right thing. Or at least the thing that makes money and then there’s the well, but our market price is in accord with social values problem, but if you can solve that problem, then a properly tuned market economy with private property is the best possible anti bureaucratic, you know, anti authoritarian crowdsourcing mechanism for helping people to organise themselves in order to do what is needed for the common good. Did you know much better to impose a carbon tax and say, you know, gas filling up your car was going to be expensive. Then too, as Jimmy Carter said to say, if your licence plate ends in an even digit, you can only fill your car with gas on even days and with an odd digit, you can only fill your gas on odd days. Friedrich von Hayek was a Dr. Jekyll positive genius and seeing this and seeing this very clearly. But as I say, he also was on Mr. Hyde style idiot. Because you’ll Hayek, having grasped on to this value of the market, he couldn’t think of anything else. And so he reached his position, which is the market economy will take modern science and technology and make us all prosperous, full stop, we need to be happy with that. We should not ask for anything else, we should not ask for an equitable income distribution or any form of social justice. Because if we do, we’ll find ourselves monkeying with the system. And when we monkey with the system, we will destroy the ability of the market to actually be productive and to make us rich. And ultimately, we’ll wind up on the road to serfdom. We won’t get social justice, and we will be at our we will make ourselves poor. And so the one thing we definitely need to do is whenever anyone starts talking about social justice, or income distribution or their rights to something that isn’t, that aren’t property rights, we need to tell them to shut up, you know that the only rights that matter are property rights, and that’s how it should be, you know, and yes, this is not social justice. You know, the market gives most things, not the people who deserved them, but instead of the people who are lucky enough to own the valuable pieces of property. But if you can’t accept that you don’t have any business doing politics or speaking in the public square. Yeah. And, you know, that’s profoundly unhealthy. That’s profoundly unhealthy in actually figuring out how we should utilise and distribute our wealth, but you know, Hayek stuck to that to the end. So much so that he was an enthusiastic supporter of Augusto Pinochet. Believing at some level that you know, Pinochet would reform Chile. And then once Marxism and Social Democracy had been stamped out, then you know, he could retire and the Chilean people could be allowed to go back to electing their governors again. But in the meantime, you definitely need it. You know, he called it the Lycurgan moment. And the myth of the semi mythical dictator, yeah, even though not a king of Sparta had established what people said was the Spartan system of government and war back in the Classical Age.
Gene Tunny 48:03
Yeah, I was shocked by that. Brad, when I read that in your book, I’ll have to go back and look at where Hayet wrote that because I mean, it’s quite shocking to think that someone who is a champion of liberty, and I mean, he’s inspired there’s a think tank in Australia, the Centre for Independent Studies, which I have a bit to do with which is inspired by Hyack. And so I mean, I’ve read Road to Serfdom, but I don’t remember anything like that, but I’ll definitely go back and look.
Brad DeLong 48:31
He gets cranky, he gets cranky or as he gets older. That, you know, in 1944, when writing the Road to Serfdom, he’s chiefly interested in trying to persuade a future British Labour Party government not to be really stupid with respect to nationalising everything in sight. But you know, he ages and as my father says when you get older, you discover that you are more like yourself and it’s not necessarily a good person. That back when you were younger and had to pretend not to be yourself and weren’t quite as much as yourself, maybe we’re better off right, Yeah. Yeah. There is a letter from Maggie Thatcher back to Hayet saying thanking him for one of his and indeed saying but you are recommending the use some Chilean and methods and do those are unacceptable given our constitutional traditions, and I haven’t been able to find out what this is in response to.
Gene Tunny 49:29
Brad DeLong 49:32
In the context of a world that is drifting towards Central planning and very heavy bureaucracy, it’s more understandable than as account. You know, Hayet’s, crankier parts are more understandable and useful as a counterweight than they are as you know, an accelerator, an accelerant for a kind of neoliberal era.
Gene Tunny 49:56
Yeah, I think you definitely make some I mean, a lot of what you’ve you’ve written I think is great. And I mean, I’ve been thinking about this myself, I think we’ve I feel it in Australia, we’ve probably managed things better than in the States. I mean, there’s definitely. And then the way I’ve thought about it is that some of the neoliberal policies we’ve enacted, I think, have been good for consumers, we cut tariffs, I mean, we used to have this very high tariff wall. So I think it was as late as 1988, or 89, we had a 57% tariff on motor vehicles. And so cars were, in real terms, much more expensive. So they benefited a lot. But there has been dislocation, but we seem to have manage that, because we’ve had a Social Security system and a public health care system. And I look at the states. And I mean, I mean, I think Americans, I think the US is a great country. But the lack of a public health care system, and the lack of a social security system, I think, is making things very difficult. And that’s meaning the politics becomes very, I mean, it’s just, it looks awful at the moment from over here. So yeah, that’s just a comment. But if you have any reflections, that’d be great.
Brad DeLong 51:09
Things are never as awful as they look on YouTube. Still, it’s still strong and rich, and you know the sense of a very, very strong sense of one nation, and we should all be pulling for each other. Which you won’t see if you go on YouTube or Twitter where it is indeed, the politics of you know, Ezra Klein says you get clicks only if you make enemies. And that’s really not how most people normally live their lives. But yeah, there’s a great book that’s getting some considerable play now by Elizabeth Berman called Thinking Like an Economist, you know, how efficiency replaced equality in the US public policy, which I think definitely could use a dose of the good Dr. Jekyll Hyatt, right. That says that demanding equality, demanding one size fits all rather than letting people crowdsource solutions on an individual level, is something that we should value greatly. And yet Elizabeth Popp Berman doesn’t value it at all.
Gene Tunny 52:21
Right. Okay. Okay. I’ll have to check that out. I might have to wrap up soon. But the final final question i’ve good is just referencing one of your quotes in your book where you talk about the power of some individuals, and you talk about the power of Keynes and FDR? Yeah. How do you think they would want to know it’s almost an impossible question, but how would they be diagnosing where we are today? And what needs to be done? Do you have any thoughts on that?
Brad DeLong 52:53
With respect to the Great Recession, Keynes would certainly say, I told you so. And with glory in it, because he was at some level of British upper class twit of the early 20th century. With respect to the rest, he would say that, by and large on my number with the predictions he made in a 1930 speech, he gave on economic possibilities for our grandchildren to have indeed come true. And that at least the global north is approaching the stage in which we do indeed have enough. And then our problems are that we’re kind of hag written by ideas and ideologies that were useful and essential in past poor age, you know, avarice, usery, and precaution. And that we’re also facing the prominent problem of the human race, which is how to take your wealth and resources and live life wisely and well. And he would say that he had hoped that we would have made more progress on learning how to live life wisely, and well than we have, and would have hoped that we were less hag written by you know, avarice, usury and precaution. By kind of not realising how wealthy we are. And you know, how broad open our possibilities should be, but being instead do to mean and ungenerous to ourselves and to others.
Gene Tunny 54:17
Yes, yeah. Okay. And what do you think? I mean, what would you have any thoughts on? I mean, what’s, what’s to be done, particularly in the US or in other? What other advanced economies? I mean, I mean, one of the challenges we’ve got here in Australia is how we pay for this National Disability Insurance Scheme. So we’ve got this permanent structural deficit in our budget now of about 2% of GDP. And the current government when it was in opposition committed to these what we call over here, these stage three tax cuts that are kicking in in a few years, where there’s, they’re more geared well, because the wealthier pay more tax just because of the way the system is set up. And the way these tax cuts work is that the bulk of the benefits go to the upper end. And there’s a big debate about whether it’s appropriate or not to have those tax cuts at the moment in Australia, but what are the levers? Is that you see, is it around? Is it taxation? Is that one of the levers for redistribution? Or is it regulation? What what do you see as the levers?
Brad DeLong 55:22
Well, you know, I think, I think the biggest and the best lever and in fact, the one in which the United States and Australia have historically been most successful, you know, is immigration, right. That over time, we have been very, very good at taking in people from elsewhere whose parents were not Americans, Australians, and making them into, you know, Americans and Australians. Like, I remember Maine Senator George Mitchell, you know, the guy who negotiated the Good Friday Accords in Ireland. And, you know, he looks like one of my great uncle’s, someone all of whose ancestors had been in Maine since 1750. And, you know, talked with an extremely strong accent, you know, um, and so actually, he’s simply a second generation immigrant, he’s half Irish, half Lebanese. He just looks and sounds exactly like my great uncles with their eight generations of, you know, hardscrabble time in the soil. But, um, we have enormously powerful and strong cultures, ideologies, and forms of Nash forms of national unity, that are actually not based on us all really being the descendants of our founders, and both countries willingness to take in large numbers of people from elsewhere. You know, Australia, taking in an enormous number of refugees after World War Two have been huge sources of national strength. And we are still largely empty countries, and you can move someone from Mexico to the United States, you know, from Malaysia to Australia. And you know, you are going to triple their productivity just by doing that alone. And that will generate a huge amount of potential wealth from a well we grow by immigration. Otherwise, the problem is that, you know, we had a steam power economy in 1870. And, you know, an electricity and diesel and chemical economy in 1900, and a mass production economy in 1940, and you know, a global value chain economy in 1990. And now we’re headed for info biotech economy and whatever worked in the sense of, you know, politics, economics and sociology, 30 years ago, back when the technological foundations of the economy are different, it’s probably not going to work well now. So anyone who says we need to go back to X is probably going to wind up unhappy. And so we should try to move forward into the future rather than trying to pick up models from the past. Although what those forward and the future models are, you know, that’s beyond me.
Gene Tunny 58:19
Okay. Okay. You’re telling the economic history story, the policy and then that’s, that’s for someone else.
Brad DeLong 58:28
But the big lesson of history is that trying to maintain social and economic systems past their sell by date as the technology changes underneath it just doesn’t work.
Gene Tunny 58:39
Right. Yeah. Yeah. Interesting point about immigration. We one of the one of the challenges in Australia we have is that, I mean, everyone wants to live in one of the big the three major capital cities. I mean, I’m in one of them, I’m in Brisbane, and Nick’s down in Melbourne, then Sydney is the, you know, the biggest, but the concern is that everyone wants to live in those cities. And there’s just not enough housing. I mean, we’ve got, I mean, I guess, it’s around. It’s in other advanced economies, too. But there’s a housing crisis and property prices have surged, although they are falling out, because the of the dynamics of the lending and what’s happened with the monetary policy, but they’re still very high rents are going up. So we’ve got concerns about housing availability. And in the short term, I think, if we’re bringing immigration back, I think that’s going to cause a lot of pressure. So we’ve got to manage that better and harder. No, there’s the environmental issues about allowing development. So I think, yeah, I agree with you about immigration providing benefits. So just see that in the short term. There are a lot of these absorption issues that we have to deal with.
Brad DeLong 59:48
A lot of people who think they have rights that things need to stay as they are. Yes, yes. And do you know to this, there’s a great Italian novel called I think Lampedusa, no written by Lampedusa, called Gattopardo, called The Leopard about Sicily in the 1860s, in which at one point, the young guy yells at his uncle, the count of Selena, you don’t understand in order for everything to stay the same. Everything has to change. Yeah, yeah. As the young guy goes off to join Garibaldi in the Italian revolution. And so I do think we need to look much more at the things that need to change. He says, sitting in a house built in 1897, we think, at a time, but it was surrounded by pear orchards. And now when it is half a mile or two thirds of a mile south of the university campus and two thirds of a mile north of the subway line. And so is a, that something so close to so many extremely desirable places, should house only three people right now. Rather than have been turned into a 10 storey apartment building is in some sense, an offence against land planning.
Gene Tunny 1:01:08
Yeah, well, I think we’ve got to find a better balance. I mean, who knows. That’s, that’s an issue for another episode, I think.
Brad DeLong 1:01:17
It is, you know, and we did actually build a cottage on our lot as soon as we were allowed to do so. But still. Yeah, so we did add to Berkeley’s housing stock. Yep. Still, you know,, the San Francisco Bay Area has seven and a half million people and looking back at the past 450 years of history, it’s easy to say how if we’d had a 1800s view toward development, we now have 20 million people, you know, we the size of Los Angeles in population. And it would probably be a better world I must say, because those other 12 and a half million people who aren’t here are in other places that are kind of less great to live in, and where they are likely to be less productive than they would be if they were here.
Gene Tunny 1:02:14
And just just finally, probably, you know, you’ve I don’t want to take too much of your time. But have one more question is, in your view, what are the most what’s the most important factor there is the governance, it always the agglomeration effects when they move countries because I know that Lant Pritchards crunched the numbers on this, and there’s this huge gain from moving people around the world. What’s the benefit? Where does it come from? Do you have thoughts on that?
Brad DeLong 1:02:38
A lot of it is agglomeration, thick market agglomeration effects that we don’t really understand that appear to be extremely large. And, but that also can very quickly turn into pollution and crowding effects if the local government is not competent at handling the process.
Gene Tunny 1:02:59
Yeah, I think that’s right. I think that makes sense.
Brad DeLong 1:03:03
And a lot more is that, you know, it is, throughout history, it’s always proven much, much easier to move people that where institutions are good, and where they can be productive than to somehow move institutions to where the people are, that attempts to build prosperity or build democracy in places where it does not seem to be strongly established, that those rarely go very well. And I would say, I do not really understand why that is the case. And I used to have a guru, a classmate of mine, who I went to about that, Alberto Alesina, to teach me. But alas, he dropped dead of a heart attack a few years. And I haven’t found another guru who I trust.
Gene Tunny 1:03:48
Okay, I might try and cover that in a future podcast episode. It’s a fascinating question. It just occurred to me then.
Brad DeLong 1:03:57
I love what Lant has to say about his numbers actually why his numbers are what they are.
Gene Tunny 1:04:05
Yes, yes. Yeah. I’ll put a link in the show notes to some of that work. Okay. Very good. Okay.
Gene Tunny 1:04:11
Well, I’m Professor Brad DeLong. It’s been a real pleasure. I’ve really enjoyed talking with you very much about your book and I’ll put a link in the show notes. And so if you’re listening in the audience, and please, I’d suggest getting a copy. Yeah. I’ve got it on Kindle. But I mean, it’ll be in bookstores and major bookstores in Australia I’m very sure. And yeah, Professor DeLong. Any final thoughts before we wrap up?
Brad DeLong 1:04:38
Just thank you very much. And I think be hopeful right that even though individually, each of us is just a jumped up East African plains ape who often forgets where he left his keys yesterday. Together, there are 8 billion of us and if we talk to each other together, we can be a very smart anthologie intelligence.
Gene Tunny 1:05:02
Absolutely. I think that’s a great note to end on. Professor Brad DeLong thanks so much. Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to firstname.lastname@example.org And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye
Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.
The National Accounts is the comprehensive data set on a country’s economic performance. It gives us GDP growth estimates and a whole bunch of other important indicators. Australian Bureau of Statistics Principal Advisor Robert Ewing takes us behind the scenes at the ABS and provides some great info and insights into how the GDP figures are prepared. Learn about the huge range of economic data from households, businesses, and governments that go into the National Accounts, the roles played by algorithms and judgment, and how the numbers are crunched using the time series database FAME, short for Forecasting Analysis and Modeling Environment.
Transcript: How the Australian Bureau of Statistics prepares the National Accounts w/ Robert Ewing – EP162
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.
Gene Tunny 00:01
Coming up on Economics Explored.
Robert Ewing 00:04
It’s the work of hundreds of people across the ABS once you count the people in the survey divisions, the data acquisition divisions, all the other publications such as the balance of payments, the capital expenditure, the business indicators publication, which all feed into the national accounts.
Gene Tunny 00:24
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 based in Brisbane, Australia, and I’m a former Australian Treasury official. This is episode 162 on how the national accounts are put together, my guest is Robert Yuen from the Australian Bureau of Statistics, the ABS. Rob is the principal adviser to the ABS statistical services group. In this episode, Rob takes us behind the scenes of the ABS and provide some great info and insights into how the GDP figures are prepared. While Rob and I chat about the Australian National Accounts, I hope this conversation is useful for you, wherever you’re living. statistical agencies around the world will be using similar data and procedures to the ABS as they prepare their own GDP figures. Please check out the show notes relevant links Information and for details of how you can get in touch. Please let me know what you think about either Rob or I have to say in this episode, I’d love to hear from you. Right now for my conversation with Rob Ewing on the national accounts. Thanks to my audio engineer, Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Robert Ewing from the Australian Bureau of Statistics, good to have you on the programme.
Robert Ewing 01:42
Very happy to be here Gene, always keen to spread the gospel of the great work that the ABS is doing statistics and trying to tell people the story of what’s going on in the economy.
Gene Tunny 01:53
Excellent. Well, I’ve been really impressed, Rob, that you’ve been communicating on LinkedIn, you’ve been talking about the data and giving us some insights into how the ABS compile the data. And I mean, one of the sets of data I’m really interested in is the national accounts and GDP, which is the statistic that measures the amount of economic activity in a certain period of time. And I’d be keen to chat with you about GDP given that you’re at the ABS and you’re involved in, in collecting the data and, and crunching the numbers to create the GDP figures. I chatted previously with a colleague of mine, Brendan Marquis Taylor, we chatted about the three different measures of GDP, would you be able to kick off by telling us what those measures are, please Rob, why do we need three different measures?.
Robert Ewing 02:48
Sure, so I should just say at the outset that, you know, today, I’m going to skip over an awful lot of the technical detail. And so I’m sure that the more statistical methodology knowledgeable are going to be screaming occasionally. But it is very complicated. The manual for the national accounts is several 100 pages long, and you know, can take a lot to get into. I think to start with, I tend to think of the GDP as it’s one concept that you can measure three ways. So GDP, as you say, is the measure of all economic activity. But we have to get a bit more specific than that. One of the things I’ve been talking about on LinkedIn is this idea of the production boundary, we have to put boundaries around GDP, because really, anything you could think of could be economic activity, we have to narrow that down a bit. And so we focus on market activity. And we focus within market activity on production. So GDP is a measure of the total value of production for the market sector in an economy over a period of time. It turns out that the way that the national accounts frameworks are set up, and it very clever frameworks developed over you know, more than 50 years by international groups. You could also measure this two other ways. So the first way is to measure how much income everybody in the economy has gotten from these productive activities. So if you measure the total amount of money that goes to labour, what’s called compensation of employees in the national accounts, and if you measure broadly, the national accounts concept of profit, what’s called gross operating surplus. And so if you add those two together across the entire economy, then you also get a measure of GDP. And that’s because if you think about production, well the measure of production is how much what you produce is worth minus how much you had to buy, in order to produce it, or the two things that are left over after that are income and profit. So it’s quite easy to see how those two match up. The third way, which is the expenditure method of GDP, is to think about it from the other side and think that will, we know, in economies and in markets, that there’s both a supply the production, but also a demand the consumption of the goods. And so the expenditure approach looks at where all this production of goods and services in the economy gets used. And so it adds together, the total amount of money spent by households, the total money spent by governments, some of the things that we produce gets sent overseas. And so we count the exports. Some things go into a warehouse, even though be produced, so we count inventories. And then we didn’t produce all the inputs that we use. So we subtract imports. And so that also gives you that same measure of how much was produced in the economy. And so those are the three measures of GDP, which are normally called the E measure, the I measure and the P measure in Australia. In theory, if you have measured everything absolutely perfectly, they will be equal.
Gene Tunny 05:58
Yeah, conceptually, from the way that they’ve that just because of the theory, and there’s a national accounting framework, isn’t there. So you were talking about this has been developed over 50 years? I mean, that’s since the you’re talking about since the UN codified it, I think, did they try and codify it in the late 60s? And then there’ll be various iterations of that approach? And we follow that there’s an international methodology.
Robert Ewing 06:27
Yeah, that’s right. So there’s the system of national accounts. So I think the first one was 1968. And that was building off kind of a lot of international cooperation. But I believe 1968 was the first time they really sit down like a consistent set of international rules. There was an update to it in 1993, and update in 2008. And if you do the math between those, you won’t be surprised to know that there’s an update currently underway thinking about further changes to the system of national accounts. And that will be due out for hopefully for endorsement by the UN statistical commission in 2025.
Gene Tunny 07:04
Yeah, yeah. And I remember from my time being on ABS reference committees for different things, or the technical reference groups, just all of the the issues you have to think about and R&D is a tricky one. I remember that, but we don’t need to go into into that today. I’m keen to understand what sort of data go into this Rob. I mean, you mentioned there’s production, there’s, there’s income, there’s expenditure. So is the ABS collecting data on all of these different transactions? You’re collecting data from businesses, you’re collecting it from households? What sort of data go into the mix, Rob for GDP?
Robert Ewing 07:46
Well, I think the short answer is anything that you can get your hands on. So a good national accountant is a bit of a data scavenger, because we’re only ever looking through kind of little windows into the economy. Kind of weird, we only have these narrow snapshots. So probably the two absolute most core measures of that production side, firstly, the annual economic activity survey. And so that’s a quite a large survey that we do once a year. And we go out to businesses, and we asked them quite a lot of questions about what they produce, how much money they made, you know, kind of how their money was spent, and so forth. And that allows us, in particular, to do what is quite a complicated little fiddly job, which is to try and convert things from the world of business accountancy, into national accountancy, because there are some things where there are some very, very important differences between the way that GDP is measured. And the way that business accounts are put together. The two most important are probably the concept of profit, which can be measured quite differently to that concept of gross operating surplus I talked about before, and also the concept of depreciation, and the differences between economic depreciation and accounting depreciation. But, you know, there are a lot of very complex nuances about that. And so a lot of the economic activity surveys asking the questions that allow us to take the business’s accounting estimates and convert them into economic estimates. So that’s absolutely kind of a foundational piece of us understanding that business side of the economy. So at a quarterly level, then its equivalent will be the quarterly business indicators survey. So that’s a somewhat smaller survey and asks a much smaller set of questions was kind of trying to give us a bit of an idea about what’s happening quarter to quarter, as well. And that’s kind of a very important survey there but the range of inputs is enormous. I’m household final consumption expenditure quarterly uses something like 15 or 20 different input data series, including retail trade, data from APRA, data from various private sector organisations who provide information, data from the quarterly business indicators surveys. So there’s a, an absolute broad range, because things like those big economic activity survey or the quarterly business indicators survey don’t necessarily cover everything. And so we bring the other bits of information to kind of tell us about, particularly the expenditure side of GDP, but also thinking about the role of government, where we have a lot of data that comes directly from federal, state, territory and local governments and tells us about their activities. We have detailed trade information, probably some of our most detailed data sets on the trade side, which allows us to get a pretty good idea of what’s going on with exports and imports. We rely very heavily on the consumer price index and the Producer Price Index publications, because they give us an idea of prices in the economy. And they allow us to convert those current price numbers into volume estimates of what’s going into GDP. So the real GDP as it’s often called.
Gene Tunny 11:17
Right, okay, yep. And that’s, that’s what’s often reported, that’s the that’s seen, that’s the data set that are the item that is looked at to determine whether the economy is going into recession or not. It’s that real GDP number, that volume number where you’re trying to abstract or control for inflation that occurs? Okay, so you’ve got less data for quarterly GDP than annual, it seems, is that right? So you’ve got detailed estimates, annually, you’ve got this other survey, quarterly, you’ve got, I mean, you still got a whole bunch of data. And what are you doing? You’ve got all of these models? You’ve got I mean, Is it done in spreadsheets? Are we able to go into that, or is it in R or or Python? And then is there some way of describing what goes on?
Robert Ewing 12:10
Well, so it is, fundamentally, it’s a very large code base, in our language and computer stuff, piece of software called Fame. And if anybody listens here, knows Fame and doesn’t currently work at the ABS, please immediately make a job application, we’ll fast track you, we need as many people who know this fairly obscure computer language as possible. And so we have here that’s 1000s and 1000s, of lines of code across all sorts of different modules. The basic approach is we’re trying to build things up from the absolute base level estimates. So we’re trying to look at the lowest level of the information that comes in and when we build the GDP up from that, so it’s very much a bottoms up approach to estimating it. The approach that we take is quite different in different areas. So in some cases, we get pretty good information, quarter by quarter on what is happening in the economy. So exports and imports, as I mentioned, is a pretty good case. We know, not perfectly but you know, we have almost census level data, we know almost every transaction that’s happening with imports and exports, there are some complexities around imports and exports of services where we don’t have as strong information. But we have a pretty good idea about what’s happening there. And so all we really need to do is just make some conceptual and timing adjustments and add everything up at the other end of the spectrum would be something like imputed rent. This is a really interesting kind of concept here in GDP. So one of the really important parts of the overall economy is the service we all get from the houses that we live in. Now some of us pay for that to the rent that we send to our landlord, kind of once every week or fortnight or month. But if you own your own home, we still want to count that value, because it’s still an economic service that’s being provided in a market like environment. And so for that we have what’s called imputed rent. So we impute how much rent is there. The data set that we have for that is primarily the Australian census. So every five years as part of the census, we go out and measure every household in Australia. And that also gives us an estimate of how many households they are there are and in what type of houses and in what locations. And so putting that into a model allows us to estimate imputed rent. But between censuses, we don’t have a solid survey or a data point. And so we have to model that. So it’s really a form of nowcasting. We’re using the information that we have about changes in the population, information about household formation and information about kind of your building construction. estimates of how much demolitions are happening to us forget how the number of households are changing and we obviously have information about rents from other series. And so at that end of the spectrum, it’s really a model, which is using a bit of data. But it’s not a massive amount of data compared to like its base, which is set every five years with the census. And that will be something the team will be turning its mind to very shortly having just had the second set of census results released.
Gene Tunny 15:21
Yes, yes. Great, great work. Everyone’s excited about that. So I saw your boss, David Gruen who’s well, it was, I mean, we both worked for him and within the various times in Treasury when we were there, and you’re working for him again, at ABS. He’s been getting a bit of media on that on people working from home, which is good to see. So all very good. Rob, can I ask you about this quarterly data? So you’ve got all of these bits of data going into it? And you’ve got these different modules? And there’s all this code? Which was a revelation. So I’ll have to do some research on that. I found that fascinating. What’s the quality of the quarterly data like? I mean, I know you revise it in the future, and there’s a statistical discrepancy, isn’t there? Could you tell us a bit about what the quality of that is like first, and then we might go into the annual data and what you’re doing there? How you’re trying to, yep. If you can tell us about that, please. That’d be great.
Robert Ewing 16:20
Yes, sure. So I think that’s so I think there’s two answers given to the quality of the quarterly data. So this is all in the context of we kind of spent a lot of time and a lot of resources and a lot of effort on making the quality, the highest it can be. But inevitably, a lot of the systems and the data in the economy is fundamentally on an annual, particularly financial year basis. So if you think about the financial accounts of the company, they will be producing kind of view monthly and quarterly financial information. But it’s only at the end of the year, that they really do that complete process of producing a full set of accounts, and making all of the adjustments and thinking about all of the different bits and pieces they need to take into account. And no matter how well you’ve gathered the quarterly data, the annual data is always going to be better. So you’re always going to have this view of the world that is a little bit sketchy. And yeah, and I think that if you look at the revisions, the revisions, they will move the numbers around, they very rarely change the story of what’s going on. So GDP might move up a little point one or point two, down to point one or point two, but very rarely does the story of what’s happening to the economy change very substantially. The other element to that is that even the quarterly estimates get a bit better with time. So we produce the estimates for GDP, roughly nine weeks after the end of the quarter. So our June quarter is published in the first week of September, on the first Wednesday in September. So that is a pretty good amount of time. But there’s still information that continues to come in, there will be businesses that we surveyed, who didn’t have time to respond, there will be data sources, for instance, ATO tax data, some of that won’t even arrive until after the national accounts has been published. So our picture of each quarter gets better with time as we gather more data, and you know, some late returns come in. And so that’s part of what contributes. But the big story is that really, GDP is fundamentally an annual measure that we can do on a finer time horizon using really a combination of different approaches. And for some things, such as household final consumption expenditure, there’s not a massive difference in the quality between the quarterly and the annual household final consumption expenditure has pretty much the same sets of information. But if you’re thinking about production, it’s quite different. And yeah, you mentioned statistical discrepancy. I think this is probably a good, a good way to talk about how we actually measure those three measures of GDP in practice, and how we actually make them equal to each other as they theoretically should be. So when we measure GDP every quarter, we can. It is very rare that the three measures come out exactly the same. Probably has happened once or twice. We were probably very suspicious when it did happen. As of now that can’t be right. There can’t be equal. We do two things in response there. Firstly, we use the differences between them as a way of looking at the different components and models and data sources and thinking about, are there gaps here? Are there adjustments that we should be making? There are other pieces of information that we should be seeking that would allow us to bring those measures closer together, but we’re not going to arbitrate them all together without some source of evidence for that. And so the three measures will be a little bit different from each other. So in order to get the measure of GDP that’s published on the front page of the webpage, what we do is we average the three of them. And so we have what’s called GDP A for average. And that is really just literally you add the three measures, and you divide by three. And you know, for those who are fans of the details, you’d notice, now we’re doing that in terms of the level of GDP, not the percentage change. Now, of course, it would be nice to get rid of that statistical discrepancy. And to do that, we need that information set that we have for the annual publication. And this brings us to, I suppose, what is the core of kind of producing like the benchmark GDP estimates, which is a process that’s called supply use balancing. And so I talked before about the idea that we can match production to income to expenditure at that top level. But in theory, we can also do that for every individual product that’s produced in the economy, that we should be able to say, for every products, let’s say, mushrooms, just picking on that one, because it’s very early in the list. We know, you know, in theory, we know we’ve produced you know, this many mushrooms. And you know, we know this many mushrooms got used by restaurants and other people and food manufacturers, this many mushrooms got sold to households, this many mushrooms got exported. And so in theory, we know well, those two numbers, the supply of the product and the use of the product have to be equal. We’ve defined as the way we’ve defined GDP, of course, the way that we’ve measured everything, through all these different surveys, we haven’t gotten a complete survey of every single person in the economy, we haven’t asked every single household what they consume. So we know there are some errors there and they don’t balance. And so every year, we go through this process of supply use balancing where we look at products, we don’t look at it at the level of every single kind of view, 375 mil Coke can, and 750 mil Coke can, and we have about 300 products that we look at so that we broad categories, like legal services, or metal, steel manufacturing products, or things like that. And we look for each of those products. We want to balance, how much was produced, how much got used by households, by government, how much got exported, how much went into inventories, and how much was used by other industries in their own production. And we make sure across all of those products, the supply and use is balanced. And once we’ve achieved that, then we have the three measures of GDP will be equal, because we’ve now brought those two halves of the measurement of the economy together. And so that’s, I suppose that’s the really, that’s the big work that kind of goes on, after a year is completed. So once we’ve finished the financial year, then the work starts on producing those supply use tables and doing that balancing. And when you’ve done that, the reason that’s important is I suppose it gives you that foundation that you can build on. So when policymakers are looking at GDP, they’re mainly going to be focused on what’s happening to GDP. Right now, they don’t care about what happened to GDP a year and a bit ago, which is about how long it takes us to produce those supply use tables. But through producing them, we make sure we’ve got an accurate representation of how much every different industry and sector and product matters. And so when we take that information, that’s you know, kind of you know, that lesser information set that we have quarterly to update the numbers and say, well, this is how much this bid has grown. We’ve given GDP the best base to sense, put everything together and give you the most accurate information out of the most recent quarter.
Gene Tunny 24:14
Okay, we’ll take a short break here for a word from our sponsor.
Female speaker 24:19
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Gene Tunny 24:48
Now back to the show. So this they supply use tables. That’s what you’d call an input-output table. Is that right Rob? This is an input-output table your developing, how these industries interact with each other, the flows of resources between them and then what goes to sales, what’s exported, etc?
Robert Ewing 25:09
It’s a very closely related cousin of an input-output table. So there are a couple of pretty technical differences between supply use tables and input-output tables. Importantly, in Australia, the input-output tables that we produce are a lot more detail. So I mentioned supply use, we’ve got about 60 industries times 300 products, when we get to the input-output tables, we’re able to expand that to about 115 industries and a bit over 900 progress. So we can give you more detail in the parameters as a couple of other technical details. But it’s broadly that same sort of concept. It’s trying to understand what is produced in the economy, and how it flows through the economy. And they’re a very powerful analytical tool.
Gene Tunny 25:53
Yeah, absolutely and Rob what I think’s interesting is you meant just, I mean, you’ve got all of this data and you’ve got these three measures that on a quarterly basis, you’re trying to get as close as possible. And you mentioned that, look, you have to make some adjustments. I mean, so there’s some judgement involved, but that’s going to be informed as much as possible by other data or whatever information you’re gathering. And you talked about he getting data from a huge range of sources, government and your own surveys, from the private sector. You probably can’t go into this. But what I’ve what I’ve been surprised at now is just how much real time data or up to date data that banks for instance, so the who else is Dun and Bradstreet, they’ve got whatever they’re called now, they’ve got more up to date data about how things are going into the economy, I presume the ABS is, is trying to get hold of some of that data.
Robert Ewing 26:52
Yeah, no, absolutely. And we have, for instance, on the bank data, we have a new publication, it’s been running since February this year, which is the monthly household spending indicator. And so that takes information from bank transactions, so credit card and debit card data. And it gives you a much broader picture of what’s happening to household consumption, then the retail trade survey does, the retail trade survey was a great survey. It’s one of the longest running surveys, and it’s very closely watched. But it only tells you about a third of consumption. Because today, in terms of things, you can walk into a store and buy or kind of buy through a retailer online, that’s only about a third of what households consume every day, when we’ve got the amount of the household spend indicator variable to expand out to more categories of consumption. And so that covers a little over two thirds of consumption of households. So that kind of finer grained data is definitely something we’re very interested in. Another example is the monthly business turnover indicator, which is another fairly recent publication. I think that started a little under 12 months ago, that takes ATO business activity statement data, and it gives you a month by month picture of how the turnover is moving in different industries. And so these are giving us that month by month picture of what’s happening in the economy. And that’s something which in the past, we’ve had to rely on the quarterly surveys and the quarterly national accounts for and I think that’s really exciting development with the data becoming more available. And, you know, the ABS showing its capability to transform that data into useful insight for people is definitely something we see is a growing kind of part of the business but going forward.
Gene Tunny 28:51
Yeah, absolutely. And it’s so important as we’re trying to monitor the economy as the RBA and the Treasury are monitoring the economy. And, and you know, that obviously feeds into policy. But yeah, that’s, that’s something for another another time. Right, on the supply use balancing, if you just got some a little bit, a few more minutes, while you’re trying to get these data internally consistent, it’s all about making sure everything adds up. All of these data are consistent. It’s the story makes sense. This balancing, I think I asked you about this on LinkedIn, what do you do, how do you do this, this a some sort of algorithm, is it..
Robert Ewing 29:31
So it’s a mix of things here? So for a lot of the large things, it is a human being looking at the data and looking at the whole picture and making a decision about all based on what I know, this is the bit here that must be wrong. So there’s a lot of it, which we’re not yet able to put into an algorithm. But if you think about I mean, I described that kind of 60 by 300 kind of matrix, you know, it’s an enormous number of cells. Once you’ve got to fill in, and so once we get past those things where you can reasonably make a human judgement. We use an algorithm, it’s a constrained optimization algorithm. And what we do is we tell that algorithm, the same things that we know from the national accounts framework. So we tell that algorithm, things like, Well, we know, you know, this supply has to equal this use. And we can also give it some other parameters, kind of like, it’s rare that the financial sector consumes many sheep directly, for instance, you know, so you can apply a bunch of constraints there, and it can then kind of go away, and it can algorithmically kind of find a sensible solution for you based on that. But the reality is that, you know, right, this second, there isn’t a good solution from a lot of this beyond a human being who can look at and just make a judgement about what makes sense here, you know, does it make more sense to kind of say that the excess rolled steel production is going to be going to export or to households? Because the algorithm is not going to have a view on that one, but the human is going to be able to say, no, no, we must have just mismeasured some exports there. Yeah, let’s have a look at that.
Gene Tunny 31:15
Yeah, gotcha. Okay. Yeah. So some constraint optimizations and judgement. Very good. And right so Rob, this is all fascinating. Is there any, any other points you think would be important for, for us to understand in detail to appreciate just the magnitude of this task? So I think I’m hoping we people understand how important these data are. And I’ve covered that in a previous episode. But is there anything else we should know, in terms of just the, the, you know, what, what are the challenges for ABS in doing this? Because it does take several months, doesn’t it, you do this on a quarterly basis, and it comes out, it comes out two months after the end of the quarter, doesn’t it? So there’s obviously a lot of work involved.
Robert Ewing 32:02
Yeah. And I think I divide that into two halves. So there’s about a month of data gathering and so this is kind of you the various surveys going out and measuring things. So it’s kind of, you know, working with partners, such as the banks and private sector, and governments, and so on to get the information streams. And then there’s about a month of what we call compilation, sitting down, running the pros, running the computer code, seeing how the numbers make sense or not. And then ultimately, you know, writing media releases and producing a publication and getting it onto the website. And just to put it in a plug, also, for our new product, which is, we are each quarter producing a nice little list of, you know, 10 to 15 things you should know about the national accounts. It’s nice and easy to digest. And you can just find that on the ABS web page. So if you find the idea of clicking on a GDP release a little intimidating, we’ve got some much more user friendly products available now. But yeah, it’s as you say, it’s about a couple of months to put it together. It’s the work of hundreds of people across the ABS, once you count the people in the survey divisions, the data acquisition divisions, all the other publications such as the balance of payments, the capital expenditure, the business indicators publication, which all feed into the national accounts, the communications team, the compilation team it’s hundreds of people across the ABS contributing to every quarter. And they are not to forget the 1000s of businesses and households answering surveys out there. I mean, the most fundamental thing is just how grateful the ABS is for the people who take the time out of their busy business and personal lives to kind of give us this data that we need to tell Australia about what’s happening.
Gene Tunny 33:57
Yeah, yeah, that’s a good point. Yeah, absolutely.
Robert Ewing 34:00
And one final point I’d make is, GDP is the figure that gets all the fun headlines. But the national accounts are a very rich publication. They tell you about a lot of different parts of the economy, they can take a bit of expertise to understand. But there’s a lot of information in the national accounts beyond GDP. It tells you about how each state is tracking, it tells you about the consumption of different goods and services in the economy. It tells you about the balance sheets of households and governments and businesses. There’s a massive amount of information beyond that top level GDP figure in there and I think a lot of the criticisms you sometimes hear about GDP not taking into account depreciation or not taking into account other things. An awful lot of that is in there somewhere. But it is a very big publication. I know it can be a bit intimidating to try and find anything in it.
Gene Tunny 34:58
Yes, yeah, but you’re right there, Rob. And, I know that there is work going on. And it may not be in the national accounts, the core national accounts, we do have satellite accounts. I know you’ve, you’ve tried to estimate the contribution of different sectors like tourism. And I’m trying to remember if you’ve done natural, natural capital estimates. So I think there are some other estimates where you’ve tried to estimate them, I’ll have to check. I remember, this is one of the issues or one of the things people are concerned about is that GDP doesn’t take into account environmental degradation. And so but there are estimates, there are people who have looked at those sorts of estimates, I’ll have a look offline and just add something in the show notes if I need to. But I know that that’s one of the issues people are concerned about.
Robert Ewing 35:49
And it looks, it’s there. It’s not my area of expertise. But there’s a whole range of work that the ABS has done on environmental economic accounts, which is really bringing together those two data sources. And I think that’s one of the unique advantages of the ABS is because we kind of sit in the middle of this data architecture, we can bring together the data that we have from these different domains and put them next to each other. And we can see how the story of the environment and particular aspects such of water align with the story of the economy. And you know, it’s something which is still like an ongoing piece of work to fully develop all the products there, but something we’ve been actively developing over the past.
Gene Tunny 36:32
Okay, very good. Rob, in from the ABS. Thanks so much for your time. I really enjoyed that. And, yeah, I look forward to seeing more of your contributions on LinkedIn. I think that I’ve been learning a lot about the work that you’ve that you do over at ABS and I’ve got a renewed appreciation for that work. So thanks again, Rob. Very good.
Robert Ewing 36:53
Thank you very much.
Gene Tunny 36:55
Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to email@example.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye
Thanks to Josh Crotts for mixing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.
The National Accounts are a huge intellectual achievement and an incredibly useful set of data, including GDP and its components. Chatting about the National Accounts with Economics Explored host Gene Tunny is fellow economist Dr Brendan Markey-Towler, author of the Substack newsletter Australian Economy Tracker. Brendan explains how the National Accounts help us track the current state of the economy as well as longer-term trends, such as shrinking manufacturing sectors and growing services sectors in many advanced economies.
Transcript: ROI of education: how economists estimate it + US economic update – EP152
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.
Gene Tunny 00:01
Coming up on Economics Explored.
Brendan Markey-Towler 00:04
So, that’s where we get the view that Australia is less and less a country that makes things and builds things. Construction, manufacturing declining as a share of GDP.
Gene Tunny 00:16
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 based in Brisbane, Australia, and I’m a former Australian Treasury official.
This is episode 153 on GDP and the National Accounts. What they are and why they matter.
Chatting about the national accounts with me this episode, is my good friend and fellow economist, Dr. Brendan Markey-Towler, who started a new sub stack newsletter, Australian Economy Tracker. Brendan explains how the national accounts help us track the current state of the economy, as well as longer term trends, such as shrinking manufacturing sectors and growing services sectors in many advanced economies.
In the show notes, you can find relevant links and any clarifications. Please send any comments or questions to firstname.lastname@example.org. I’d love to hear from you. I’ve been very grateful for all the comments on recent episodes. Your comments really helped me figure out the issues that you’re interested in, and the types of guests that you’re interested in hearing from. So, please keep the comments coming to me.
Right oh! Now for my conversation with Brendan Markey-Towler on the national accounts. Thanks to my audio engineer, Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Brendan Markey-Towler, welcome back to the program.
Brendan Markey-Towler 01:43
Gene, it’s always a pleasure to be here. Sorry, I’m a bit husky today, but I’ve bruised my throat. I’d like to pretend that it was under heroic circumstances, but it was not.
Gene Tunny 01:52
Okay, well, thanks for participating. I understand it’s not damaging your throat, you’re able to talk, you’ve been talking all day. And you’re still happy to talk.
Brendan Markey-Towler 02:01
I could talk under wet cement, mate. So, a bruised throat isn’t going to stop me.
Gene Tunny 02:07
Well, you know, now, you can get a job as a rugby league commentator, possibly?
Brendan Markey-Towler 02:14
That’s true. I’m more of a union man. Yeah, but I will go with league. That’s good.
Gene Tunny 02:18
Right oh, okay. So, the topic of today, national accounts, what it is, why it matters? You’ve started a sub stack and one of your first pieces that came out on the sub stack was on the national accounts. And you displayed a level of enthusiasm for the national accounts that is very rare. And it actually reminded me of just how marvelous the set of data – the national accounts are, and what a superb intellectual achievement.
So, going back to the work of Simon Kuznets, and Colin Clark, who, was it Stone as well, Richard Stone, who formulated the methodology financial accounts, and then it was like a system a toss by the UN. So, I think, what your note did was it really helped us; well, it really reminded me of just how impressive those national accounts are. So, could you just tell us first, what you were trying to do in that note? And what’s your sort of general take on the national accounts, please, Brendan? Why do you think they’re so important?
Brendan Markey-Towler 03:28
Partly to justify why I had no friends at school. Because I get excited about nerdy stuff like this. But look, when you actually know what the national accounts are, they’re extremely interesting. And what they really do is they aim to provide a snapshot of the activity within an economy over a set period of time. So, in Australia, and throughout almost the world, I’m not sure of any country that doesn’t do it this way. It gives you a snapshot of all the activity that went on in an economy over the previous quarter. And the central number that depicts that activity is the number that we call gross domestic product. And gross domestic product is a measure of how much wealth was added to the economy, how much production, how much activity, and under the three great categories production, exchange, and income, or earning. That’s what the national accounts do. And they add that up into a single number, GDP. And that tells you how much activity went on in the economy over that quarter.
Now, where it gets really interesting, is that number not alone would be kind of cool. And we talk about the GDP growth rate. That’s what we mean when you hear on the news that people say economic growth or the economy grew by, that’s what they meant that GDP number increasing or decreasing. But where it gets really interesting is that we approach GDP in three ways. And you can think of this as looking at the economy as the same thing, but from three different directions. And that changes the way that you interpret that number. So, we call these GDP I, or at least I call them GDP I, GDP O, and GDP E. That is, GDP expenditure, GDP income and GDP output.
And what those numbers are doing are adding up GDP, the activity in the economy, looking at that activity from one to three ways: as a production, as an expenditure, and as an income, right. So, if you think about it this way, when you go down and you buy something that’s dear to our heart, here in Queensland, you go down into buy your coffee, there’s three things going on, there’s three ways that they get that same transaction gets measured and add to GDP. From the expenditure side, the expenditure that you make, when you buy that coffee goes into GDP E, and we add all of those up together, and we get GDP. That expenditure becomes income from the perspective of the person behind the bar. And that gets added up into GDP income.
And there’s also an interesting concept of gross value add, which is how much value has been produced by that transaction. The way that we measure that in GDP O, is we take the value of the output that was sold and subtract the value of the inputs that went into it. And that by definition, that’s the value that was added.
So, that’s the three ways that we add up GDP and we get an interesting view of the economy from that. A little bit further breaking that down, obviously, you can break that down to the level of the individual transaction. But the you know, you don’t get a huge amount of information that you get so much information, you have no information. So, we categorize at a high level, these different activities to get a sense of what’s driving GDP. So, within GDP E, the expenditure, which is the most popular and most focused on of the national accounts measures of GDP, we break down expenditure by consumption, investment; in Australia, we break down by housing, as well, government expenditure, both consumption and investment, and net exports.
Gene Tunny 07:34
And by investment, we mean capital investment, we mean expenditure on capital goods. So, we mean, new housing developments, or we mean, new, non-residential buildings, new schools, new factories, new capital equipment that’s purchase.
Brendan Markey-Towler 07:55
That’s right. Yeah. So, in Australia, we call it gross fixed capital investment, which is at the addition to the capital stock of the country in the capital stock of the country is; in Australia, again, we trade a little, perhaps, oddly, that we add housing into that. But factories, equipment; we actually add intellectual property as well. So, science and technology research get added into that figure. And so that’s what we that’s, that’s the way that we break down the economy.
So, when we break down GDP E that way consumption, investment, government spending net exports, we get a sense of which sector of the demand side of the economy is pulling the economy along. Is it household consumption? Is it buying new houses or building new houses? Is it businesses investing? Is it government consuming, spending money? Or is it government investing? Or is it coming from the international sector? And that gives us a lot of information about the activity within a country, it also gives us information about what might be dragging economic growth as well. So, that’s expenditure.
Another really interesting measure, well, I mean they’re all interesting, but the second measure GDP O – GDP output, sometimes called GDP gross value add, gives us a sense more of the supply side of the economy.
So, expenditure gives us a view of what’s driving the economy on the demand side. GDP O gives us a view of what’s driving the supply side. So, we get GDP in Australia, broken down by industry. And that’s where it gets really interesting because we can see which industries are adding the most to GDP. So, that’s cool. We can say, oh, mining adding more? Or how much is mining adding to GDP and how much is it driving or dragging on GDP? Ditto for professional scientific and technical services is another one that we use, agriculture and fishing, public administration safety; how much are these sectors adding to GDP and how much are they dragging or driving GDP. And then finally, the GDP I number. This is typically not quite as informative as the others, which is kind of ironic because it’s the easiest to add up because we just look at the tax returns. GDP I, breaks down GDP by income. And in Australia, we do it by what we’d call the greatest states of Australian society. So, wage earners, non-financial corporations, financial corporations, and government. And we can get a view of who’s earning the income within GDP. How what of that GDP that’s expended and outputted. Where is the income from that activity accruing to? Is it accruing to wages? Is it accruing to company profits? If it’s an accruing company profits, is it occurring to financial or non-financial companies? So, that’s some of the really interesting stuff that we get from GDP, it gives us this, really, especially in Australia, because our accounts are quite amazing.
Gene Tunny 11:05
Yeah, we’ve got some of the best in the world for sure.
Brendan Markey-Towler 11:09
They really are and we get a really rich view of what’s driving and dragging the Australian economy. What’s creating the wealth in our economy and what’s potentially dragging on the wealth of our economy. And kind of, we get a sense as well, where it’s going.
Gene Tunny 11:26
Okay, so the few things I want to talk about there, Brendan. Okay, so you mentioned that GDP; well, is it an approximation of the addition to wealth? Let me think about this. I mean, part of it is in addition to wealth, to the extent that you’re increasing the capital stock, but then part of it is consumed, and then part of the investment is consumption of fixed capital. So, I mean, it’s national income really, isn’t it? I mean, it’s related to wealth. Yes. So, it’s certainly related to that. It gives us a picture of our national income. I think national income was the original term for it, wasn’t it?
Brendan Markey-Towler 12:11
Yes, although national income gets a little trickier because the we focus on GDP, because it’s really limited to the geographical definition of the country. And that distinction was made early on in the development of the methodology, because national income is a bit fuzzier because it’s typically added up by nationals, rather than by where the activity occurred. So, that’s why the classic example that we give in an economics course, is that national income for a country like Luxembourg is, I think, Ireland, sorry. National income for a country like Ireland is actually much higher than its GDP, because a lot of its nationals live overseas. So, there’s few distinctions that we make within it. But really, what it’s giving you is a view of the activity that’s occurred in the economy, the economy being that system of human behavior, why we produce and exchange stuff that we need for everyday life. And so obviously, that adds to the stock of wealth in the economy, because some of that gets consumed and taken out and other elements of it gets allocated to the national wealth.
So, yeah, it’s a flow metric in the classic distinction between stocks and flows. It a reflection of the consumption and investment activity in an economy during a particular period.
Gene Tunny 13:40
Yes, it was developed during, well; the need for it became obvious during the 30s, when they were trying to quantify the extent of the Great Depression, I think Kuznets produced a report for the US federal government that strangely became a best seller. I mean, it was the first time someone had produced numbers like this. There’s a great planet money episode on that. I’ll try and find it and link to it in the show notes.
Brendan Markey-Towler 14:09
Well, that’s a good point, right? Because before then everyone kind of knew when times were good, or times were bad. And so, you could tell there were panics and manias and crashes as Charles Kindleberger famously said, but before the national accounts were developed, we never really were able to quantify what that was. And a lot of this was crystallized by John Maynard Keynes, his famous book, The General Theory of Interest, money and employment. I’ve got that wrong, interest money I think I got three. I’m one of the few in my in my generation, I think who actually read the book, which is, which is why it’s embarrassing I can’t remember the name because we always refer to it as the general theory. And what Keynes was trying to do there was give a theory of why we experienced these manias, panics and crashes, you know, boom and bust. And the problem was that when he wrote it, he was dealing with a lot of abstract thoughts and that needed to be measured. And I’ll actually give a little plug here for our home state of Queensland because Queensland was at the forefront of this, currently the building out at UQ, which houses the School of Economics, the University of Queensland, the School of Economics there is housed in the Colin Clark building, which is kind of ironic because Colin Clark didn’t become an academic at UQ until much later in life, I think around the 1980s. But Colin Clark was at the forefront of developing the methodology, not only for what the national accounts are, but how you actually design the surveys that add up those numbers and find out what the numbers are.
Gene Tunny 15:49
And he’s quoted in Keynes’s book because Keynes used his estimates of consumption spending for Great Britain, if I remember correctly, in the general theory.
Brendan Markey-Towler 16:01
And it’s kind of funny. So, Colin Clark who came out here to Australia and did a tour of Australia and he was the hotshot wizkid political economist from Cambridge. And he met with all of the premiers because back in those days, we understood the constitution. So, the premiers were much more powerful than the prime minister. And when he came up here to Queensland, the premier at the time William Forgan Smith, which the alumni of UQ will know, is that is the main building at the University of Queensland. Kind of, a nice little coincidence. Forgan Smith basically said to him, look, do you want to come and be my adviser on all things economics? As Forgan Smith was a great reformer and trying to develop the Queensland economy, he needed to be able to measure the size of the Queensland economy: what was driving, what was dragging, what was causing development, what was dragging on development. And there’s a famous letter that Colin Clark writes back to Keynes to say, I’ve been offered a job to basically become the shadow premier of Queensland. I’m not going to turn that down. And Keynes, I think said something to the effect of where is Queensland. So, then, Colin Clark came out, join the Queensland Statistical Bureau and, he was instrumental in the development of the national accounts and as a point to why the national accounts are so important. While Colin Clark was doing that, he’s obviously thinking about what goes into an economy? What is an economy? What exactly does it mean to say an economy? Because when you actually; we all kind of know what it is, is the economy stupid?
Gene Tunny 17:44
It’s an abstraction, isn’t it?
Brendan Markey-Towler 17:47
But it is an abstraction. And so, he had to think about, Okay, what does it actually mean? What is an economy, what counts as economic activity? And this is becoming very pertinent again, in these days, where we’re talking about things like Facebook and Amazon and Google where a lot of the activity that goes on there, we sort of think of as economic but it doesn’t measure it. But what happens as a result of Colin Clark thinking through these questions, is he’s starting to develop views of how economic development occurs. So, he ends up writing a large book, which sort of became a classic and development economics on how economies develop, what the basis for economic development are, what the settings for economic policy should be to encourage development. Particularly important question here in Queensland, which was a quite underdeveloped economy at the time.
And as a result, he became a very close adviser to Bob Santamaria, who those diehard fans of Australian politics will know was instrumental in the foundation of the Democratic Labor Party. So, this is the guy who invented a lot of the methodology behind the national accounts. So, when you understand something at that level, when you understand what an economy is, when you know how to measure it, imperfect as that measure may be, you get really rich insights into how an economy is tracking over time. And you get really rich insights as a result that develop over a long period of time of working with these things of what drives economic growth. You can situate those numbers in a history that tells you why the economy is growing, or why it’s not.
Gene Tunny 19:32
Yeah. Where do you get that Colin Clark story from? Is that in that book you keep talking about by, was it Millmow?.
Brendan Markey-Towler 19:38
Yeah. Alex Millmow, A History of Australasian Economics Thought. I think that’s where I got it from. Yes, it is where I got it from. It’s a really good book because Alex points out that a lot of Australia’s economic contributions to economic thought came from really practical questions like this. How do we measure?
Gene Tunny 19:57
Absolutely. Yeah, yeah, absolutely. Okay, we’ll take a short break here for a word from our sponsor.
Female speaker 20:07
If you need to crunch the numbers, then get in touch with Adept Economics. We offer you frank and fearless economic analysis and advice. We can help you with funding submissions, cost benefit analysis studies, and economic modelling of all sorts. Our head office is in Brisbane, Australia, but we work all over the world.
Now back to the show. Okay, now, I did want to go back to the point you made about the difficulty of well, the issues around the modern economy and the India head, etcetera. There was a great lecture that John Quiggin, who’s a professor at UQ. And if any Australian economist is going to win a Nobel Prize, it’d be John. I mean, he’s one of the most cited academic economists that Australia has. I mean, maybe, Warrick McKibben could win one. So, but yeah, certainly, John is;
Brendan Markey-Towler 21:11
I always like for John Foster personally.,
Gene Tunny 21:15
Well, John Quiggin, is incredibly distinguished economist and his view at the this lecture he gave was that the problem with GDP is that it’s gross, its domestic and its product. Okay, so we’ve already talked about the domestic issue. So, the fact that you could have a lot of production, but if all your incomes remitted overseas, okay, because it’s just foreign mining companies producing and sending profits home, and then you may not see all of that benefit. But the point he was making is it because its product, and it’s measured at market prices, what you could be missing out on is consumer surplus, you’re not necessarily measuring the benefit to consumers, because all of these products are provided for, well, a lot of them for free. But yet, the foreign company makes money out of you in some other ways, because it’s monetizing your attention, isn’t it?
Brendan Markey-Towler 22:11
Yeah. And so, this is a debate that’s been really reopened, it’s been a perennial debate in economics, and there’s a lot of interesting ideas floating around, inspired by it, which is that when we talked about, you know, how GDP is added up, we talked about the exchange, okay. But the only way that we really observe and exchange is by the exchange of money, right? So, the price multiplied by the quantity of goods or services sold. Now, the problem merges; what happens in a world full of freemium models? What happens in a world where the price of a Facebook membership is zero? That sort of kind of, well, I don’t particularly like Facebook. So, you know, I would challenge just how much consumer surplus is creating, but there’s, you know, many people would argue that there is a value added.
Gene Tunny 23:11
I think TikTok is creating the most at the moment. Especially among the younger generation..
Brendan Markey-Towler 23:16
Massively, yeah. the only thing that shows up in the national accounts from Facebook, Google, TikTok, Instagram, is the data sales. That’s the only thing that shows up in the national accounts. I mean, apart from the marketplace exchanges that go on as well in the Facebook marketplace, and so on like that. But really, it’s ultimately the advertising for Google the sales of data from all of them. That’s the only thing that shows up in the national accounts. So, but there’s more than that, as well. Another problem, And Peter Thiel has recently raised this issue.
Gene Tunny 23:53
Oh, the billionaire? Right.
Brendan Markey-Towler 23:57
The chap who founded PayPal, he thinks that we’ve actually had no economic growth or very little economic growth in the past 70 years. And the reason he says that is because he contends that what is observed as economic growth in the past 70 years, is actually just us bringing production and exchange; valuable production exchange that used to happen in the home, into markets. So, cooking, cleaning, keeping the house in order, gardening; all this stuff gets done on marketplaces, rather than in the home. And that’s a bias in GDP. It doesn’t measure that stuff because it’s not on a marketplace. It can’t be observed. So, that’s another argument.
You know that GDP doesn’t measure the actual value that’s being created. Now, the problem ultimately is, this goes back to a problem of micro economic theory, which is what is utility? And what is consumer surplus? And actually, from my perspective, why I ultimately say, look, let’s stick with GDP. It’s the worst measure we have, except for all the other things. Some countries have toyed with measuring gross national happiness. You know, New Zealand is toying with that at the moment, Bhutan famously measured it. The UN uses the Human Development Index, which is a weighting of GDP per capita literacy rates and life expectancy, I think.
Gene Tunny 25:31
All of which are highly correlated, aren’t those?
Brendan Markey-Towler 25:33
Yeah, and so, that was a March Ascends Brainchild, Jagdish Bhagwati famously said, well, yeah, they’re correlated. So, what are we talking about here? So, all those debates over replacing GDP ultimately, were reduced to a deep, deep philosophical problem, which economists are not well placed to solve, which is, what is value? What is good, what is true, what is beautiful? And I got some views on that. But as an economist, I ain’t got nothing to say about that. And so, when economists start dabbling in it, you kind of go, I used to be a fan of the happiness literature. But now I read and go, ah, this is, you know, it’s very simplistic. We’re going to use subjective wellbeing measures to add up Gross National Happiness. Okay, fine, that’s a really subjective and not very tangible measure. Whereas I can look out the window and see the cranes on the skyline here in Brisbane and see that’s an objective, measurable thing.
Gene Tunny 26:37
Well, it stood the test of time, hasn’t it? So, we’ve been using it for decades now. And there’s a general feeling that it does capture the state of the economy reasonably well. I mean, there are going to be people who grumble about it from time to time, but generally well, in Australia, at least when we had the recession, I mean, I always remember the 91 recession, because I was in high school at the time. And like, things just look bleak for anyone who was in high school and wanted to get a job. But then that was the period when retention rates at high school really ramped up. So, it was it was telling us something important there and it tends to; like it could give false signals, there’s a big debate at the moment over what’s happening in the US. But then look, the economy’s looks like it is slowing to an extent. There’s the impact of the Federal Reserve hikes. So, let’s wait and see how it all plays out. I mean, my feeling is, it’s generally a pretty good indicator of the state of the economy.
Brendan Markey-Towler 27:38
I look bad, I’m a Queenslander first, Australian second, and as a result, I do have a bias which is towards tangible reality. Right, feelings are very ephemeral. And feelings are important, right? They are very important, but they’re really difficult to measure. And they’re very subjective, and they can be easily manipulated. Now, GDP can be manipulated as well, depending on how you count things up. But at the end of the day, it’s stuff that’s being produced stuff that’s being consumed. And it’s tangible, observable goods and services. So, insofar as I really have a criticism of GDP, my major criticism is that it really; I agree with Peter Thiel largely, biases us away from realizing the value that is produced in a house.
And look, I’ve got a young, I’ve got a four-month-old son now so and my wife is at home, taking care of that. And I tell you what, that is incredibly mind blowing valuable work that she’s doing; doesn’t show up anywhere in GDP. Now, that doesn’t negate GDP. Because I think the solution to that is really, let’s just realize what GDP is actually measuring. Now, that does work in a political debate, because in politics and the way that the media works, you need a number and you need that number to be growing, otherwise, elections get lost, and so on and so forth. But when you’re, you know, when you’re doing grown up analysis instead of politics, I think the solution is to look at what GDP is actually measuring. It’s not a measure of value and if you think of it that way, then you’re wrong. Stop thinking of it like that. Think of it as it’s a measure of the production of stuff and the exchange of stuff within the economy, within the market that we can observe. Don’t try and start thinking about as a measure of all of the economic activity that ever happens in an economy. Just recognize the limitations, it doesn’t measure this stuff that goes on the household and that’s incredibly important.
Gene Tunny 29:51
Yeah, fair enough. That’s a good point. I’ll have to come in another episode to this issue of what’s in GDP? What’s out? What does it all mean? I’ll try and have that discussion in a future episode because there is a couple of other things I wanted to pick up on from your note; your note reminded me of a couple of things. And it’s the fact that this system is so beautiful, I mean, we end up getting from two different directions, possibly two different sets of data. I mean, we can look at what spend on consumption goods, final consumption goods, now, we have to be careful, we’re talking about final consumption goods and final investment goods, because what we’re trying to do is avoid double counting, we’re trying to get; because there are a lot of business to business transactions, businesses selling to other businesses inputs, so you have to take care of all that and make sure you’re not double counting title output, you want the expenditure on final goods and services.
So, if you look at that, that ends up telling you what GDP is, once you add exports, subtract imports, because, well, if you import something, then you don’t have to produce it here. So, there could be stuff that shows up a consumption spending or an investment spending that’s imported, and we didn’t produce it here. So, you have to subtract it. And likewise, if we’re exporting something, well, we produced it here, we know we produced it here, then that adds to our output. But then, you look at spending data, on the other hand, you can look at income data. So, you are saying, look at the wages data, look at the profits data. And yeah, I guess it is coming from the ITR. I’m not sure exactly where the IBS gets it from. But I mean, that’s a likely source. I do surveys of businesses.
I’d have to check exactly how much they’re using ATO data, but I know they do surveys of businesses to get that information. They’ve got a household expenditure survey, they’ve got surveys of, well I guess they got their business server; I’d be looking at what they spending on capital goods. Looking at what they’re earning. And so, they build up this picture of earnings that way, and also the gross value added in the business. Which as you described, is their revenue less their production costs, and wages are part of the value added to. So, wages plus the gross operating surplus, is your value added in the business?
Brendan Markey-Towler 32:21
Yeah, it’s a very slippery definition, because it’s not quite profits. But it’s, you know, the value of inputs minus the value of outputs. And that by definition has to be the value that is added by that business to the economy, insofar as we can measure it.
Gene Tunny 32:35
This is because we’re talking about gross domestic product. So, we haven’t subtracted for the depreciation of capital stock, because some of the investment that occurs is just replacing existing capital stock. So, the building wears out and we have to replace it.
Brendan Markey-Towler 32:52
Too hard. We set that aside. Depreciation is very funny thing to talk about.
Gene Tunny 32:56
Right? Yeah. Well, we’ll leave that for now. You got time just to chat about your great quote? I should have brought it in earlier. You use these different perspectives on GDP to provide a really nice summary of what’s been happening in Australia. I thought this was very good. Exactly. Okay, so after you analyze where the growth has occurred, and you know, it’d be good if you could explain this at the moment. You concluded this; to put it somewhat tribally, Australia is less and less a country that derives its wealth from making and building things. Still a country that makes its wealth by digging stuff out of the ground and renting houses, and more and more a country that consults and cares. Could you please explain how you came to that conclusion, Brendan?
Brendan Markey-Towler 33:53
Well, you so what I did there, this is one of the most informative aspects of the national accounts I’m very interested; everyone focuses on the demand side of the economy, because we’re all Keynesian.
Gene Tunny 34:07
What we’ve been heavily influenced by Keynes, yes. There’s no doubt about that, whether we’re Keynesian. So, that’s another question. You can go ahead. Yes.
Brendan Markey-Towler 34:13
We are all Keynesians. But the supply side of the economy is super interesting. See which sectors of the economy are generating the wealth. Now, the way that you can do that is by looking at gross value add, right. So, then you take the gross value added by each industry divided by the total GDP and you get the share of GDP, economic activity, economic value that is being created by that industry. And you can track that over time. Now, the problem with that data why almost no one really uses it? Some people do, but almost no one does. And you’ve used it, Gene, is that there’s a lot there, the ABS breaks the economy down by I think its 20 sectors. possibly 25. So, you’ve got to kind of cut it down to get some useful insights from it.
So, the way I did it was alright, let’s cut out everything that’s less than 5% of the economy and look only at things that produce more than 5% of Australian GDP. Now, no sector really produces more than about 15. But there’s a clear standout. And there are clear standout trends once you do that, and you clean the graph up by eliminating all the Martin “minor sectors”. And you see some very strong trends.
Trend number one that’s quite striking, and I should emphasize, this is all by real data. So, we hold prices constant to see what’s going on at the volumetric level in each of these sectors. So, we hold P constant, and we look at what’s changing in Q. Q is for quantity. And so, there’s benefits and costs to doing that. But it’s valuable as an exercise as long as you’re aware of the limitations of doing that. First interesting thing, manufacturing and construction are in decline in Australia. They’re not producing as much value add. In volumetric terms, they’re not producing as much value add anymore. They’ve been declining for the past 10 years as a share of GDP. So, that’s where we get the view that Australia is less and less a country that makes things and builds things; construction, manufacturing declining as a share of GDP.
Gene Tunny 36:30
So, with manufacturing, we had a car industry once, we subsidized a car industry, we tried to buy ourselves a car industry, and it just could not be viable on its own. And there wasn’t any more money we could throw at it to keep it open.
Brendan Markey-Towler 36:48
And you look at somewhere like Maroubra or Ipswich. Which would you know, once kind of manufacturing ish areas in Queensland. Maroubra main manufacturing now is government contracts, building bullets for the Australian Army.
Gene Tunny 37:03
And do they build trains, still?
Brendan Markey-Towler 37:06
They do now. Yes, Maroubra now has a trains contract to build trains for the Queensland Government as well. And I think Ipswich still has a little bit of a train industry as well. But really not too much, by the way of price manufacturers. It’s not to say that it doesn’t exist, and it’s not to say that it’s very valuable. Queensland, for instance, has very vibrant medical manufacturing sector. That’s kind of grown up on the back of our extremely good hospitals and medical research. But generally, across Australia, the story is one of the car industries; we don’t really make stuff anymore. It’s just not competitive to build stuff. And so, that number is reflecting something that you see a lot when you go down to Fortitude Valley here, which, you know, the state would like to think Silicon Valley. Yes. Anyway, it’s Fortitude Valley, Queensland Silicon Valley, you see that a lot of the companies there just want to grow big enough that they can afford to offshore their manufacturing elsewhere. And the classic one is, I think Trivium, the electric car battery manufacturer, which is, as soon as they got big enough, they got a loan from the Queensland Government and then went to build factories in Tennessee.
Gene Tunny 38:17
Is that right? Is that a good use of taxpayers’ money?
Brendan Markey-Towler 38:21
Well, I’m completely agnostic on that. So, that’s what’s that number is reflecting. Similarly, construction, this runs a bit counter to the crane index that we’re seeing in the city at the moment, but construction has been adding less and less to the economy. It’s not just large construction projects, but construction is declining as a share of GDP.
Gene Tunny 38:48
Well, I’ll have to look at this. But I think what could be explained is 10 years ago, we had that massive project up in Gladstone at Curtis Island where we built the three LNG terminals or what are they? Refrigeration or liquification facilities. They turn the methane that comes from the coal field, the coal seams to liquefy it so, they can put it on a boat economically and ship it to Japan or Korea. And that was like $70 billion.
And it basically doubled the level of capital expenditure in Queensland at the time. It’s absolutely extraordinary.
Brendan Markey-Towler 39:31
There’s a huge effort on part of government corporations to get that going.
Gene Tunny 39:35
And then in the southern states, maybe a few years later, I can’t remember the time; we had that big apartment construction boom. So, that could be explained. I’ll have to look at the data but go on.
Brendan Markey-Towler 39:48
And that’s what’s really good about the national accounts is kind of counter to what you’re seeing if you’re walking around, particularly, Brisbane at the moment. The number of cranes in the sky is astounding, but this is why statistics are important because what’s local loss to a particular area is not necessarily true of the entire country. And what’s even true of a particular sector of construction, residential construction, government construction is not necessarily true, it might mean that we’re not building that many mines, which ties into the second point, which is, although it has declined in volumetric terms, the mining sector is still the single biggest contributor to Australian real GDP. And it’s not close, it’s way up; I forget the exact number, but it’s well up towards 10% of the entire Australian economy value added is produced by the mining sector.
So, that’s, you know, digging stuff out of the ground, selling it to various countries around the world.. Behind that really interesting sector is, is the rental sector. So, a lot of value added in the Australian economy. It’s the only sector that holds candle to mining is the rental sector where people are building houses and renting them.
Gene Tunny 41:03
Okay. So, when you analyzed that, did you look at the industry, is it rental services? Or did you look at what’s in the national accounts as; there’s rental income, isn’t there? What do they call it? Trying to remember what the label is in the national accounts, but they impute rent for owner occupied dwellings as well, in that sector. If I remember correctly.
Brendan Markey-Towler 41:29
Rental services. I’m pretty sure is the exact name of the sector.
Gene Tunny 41:33
Looking at it by industry. Okay. Yeah.
Brendan Markey-Towler 41:36
So, that’s an important point, right? Because rent to also shows up as an income segment as well. Not nearly as big there. But the value add is quite large. And so that’s saying, you know, the Australian economy is very much one that is dominated at the moment, by digging stuff up out of the ground, and then sending it offshore, and providing housing for people. Those are the two biggest sectors of the Australian economy. And then, finally, the very long-term trend, we come to the third part of that bond ma that you so ably quaffed, which is, surprisingly, the sectors that are growing fastest as a share of the Australian economy are; you’ll have to double check me on this, but I’m pretty sure it’s called health care and social assistance.. And professional scientific and technical services. Those have gone quite strongly over the last few years as a share of GDP.
Scientific and Technical Services is obvious enough, right? That’s the IT department and you know, the lab.
Gene Tunny 42:45
There’s professional too.
Brendan Markey-Towler 42:49
Yeah. Professional Services is the big one. So, this is your consultancy lawyers. So on and so forth, right. It’s Eagle street, the consulting firms along Eagle street.
Gene Tunny 42:58
Where we are in Brisbane, in the top end of town, would you call it the big end of town? You’re sitting in water from place to the moment and the offices of Hopko Gannon, thanks, again for allowing us to use.
Brendan Markey-Towler 43:13
And so this area is growing really strong. I forget where the legal services are counted among professional service.
Gene Tunny 43:18
But I think I would be Yeah, sure.
Brendan Markey-Towler 43:21
They might be under administration, administrative services. But professional, scientific and technical services, basically, scientific and technical can kind of be in house. But a huge majority of that professional services is consulting, right? So, Australia is doing a lot more consulting as a share of GDP.
Gene Tunny 43:40
And this is business to business, typically? Business-to-business consulting services or business to government.
Brendan Markey-Towler 43:47
Business to government is the big one, especially here in Queensland right now. That’s not backed by a number. But that’s you know, that’s kind of;
Gene Tunny 43:58
There are numbers for the Australian Government. I’ll put them in the show notes, because I looked at what the Australian government has spent on the Big Four consulting firms like KPMG and PwC. And it’s hundreds of millions a year, right? It’s big money.
Brendan Markey-Towler 44:12
And then, you go step below and the state governments will probably be even bigger again, because every consulting project by the Department of Public Works now gets a cut benefit cost analysis written by one of the big firms, right. So, just because of the procurement rules around that, so professional, scientific and technical services really growing as a segment of GDP, but also health care and social assistance. And so that I would posit is really a reflection of the ageing population. Ageing population, you need more health care and social assistance, certainly. That sector is growing very strongly – aged care.
Gene Tunny 44:49
Yeah. Which is NDIS too, the National Disability Insurance Scheme.
Brendan Markey-Towler 44:53
Absolutely massive, huge boom. You throw a stone in Brisbane and you hit NDIS provider, which is really not good, you shouldn’t do that because that’s naughty. And that getting on the back of Yeah, health departments are in Queensland; Queensland Health is the largest single employer in the state. That’s a massive sector. It’s a $20 billion in the state budget. That’s a big number, right? And we’re always trying to spend more on it. So, very big sector that. So, those are the two real growth sectors in the Australian economy. And again, I should stress by volumetric measures, right? So, notice that that kind of cuts against the mining booms like us, and that goes to the difference between real and nominal GDP. Real being a volumetric thing where we’re trying to hold prices constant, and the reason we do that is because nominal GDP could be growing because the actual underlying productive capacity of the economy is growing, or because inflation is growing. And real GDP tries to say, what’s the underlying volumetric productive capacity of the economy? How’s that growing and contracting. And in that measure, you really see the big growth sectors, mining is actually declining as a volumetric share of GDP as a share of real GDP, but it’s still the biggest by far professional, scientific and technical services, and healthcare and social assistance really, really growing. Yeah, that’s where the saying, that’s where my little trite way of putting it came from. Australia is less and less a country that makes things and build things. It’s still very much a country that digs stuff out of the ground and provides housing, but it’s more and more something of a white collar economy.
Gene Tunny 46:43
Oh, yeah. It’s postindustrial. We’re moving more to services. Yeah.
Brendan Markey-Towler 46:49
Natural I mean, with the natural resources sector.
Gene Tunny 46:52
Yeah. that’s right. And I mean, because the world wants to buy our resources. And for the last year or so, they’ve been paying ridiculously high prices for them. It’s an open question over whether we want to sell it. Right. Well, yes. I mean, there’s the big issues there of course that we don’t have time for.
You’ve been very generous with your time, Brendan
Brendan Markey-Towler 47:22
You are very generous letting me on the podcast to talk to people again, Gene.
Gene Tunny 47:27
You’re a great talker. Always enjoy having you on.
Brendan Markey-Towler 47:30
Even with the bruised throat? Like I told you, I could talk through a wet cement.
Gene Tunny 47:35
Very good. So, any final points before we wrap up?
Brendan Markey-Towler 47:39
No, it just ends up on I ended up with the note of circling back to where we started, which is don’t underestimate the national accounts. They’re a really, really, really interesting data set. They give us such a rich view. We didn’t even talk tonight about how in Australia, they break down by state as well, so, we can get an even richer view of how the different states are doing because you know, Australian economy tracker – my blog.
Gene Tunny 48:06
Okay, right. On Sub stack, is it?.
Brendan Markey-Towler 48:09
Yeah, on Sub stack. Please subscribe and contribute to the Markey-Towler retirement fund. It’s founded on two points, which is that one, the perfect graph says more than a doctoral thesis and two, there’s no such thing as an Australian economy. There’s actually six different city state economies and two territories. So, the national accounts in Australia are amazing, not just because of the depth of analysis, they allow us on the supply side of the economy, but on the demand side as well. We get some really, really rich version. So, a plug to remember has to diehard nerds who didn’t have friends at school, but now we have the national accounts.
Gene Tunny 48:53
I’m sure you had friends at school, Brendan. Brendan Markey-Towler, that’s been terrific. I really enjoyed talking to you about the national accounts.
I really enjoyed talking to you, Gene. Thanks for having me.
Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to email@example.com and we’ll aim to address them in a future episode. Thanks for listening. Till next week, goodbye.
US Treasury Secretary Janet Yellen claims the US economy is not in a recession, despite two consecutive quarters of declining GDP. Economics Explored EP151 guest Darren Brady Nelson disagrees with the Treasury Secretary and argues she is taking a political position. Whether she’s being political or not, Janet Yellen has certainly taken a big risk, as Darren and Gene discuss. Darren and Gene also talk about the review of the Aussie central bank, the Reserve Bank of Australia, particularly how climate change could figure in that review. Darren argues the review team should have a broader range of views represented, including Monetarist and Austrian perspectives.
Transcript: US recession, climate change & monetary policy w/ Darren Brady Nelson – EP151
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.
Gene Tunny 00:01
Coming up on Economics Explored
Darren Brady Nelson 00:05
like to see seemed to have sold or sold for political purposes as the head of Treasury in the US each year is a political appointee. So, that is, to some extent a political position.
Gene Tunny 00:19
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 based in Brisbane, Australia, and I’m a former Australian Treasury official.
This is episode 151 on whether the US economy is in a recession. Joining me is returning guest, Darren Brady Nelson.
Darren is Chief Economist of the Australian Think Tank Liberty Works. And he’s also an Economics Associate at the CO2 coalition in Washington DC. As well as chatting about the US economy. Darren and I discuss climate change and the review of the Reserve Bank of Australia.
In the show notes, you can find relevant links and details of how you can get in touch. Please let me know your thoughts on what either Darren or I have to say. I’d love to hear from you.
In the show notes. I’ll include links to some great commentary on whether the US actually is in a recession from two previous guests, Michael Knox and Steven Kirschner. So, make sure you check those links out.
Right on, for my conversation with Darren. Thanks to my audio engineer, Josh Crotts, for his assistants in producing this episode. I hope you enjoyed it.
Darren Brady Nelson, Chief Economist at Liberty works. Welcome back unto the program.
Darren Brady Nelson 01:35
Thank you. Good to see you. I guess it’s been a while since we last spoke about Work Capitalism, I think.
Gene Tunny 01:41
Yes, that’s right. That was a few months ago. So yes, it’s good to catch up again. This is a 151st episode, and this is your 11th appearance on the show if I’m counting correctly. So yeah, we get around to another chat every 15 episodes or so. So, it’s about time to catch up with you. So, it’s great to have you on the show again.
Darren Brady Nelson 02:06
Yeah, congratulation, because I’ve been so prolific. 151 That’s great.
Gene Tunny 02:11
Yeah, well, it’s just drip by drip, really. It’s one per week, and they mount up, yes. Thankfully, we’re out of the COVID period, although I had it recently. And I was in isolation, but we’re over all of that craziness which was dominating the conversation for a while, and now we’re getting on to other issues.
Okay, so I thought we could chat now about the US GDP figures and we had some big news last week, in Australia. You’re still on Saturday there; I think Darren, there in the states in DC. And now we’ve got two consecutive negative quarters of GDP growth. So, GDP grew at an annualized rate or didn’t grow, it fell at an annualized rate of 0.9% in the June quarter, and that followed a decline of, I think it was 1.6% in the March quarter, that’s at an annualized rate. Okay, so there’s a big debate about whether the US is in recession or not. Darren, what do you think? Is the US in a recession at the moment?
Darren Brady Nelson 03:26
Well, yeah, I would say so. I must admit, in this conversation, certainly, you’re going to be more expertise than I. You’re a guru of sort of macro-economic indicators, and all that, particularly from your treasury background, but other things you’ve done, too. So, maybe I’ll be asking you some questions, too, and hoping to get some answers. But yeah, I’m not sure; maybe you know the answer to this, but, the entire time I’ve been, first studying economics and being an economist, putting aside the debates on whether two consecutive quarters is the greatest definition or not, it seems to have been the definition for a long time. And the most interesting thing I’ve seen recently, and I guess this would have been headlines, I imagined in Australia as well, was the Biden administration going. No, no, that’s not really the technical definition of a recession.
I don’t think I recall an administration, democrat or republican ever; they may come up with excuses and say, it’s not well, it’s not our fault. It’s the previous administration and all that sort of stuff, or you know, external circumstances. But this is really the first time someone’s ever, including, some of the economists that the Biden administration has. On record, obviously, talking about in the past that yes, the recession. You know, the technical definition, if you like, is the two consecutive quarters of negative growth. So, it’s been very interesting times. Again, I guess in the 2020s, including a lot of media organizations and our favorite, sort of Neo Keynesian Economist, Krugman coming out and also defending that the Biden administration on oh, well, it’s not really a recession. So, it certainly fits the technical definition that, if you’d like I grew up with. And, that’s certainly my impression, just actually being in the US. Is it dire just yet? Yes. On the inflation front, yes. But unemployment, still is fairly low. And putting aside the fact that participation rate, that’s a little bit of a worry, but the unemployment rates not so bad at this stage. And usually, obviously, that’s, if you’d like a key secondary indicator, besides GDP itself, that people usually turn to right away, before they maybe dig into, what aspects of GDP have gone down, energy manufacturing, etc, etc.
Gene Tunny 06:02
Yeah. Okay. So, there are a few things you mentioned there, Darren,
Darren Brady Nelson 06:09
So, yes. Not a strong yes. So, yeah, I’d say yes. Technical definition? Kind of weak, yes in a kind of more judgement point of view.
Gene Tunny 06:16
Yes. So, you referred to what the White House was saying, and what Janet Yellen in the Treasury was saying. So, I might just read that out. And then we can go from there. And I can let you know what I thought about that.
So, what Janet Yellen said and this is reported by the Financial Times. “The White House has maintained that the US economy is not at present in a recession, with Treasury Secretary Janet Yellen saying earlier this week that she would be amazed if the NB declared it was okay.” So, what she’s talking about there is the National Bureau of Economic Research, which is I think it’s attached to; is it attached to Harvard or MIT or one of those East Coast universities? There’s this elite group.
Darren Brady Nelson 07:01
I think it’s independent. I mean, look, I don’t know, but I think it’s more independent than even being associated with one particular university, I think.
Gene Tunny 07:10
Yeah, I think you’re right. Yeah. But it’s an elite group of macro economists, some of the top people and you’ll have some of the leading lights of economics on it. And they will date the business cycles, they will declare whether the economy’s in recession or not. And generally, what they’re looking for is a sustained downturn that lasts several months, so more than one quarter. And they look at a broad range of indicators. So, it’s not just GDP. But that having said that, it looks like GDP is an important part of it, because it’s that comprehensive measure of economic activity.
And one thing I noticed when I was preparing for our chat, is there was a report from CNBC, where it noted that I don’t think there’s ever been a recession that the NBR has called, which didn’t have two consecutive quarters of GDP growth, if that makes sense. So, where’s the actual passage?
Darren Brady Nelson 08:21
I think that’s not correct. I think they call the recession, during the pandemic, and that wasn’t two quarters, I think. So, they do have a bit of leeway. But they tend to usually use the two quarters as part of the definition as a key component.
Gene Tunny 08:38
Okay, look, I’ll have to check that, I thought I read that earlier today. I had that somewhere here in my notes.
Okay. So, we might go back to what Janet Yellen, what she said here. She underscored the message at a press conference on Thursday, emphasizing that the economy remains resilient. Most economists and most Americans have a similar definition of recession, substantial job losses and mass layoffs, businesses shutting down, private sector activities slowing considerably, family budgets under immense strain. In some abroad-based, weakening of our economy. She said, that is not what we’re seeing now.
Okay. It seems to me that’s a pretty risky call from her because she is running the risk that the NBA does eventually define this as a recession. And that’s going to be incredibly embarrassing for the administration. So, yeah, that would be my sense of it. I think it is a big call from Janet Yellen. And it may be too early to tell. But look, there are a lot of Economists out there who seem positive about the US economy. But that said, it does appear that I mean, is it the interest rates, is it what the Federal Reserve’s been doing that’s causing issues? Is it inflation that’s hitting Consumers? What do you think are the main forces affecting the US economy at the moment, Darren?
Darren Brady Nelson 10:06
Yeah, I think, you’ve definitely touched on two key components. But just to comment on Janet Yellen. But you know, Janet Yellen was totally wrong on inflation. So, that didn’t seem to impact her credibility within her circle that she goes around with, and the people who hire her; that didn’t seem to make any difference. So, probably when she’s proven wrong on recession, which I think she already has been. Yeah, I mean, that inflation is like, one of the key things; it’s the biggest problems in the US, and obviously, even the Federal Reserve, which has been; our Federal Reserve is part of the process of creating inflation. So, they’ve gotten spooked. Biden administration itself has not, which they, at least publicly, they keep on, they don’t seem to be, they acknowledged it a bit, but they don’t really kind of acknowledge it as bad as, even though the official statistics are showing. So, you have, like, I guess we’ve talked about this many times, but, you have kind of two things going on at once, the unprecedented levels of money printing, and the credit that goes with it, which, if you’d like, from a macro point of view, is hitting the demand side. And then on the supply side, they’re doing all sorts of, the Biden administration’s policies are just hurting supply, and hurting productivity and competition.
So, that can sometimes, make up a lot for that money printing. The supply side can react to it, and really dampen what, it’s for the money to the demand side of things. So, energy is a classic one, they had a complete 180 on their energy policy. So, the US went from the number one energy producer in the world to not that anymore, and, record time, essentially?
Gene Tunny 12:08
And is that the Biden administration’s fault in your view?
Darren Brady Nelson 12:12
Well, exactly. It’s not just their fault, that is literally their policy. You know, they’re going for the green transition, if you like, come hell or hot water, right? So, which includes, not allowing oil companies to extract oil and all sorts of things. Oil, natural gas, coal, etc. And they’ve also hit agriculture with bad policies as well. You know, manufacturing; yeah, literally, if you want to destroy an economy, the Biden’s administration is basically ticking all the boxes with their policies. And, putting aside, you can argue whether that’s intentional or unintentional, but I think there’s not too many, if you like, remotely free, market friendly economists who think the Biden’s policies are particularly good.
Gene Tunny 13:10
Right, okay, I’ll have to have a closer look at some of the policies and come back to that. I just want to go back to that definition of recession; I think I might have missed or may not have communicated properly what that factoid in that CNBC report was. So, what they were saying was that, in fact, every time since 1948, the GDP has fallen for at least two straight quarters. So, they’re not saying that, there could be recessions if you don’t have this, and that’s what you were saying with the pandemic, that was, like you could call a recession, if you don’t have the two negative quarters. But what this point is, is that, in fact, every time since 1948, the GDP has fallen for at least two straight quarters. The NBER ultimately, has declared it a recession. So, you can have a recession, even if you don’t have the two quarters, but every time you’ve seen it in the data, the NBER has ultimately called it a recession. So, what Janet Yellen has done is, yeah, that’s a really big call on her part. And, I mean, Janet Yellen, someone with a distinguished academic reputation, and yep, so really, really big call and potentially, it will backfire on her. We have to wait and see about that. Yeah.
Darren Brady Nelson 14:38
Janet Yellen in not going to make, you know, like she’s she seemed to have sold or sold for political purposes. Not unusual that; it’s not like this has never been seen before. Most of her sort of, like topics when she gets into public is less focused on inflation and recessions and she’s talking about equity and diversity and inclusivity and all that sort of stuff. Well, I guess as the head of Treasury in the US, each year is a political appointee. So, I guess, that is, to some extent, a political position. Although, usually in the past, it’s been Department of Justice and Treasury have, usually been less partisan, if you like. The people regardless of whether it was democrat or republican in charge, but you know, things have changed quite a bit. Certainly, this century and certainly in the 2020s.
Gene Tunny 15:33
Yeah, exactly. Okay. So, you mentioned the supply side before, well, one thing we’ve had in Australia here is just the ongoing disruption to supply chains. And I mean, the random things just been unavailable in the supermarket’s. Quantas seems to have lost its mojo; can’t seem to run a flight on schedule any time anymore. And partly, that’s because they lost people during the pandemic. And now we’ve got people on isolation leave, like if you get COVID, you have to isolate for seven days, and that’s disruptive. Things just don’t seem to be working as they once did. Is that the same in the States? Have you noticed that in the US?
Darren Brady Nelson 16:21
Yeah. I think some extent, less. Although I understand aviation has been kind of bad here, too. But I haven’t actually been, I’m just going on to sort of news reports and talking to other people that, yeah, they’ve had, things. Well, what happened in the US probably, maybe more than Australia is a lot of pilots, either were, let go or just left because they didn’t want to get the vaccine, right? And the federal government has a bigger say in aviation than they do and other industries, for instance, particularly on employment. And so yeah, that’s all contributed, including also I understand, not just pilots, but other people in the aviation industry, various hubs, the people needed at the airports and the hubs as well, similar sort of circumstances. The supply chain disruption in general, I haven’t noticed it as much in terms of like at the grocery store, there was a period where there was a little bit of that. Not as bad, but certainly, there were issues as well, in the US, perhaps, maybe not as bad in terms of like, grocery stores and whatnot.
So, the 2020s have been very weird times. And I don’t think it’s some sort of like natural market outcomes as such. Obviously, markets wrecked, and they impact, but I think there’s just the amount of, really over the top interventions and status sort of policies in the 2020s have taken me by surprise. We’ve been prepping backwards, if you like, towards bigger and bigger government, and I think, reaping the rewards. I don’t know why people, even people who; seasoned economists, who should kind of, know better, the more the government does stuff and interferes, the worse things get. It literally, is becoming, more and more like an Atlas Shrugged world. I don’t know if you’ve read Atlas Shrugged; probably familiar with the premise anyway. It’s like that. I’m like Atlas Shrugged there, but, there were places to escape to in that world, the fictional world of as many, as you can see, in this world, when, all the governments are, have uniform sort of policies on COVID and uniform policies of not tackling inflation, and all that. And maybe it will be interesting to see if the elbow government copies the Democrat lead, which I suspect they will, if Australia gets two quarters of negative growth, they’ll go that’s not really a recession, we’ll be interesting to see if they go down that road as well.
Gene Tunny 19:12
Yeah, one thing that we’ve traditionally relied on to keep the economy growing is migration, just the addition of people and that those consumption, and so that’s starting to pick up again. Possibly, that try and redefine it. I mean, I don’t think we’re at risk of that at the moment. Although having said that consumer confidence has dropped with the higher interest rates, so people are freaking out over just the increases in interest rates we’ve seen already, because it looks like they just borrow lots of money when interest rates were really low. The Reserve Bank, Governor, I couldn’t believe it. Last year, he was saying, oh, the interest rates will; our official cash rate will stay at 0.1 until 2024. And arguably, he misled people. And so, I mean, he really has a lot of questions to answer for. And there is the Reserve Bank of Australia review, which I’ve talked about in this program. I don’t know if you’ve had a look at that at all, Darren?
Darren Brady Nelson 20:22
No, no. Give me a synopsis of what drove that. And what’s happening?
Gene Tunny 20:28
Well, the RBA has been under a lot of criticism in recent years for different reasons. There’s been one group of economists who’ve been critical of it, because they argue that they didn’t; that they had interest rates too high in the lead up to the pandemic. Now, whether that’s true or not, I think it’s debatable. But I’ve had people like Peter Tulip and Steve Kirschner on the show. I mean, they’re very good economists. I think it’s worth considering their view for sure.
Their argument is that if you’re trying to achieve the inflation target of 2 to 3%; they were arguing that because inflation was actually lower than that, you had scope to have looser monetary policy, lower interest rates, to have more employment growth. And there was some modelling that was done by Andrew Lee, who’s a Labor Party MP and a former and new professor, and Isaac Gross, who’s an economist at University of Melbourne, I think. And they showed that if the RBA had met its inflation target, if it had lower interest rates and let the economy grow faster. You could have had; I think it was like 250 to 300,000 more jobs in the economy. So, there were a group of economists criticizing the RBA from that direction. And they were saying that the RBA was too concerned about households taking on too much debt. So, they didn’t want to put interest rates lower.
I could see why the bank would be concerned about that. So, that’s why I’m not fully on board with that criticism of the bank. That said, I think it is good to review the Reserve Bank, because it is a bit of a; it’s not exactly transparent what they’re doing. So, I think there could be greater transparency. And since last year, when Phil Lowe was making those sorts of bold calls, that turned out to be wrong within months, right. It was obvious that we’re in the in the new year when we started getting those inflation numbers that the Reserve Bank would have to act. So, I think they lost a lot of credibility over that.
So, it’s important now to have this review. And they’ve appointed Caroline Wilkins from, she’s a former Deputy Governor of the Canadian Central bank. They’ve got Gordon De Brouwer, who’s a former bureaucrat, I worked for him when he was in the treasury. And he was also at a new at times. He’s good. He’s good value. And Rene Fry McKibbin, who’s a professor of Economics at ANU.
They’re going to review the board like there are issues to do with board composition, who’s on the board? There are issues to do with the inflation target; but I’m not sure they’ll do much about that. They might tweak some of the language. And then there’s issues to do with the transparency of the board’s decision making; what do they release to the public every month? So that’s essentially what the review is about and I think it’s, it’s a good thing that they’re doing that. So, yeah, that’s it. So, yeah, it’s worth definitely worth keeping an eye on.
Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 24:30
Now back to the show.
Darren Brady Nelson 24:33
So, are they the reviewers? Are they sort of, left or center, for the most part, like a Keynesian and MMT and, something else or what? What’s the story there?
Gene Tunny 24:47
I’d say the typical mainstream macro economists. So, however you’d like to characterize that, they’re definitely not MMT. If you had to give them a label, maybe you give them a new Keynesian label, possibly. But yeah, they’re not I don’t think they’re radical in any particular direction. They’re nonpolitical appointees, which is a good thing. One of the big questions and something that I think the Prime Minister, Anthony Albanese, Albo, as we call him, one thing he will be, he’ll be getting pressured to put a trade union representative on the board. So, they’ve had one in the past, I think Bob Hawke, our former Prime Minister was on the board in the 70s, when he was the head of the ACTU.
And then we’ve had various other ACTU secretaries on the Reserve Bank Board. There are some people pushing for a regional rep., but, one thing that Peter Tulip, who’s Chief Economist at Centre for Independent Studies has been pushing for is, he said that the problem is, we don’t have enough people who know about inflation and monetary policy on the board. And so, we need more of those people. We need more, it’d be better to have more economic experts or economists on the board.
Darren Brady Nelson 26:05
Yeah. And maybe, also further, how about a variety of use, and not just the one kind of, you say, mainstream, and but that’s still a worldview, it’s still a way of looking at things. And it’s not the only way of looking at things. The combination of, essentially New Keynesians, for the most part, with maybe a little, like 80-20 Keynesian monetarist; that’s maybe what, most mainstream sort of, macro folks, that’s kind of what they’ve learned and whatnot, be good to have somebody else. Have an Austrian point of view, have maybe a full on monetarist point of view, whatever; just something that’s not just the one point of view, , so it’s not just Tweedledee and Tweedledum, every time either on the board or this review.
I’m not saying these people aren’t smart, or anything like that; the three people you mentioned, but I suspect there’s not going to be a whole lot of push and shove between the three.
Gene Tunny 27:04
So, I think the review in a way, presumes that there won’t be radical changes. The Reserve bank is going to continue as an institution, we’re still going to have Fiat money. Is that the sort of thing that you think should be up for review, that we should be looking at something more fundamental?
Darren Brady Nelson 27:25
Well, at least you have one person on there who can be the dissenting voice to say, something like that, but I’m saying, even if it was, say, one Keynesian, one monetarist, and one Austrian, I think you might get a pretty decent review out of that, with the monetarist if you like, in between the two, to some extent.
So, you still have 2 – 1, want to keep a central bank going, but we just, good to kind of be realistic about, what a Central bank does and what inflation is, what monetary policy is, all that sort of stuff. That’s fine, if the board, I’m not saying, the board should be all full of economists, even if it was a mix of those types of economists, I think it’s fine to have some other, you know, depending on how big the board is, you know, there would be room, I guess, for a union and a business representatives and maybe some other stuff as well, that’s fine.
And then they should also review, also the goals of the Reserve Bank; what’s legislation. There’s a lot of stuff in there besides inflation, maybe, just to look at it, and kind of whether all that needs to be in there, or whether there’s should be a better balance, or you should prioritize and go, inflation is number one, and then something, that type of thing. It’d be great.
A lot of these reviews aren’t all that genuine, they already have a political goal. I mean, you say they’re not political, but it always is, you know, to some extent, they’re under certainly under pressure anyway, regardless of who they stick in there to review things. Now, in the past, some of these reviews have been a lot less political than others, there’s always a political element, like the competition policy review wasn’t particularly political, but there’s always a little bit of an aspect to it, of course, I’d be surprised if they’re not under, some fairly great political pressure to start going beyond and started looking at, kind of cultural war type stuff, too, that they want to ingrain, sort of, race and gender and all that other stuff. I’ll be I’ll be pleasantly surprised as if that isn’t going to be a part of the review.
Gene Tunny 29:37
So, as far as I’m aware, race and gender won’t be at this stage, I don’t think. But one thing that possibly will be, now whether there’s a culture war issue or not, I don’t know. I think I’m not sure it’s, I guess there are aspects of it that are part of the cultural war but the debate about the climate. So, Warwick McKibbin, who is he’s a Professor of Economics at ANU, and he’s actually the husband of one of the reviewers. But you know, she’s independent of; she’s her own person… Renee Fry McKibbin; she’s Warwick’s wife.
Darren Brady Nelson 30:22
Actually, by definition, at least the old school definition marriages, you’re not, you’re one flesh. But anyway, I understand what you’re trying to say.
Gene Tunny 30:29
Okay, yes. So, I don’t think she’ll necessarily go along with Warwick’s view. But Warwick was at the conference of Economists in Hobart two weeks ago, where I caught COVID. And, it was a good conference other than that, it was a great conference.
Darren Brady Nelson 30:46
And super spreader of it.
Gene Tunny 30:49
Yeah, that’s right. And Warwick was on the panel. And now we’re talking about the Reserve Bank review. And one of the points he made is that we may have to amend actually, I think he’s saying we will have to amend our inflation targeting settings or our goals or objectives. We’ll have to amend that to incorporate climate change, because we have to recognize that if we’re going to be responding to climate change, we’re going to introduce a carbon price and one that increases over time. So, that’s what you need to have that sort of lowest cost adjustment path. So, to minimize the cost of adjusting to climate change, you’ll need to have a carbon price that increases and so that’s going to be increasing prices. So, you’ll need to look through the inflation, you’ll have to ignore the inflation that comes from the carbon price. So, I think culture war issues won’t come into it. But I think the climate change will come into the RBA review.
Darren Brady Nelson 32:01
Okay, well, that’s good to know. It’s terrible news. But it’s not surprising though.
Gene Tunny 32:06
But doesn’t it make sense what Warwick is saying? I mean, if a government does introduce a carbon price, and you’re going to have increasing prices because of that, then that’s not really inflation that the Central bank should be concerned about. What do you think of that perspective?
Darren Brady Nelson 32:25
It still should be concerned about it, even if, you know; this is all about thinking about the costs and benefits. It sounds like, just assuming, okay, well look, we’re just not going to worry about the downside of our carbon tax and our climate policies, because it’s such a, unquestionable good to pursue this. That’s ideology, that’s not economics, that’s really bad economics. And it’s also bad constitutional law, like, to what enshrine you know, certainly a very long-standing fad, of the climate sort of industry. But, the concept of inflation is something that stands the test of time. You can disagree on various aspects of it, but it’s always going to be, to the extent you’re going to have monetary policy, inflation is going to be an important thing to be thinking about, right. Climate change, may not be.
I’ve been following this debate since the mid-90s. And, I can tell you; well, just look at the polling, I can’t speak for Australia, but in the US, it’s something along the lines of; it’s well outside the top 10 of topics that people are concerned about in the US, for instance, then you want to start because, elites like him, are in a position to influence these things. They want to shove in the things that they care most about. And I think it’s just atrocious to think you can stick that into the Reserve Bank act. I assure you another government can come along and potentially change that if they want, if the electorate says, alright, you’ve been trying to convince us that the end of the world has been coming for 30 years, it hasn’t arrived, we no longer trust you. Sure, that might happen. And then, government could change things, but you know, so it’s a bit hard to change stuff in legislation, a lot of damage can be done in the meantime.
Gene Tunny 34:20
Okay. So, on where is where they’d make the change? It probably wouldn’t be in the act, they would have it in the agreement between the treasurer and the Reserve Bank. If I remember correctly, I think the general view on the Reserve Bank act from the late 50s was that, look, some of the language is a bit outdated. But you know, maybe leave that alone, you can do all you need you want to do within the agreement between the treasurer and the Reserve Bank. So, I think that’s where they would adopt something like that.
Just on that Reserve Bank Act, I think what they talk about in that is that the Reserve Bank is supposed to set monetary policy to have a stable currency to achieve full employment and to promote the prosperity of Australians or something. Something broad like that. Yeah. So, they’ll probably leave that and they’ll do whatever they want to do with if they did want to put some wording in about climate change, it’ll probably be very vague, because it is all very vague. We don’t really, I mean, I’ve got no idea what’s going to happen here in Australia. Politically, it’s, it’s such a vexed issue. And you’re saying is not in the top 10 issues in the US, it’s certainly in the top 10. It’s top five; top 3 here in Australia.
I mean, the previous government lost Blue Ribbon seats, seats that it’s held for decades, seats in affluent areas of Sydney and Melbourne. And it lost them because of climate change, because people in those seats are extremely concerned about it.
Darren Brady Nelson 36:07
Yeah, there’s a different point of view. Certainly, they did, but I wouldn’t extrapolate to say that means Australia as a whole has the same views as these inner-city suburbs, they’ve just changed the demographics and the ideological viewpoints of these people. That’s why they lost. Just like we’ve seen around the world, it’s the rich and upper-class professionals who gravitate towards status policies and status causes, like climate change. The working class, and in the middle, and lower middle classes do not. And electoral politics, isn’t just a straight representation of what the entire nation views necessarily. And putting aside the fact that the polling is often biased and bad and misleading and all that sort of stuff, but that decide.
I’ve seen some other people who; intelligent Australian commentators, James Allen, and people like that. We’ve been having a bit of look at that, to see whether, that mainstream narrative is actually true. They certainly lost obviously, those seats, they were blue ribbon, but they’ve been changing and moving left for a while now. So, particularly in the US, how climate change is almost really a non-issue from a broad electorate point of view, not any specific electorates.
Yet, that doesn’t stop the policies from carrying on and then you have all these perverse outcomes of like, I imagined Albanese will get more copy a lot of what the Biden administration so, the push for electric vehicles. Well, electric vehicles are still being produced by coal and natural gas, you know. So, you’re really in many ways, you actually might even be increasing carbon dioxide emissions through transitioning to electric vehicles from petrol vehicles. And the fact is, most of the world is actually increasing the use of coal, mostly India, China, Brazil, etc. And there’s even been a coal like I said, there’s been a coal comeback, even in Western countries as electric vehicle usage gets ramped up. So, these people don’t go, oh, no, we; the same people who say there’s an existential problem, keep on producing, keep on pushing electric vehicles, for instance. So, that their actions speak louder than their words that it isn’t really an existential crisis. Putting aside the fact obviously, all these elites tend to keep on buying beach side homes and all these sorts of stuff. I think just look at their actions, speak much louder than their words.
So, we’re getting this system where we get a worse electrical system because they keep on showing throwing more and more unreliable and expensive renewable energies on top of it, yet, they’re not actually starting to take much of the load of electricity production, they’re just sitting there costing more money and hurting the rest of the system. Yet, we’re still relying, and we’re going to keep on relying on coal and natural gas and the only renewable energy we’re going to lie and it’s going to be, water – hydro. Putting aside the fact you know, allow many new hydro to be built, but it’s bloody reliable. In the US, if it wasn’t for Quebec, all the hipsters in New York would be having more blackouts because they’re running on water; hydro from Quebec coming down into the US.
Gene Tunny 39:55
Where is that is that near Niagara Falls, or is it is that up in that Region.,
Darren Brady Nelson 40:00
Yeah. Quebec is like, the king of hydro in that part of the world, not just for Canada. In fact, Quebec is mainly supplying electricity to the US, part of the population that’s bigger. And that sort of the northeast of the US. So, that’s kind of insulating on, they can shove on some more solar panels and wind, but that’s not really generating a lot of electricity. And we also have the perverse effect from the main thing that, besides all the kind of pollutants, actually the toxic sort of, chemicals, and all the stuff that it’s needed for electric vehicles, needed for solar panels, needed for wind turbines, which obviously have detrimental environmental effects. They need coal, natural gas, and hydro to make those things in the first place. Not just to be the ones that really, supplemented when the wind’s up blowing, and the sun’s not shining. But if it wasn’t for all the fossil fuels, it couldn’t even build this stuff in the first place. So, all you’re doing is shoving all this stuff, people making a lot of money. A lot of people are virtue signaling, sort of, they keep on crying wolf for what, like 30 years now. There’s, nothing; there’s no significant evidence that we have a problem.
Gene Tunny 41:15
Well, I’ll push back and say we just had a 40-degree Celsius day in England that they’ve never had in their whole history.
Darren Brady Nelson 41:23
That’s not true. You go back, and we look at the Paleo challenge. You look at the evidence. For instance, in the US, this damn out in the Colorado River is having; it’s because of climate changes is at its lowest level, lo behold, a study, two weeks prior to them making such statements show that they’ve had more levels on the Colorado River 2000 years ago.
We’ve had warmer periods, we’ve had more carbon dioxide in the atmosphere in times. No, none of this is accurate. It’s all cherry picked to scare the poop out of people to accept these policies they want anyway. And you watch it when we’re old men, we’re going to be the people will go yeah, we’ll look okay, this thing didn’t happen. But I think it was the right thing to do anyway.
You hear that a lot, even now. They go like it will even for wrong, it’s the right thing to do. How’s it the right thing to do to make people poor? And have people in Africa starve? How’s that the right thing to do?
Gene Tunny 42:22
Okay, so in a future episode, we’ll have to come back to this, Darren, and we’ll see where we are with the with the data.
Darren Brady Nelson 42:28
You want to see the green policies and action? Look at Sri Lanka.
Gene Tunny 42:31
Yeah. Look, I’m not advocating for these policies, necessarily. Yeah. But I do recognize;
Darren Brady Nelson 42:42
That’s not about you, that’s just kind of aim at whoever’s watching this. It’s like, you want to see the future? The potential future? That’s Sri Lanka. That’s the way Australia could look, if they’re not careful.
Gene Tunny 42:55
And what did they do? They actually required organic produce, did they? Did they ban the importation of some fertilizers or something?
Darren Brady Nelson 43:07
Yes, fertilizers. Fertilizer was the main thing using green organic things instead of actual fertilizer. This is what’s happened in countries like Sri Lanka and African countries is to get their aid money. They do the green agenda, essentially. And it’s just a disaster.
I’ll tell you the countries that won’t be, it won’t be China, it won’t be India; the bigger countries that don’t need the foreign aid. And there’s also strategic implications, obviously. Who controls the green energy market, ultimately? China – communist China.
Gene Tunny 43:51
They are producers of a lot of the solar panels. That’s correct. Yeah.
Darren Brady Nelson 43:54
They are almost a monopoly on this, and increasingly, all the support technology for it as well. So, in China, this is not a coincidence. It’s not like, oh, the market chose China, they were just the best people to do it. This is like, this is a plan. It’s a strategy by the Chinese government, and you can see it’s written down. There are books written on this by them to say, oh, this is what we’re going to be trying to do. That basically, it’s their mind calm. So, don’t be surprised, when some of this stuff comes true.
They have a plan that the Chinese economy is not a free market economy by any stretch of the imagination. You know, it’s a government controlled run for the purposes of, for the benefit of the Communist Party and the strategic interests of China. It’s not like you’re dealing with the Netherlands, that sort of thing. So, that’s also a huge thing. Because they’re an aggressive military power.
When the time’s right, they’re going to take action. Taiwan and whoever else, eventually over time gets in their way. So, to aid and abet this through these green policies that are aimed at a problem that doesn’t really exist or certainly not in the scale. And certainly, even if the problem doesn’t exist, too deep, to essentially decarbonize the economy is just like literally the worst solution for it. And to decarbonize it in a way that, benefits China immensely. These’re just terrible policies the whole way through and people hopefully one day will be held accountable for this.
Gene Tunny 45:46
Right, okay. We might go back to GDP just before we wrap up, and yeah, I think I agree. There’s a big debate to be had about those policies for sure. I mean, from Australia’s perspective, given that we’re such a small part of the world, doesn’t make sense for us at this stage to adopt those policies on a large scale. My view is we should try to cooperate internationally. But we need to ensure that other countries are following through with their commitments. And I’m not sure that that has always been the case, or it is the case. So, that my perspective on that.
On GDP, I guess the view is that; my sort of thought is that, Janet Yellen certainly went too far. The US possibly could be in a recession, despite the fact that jobs growth has been strong, despite the fact that you’ve got unemployment at 3.6%, you could be going into; you could be in a downturn. The GDP figures, if you look at the composition of them, you had inventories falling, that was a big part of it. So, businesses were selling goods, but they weren’t replacing their inventories. So, that could be a signal that they’re not expecting; they’re worried about the future, about future sales. We had a drop in residential construction. That was one and that’s probably driven by the increase in interest rates. At the same time consumption spending was up. So, that’s why the summer economists are thinking it’s a bit of a mixed report. And we’re not entirely sure, but my take on it would be the GDP numbers are definitely something be concerned about and Yellen probably went too far when she said, we’re not in a recession. I think that certainly could come back and bite her.
Darren, do you have any final thoughts on the GDP numbers? Or where the US economy is that?
Darren Brady Nelson 47:55
Pretty much agree with what you just said. And obviously, time is going to tell. I think the bad ministration policies are very bad. And that’s going to come home to roost. So, I think, it’s not going to be good times, economically for the US and if it’s not good times, economically, for the US, it’s not worth it. China is obviously a major player, but it’s not the engine of growth for the world just yet. The US still pretty much is. When the US sneezes, everybody catches a cold.
Gene Tunny 48:39
Yeah, that’s right. I remember that. That was a popular saying in Australia, at the Reserve Bank and Treasury. So, yeah, absolutely.
Okay. Darren Brady Nelson. Thanks so much for your time. It’s great to catch up, yes. And I look forward to chatting with you again in the future.
Darren Brady Nelson 48:58
Always great to be on your show and see you, Gene, thank you.
Gene Tunny 49:02
Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to firstname.lastname@example.org and we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
Thanks to this episode’s guest Darren for the great conversations, and to the show’s audio engineer Josh Crotts for his assistance in producing the episode and to the show’s sponsor, Gene’s consultancy business www.adepteconomics.com.au.
Market monetarists such as Stephen Kirchner argue nominal GDP targeting would be better than inflation targeting and could help central banks such as the RBA and the US Federal Reserve get back on track. Stephen is Director of the International Economy Program at the United States Studies Centre at the University of Sydney.
Stephen spoke about nominal GDP targeting with Economics Explored host Gene Tunny in episode 135 of the show, recorded in April 2022. Among other details of nominal GDP targeting, Stephen discussed the potential role of a nominal GDP futures market and for blockchain and Ethereum in such a market and in financial markets more broadly. You can listen to the conversation using the embedded player below or via Google Podcasts, Apple Podcasts, Spotify, and Stitcher, among other podcast apps.
About this episode’s guest – Dr Stephen Kirchner
Dr Stephen Kirchner is Director of the International Economy Program at the United States Studies Centre at the University of Sydney. He is also a senior fellow at the Fraser Institute in Canada, where he has contributed to research projects comparing public policies in Australia, Canada and New Zealand.
Previously, he was an economist with the Australian Financial Markets Association, where he worked on public policy issues relating to the efficient and effective functioning of Australian financial markets and Australia’s position as a regional and international financial centre.
Stephen has been a research fellow at the Centre for Independent Studies, a senior lecturer in economics at the University of Technology Sydney Business School and an economist with Standard & Poor’s Institutional Market Services based in both Sydney and Singapore. He has also worked as an advisor to members of the Australian House of Representatives and Senate.
He has published in leading academic and think-tank journals, including Public Choice, The Australian Economic Review, Australian Journal of Political Science and The Cato Journal.
His op-eds have appeared in publications including The Wall Street Journal, Straits Times, Businessweek, The Australian Financial Review, The Australian, and Sydney Morning Herald.
Stephen holds a BA (Hons) from the Australian National University, where he was awarded the L. F. Crisp Prize for Political Science, a Master of Economics (Hons) from Macquarie University, and a PhD in Economics from the University of New South Wales.
Transcript of EP135: Nominal GDP targeting w/ Stephen Kirchner
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.
Gene Tunny 00:01
Coming up on Economics Explored.
Stephen Kirchner 00:04
If you want to avoid, you know hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve and then monetary policy has to work a lot harder to stabilise the economy.
Gene Tunny 00:23
Welcome to the Economics Explored podcast, a frank and fearless exploration of the important economic issues. I’m your host, Gene Tunny. I’m a professional economist based in Brisbane, Australia and I’m a former Australian Treasury official. This is Episode 135 on nominal GDP targeting. My guest this episode is Dr. Stephen Kirchner, who is Director of the International Economy Programme at the United States Studies Centre at the University of Sydney in Australia. In this episode, Stephen tells us why nominal GDP targeting would be better than inflation targeting and how central banks such as the Reserve Bank of Australia and the US Federal Reserve can get back on track. Please check out the show notes for relevant links and for details of how you can get in touch with any comments or suggestions. I’d love to hear from you. Righto, now for my conversation with Dr. Steven Kirschner on nominal GDP targeting. Thanks to my audio engineer Josh Crotts for his assistance in producing this episode. I hope you enjoy it. Dr. Steven Kirchner of the US Studies Centre. Welcome to the programme.
Stephen Kirchner 01:36
Thanks for having me, Gene.
Gene Tunny 01:37
It’s a pleasure, Stephen, keen to chat with you about a paper you wrote last year on Reforming Australian Monetary Policy: How Nominal Income Targeting Can Help Get the Reserve Bank Back on Track. So there’s a lot to talk about here. And I think this is of general interest to people in other countries, as well, other than Australia, because this idea of nominal income targeting, it’s been raised in other countries, I know that you’ve appeared on David Beckworth’s podcast, Macro Musings, and I know that David Beckworth is a proponent of this in the United States. So I’d like to ask about, essentially, what is this nominal income targeting compared with how we normally, or how central banks have been running monetary policy? Would you be able to give us an overview of that, please?
Stephen Kirchner 02:38
Sure. I think nominal income targeting is actually not a huge change from where we are at the moment. So most central banks do what they call inflation targeting. And as part of an inflation targeting regime, they’re typically adjusting their monetary policy instrument, usually an official interest rate in response to deviations in inflation from target. But also responding to deviations in output from its full employment, or potential level. And the reason you have output as part of your reaction function is the output gap is predictive of future inflation outcomes. So if you’re running an inflation targeting regime, you want to respond to both deviations inflation from target, and output from potential.
Well, if you think about those two things, inflation on the one hand, and output on the other, if you put those two things together, then you’ve got nominal income, or nominal GDP. So in some respects, nominal GDP targeting or nominal income targeting is just a really weighting of that standard central bank reaction function. So if you think about a Taylor rule, which is just an empirical description of how the interest rate responds to deviations and inflation from target, and output from potential, all nominal GDP targeting is doing is saying you want to put inflation output together and weight them equally in terms of the interest rate response.
Gene Tunny 04:14
Ah, right. Okay. Yeah, that’s a good way of describing it. Yeah, please go on.
Stephen Kirchner 04:18
Yeah, so in that sense, it’s not a huge leap from where we are at the moment. But what it does mean is that the central bank is a bit more agnostic about its response to inflation, and deviations in output from potential. So it’s saying really we want to stabilise both, and the reason you want to stabilise both is if you’re just focusing on inflation, one of the problems you face is not all of the deviations in inflation from target are reflective of aggregate demand shocks. As we know, especially at the moment inflation can deviate from target due to supply shocks. Supply shocks have the effect of lowering output. And so this creates a dilemma for a central bank in how do you respond to a supply-driven inflation shock, or deviation from target. Because if you respond to the deviation in inflation from target and raise interest rates, then that’s going to compound the reduction in output you’d get from a supply shock.
Gene Tunny 05:28
Right. So one example, I’m just thinking, Stephen, is one example of this, did this occur, arguably a policy mistake? Was it 2008 when the European Central Bank put up its policy rate? Not long before the financial crisis? Because there was a supply shock? Or was there an increase in the price of oil? I’m trying to remember, is that one of the examples I give?
Stephen Kirchner 05:55
Well, I think the canonical example here is what happened in the 1970s, when you had very significant increases in oil prices giving rise to higher rates of inflation. And central banks did respond to those oil price shocks through tighter monetary policy. And so there’s an influential paper by Ben Bernanke, Watson and Gertler in 1997, which showed that the propagation of the oil price shock to the US economy was essentially through the monetary policy reaction. And so it was the central bank that actually put the stag into stagflation.
Another example of this would be if you go to September 2008, the FOMC meeting took place a couple of days after the failure of Lehman Brothers. And this was at a time when inflation expectations were collapsing and nominal GDP expectations were collapsing. At that meeting, the FOMC incredibly left the Fed funds rate unchanged, and cited inflation pressures arising from higher oil prices as the reason for keeping monetary policy steady. So this is a very good example of monetary policy being led astray by inflation outcomes that are being driven by supply shocks rather than aggregate demand shocks.
And so what we want is the central bank to respond to inflation pressures to the extent that they’re reflective of aggregate demand shocks, not aggregate supply shocks. And nominal GDP lets you do that without actually having to take a view on what’s driving inflation. So nominal GDP outcomes will tell you the extent to which your inflation issues are being driven by aggregate demand rather than aggregate supply.
Gene Tunny 07:51
Okay, so yeah, a few things to try and explore here. Stephen, inflation targeting. So it’s typically going for something around well, in Australia, it’s 2 to 3%, we’ve got a target band for inflation. And in the US, is it 2%? Or I remember thinking of Bank of England? But the different countries have just slightly different targets.
And what’s fascinating is that when these things were first formulated, we had much higher inflation. And I think no one ever expected we’d be getting consistently, we’d inflation outcomes consistently lower than those targets. And it makes it difficult to think about what’s the appropriate monetary policy response.
I better make sure I understand your argument about why you think the Reserve Bank needs to get back on track. Are you suggesting that the fact that Australia is similar to some other advanced economies, who’ve had inflation outcomes below the target for a substantial amount of time, that would imply that the Reserve Bank, the central bank had scope to expand to have a more expansionary monetary policy which could have pushed the economy closer to full employment? Is that the argument, broadly?
Stephen Kirchner 09:14
Yeah, that’s certainly true of the sort of pre-pandemic period basically, the period in which the RBA was undershooting from approximately 2014 through to the onset of the pandemic and even into the pandemic. So it’s certainly in the last couple of quarters that inflation has returned to target. I mean, I think the specification of the inflation target inevitably is a little bit arbitrary. What matters most is not the exact target range, but the fact that you hit that target more often than not over time and thereby establish your credibility in relation to that target. So ultimately, what you’re trying to do is condition the expectations of price, and wage setters in the economy should be consistent with that target. And so whether it’s a 2% target or 2 to 3% target, it’s less important than the fact that you have one and that you actually stick to it.
But the case for nominal income targeting is to say if you’re only targeting inflation, and this creates a bit of a presentational problem and a sort of implementation problem, which is that what happens in the context of a supply shock when inflation might be above target? How do you explain to people the fact that you’re not hitting your target, even though there’s probably a very good reason why you’d want to look through that supply shock.
If you’re expressing your monetary policy target in terms of nominal GDP, that task becomes a lot simpler, because yes, you may be above target on inflation, but in the context of a supply shock, output is going to be lower. And so you don’t get the same sort of deviation from target under a nominal GDP targeting regime than you would under an inflation targeting regime. Policymakers are less likely to be led astray, because by focusing on nominal GDP, they don’t have this issue of trying to figure out whether inflation outcomes reflect demand shocks or supply shocks.
Gene Tunny 11:23
Okay, so how would this work in practice? So in nominal terms, so by nominal, you’re talking about, we’re not talking about a real GDP measure where we adjust for inflation, we try and get things in consistent dollars, you’re just talking about the total value of the economy, in GDP in nominal terms, so what it is in current dollars, and say that it’s over $2 trillion in Australia annually. And so would the Reserve Bank have a target? They would have an expectation of what that nominal income for Australia should be in 2022, what it should be in 2023. So it should be 2.3 billion by this date or something? Is that Is that how it’s formulated? A trillion I meant, not billion. Sorry,
Stephen Kirchner 12:16
You can’t express it in level terms. So with a nominal GDP target, you can express it both as a growth rate or an implied path for nominal GDP. But I think it’s important to emphasise that, just as with inflation targeting, you don’t target inflation outcomes, necessarily. What you’re targeting is actually the inflation forecast. So what you’re saying is, in future, you’re going to be realising inflation outcomes consistent with target, or with nominal GDP targeting, it’s exactly the same thing. So you want to specify a target path for the future evolution of novel income or novel output. And you want to adjust your monetary policy instruments to be consistent with that target path.
So if in any given quarter, your level of nominal GDP is a little bit above or a little bit below the target path, that’s not necessarily a problem. Again, what you’re trying to do is conditions people’s expectations in relation to what future nominal income will be. And I think that has very useful properties from the point of view of stabilising the economy, because if you think about things like wage and price contracting in the economy, people borrowing and lending, all those activities are conditional on expectations for future normal income. And so if you can stabilise both expectations for that future nominal income path, and by implication, also nominal GDP outcomes, then I think that’s a recipe for macroeconomic stability, more so than if you’re targeting inflation without regard to whether inflation is being driven by demand or supply shocks.
Gene Tunny 14:13
Right. Okay. Might go back to that Taylor rule. So you mentioned the Taylor rule. And you mentioned you can actually think of nominal GDP targeting in a, you call it a reaction function, so how the central bank reacts to the macroeconomic variables. And you said this gives equal weight to deviations of inflation from the target end of real GDP from the target. What does the Taylor rule typically do? Do ou know, what sort of normal parameters there are in that reaction function and what that means?
Stephen Kirchner 14:53
So the Taylor rule was due to John Taylor, who in the early 1990s sat down and said, well empirically, how do we characterise movements in the Fed funds rate. So he regressed the Fed funds rate on various macroeconomic variables. And the empirical description that he came up with for the Feds reaction function was to say, well, the Fed responds to deviations in inflation from target, and had estimated a weight of about 1.5 on that deviation, and also response to deviations and output from potential. And he estimated a weight of .5 on that.
But to sort of round out that empirical description of the Fed funds rate, you also needed an estimate of what the neutral Fed funds rate would be. So in other words, what happens when inflation is a target and output is a potential? What is the Fed funds rate consistent with that? And so that just ends up being a constant regression.
One of the big issues that sort of comes out of that is that’s obviously a historical estimate. What happens if your equilibrium real interest rate changes over time. So you then have the issue of, if you’re responding based on those historical relationships, but the actual equilibrium interest rate changes, and you may end up with monetary policy being miscalibrated. And I think that arguably happens in the United States, and to a certain extent here in recent years, where I think the equilibrium real rate probably fell considerably. And that meant that monetary policy ended up being tighter than central banks intended.
Gene Tunny 16:53
Okay, we might come back to that, I just want to go back to the Taylor rule that you mentioned 1.5. So that means for every percentage point that inflation would be above the target, so if the target’s 2%, and inflation is 3%, the central bank would put up the policy interest rate, the overnight cash rate or the federal funds rate by 1.5 percentage points. And the idea is there that you’re trying to engineer an increase in the real interest rate. So you want to make sure the interest rate increases more than the inflation component of it. Actually, yeah,
Stephen Kirchner 17:41
Yeah, that’s right. So this thing actually has a name, it’s called the Taylor principle. And the Taylor principle says that you want to move your nominal interest rate by more than one for one with the deviation inflation from target, because if you just do a one for one or a less than one point move, then you’re not going to move the real rate, you’re not going to move it in the desired direction. So it has to be a move that is more than the change in inflation. So that’s why you get a parameter estimate of a little bit more than one.
For some central banks, you get higher responses to inflation. So the BOJ, Bank of Japan, the ECB, depending on what sort of model that you look at, sometimes their reactions will be up around two. But yeah, the basic Taylor principle is that you want a response to inflation that is greater than one. But essentially, nominal GDP targeting says that you want to combine inflation and output in the form of nominal GDP, and you want to respond to that.
Gene Tunny 18:46
So I guess one of the points that you make, and I think it is a good point, that to do this Taylor rule properly, you need estimates of these unobservable variables, such as this equilibrium real interest rate. And as you rightly point out, I mean, this is something that… Interest rates are much lower now than we ever expected. You compare historically, it’s quite extraordinary what we’ve seen since the financial crisis in Australia, and the US and UK, and even before then in Japan, since the ‘90s. Absolutely extraordinary.
So I want to make sure I understand the logic again. You mentioned that this means that monetary policy was not as aggressive or as accommodative, or however you describe it, because the equilibrium real interest rate, whatever that is, whether it’s… Say it was 4% and now it’s much lower than that. How does that logically work, Stephen? Can you take us through that logic? I just want to make sure I understand how it would lead a central bank to go astray.
Stephen Kirchner 20:00
Actually, the problem is a bit broader than that. So there are potentially three unobservable variables it would impact. Taylor rule style reaction function, and potentially monetary policy Australia. So one is the real equilibrium interest rate, as we’ve discussed. It’s not directly observable. And it could be higher or lower than we think. But I would say it’s probably been lower than policymakers have thought. In terms of the output gap, then you have the problem that we don’t directly observe potential output either. And so that could be higher or lower than we think. And so policy can be miscalibrated on that basis.
An alternative way of thinking about the output gap is to think in terms of an unemployment gap. So the deviation in unemployment from its full employment level, and this is of course where we get the NAIRU from. So the idea that there’s an unemployment rate that’s consistent with the stable interest rate. And both the Federal Reserve and the RBA have conceded in recent years that the NAIRU has actually been a lot lower than they realised. So they have downwardly revised their estimates of the NAIRU.
And so for much of the post financial crisis period, I think both the Fed and to a lesser extent, the RBA were conditioning monetary policy on a view that the unemployment rate was pretty close to the NAIRU, when in fact, it was probably sitting quite a bit above the NAIRU. And so what that meant was we had monetary policy that was two tight. They could have actually pushed the unemployment rates lower. And done it in a way that would have meant that inflation was more consistent with target as well.
So you can see that the problem with a sort of Taylor rule type approach is that embedded in the Taylor rule, you’ve got at least two unobserved variables. You’re trying to estimate what those unobservable variables are and condition policy on it. So what nominal income targeting says is well, in fact, you don’t need to take a view on either the equilibrium real rate or the NAIRU or potential output, because nominal GDP in and of itself is a complete description of the stance of monetary policy. And in the long run, nominal GDP is fully determined by the central bank. So the central bank can both influence the long run level of nominal GDP, and the level of nominal GDP tells you whether monetary policy is too easy or too tight at any given time.
You don’t need to do what’s sometimes called navigating by the stars, which is, in macroeconomics, when you write this stuff down in the form of equations, the equilibrium values, the real interest rate, the NAIRU and potential output, those variables denoted with an asterisk or a star. And so we were first and policy that sort of conditions on those variables as navigating the stars. This is what leads monetary policy astray. It’s the problem that nominal GDP targeting seeks to address
Gene Tunny 23:24
Okay, so by NAIRU, N-A-I-R-U, which stands for non-accelerating inflation rate of unemployment, such a horrible expression. We use it all the time. Okay, we’ll take a short break here for a word from our sponsor.
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Gene Tunny 24:14
Now back to the show. So how’s this gonna work in practice, Stephen? I’m wondering, and does that mean the main thing the central bank is looking at it in their deliberations, so the board meeting of the Reserve Bank or at the Federal Open Markets Committee, or the Monetary Policy Committee, in the UK, or in the FOMC and in the US, they’re just looking at what the latest data are telling them about GDP, about nominal GDP? They’re trying to forecast that themselves based on a range of indicators, I suppose. Have you thought about how it’s going to work in practice?
Stephen Kirchner 24:55
I think central banks should basically look at all the information that’s available to them in forming a view. So the question is more in terms of what their target is and how they specify that target. And, importantly, also how they describe their policy actions in relation to that target. And so, the purposes of adopting a nominal GDP target, one way to do that is to specify a target path for the future evolution of nominal GDP. So you can do that out a few years in advance. And you would then explain your changes in your operating instrument in terms of an attempt to hit that target path.
So for Australia, for example, it would be a simple matter of rewriting the agreement with the treasurer, what we call a statement on monetary policy, which basically sets out what the RBA is trying to achieve through its conduct of monetary policy. And you would specify that in terms of a path, the future path for nominal GDP.
One of the things I do in my paper for the Mercatus Centre is to estimate an implicit forward-looking nominal GDP targeting rule for the Reserve Bank. So I basically do for the RBA, what John Taylor did for the fed back in the early 1990s, and say, How would an empirical description is nominal GDP targeting of how the RBA has actually changed the cash rate in the past?
And as it turns out, it’s actually not a bad empirical model of what they’ve been doing historically, because even if you’re thinking of monetary policy material type framework, you know, you’re still trying to stabilise nominal GDP. You’re just putting different weights on those two components of inflation output. But if you think of monetary policy as just responding to the nominal GDP, well, to some extent, the RBA is already doing that. Where I think nominal GDP targeting is helpful is, at the margin, I think it would lead to better monetary policy decisions, for the reasons that we’ve already talked about that. At the margin, they would be focusing more squarely on nominal demand shocks and looking through supply shocks, which I think is where monetary policy has run off track in the past.
Gene Tunny 27:34
Okay, so I want to ask about the RBA. So you want to get the RBA back on track. And one of the areas or one way you think that it’s off track is that over the last decade or so, or maybe over the last five years, or maybe a bit longer than that, it’s paid too much attention. Am I getting this right? You think it’s paid too much attention to financial stability risks, and this is called leaning against the wind? I think it’s denied that it actually does lean against the wind. Is this one of your criticisms of it, Stephen? And if so, what’s wrong with taking financial stability risks into account when setting monetary policy?
Stephen Kirchner 28:15
So there’s a long running debate about the role of financial stability, inflation targeting framework, and to what extent you should take financial stability concerns into account when doing inflation targeting. And one conception of this is to say that if you are doing inflation targeting, and you’re underpinning nominal stability in the economy, that this in itself is conducive to financial stability. And so, you want to prioritise nominal stability and that is the way you get financial stability.
And to the extent that financial instability becomes a problem, then monetary policy can always address that ex post. So the way the debate is sometimes characterised is between leaners and cleaners. So if your reaction to financial instability is ex post, then you’re cleaning up after you get a financial stability problem. If you’re a leaner, then you’re trying to sort of anticipate those financial instability problems. And to that extent, you’re going to potentially sacrifice your inflation target in order to head off some of those concerns.
So central banks will always obviously have to respond to financial instability after the fact to the extent that it creates problems for the macro economy. The real question is, to what extent do you try to do that preemptively. And I would argue that we don’t have enough information about financial stability risks to really do that successfully, preemptively. And traditionally, that was kind of the view that the RBA took. So if you look at the 2010 statement on monetary policy agreed between the treasurer and the RBA governor, that statement was the first to incorporate financial stability as a consideration. So it was the first statement after the financial crisis. And so it’s no surprise that that statement took on financial stability concerns.
And in that 2010 statement, it says very explicitly that, yes, the Reserve Bank should take account of financial stability, but without compromising the price stability objective. So financial stability concerns were made explicitly subordinate to price stability. And so that reflects the view I talked about before where you view nominal stability as being the most conducive way to address financial stability risks. So that would be the way that I would tend to formulate that relationship between price stability and financial stability.
What happened when Philip Lowe became governor in 2016 is there was a change in the wording on the statement on the conduct of monetary policy, which essentially turned that relationship on its head. So that statement explicitly provided for short-term deviations in inflation from target in order to address financial stability risks. So that agreement was essentially saying that there may be times when in the short run, we’re going to allow inflation to deviate from target in order to address financial stability concerns. And those concerns were explicitly nominated as a reason why you might look at the inflation target.
Gene Tunny 31:51
They might accept lower than the target inflation, because they don’t want monetary policy so stimulatory that it means that there’s a big growth in housing credit and house prices. Is one of the criticisms of what the RBA is doing now. I mean, I’m interested in your views on what it’s done during the pandemic, because we’ve had very aggressive monetary policy response. And this has arguably contributed to the boom in housing credit and house prices where we’ve got double digit, we’ve had house prices increase by over 20% In some cities. And I mean, to me, I mean, it looks like monetary policy has been too aggressive during this period. But yeah, I’m interested in your view on that, Stephen. And I mean, how does what they’ve done, how do you assess that given you’re an advocate of this nominal income targeting? How compatible is what they’ve done with that, please?
Stephen Kirchner 32:58
So if you look at the period from 2016, through to the onset of the pandemic, that changed, and the wording of the statement in the conduct of monetary policy ended up then being a very good description of monetary policy under Governor Lowe. So, through that period, the RBA very explicitly traded off concerns around, in particular the household debt-to-income ratio, and said, Well, the reason why we’re letting inflation run below target is we’re worried that if we provide more stimulatory monetary policy settings, then that would trigger more household borrowing, and potentially create risks in in the housing market. And the concern was that by the household sector taking on increased leverage, that this would increase the household sector’s exposure to a shock. So essentially, you’re trying to fight the last war in terms of the 2008 financial crisis. They were trying to mitigate what they saw as the risks that led to that particular event.
Now, one of the criticisms of leaning against the wind, I think, and this is a criticism that’s been made very persuasively, I think, by Lars Svensson, Swedish economist, is to say, well, if you’re conducting monetary policy on the basis of an apprehended financial stability, its annual trading off inflation and output against those risks, then in a sense, what you’re doing is you’re setting yourself up to have a weaker starting point if and when a financial crisis does occur. So the starting point for the economy is actually going to be weaker because you’ve been running monetary policy, it’s been too tight. And so this is a mistake that the Swedish central bank made In the early 2010s, and which led Lars to sort of formally model leaning against the wind and coming up with that characterization.
Peter Tulip who was a former Reserve Bank economists, when he was at the bank. He also did some work, basically applying Svensson’s framework to Australia and showing that in terms of the trade-off between the central bank’s objectives and financial stability risks, the RBA was basically incurring costs anywhere from three to eight times the benefit in terms of mitigating financial stability risks. So the cost in terms of having unemployment, for example, higher than would have been otherwise, you know, more than offset any gain in terms of reducing financial stability risk.
So essentially, I think this is a hierarchy in knowledge problem that the central bank really does not have enough knowledge about the economy to be able to successfully lean against the wind. This explains why the RBA undershot its inflation target for the better part of seven years. And it was an explicit policy choice, you know. This wasn’t an accident.
Going into the pandemic, I would say that the initial monetary policy response was inadequate. And this was essentially a function of the RBA trying to conduct monetary policy within its traditional operating framework. So they were still trying to use the cash rate as their main operating instrument, even though the cash rate was constrained by the zero lower bound on a nominal interest rates.
Gene Tunny 36:43
So we had a cash rate of, was it .25% going into the pandemic?
Stephen Kirchner 36:49
Going into the pandemic, it was point .75.
Gene Tunny 36:52
Oh, right. Yeah, sorry.
Stephen Kirchner 36:54
In March of 2020 they lowered it by 50 basis points in 2 increments of .25. And that took it down to a quarter of a point, which they argued at the time was an effective lower bound inasmuch as the RBA operates a corridor system around that target cash rate. And so the bottom of the corridor would have normally been at zero, if they had maintained that system. Subsequently, of course, the RBA did lower the cash rate below .25. So it turned out that it wasn’t a lower bound after all. It was very much a self-imposed constraint.
But going into the pandemic, they tried to conduct monetary policy very much within that conventional operating framework with the cash rate as the main operating instrument. And I think, because they allowed the level of the cash rate to determine how much stimulus they would provide… And initially, monetary policy was way too tight. So even though they had lowered the cash rate, what we saw between March 2020 and November 2020, when they finally adopted QE, was that the Australian dollar appreciated significantly. So the Australian dollar outperformed all of the other G10 currencies over that period. The appreciation on the trade-weighted index was about 10%.
And so what this is telling you is that in relative terms, we were not doing nearly as much as other central banks. And we were paying a penalty for that on the exchange rate. The other element of this, of course, was the macroeconomic policy mix, so the relative weight on monetary and fiscal policy. So our fiscal policy response was one of the strongest in the world. But our monetary policy response wasn’t.
Gene Tunny 38:52
Initially, yeah, gotcha.
Stephen Kirchner 38:54
At least up until November 2020. And so this is a recipe for the open economy crowding out effects that you discussed with Alex Robson, when you talked about Tony Makin’s work on open economy crowding out. So if you have a fiscal policy response, if you’re overweighting on fiscal policy relative to monetary policy, you’ll pay a penalty for that exchange rate. And that’s exactly what happened. And that was a pretty strong indication that monetary policy of this period was too tight. The RBA could have done more but didn’t because it was trying to conduct policy within its traditional operating framework.
Gene Tunny 39:33
Right, and by more you mean quantitative easing or large scale asset purchases, creating new money, printing money electronically and then using it to buy financial securities bonds, for example?
Stephen Kirchner 39:48
Yeah, so there are two alternative operating frameworks that they could have used. One is negative interest rates and the other is large scale asset purchases or QE. And so by November 2020, the RBA conceded that other central banks had done more to expand their balance sheet. And they needed to do the same. They also lowered the cash rate target from .25 to .1. And they lowered the bottom of the cash rate corridor from one to zero. So effectively, they conceded that they could have done more and needed to do more, and they finally delivered. And at that time, they did adopt a very aggressive asset purchase programme because they were playing catch up to other central banks. And so by the time we’ve got to the end of 2021, in fact, the RBA had expanded its balance sheet as a share of GDP by an amount that was broadly equivalent to what the Fed had done.
So one of the ironies here is that the RBA’s attempt not to expand its balance sheet actually ended up being a balance sheet expansion that was comparable to that of the Fed. And I think this is an important lesson for monetary policy generally, that typically, if central bank is using its policy instruments aggressively, and over a very extended period of time, that’s usually an indication that it didn’t do enough upfront. So in fact, if you want to avoid, you know, hitting the zero lower bound or expanding your balance sheet by a significant amount, the way to do that is to respond quickly and aggressively upfront. If you don’t do that, then you fall behind the curve, and then monetary policy has to work a lot harder to stabilise the economy. And I think that’s what ended up happening in Australia in response to the pandemic.
Gene Tunny 41:42
Right, okay. You’ve written another fascinating paper on this, Stephen. The paper’s titled The Reserve Bank of Australia’s Pandemic Response and the New Keynesian Trap. So this was published in Agenda, which is a journal put out by the Australian National University. And I want to ask you what you mean by New Keynesian trap. But I think I sort of know, I think you’re sort of alluding to the fact that a new Keynesian policy approach would be inflation targeting, but you can correct me on that. But the point you make, and I think this is fascinating, you want to explore this and make sure I understand what you mean here, you write, “A monetarist conception of the monetary transmission mechanism would have encouraged more rapid adoption of alternative operating instruments.” So could you explain what you mean there, please?
Stephen Kirchner 42:33
Yeah, so the New Keynesian trap was exactly what I was describing in terms of the monetary policy response to the pandemic. The New Keynesian framework for monetary policy analysis relies excessively on an official interest rate as not just the central bank’s only operating instrument, but also the only way that you get monetary policy into that model. And the problem with this is that if the central bank thinks of monetary policy implementation and monetary policy transmission exclusively in terms of an official interest rate, then that’s going to be a problem when your official interest rate hits the lower bound, because at that point, your model basically blows up, because if you can’t lower the nominal interest rate, in a situation which is calling for easy monetary policy, then that’s a recipe for macroeconomic instability. And in fact, it becomes a downward spiral because the economy deteriorates and you can’t respond through your conventional monetary policy instrument.
And in the sort of New Keynesian literature on monetary policy, there are all sorts of ways in which they try and sort of solve this problem. So in some of that literature, for example, there’s just an assumption that fiscal policy steps in to bail out the central bank. And to some extent, that’s what we saw with the pandemic response, which was that you might have noticed during the early stages of the pandemic, the Reserve Bank Governor was begging the federal and state governments to do even more with fiscal policy than they were actually doing, even though the fiscal policy response is quite large. And so really what he was saying was, my hands are tied, you need to do more to stabilise the economy.
Now, were the central bank’s hands tied by its operating framework? Well, only in the sense that they perceive that framework to be binding on their decision making. If you go back to November 2019. Governor Lowe gave a speech in which he addressed the issue of negative interest rates and quantitative easing. And he was arguing that it was very unlikely that the central bank would have to go there. And if you read that speech, you can see he’s very reluctant to contemplate using either of those policy instruments. So for me, the New Keynesian trap, it’s a self-imposed constraint on monetary policy. It’s because of the way you’re conceiving both the monetary policy instrument and the monetary policy transmission mechanism, it leads you to pull your punches in an environment where you need to adopt a new operating frame.
And for me, the fact that the RBA walked away from that framework in November of 2020 basically concedes the point, they realised that their traditional operating framework was not adequate in responding to a massive shock when the interest rate was hitting the zero bound, and so they needed to think of monetary policy in an alternative framework. And so this is where an RBA officials started giving speeches about the role of quantitative policy instruments and quantitative transmission mechanisms in the monetary policy implementation. If they had done that back in March of 2020, I think we would have had a more timely, more effective monetary policy response and avoided what I’ve called the New Keynesian trap.
Gene Tunny 46:22
Yeah, yeah. Okay. I mean, I think you’ve been rightly critical of the RBA. If they eventually had to adopt these measures, and arguably, they should have done them earlier. So very good point. I want to make sure I understand why it’s a monetarist conception, why that would have led to more rapid adoption. Is that because a monetarist would have been looking at the monetary aggregates, they would have been thinking about, well, how, how could we make the monetary aggregates grow at the rate that would be optimal? Is that what you’re thinking? And you’re just not thinking in terms of a cash rate? You’re thinking in terms of the money supply?
Stephen Kirchner 47:03
Monetarists have always been very critical of the idea that an official interest rate is both the best characterization of what monetary policy is doing, but also the idea that it’s a complete representation of the role that monetary policy plays in the economy. So it’s true that, you know, in equilibrium, you could say that an official interest rate might be a good representation of the contribution of monetary policy.
The way monetarists tend to think of the long run evolution of the price level is in terms of the long run supply and demand for real money balances. And so they tend to think of the evolution of monetary policy in a quantity framework rather than a price framework, the price being the interest rate. So you can think of monetary policy instruments either working through a price, which is the interest rate, or quantity, which is the supply and demand of real money balances. I think both modes of analysis have their place, and they’ve clearly linked. But the focus on official interest rates, I think has been very misleading, because you know, of itself, the level of the cash rate, tells you very little about the stance of monetary policy.
I think one of the mistakes monetary policymakers have made internationally and in Australia has been to assume that because the nominal cash rate is low, monetary policy must be stimulatory. And one of the points that Milton Friedman made repeatedly was to say, if the nominal interest rate is low, then that’s probably indicative of tight monetary policy because that probably means that inflation is very low as well, if you think of the contribution that inflation makes to the nominal interest rate. So if you’ve got very low nominal interest rates, that’s probably an indication that monetary conditions are too tight, rather than too easy. And I think it’s a mistake that monetary policymakers have repeatedly made.
Milton Friedman warned against it in his 1968 presidential address to the American Economics Association. And throughout his life, he tried to impress upon policymakers the significance of this. But it’s something that’s still eludes policymakers, I think, and you can see it in some of the comments that the RBA and Governor Lowe has made in recent years where they often emphasise the low level of the cash rate as being self-evidently indicative of an easy monetary policy stance when, in fact, if anything, it’s probably an indication that monetary policy is too tight.
By the same token, if you go back to say, the late 1980s, in Australia, when we had double digit inflation rates, well, we had double digit interest rates as well. At that time, very high level of interest rates was in fact indicative of the fact that the RBA had run monetary policy in a way that was way too easy, giving us high inflation.
Gene Tunny 50:34
Yeah. And it was that experience that did prompt the adoption of inflation targeting because we weren’t inflation targeting back then. They had some checklist approach or whatever. This was just after they had the brief experiment with monetarism, and then they had a checklist or something and they didn’t have an explicit inflation target until the early ‘90s. I mean, Stephen, would you agree that arguably, inflation targeting was a good thing to adopt at the time? I mean, did it actually improve? Do we get better monetary policy for a while with inflation targeting? Was it better than what we had before?
Stephen Kirchner 51:09
I think inflation targeting was a very important and helpful innovation. They’ve got central banks focused on nominal stability, which is what you want them to do. And I mean, I’m still a defender of inflation targeting as much as I think you could make the current inflation targeting framework work better. And the way in which you would do that would be to focus on as you’re looking through supply shocks, so in other words, not responding to increases in inflation that are clearly driven by supply side constraints, like some of the inflation pressures that we’re seeing at the moment. Where nominal income targeting is helpful I think is helping you to do that.
So one way of thinking about nominal income targeting is you could think of nominal income as an indicator variable or an inflation variable, which tells you when you need to respond to inflation with monetary policy and when you shouldn’t. So that would be one way in which you could improve an inflation targeting regimen would be to sort of look at both variables and use that to help you sift through what inflation shocks you want to respond to, what inflation shocks you want to look through. I don’t think we have to necessarily give up on inflation targeting but we probably do need to change the way we do it, because I think inflation targeting in recent years has failed on its own terms, because central banks have said, well, we’re targeting inflation, but in fact, they’ve missed the target. So if you’re missing the target, you’re not doing it properly. So clearly, you need to change the way you’re doing it.
Gene Tunny 52:49
So as an implication of what you’ve said, are you implying that there’s a risk of the Reserve Bank could increase the cash rate too much, because it’s reacting to CPI data that partly, the inflation is going to be driven by this supply shock? Is that a concern of yours?
Stephen Kirchner 53:12
Yeah, I mean, we’ve certainly seen that in the past. So we talked before about the Fed, and the ECB in 2008 I think clearly made that error. And I think it’s a risk at the moment. At the moment, we have both supply and demand shocks driving inflation. So there’s been a huge dislocation in the supply side of the global economy due to shifts in demand, so that the speed of the recovery has basically caught the supply side of the world economy short. It’s struggling to keep up. And so there’s a big supply component to existing inflation pressures.
In the United States, I’d say there’s also a demand component inasmuch as one of the things that Mercatus Centre has done has been to develop what they call an NGDP gap, which is basically a measure of the deviation in nominal GDP from long-run expectations. At the moment, we have a positive nominal GDP gap in the United States. And so consistent with the nominal GDP targeting framework, that’s saying that there are excess demand pressures in the US economy. And so you would want monetary policy to respond to that. And so I think this is why the Fed is tightening at the moment. It’s appropriate that they do so because there is excess demand in the US economy, and GDP expectations are a good guide. But at the same time, there’s a very significant supply side component to this. And that is something you probably want to look through.
So one way to think about US monetary policy at the moment is the Feds should be tightening with the views of closing that nominal GDP expectations gap on the Mercatus measure. That would require some tightening of monetary policy but not nearly as aggressive as if you were trying to fully stabilise consumer price inflation.
Gene Tunny 55:13
Right. So nominal GDP in the US by that Mercatus measure, it’s higher than that path that long-run path. Is that right?
Stephen Kirchner 55:25
Yeah, that’s right. So on their measure, the level of nominal GDP is running at about, I think, 3% above the path implied by long-run expectations for nominal income. So from a nominal GDP targeting framework, you would certainly want to respond to that.
Gene Tunny 55:41
Right. Now, this is one thing I’ll want to just make sure I understand. In your paper, you talk about how it’s good to correct for deviations from that target path, that nominal path. Why does a target path in nominal terms? Why is that relevant? I think one of the points you make is that, traditionally, central bankers wouldn’t really worry about the nominal path, or they if you did have low inflation for a period, and that meant that you were below that nominal level, it’s not as if you’re going to ramp up, they wouldn’t have a more stimulatory monetary policy just to try and hit a particular GDP number in nominal terms, say two and a half trillion or something, because well, what does the actual nominal value of it matter? What matters is what’s the real value of it and how many people are employed, that sort of thing? I want to understand that. Are you saying that we should try and get back to some sort of the nominal GDP number that was implied by the path we’re on?
Stephen Kirchner 56:54
Yeah, I would say that nominal GDP stabilisation is still implicit in what the RBA and the Fed do today. So if you’re stabilising inflation around target and output around potential, then that will certainly be conducive to stability in nominal GDP. It’s just that we’re not explicitly framing monetary policy in those terms. So at the moment, we frame it in terms of the cash rate responding to deviations in the inflation target, or deviations in output or the unemployment rate from their assumed equilibrium values. All I’m saying is you want to reframe the way in which you implement monetary policy in terms that are currently implicit, but arguably should be explicit.
So really, I’d say monetary policy is trying to stabilise a path for the future path of nominal GDP. Were just not explicit about it. So it’s really reframing monetary policy in those terms, to bring out those relationships. But I think it does it in a way that’s less conducive to monetary policy running off track, for all the reasons that we’ve talked about, that you’re no longer making guesses about the equilibrium interest rate, the equilibrium unemployment rate, or the equilibrium level of real output. You can abstract from all of those things and just ask the question, How is nominal GDP evolving relative to, A, expectations, or B, in my sort of operating framework, you know, where you want monetary policy to be. So just be explicit about that and nominate a target path.
One of the advantages of doing that is in fact, I think, better financial stability outcomes, reason being if you think about the decisions that lenders and borrowers are taking in credit markets, whether it be in relation to housing or business lending or any other type of credit, the serviceability of those contracts depends entirely on the future flow of nominal income. So putting yourself in the shoes of a holder of a mortgage, for example. The amount I borrow is very much a function of what I think my future nominal income is going to be. And the lender is making the same assessment, right? They’re saying, Does this person have the capacity to service a mortgage? Well, that’s a function of what’s going to happen with their normal income in the future.
So by stabilising both expectations for nominal income and actual outcomes for nominal income, I think that’s conducive to financial stability because then the economy is going to evolve in line with the expectations embedded in those credit contracts. So I think you’re less likely to run into financial stability concerns in that context.
So this is essentially Scott Sumner’s critique of US monetary policy in response to the global financial crisis. So what Scott Sumner argues is that the recession in the United States was made deeper by the fact that nominal GDP and expectations for nominal GDP in the early stages of the crisis were allowed to collapse, and that more than anything affected the ability of people to service their mortgages.
Gene Tunny 1:00:42
That’s an interesting argument. I’ll have to have a look back over his work. I’ve seen it in the past. But have you got time for two more questions or do you have to get going? Because there are a couple –
Stephen Kirchner 1:00:52
Oh no, absolutely. Take all the time in the world.
Gene Tunny 1:00:55
Great. There are a couple other things I want to chat about. On page 27 of your Mercatus Centre paper you write, “There’s a growing empirical literature on the advantages of NGDP targeting relative to inflation targeting and other policy rules. I’m interested what that literature is. What does it comprise of? Is it cross-country regression studies, or how do they determine that, that this actually is superior to what we’re doing at the moment?
Stephen Kirchner 1:01:23
So there’s a long history is who the literature on monetary policy rules. And it really goes back to a Brookings Institution project back in the early 1990s. And it was as part of that project that John Taylor published his Taylor rule estimates. And Warwick McKibbin, the Australian economist, was actually an early contributor to that literature as well. And I mean, one of the things I did, as part of that Brookings Institution project was to just simulate different types of rules. So on one hand, you can estimate empirically what the central bank response to macro variables is . But you can also do simulations, where you say, well, what would happen in a economic model if the central bank responded to nominal GDP or some other specification of the monetary policy reaction function.
And I think it’s fair to say that, in that early literature, both nominal GDP targeting, whether in level or growth rate terms, did not fare well, relative to the sort of more Taylor rule type specification. The problem with that literature was that it wasn’t taking account of the knowledge problems that we talked about earlier, which is the unobservability of some of the key conditioning variables, namely the real equilibrium interest rate, either potential output or an estimate of an error. Once you take account of those knowledge problems, then the Taylor rule literature becomes much less robust. And nominal GDP targeting becomes much more robust. So once you allow for the fact that there’s uncertainty around those assumed equilibrium values, then inflation targeting as it’s currently conducted in a Taylor rule framework looks a lot less attractive. So really, that early literature was conditioning on historical relationships, which, when you’re operating in real time, become much more problematic.
Gene Tunny 1:03:53
Okay. I have to ask you about an NGDP futures market. So this was mentioned in your Mercatus Centre paper. Why would that be useful? And what’s the role of Ethereum, so a cryptocurrency, isn’t it? What’s the role of Ethereum in that?
Stephen Kirchner 1:04:15
So if you’re targeting nominal GDP, then one of the things that would be very helpful in that context would actually be a market-based estimate of where nominal GDP is going. People like myself who call themselves market monetarists, the market part of that expression refers to the fact that we think that markets are in fact the best gauge, financial markets at the best gauge of the stance of monetary policy and also what effect any given policy change is likely to have on the economy.
So if you take that view, then what you want to do is get a market-derived estimate of where nominal GDP is going and then base your monetary policy response on that estimate, because that’s going to be your best guess of where nominal GDP is going. And there are various versions of this. Scott Sumner has a version where the central bank would actually tie its open market operations mechanically to prices in that nominal GDP market. So monetary policy would then basically become market-driven. But you don’t need to go quite that far. I mean, it would be sufficient, I think, just for the central bank to take account of what the nominal GDP market was telling you about the stance of monetary policy.
The beauty of this is that any macroeconomic policy measure that you might implement, the nominal GDP futures market will give you instant and real time information on what the market thought that was going to do to the economy. So for example, if you had a fiscal stimulus package, a nominal GDP futures market would tell you basically on announcement, what it thought the impact of that package would be. And my expectation would be that if we had a nominal GDP futures market and you announced a big fiscal stimulus, we would actually probably see very little movement in the nominal GDP futures market because most of the economy crowding out effects that we discussed before, I suspect that in a small open economy with a floating exchange rate like Australia, fiscal policy actually doesn’t do very much in terms of aggregate demand.
Gene Tunny 1:06:45
Stephen Kirchner 1:06:46
We see that a little bit already, because although we don’t get sort of very clean or discreet announcements of fiscal policy measures, typically when the budget lands every year, and they announce what the change in the budget balance the share of GDP is going to be, which is your sort of best measure of the impact that fiscal policy is going to have on the economy. The national markets very rarely move in response to that announcement.
So the case for a nominal GDP futures market is you want that market to basically inform monetary policy decision making. And it really goes to the issue of what paradigm do you want for monetary policy? The market monetarist paradigm is essentially to say central bank is a lot smarter than financial markets when it comes to assessing where the economy is going. And we should do away with the fiction that they know more than what’s embodied in financial crises. And so conduct monetary policy on the basis of the best available information, which is what financial markets are telling you about the evolution of the economy,
Gene Tunny 1:08:01
What does this instrument look like? And who sets up the market? Does the central bank set up the market? I mean, people are gambling, or they’re betting on what future nominal GDP is. But how’s the market actually work? Has anyone thought about how it would be designed? Does the central bank have to run out or could it be a privately owned market?
Stephen Kirchner 1:08:26
So this could be a conventional futures markets? So we have at the moment futures contracts available, various financial instruments, so there are futures contracts for 10-year bond yields for the Australian dollar. We effectively have futures contracts on inflation outcomes, which is the difference between the prices on bond yields and index bond yields, so that it’s bond yields adjusted for inflation. So we actually already effectively have a futures market in inflation outcomes. And that’s actually a very important input into monetary policy decision making.
So one of the things that the RBA pays very close attention to is what market prices are saying about the future evolution of inflation? So we already have one half of the equation. What we need is the other half, which is to say, a view on what’s going to happen with real output. But if we combine those two things, and what we’re saying is we want a financial market view on where nominal GDP has gotten. So it’s very straightforward to design a futures market contract that you would list on the Australian Stock Exchange, which would be traded by financial market participants.
And I think another thing that would be useful that comes out of this is it would be a very good hedging instrument. So we think of corporations, their top line revenues are in fact often largely a function of nominal GDP. So one of the things the company will look at when they’re forecasting their revenues is an assumption about what nominal GDP is going to do. So corporates could actually use a nominal GDP futures market as a hedging instrument. And that increases the information content of NGDP futures prices. It becomes highly informative of what decision makers in the economy are expecting in relation to the future evolution of nominal income. That information is very useful for policymaking.
And my argument to the Reserve Bank, when I’ve presented this work to them, is to say, Do you think that would be useful input into monetary policy decision making? And of course, the answer has to be yes. You know, you want more information, not less. And so my argument to them is, well, if that information will be useful, then it’s probably worth incurring some costs in order to get that information. So what I’ve suggested is they need to remove some of the regulatory barriers to the creation of a nominal GDP futures market.
A huge regulatory barrier to any sort of financial innovation in Australia is the fact that the costs of financial system regulation in Australia are paid for by the financial sector. So all of the costs of ASIC and APRA in regulating the Australian financial system is recovered from market participants, economic institutions. But that cost recovery framework has a public interest clause, which basically says you should be able to get relief from cost recovery if there’s a public interest in doing so. And so I like it that the creation of a nominal GDP futures market is a perfect application of the public interest case for relief from cost recovery. So basically, the institutions and the Securities Exchanges that would put together that market should basically get an exemption from regulatory cost recovery. I think that would give a huge boost to making that sort of market commercially viable.
Gene Tunny 1:12:37
It’s a fascinating idea, because occasionally, you do have these new financial instruments. I mean, I know in the US they have a market in… Is there a futures market for house prices based on the Case-Shiller Index?
Stephen Kirchner 1:12:51
Yeah, that’s right. There’s derivatives around house prices in the United States. The NSX tried to get a derivatives market in house prices up and running a few years ago. I would argue that, yes, we should have house price futures as well, for exactly the same reasons. It’s informative for policymakers, t gives them information that they would not otherwise have. It will tell you, for example, when APRA changes its regulation of financial institutions. A house price futures market would tell you straightaway what the implications for that are for house prices. It’d be useful hedging instrument as well. So yeah, ideally, I think we should have both markets.
I think the impediments to those markets, given that they are potentially so useful, are most likely regulatory in nature. And so we need to lower the regulatory barriers to the creation of those markets. And arguably, I think there’s a case for implicit public subsidies for those markets as well, so relief from regulatory cost recovery. I think the RBA could use its balance sheet to become a market maker in those markets. So not with a view to influencing the prices, but just providing, being a liquidity provider, which would lower costs for other people transacting in those markets and would help get them up and running.
Gene Tunny 1:14:25
I was just thinking, I was just trying to think, how would this actually start up? And, I mean, you’d need someone to actually develop the instruments, create the contracts and sell them, so that could be say, an investment bank, for example. It could be a Goldman Sachs or it could be a Morgan Stanley or one of those businesses. It’s a fascinating idea.
Stephen Kirchner 1:14:50
Yeah, I mean, in my Mercatus paper, I make the case that the council of financial regulators should jointly mandate the creation of a nominal GDP futures market. And I mean, when regulators mandate something in financial markets, it usually happens. So it’s not uncommon for the financial regulators to actually come out and say to financial market participants, okay, we’re doing this. If it becomes a regulatory mandate, then the financial market participants will cooperate with that mandate. And you know, I think it would be enthusiastic participants. So I think it’s really incumbent upon the RBA to say this is something that we want and need, would be helpful for policymaking and for hedging, as I’ve described. And so we’re going to sit down with financial market participants and make it happen
Gene Tunny 1:15:46
And just finally, you’ve mentioned that there could be a role for blockchain. So you talk about how US NGDP futures have already been implemented on the Augur blockchain. Did I pronounce that right? And then, Eric Falkenstein has also developed Ethereum-based derivatives contracts. These contracts could provide competitive alternatives to listed securities, okay, on existing exchanges and require little or no public support while still yielding useful information about monetary policy in the economy. So is there anything special about the blockchain in this context?
Stephen Kirchner 1:16:22
Well, the role for blockchain I think is just in terms of lowering the costs of doing it. So as we’ve already discussed, there are significant cost barriers to listing nominal GDP futures on our traditional securities exchange. I’ve argued that we should try and lower some of those costs. But another way of doing this is to implement it in blockchain space. There’s already been some interest in doing this in the US. I think, eventually, almost all financial derivatives will move off exchanges and onto the blockchain at some point, main reason being you can then do instantaneous clearing and settlement. So you no longer have trillions of dollars tied up in collateralizing clearing and settlement of financial derivatives. So if derivatives markets are going to move onto blockchain, then arguably NGDP futures should move on to blockchain as well. But I think there’s more scope for innovation in the blockchain space at the moment, just because it’s a different regulatory environment.
And so I’ve sort of argued for a two-prong approach where on the one hand, you want to go through sort of the conventional channel other listed securities market for NGDP futures. But at the same time, I think there’s scope for entrepreneurs to innovate in the blockchain space and do something similar. And hopefully, what we get out of this is a viable future market, not just in nominal GDP, but [with] other macro variables included. And I think it would not only provide policymakers with useful information, but it would really change the way people think about financial markets and monetary policy, because you can’t beat the sort of real-time financial market verdicts on what policy is doing.
It would eliminate a lot of arguments about the implications of various types of public policy, because let’s say the government is proposing a change in some tax rate, and there’s an argument about what the implications of that tax change is for the economy. Well, a nominal GDP futures market will instantaneously settle that argument, because when the tax change is announced, you can observe what the change in the nominal GDP futures is. And that basically tells you what the economic impact is,
Gene Tunny 1:19:07
Assuming the market expectation is correct.
Stephen Kirchner 1:19:11
It doesn’t have to be correct. It’s probably our best guess.
Gene Tunny 1:19:15
Best guess, gotcha. Yeah. I agree. I was just wanting to –
Stephen Kirchner 1:19:19
Ex post it could be completely wrong. At the time of the announcement, it would be the best guess of everyone who actually has a real-time financial stake in that outcome.
Gene Tunny 1:19:31
Yeah, very good point. Okay, Stephen, this has been terrific. I’ve learned so much and it’s made me think about a lot of a lot of things that hadn’t been thinking about before. I love this idea of futures markets in economic indicators. I think that’s brilliant. So yes, I’ll have to come back and explore that in the future. So Stephen, you’ve got a sub stack, which I’ll put a link to in the show notes. I’ll also put links to your two fascinating papers on monetary policy. Any final words before we wrap up?
Stephen Kirchner 1:20:06
I think this has been a great conversation. I’ve really enjoyed it, Gene.
Gene Tunny 1:20:09
Thank you, Stephen. I’ve really enjoyed it too. I must admit, initially I don’t think I’ve really understood this nominal income targeting idea and its merits and what the problems with inflation targeting were as much as I do now, I think I’ve got a much better understanding. So absolutely, really appreciate that. So, again, thanks so much for coming on to the programme. And yeah, hopefully, I have you on again, sometime in the future. We could chat more about these issues. So thanks so much.
Stephen Kirchner 1:20:46
Thank you, Gene. It’s been a pleasure.
Gene Tunny 1:20:49 Okay, that’s the end of this episode of Economics Explored. I hope you enjoyed it. If so, please tell your family and friends and leave a comment or give us a rating on your podcast app. If you have any comments, questions, suggestions, you can feel free to send them to email@example.com And we’ll aim to address them in a future episode. Thanks for listening. Until next week, goodbye.
Big thanks to EP135 guest Stephen Kirchner and to the show’s audio engineer Josh Crotts for his assistance in producing the episode.
I did a livestream earlier today (Friday 3 December 2021) with my regular co-host Tim Hughes on the latest economic news of the week, including the latest US initial jobless claims confirming a strong US economy, the impact of the omicron COVID-variant on equity markets, and the September quarter Australian GDP figures which revealed the adverse impacts of NSW and Victorian lockdowns. You can click on and watch the video on YouTube below. You can also download the slides I showed.
In the livestream, from around 22:05, I reflected on the late Professor Tony Makin’s contributions to the Australian economic policy debate, particularly on whether we should worry about the current account deficit in the late 80s/early 90s and on the effectiveness of the Rudd Government’s fiscal stimulus. On the current account deficit, Tony’s articles, along with the contributions of John Pitchford, clearly led to a change in the policy consensus on the current account, so it was no longer something that would be a macroeconomic policy target. Sadly, Tony died unexpectedly earlier this week. This came as a huge shock to so many of us, and it’s obvious from all the conversations I’ve had about Tony over the last few days just how much respect and admiration his colleagues and former students had for him. Tony’s funeral is on Monday on the Gold Coast (see notice below).
Economics Explored Live for 15 October 2021, the first edition of what I’m planning to be a weekly livestream, covered:
the growing concern internationally about accelerating inflation, prompted by the latest US CPI figures (see chart below;
the September ABS Labour Force data revealing big drops in hours worked and workforce participation in the locked-down economies of NSW and Victoria; and
my state of Queensland’s relatively low vaccination rate (72% for 1st dose vs 84% nationally) and what it could mean for the state’s reopening and the economy – it’s pretty obvious the Queensland Premier should set a date for re-opening ASAP to encourage people to get vaccinated promptly, as suggested by the Queensland branch of the Australian Medical Association.
Here’s the video of the livestream, which was streamed to YouTube and LinkedIn Live:
As brilliant and lucky as they have been, today’s generation of central bankers is afflicted with the same sense of denial that proved problematic in the 1970s. Due to a lack of experience and institutional memory of that tough period, the risk of another monetary policy blunder cannot be taken lightly.
Certainly, central banks have been running a massive monetary policy experiment with ultra-low interest rates and Quantitative Easing, which have been associated with double-digit growth rates in money stocks. I agree with Roach regarding the potential for a “monetary policy blunder”.