Thursday, October 25, 2007

Our economic future under Labor

It seems likely that Kevin Rudd will win the coming Federal election. What will happen if he does? This depends very much on what will happen to the economy over the next few years. It seems almost certain that the specific commodity boom will continue, fostered by continuing high growth in the Asian economies and that the economy-wide investment boom will also remain strong at least for some time.

But there is no question that confidence in macroeconomic management will fall. Poll after poll shows much higher levels of community confidence in the ability of the Coalition to manage the economy. This is not just a matter of perceptions - there is little economic expertise or experience in the Labor team.

Moreover, the success of Coalition policies in driving unemployment to a 34 year low and operating the economy at full pace in itself poses problems for Labor. Currently, despite moderate cost-push inflationary pressures, the underlying rate of increase in the CPI at 3.1% is at the upper range of the RBA’s range of tolerance.

There are 8 trade unionists on Labor’s front bench and the trade union movement has spent $20 million funding the deceitful campaign against the Coalition’s industrial relations reforms. There will necessarily be a need for payback given a Rudd victory whatever Rudd says about ‘governing for all Australians’. Wage demands were likely to increase anyway but will now increase faster as will general cost-push pressures in the economy. That Labor markets will be more regulated with union control of workplaces and pattern bargaining under a Rudd Government will mean that the chances of a wages ‘breakout’ increase.

The prospect of higher tax collections acting as a macroeconomic stabiliser has been reduced by Rudd’s proposal to match the Coalition tax cuts. My guess is that in this tax offer might in fact not be realised but, if it is, there will again be further pressure on interest rates and inflation.
So what are the prospects? My guess is that the economic fundamentals facing the Australian economy will tend to remain sound but that electing a Rudd government will lead to higher wages growth, higher inflation and hence higher interest rates. These factors in conjunction with lower economic confidence suggest higher unemployment and hence lower economic growth.

There are high levels of private sector debt and these will create straightforward solvency issues for business and households were markedly higher interest rates to emerge. Whether this will go as far as triggering a recession I do not know but the unparalleled 17 year period of continuing economic expansion definitely seems under threat.

The Labor Party may win the coming election on the basis of its misrepresentations about WorkChoices and its scurrilous abuse of John Howard but the successful economic management it has delivered has created an explosively growing economy that presents problems for Labor.

The large tax cuts offered by Howard and Costello might be deliverable without harmful macroeconomics implications, by a talented team of fiscal conservatives, but to a union-dominated Labor Party which feels a strong need to implement an expanded social program in heath and education it spells trouble.

I’ll be interested to observe the stock market in the remaining weeks up to the election. The market has closed in the red in 7 of the last 10 trading sessions. Valuations will appear high if firms anticipate markedly higher wage and capital costs. A plunge over the coming weeks may be the first of a series of warnings we will receive about our likely economic life under Labor.

11 comments:

Bring Back CL's blog said...

Harry,

you wage rises two ways under the ALP
1) EBA or
2) common law contract

history and commonsense tells us neither have produced inflationary outcomes indeed quite the opposite!

Ken Henry has the opportunity to say to Ruddy and Swanny look how bad the structural part of the budget is and so you will have to curtail part of your program
Circa 1983 or 1996
He cannot do this with howard.

I might add Neither howard's time as treasurer nor Costello time in parliament provided any confidence in both prior to 96.

It could be said for those two union officials Hawke and Keating as well!

interest rates having to rise five noe 6-7 times since 2004 merely shows fiscal policy has not been tight enough

Mr Denmore said...

Harry, with respect, you sound like a Liberal Party stooge. The simple fact is that there is no difference between the major parties on macro-economics, as any market economist will tell you.

After all, it was Labor under Hawke and Keating that did the heavy lifting in economic reform - including floating the $A, liberalising capital markets, cutting tariffs and decentralising wage fixing in a pragmatic, non-ideological way.

In terms of economic reform, tell me what exactly have Howard and Costello done other than introduce the GST? Lest you point to WorkChoices, unemployment was low and falling under the existing enterprise bargaining system set up by Keating.

Interest rates? They have gone up 10 times since mid-2002, five times since Howard stole the last election on a lie about keeping them at record lows (and a completely untestable thesis that they would always be lower under the Coalition rather than Labor).

Howard and Costello have run a pro-cycical fiscal policy and pork barrelled their way to successive election victories. There is now way that conservatives such as yourself would have let a Labor government get away with the shameless middle class welfare that Howard has made a habit of.

Just about every independent observer, including Treasury and the RBA, have warned that demand has run ahead of the economy's productive capacity because of a lack of willingness by federal and state governments to invest in infrastructure.

The states have sat on their hands because Howard and Costello have somehow convinced the electorate that it debt is the height of economic irresponsibility, even if governments are investing in supply-boostiing infrastructure.

Their claim that fiscal rectitude is defined by a budget surplus of 1 pct of GDP and that their tax giveways are not stimulatory has been widely ridiculed by private sector economists.

And now Costello is trying to bully the RBA into not raising interest rates because the headline CPI is at a 4-year low, completely ignoring the fact that the central bank focuses on the core rate. Indeed, if we were to take headline inflation as the pointer, the bank should have raised rates last year when banana prices pushed the CPI up to 3 pct. But it chose to look through that.

The fact is Howard has been lucky, governing at a time when the structural reforms of Hawke and Keating have borne fruit, when the global economy has been enjoying a synchronised expansion, when commodity prices have been at five-decade highs and when China's entry to the global economy has pushed down inflation and interest rates everywhere.

But as Alan Kohler argued cogently last week, Howard has failed to manage our prosperity. And it is Labor that is best placed to put in place the long-term investment in infrastructure and skills needed to support Australia beyond the commodities boom.

hc said...

Mr Denmore

Its true I support the Coalition but this was not the intent of the post. BTW I am not a stooge of anyone and I dislike the implication.

Labor supporters tend to dominate blog discussions and it gets to the stage where expressing a contrary view is seen as extremist. It isn't - the Coalition have been in power for 11 years with most Australians backing them.

The intent was - given the current state of the economy (high private debt, very high levels of activity) how will Labor perform?

Many of your points I agree with - role of early Labor reforms, interest rates, debt - but that doesn't alter the point of my post.

I also agree with some of your criticisms of Coalition policies - again irrelevant.

My view is that problems will develop because of Labor debts to the unions, inexperience and the current high-activity structure of the Aussie economy.

Homer

Many of the above comments apply to you as well. You know my politics - I think your point on the fact that fiscal policy is not tight enough dstrengthens my argument.

Bring Back CL's blog said...

Harry,

The coalition is in no position to tighten fiscaal policy whereas the ALP is in a position to do it.

you still haven't outlined how wages will magically breakout

Slim said...

The biggest pressure on wages at the moment is the acute and chronic skills shortage. If there is any truth to the claim that WorkChoices are making workers better off it is because of this shortage rather than flexibility.

You give no account of what impact there will be from a Rudd government investing significantly in enhancing capacity - eg transport infrastructure such as ports, and in education and skills training - something Team Howard has consistently failed to do.

hc said...

Homer, How will the wage increases occur?

In Victoria this morning the State Government has given a wage increase to nurses which averages between 3.5 and 6% over each of the next 3 years and the head of the Nurses union says that productivity increases are window dressing. The Minister says the outcome is consistent with guidelines of up to 3.5%. I don't follow his maths!

The Victorian Teachers want 30% over 3 years.

Hawke and Keating were operating in a period of high unemployment - the unions were constrained. That's not now.

I confidently predict disasterous wage outcomes. much higher interest rates and an inevitable long-term monetary crunch that drives up unemployment. Mutterings about 'working families' will be a distant memory.

Spiros said...

Harry

you are being absurd and inconsistent.

The Victorian nurses got their pay rise under WorkChoices.

The purpose of WorkChoices isn't to constrain wages, it is to let market forces rule in the labour market.

When there are skills shortages, skilled workers get big pay rises. It's the market at work. The unions are mere window dressing in all this. The nurses could have got big pay rises if they'd bargained as individuals,just as independent plumbing contractors are making huge amounts right now.

It will continue regardless of who wins the election.

Only a professor of economics could fail to see this.

hc said...

Spiros, There were no market forces involved here at all. These are public employees. They blackmailed the Victorian public by imposing work bans.

The Vic government initially set a limit of 3.25% on all public salary increases without productivity gains. mThey caved in on both counts. The increases are from 3.8-6%, nurse numbers increase and, according to the Nurses union, there will be no productivity gains.

Sir Henry said...

If I may inrerrupt your reverie for a moment H:

1. Polls after poll and/or indicators of community confidence (by way of some desperates in a cubicle making 250 phone calls at $12.50 an hour) are not quite as reliable as RBA data or AFX researchers or indeed any of the bank economists, etc.

2. Is this an economic literate talking? "You are going to get huge reversals of financial flows around the globe, which will affect all exchange rates, that's why I compared it to a tsunami.”

3. Agreed, this is not just a matter of perceptions (whose?), it is a matter of you aping Liberal Party propaganda. Here is Costello on the radio:
"A Labor Government, with no experience in economic management would be ill-equipped to handle such a tsunami."

4. Costello and Howard are economic illiterates. With the election having been called, and the Govt in so-called caretaker mode, Howard and Costello, the economic managers no longer have the benefit of Treasury boffins to give them a breifing paper and they have to fly by the seat of their pants. It shows: explaining the difference between the headline rate and the underlying rate of inflation Costello blustered that there are "other measures of inflation, more technical measures" and he couldn't understand how the Resreve could get it so wrong.

Costello and Howard are conmen. They do nothing except rely on briefings from economic professionals. They know nothing. And neither does Labor. And Labor, when it wins, will have the benefit of the same professional advice.

Th intellectually insulting propaganda, which seems to be targeting illiterate villagers in the highlands of PNG with cargo-cult like scare campaign, is not going to work I am afraid, with or without your help, H.

Stephen Lloyd said...

Sir Henry,

Costello was referring to the very real problem of the Chinese revaluing their currency via floating it on the market. They will need to do it everntually and when they do the US economy will implode, as its huge deficits are underwritten by an artificially low Chinese currency.

That is, the Chinese are paying for US consumption right now. When they float their currency, as they surely will, it will skyrocket and it will be a massive problem for the US, and despite protestations by leftist economists talking to Crikey, the world economy most certainly does revolve around the US.

I do not trust the Labor party to handle that kind of a financial crisis at all. The Chinese have the US economy by the short and curlies and if they need to cash in at some point, we will all pay for it.

hc said...

Jack, Most of your comments I agree with.

But I do think that capital market problems do tend to induce contagion partly because of high levels of economic interdependence. This increases today because of the complexity of financial products.

Flexible exchange rates do tend to insulate the economy from international disturbances a bit - particularly if the disturbances are real demand and supply shocks. But capital market interdependence is an issue.

Something might well happen as a consequence of China's vast accumulation of depreciating US dollars. I do fear Labor immaturity at dealing with these issues.

Australian does have an encviable record of economic stability - this is not just economic jargon. It means hundreds of thousands of people have moved into jobs.