Sunday, May 6, 2012

Don't mention the A-word

The Eurozone, the US, Japan and the UK are all suffering prolonged economic stagnation. [You can see how serious it is in the US here.] It is sensible to suggest that they are doing something (or perhaps many things) wrong and need to change policy. 

What is not sensible is ignoring a developed world economy that has conspicuously not suffered any of the economic stagnation problems that have hit the major developed economies. Indeed, has not had a recession (in the sense of two quarters of economic contraction) since 1991. That sailed through the Great Recession and Global Financial Crisis (aka GFC) with barely a ripple. Whose current problems are not of economic stagnation but of maintaining economic balance when one part of the economy is doing much better than another.

That country is Australia. Yes, it is true that the surge in commodity demand (centred on China) has been a boon to the Australian economy (well, to the commodity exporting States; the resultant surge in the value of the $A has been a problem for the tourism-and-goods exporting States—the commodity boom has been a distinctly mixed blessing). But Australia had also managed to avoid recession even when its terms of trade (the ratio of the price of what it sells to the price of what it buys) were in long-term decline and when commodity prices dropped dramatically at the onset of the Great Recession. Indeed, the fall in Australia’s exports as a % of GDP was worse than the US’s.

Yet the Australian success gets mostly ignored. A classic example is Raghuram Rajan’s recent piece in Foreign Affairs. (Non-gated version here [pdf].) Much of what he has to say about the desirability for supply-side reforms is sensible. Indeed, much of what he advocates Australia has already done; which makes the failure to mention what should be the poster-polity for what he is advocating all the more of a glaring failure.

The problem with mentioning Australia is that it does not conform to the stories that Rajan and others want to tell about what went wrong. Rajan essentially ignores monetary policy, both in the commonly offered solutions to economic stagnation (fiscal stimulus and even-lower interest rates: interest rates are a very limited way of looking at monetary policy) and in diagnosing why the economic stagnation descended. So Rajan writes:
today’s economic troubles are not simply the result of inadequate demand but the result, equally, of a distorted supply side.
Australia has done a lot of supply-side reforms, so perhaps it can be ignored. Except Rajan goes on to say:
For decades before the financial crisis in 2008, advanced economies were losing their ability to grow by making useful things. But they needed to somehow replace the jobs that had been lost to technology and foreign competition and to pay for the pensions and health care of their aging populations. So in an effort to pump up growth, governments spent more than they could afford and promoted easy credit to get households to do the same. The growth that these countries engineered, with its dependence on borrowing, proved unsustainable.
Does anyone really think Australia just magically averted such structural problems, that its economy is somehow profoundly different from other developed countries? Given its per capita GDP growth has been respectable but not outstanding. In particular, while its public finances were much sounder, with public debt reduced to very low levels, enthusiastic embrace of private debt meant that the total level of indebtedness was and is comparable to other developed countries.

 The story that Rajan wants to tell is that:
the common thread was that debt-fueled growth was unsustainable.
Except, apparently, in Australia. Australia ran a mildly higher inflation rate than the US during the “Great Moderation”, so its monetary policy was more “lax” than “easy money-easy credit” US.

[Read the rest at Skepticlawyer or at Critical Thinking Applied.]


  1. Like Australia, Sweden (the only other rich country performing anywhere near Oz these days) has high private sector debts and low government debts.

    Debt ratios don't seem to say much about the future path of the economy so long as nominal growth is stable. Indeed we might say the opposite, a long history of nominal income stability begets high debt. A Recently minted MD has a massive 'debt to GDP' ratio too, but few would say that debt was 'unsustainable'.

    1. Basically yes. There are some other issues about debt -- Japan and the UK have gone on public debt binges, but they are outliers.

  2. Lorenzo
    As you know, back in 1997 I got interested in Australia, especially how it performed relative to NZ following the Asia crisis and the ensuing plunge in commodity prices.
    At the time I wrote a piece in portuguese (that more recently I adapted as a post (which you´ve seen)). But Brazilians are too hard headed and just dismiss Australia as a model.
    In the past few years we "surfed the China/commodity wave" but stopped doing the sort of structural (microeconomic) reforms that sustain higher levels of growth over time. Last year growth was a meager 2.7% and will likely repeat that this year.
    BTW, did you see my post on Brazil from 2 weeks ago?

    1. Yes, I did. (Have been travelling, hence delay in responding.)