Tag Archives: budget deficit

Flat-earth economists lead the hysteria over budget deficits

The Conversation

Beth Webster, Swinburne University of Technology

Back in the good old days of the 19th century when market economies oscillated between boom and prolonged recession, economists believed that nations were like households. They had to balance their budgets. If they spent more in one year they would have to save more the next to pay off the debt. Sound advice for a household. But not so for an economy as a whole.

Welcome to the Keynesian revolution

Keynes proved this in 1936, and subsequently governments followed this theory to get their economies out of depression and onto the long economic boom that lasted until the mid-1970s.

What essentially did Keynes, and his doppelgänger Kalecki, argue? Let’s use a very simplified model to illustrate the point. Say there are two types of people who are active in the market economy: employees and investors. The investors own the assets of the business in which the employees work.

Altogether the businesses in a country produce $100 of goods and services in a year. If they could sell these goods and services, then say for illustrative reasons, that $70 would go to the employees as wages and salaries and $30 goes to the investors as a profit (return on their capital).

Now the businesses can only sell their goods and services if people with incomes (the same employees and investors) spend $100 buying these goods and services. No business keeps producing things that are not bought. The employees may be happy to spend their $70 on goods and services. But the investors will only spend their $30 if they can feel confident that they will get their $30 back plus a return for risk. This return may be 5% or more depending on the economic climate. Suppose the optimistic investors, in the first year, spend their $30 of dividends (or profits) on the goods and services. But at the end of the year, the business only makes $100 of sales and the investors only get back $30 (as $70 goes to employees). Not a good investment. Rate of return = zero.

So what do investors do? In the next year, they only spend $20 on investment goods and services. But then the combined purchasing power of employees and investors is $70+$20 = $90. The business cannot sell all their product ($100). With only $90 in income they pay wages of $70, leaving $20 for the return to investors, but in addition, they cut back on production and retrench staff in the following year. Investors also cut back on spending as they also got a rate of return below what they feel reasonable given the risk of investing. It is safer to leave the money as cash in the bank or under the bed. And so the economy enters a downward spiral. Investors cut back, businesses sack staff and unemployment rises.

Downward spiral

What stops this downward spiral? There needs to be an external injection of spending into the system. This is the essential Keynesian message. By external, we mean something that does not originate from employees (householders) or the investment community. It has to come from either the government in the form of
perpetual budget deficits or perpetual exports.

Clearly from the point of view of the world as a whole, exports cannot be the source. Some countries, for some of the time, can get income stimulus from exports (i.e. China for the last 30 years) but this is at the expense of other economies. At the end of the day, the stimulus to incomes has to come from governments who control the money supply and can thus spend without having to borrow. Essentially, they can monetise the debt. They do not have to pay this debt back – it is spending financed by central banks. The point is that if the government adds to spending (and production) without extracting an income for itself, it allows investors to realise the minimum rate of profit necessary for them to invest again.

This is what occurred for the 25 years following WWII. So what stopped it?

Inflation

Inflation. Inflation instigated by a series of oil price shocks but then prolonged by excessive government spending in the US to finance the Vietnam war. Governments in the late 1970s and 1980s reacted to inflation by drastically cutting spending. But the rate of inflation did not fall until the price of oil fell in the 1990s and China flooded the world with cheap manufactured goods. Certainly, if an expansion of the money supply is excessive we will get inflation. But taken to an extreme in the other direction, we get low growth and unemployment.

Where do you think we are in 2016? With 700,000 official unemployed, close to another 700,000 under-employed, and an inflation rate below 2%, I would say we are swung too far to the parsimonious side. It is all about balance. It should not be about blind and mechanical fear mongering about government budget deficits. The current political debate is on level with a Tony-Abbott-climate-change debate. Misguided, low brow and damaging to the well-being of many people.

Productivity growth

And incidentally, for those wondering, productivity growth will not break the deficient-demand impasse described above. Productivity growth would have to achieve a consistent rate of over 5% per annum to fill the void in spending. Given the historic rate has been about 1%, I would not count on it.

The ConversationBeth Webster, Director, Centre for Transformative Innovation, Swinburne University of Technology

This article was originally published on The Conversation. (Reblogged by permission). Read the original article.

 

Leave a comment

Filed under Reblogs

For this generation, and the next, it’s time to bring back the carbon tax

The Conversation

By Max Corden, University of Melbourne

Australian Treasurer Joe Hockey will release the Intergenerational Report on Thursday, and has invited Australians to join in a conversation about the economy and the challenges facing the budget.

I’d like to argue the case for bringing back the carbon tax.

Tony Abbott, when leader of the Opposition, promised to repeal the carbon tax brought in by Prime Minister Julia Gillard. And he has fulfilled his promise.

Now circumstances have changed: the budget deficit and public debt have turned out to be important problems in the eyes of the government because of the somewhat unexpected decline in export prices. So Abbott, or his successor as prime minister, would be justified in re-imposing this tax.

The revenue from a carbon tax could make a significant contribution to dealing with the deficit problem. Of course, it would not be enough, and, as is well known, other measures or reforms to generate revenue for the government are available and certainly needed.

The carbon tax as a burden

Prime Minister Abbott certainly convinced his fellow Australians that this “great big new tax” would be a burden. But all taxes impose burdens or costs somewhere, whether on companies or individuals. One might reflect that, in current budgetary circumstances a “big new tax,” and perhaps more than one, is just what doctor Hockey ordered.

The carbon tax was paid by numerous businesses, but this did not mean they carried the final “burden”. Mostly they would have passed it on to their customers, both households and businesses. Essentially it might be regarded as a fossil energy tax.

When the tax was repealed Abbott argued households would benefit on average by A$550 a year, with gas prices to fall by 7% and electricity prices by 9%. His much-repeated and persuasive message was that the carbon tax raised the cost of living and this was “toxic” and “has been hurting ordinary people”. He also argued a tax that raised energy prices would have led to job losses.

All this seemed very persuasive. The persuasion was reinforced by the fact that earlier – essentially from 2007 to 2010 – electricity prices had risen sharply for other reasons, essentially to pay for the high costs of excessive investment in networks (poles and wires). In many minds those price rises were mixed up with the expected effect of the carbon tax.

Where did the revenue go?

But Abbott never refers to the government revenue that was raised because of the carbon tax. Did the tax not have any beneficial effects for households or businesses to compensate for the directly adverse effects of the higher prices of energy? Where did this revenue go?

In fact, some of it was used to compensate firms that competed in international markets, while a substantial part compensated low income households through reductions in their income tax. The latter was an important element of the Gillard program. What was taken out of the income stream by the carbon tax at one point was put back by the compensation at another point. If there were job losses at one end, there would be job gains at the other. Furthermore, reducing income tax, at least in the low income ranges, would increase the incentives to seek work, a highly desirable economic effect.

Possibly some of the revenue led to greater government spending which benefited households. By ignoring all these offsetting revenue effects Abbott was able to conclude that the carbon tax had a severely adverse effect on incomes and employment. Did he really believe this?

At this point one might ask: what was the point of the whole exercise when funds were taken out of the economy at one end and put back at the other. The answer seems obvious. The carbon tax would produce market inducements that reduced harmful emissions of greenhouse gases. Of course, if one does not believe that climate change is a problem, or that Australia could make any difference, the whole business seems pointless. And if one assumes that nothing happens to the revenue, the tax would seem not just pointless but harmful.

Use the revenue to reduce the deficit?

In the event of the carbon tax being reinstated, the whole of the gross revenue might be used to reduce the budget deficit. It would not finance increased government spending. How much money would be available? According to official estimates, in the first two years of operation the carbon tax raised A$15.4 billion in gross revenue.

If the carbon tax revenue actually reduces the budget deficit without compensating tax or spending changes elsewhere, the benefit would then be in the future (when debt is lower than otherwise), while the return of the “big new tax” would indeed impose a present cost. Hockey would then get his deeply desired budget improvement but this would still be at odds with Abbott’s desire to avoid new taxes.

The economic impact of climate change

Australia has a group of “realists” who do not deny climate change, but argue Australia generates such a small proportion of the world’s harmful carbon emissions that we cannot make any difference anyway. So, why bother with a carbon tax?

We can make a difference, and, above all, it is in our interest that we do. We may not be able to directly affect world climate alone, but it certainly will affect us, so we must try and influence collective global action.

First there is the direct effect of climate change on Australia, and especially its coastline, as set out by the CSIRO. Likely effects include reduced rainfall in southern Australia, more extreme fire weather, adverse effects on the Great Barrier Reef, on coastal populations, and so on. Particularly important for Australia are increasing heatwaves. Heatwaves have killed more Australians than all other natural hazards combined.

Second, the rise of the sea level in association with severe weather events is likely to have a serious impact on Australia’s neighbouring islands and island countries, including Indonesia, with many of its population of 250 million people highly vulnerable.

For selfish reasons we need to use our maximum diplomatic influence to encourage other countries to take the necessary measures to drastically moderate or avoid climate change. And we can only do this if we set an example ourselves. A restoration of the carbon tax would be the first step.

Of course, eventually this might evolve into an Emissions Trading Scheme. In both cases carbon emissions will be discouraged and the government will receive revenue.


Editor’s note: Max will be answering questions between 10 and 11am on Thursday March 5. You can ask your questions about the article in the comments below.

The ConversationThis article was originally published on The Conversation. (Reblogged by permission). Read the original article.


Leave a comment

Filed under Reblogs