In criticizing Boris Johnston, Ross Gittins at The Herald, unwittingly highlights the hubris of the economics profession:
When Boris Johnson, Britain’s Foreign Minister, visited Oz lately, he implied that our record 26-year run of uninterrupted economic growth was owed largely to the good fortune of our decade-long resources boom.
Johnson, no economist, can be forgiven for holding such a badly mistaken view – especially since many Australian non-economists are just as misguided. They betray a basic misconception about the nature of macro-economic management and what it’s meant to do.
It’s clear that Johnson, like a lot of others, hasn’t understood just why it is that 26 years of uninterrupted growth is something to shout about.It’s not that 26 years’ worth of growth adds up to a mighty lot of growth. After all, most other countries could claim that, over the same 26-year period, they’d achieved 23 or 24 years’ worth of growth.
No, what’s worth jumping up and down about is that little word “uninterrupted”. Everyone else’s growth has been interrupted at least once or twice during the past 26 years by a severe recession or two, but ours hasn’t.
That’s the other, and better way to put it: we’ve gone for a record 26 years without a severe recession.But now note that little word “severe”. As former Reserve Bank governor Glenn Stevens often pointed out, we did have a mild recession in 2008-09, at the time of the global financial crisis, and earlier in 2000-01.
So, yet another way to put the Aussie boast is that we’ve gone for a period of 26 years in which the occasional increases in unemployment never saw the rate rise by more than 1.6 percentage points before it turned down again.
What you (and Boris) need to understand about macro-economic management is that its goal isn’t to make the economy grow faster, it’s to smooth the growth in demand as the economy moves through the ups and downs of the business cycle.
This is why macro management is also called “demand management” and “stabilisation policy”. These days, the management is done primarily by the Reserve Bank, using its “monetary policy” (manipulation of interest rates), though both the present and previous governor have often publicly wished they were getting more help from “fiscal policy” (the budget).
When using interest rates to smooth the path of demand over time, your raise rates to discourage borrowing and spending when the economy’s booming – so as to chop off the top of the cycle – and you cut rates to encourage borrowing and spending when the economy’s busting – thereby filling in the trough of the cycle.This is why the economic managers find it so annoying when the Borises of this world imagine that the decade long resources boom – the biggest we’ve had since the Gold Rush – must have made their job so much easier.Just the opposite, stupid. Introducing a massive source of additional demand in the upswing of the resources boom made it that much harder to hold demand growth steady and avoid inflation taking off.
But then, when the boom turned to bust, with the fall in export commodity prices starting in mid-2011, and the fall in mining construction activity starting a year later, it became hard to stop demand slowing to a crawl.
We’re still not fully back to normal.This is why the macro managers’ success in avoiding a severe recession for 26 years is a remarkable achievement, and one owed far more to their good management than to supposed good luck (whether from China or anywhere else).
But what exactly is the payoff from the achievement? Twenty-six years in which many fewer businesses went out backwards than otherwise would have.
Twenty-six years in which many fewer people became unemployed than otherwise, and those who did had to endure a far shorter spell of joblessness than otherwise.
The big payoff from avoiding severe recessions – or keeping them as far apart as possible – is to avoid a massive surge in long-term unemployment that can take more than a decade to go away – and even then does so in large part because people give up and claim disability benefits or become old enough to move onto the age pension.
Dr David Gruen, a deputy secretary in the Department of the Prime Minister and Cabinet, has demonstrated that, though the US economy had a higher proportion of its population in employment than we did, for decades before the global crisis, since then it’s been the other way around.”The key lesson I draw from this comparison is that the avoidance of deep recessions improves outcomes in the labour market enormously over extended periods of time,” he concluded.
“What you (and Boris) need to understand about macro-economic management is that its goal isn’t to make the economy grow faster, it’s to smooth the growth in demand as the economy moves through the ups and downs of the business cycle.”
Well how’s that been working for ya, Ross, over the last three decades. Attempts at smoothing the global economic cycle (primarily led by the US Fed) have achieved two of the most severe recessions in the last century. Smoothing out the natural creative destruction of the capitalist system allows imbalances to build. Periods of uninterrupted growth may be longer, but when the dam wall breaks, as it did in 2008, the severity of the backlash when the economy tries to restore equilibrium (or “balance” as us non-economists like to describe it) threatens to break the very foundations of the financial system.
Not exactly a time for high-fives and self-congratulation for the economics profession. To me economics should focus on the study of unintended consequences, of which there are many examples in the last 30 years.
The presumption that macro-economists can improve on the performance of an economy by constant intervention has clearly been demonstrated to be a fallacy.
Mechanical engineers in the 1800s were confronted with a similar problem when building large steam engines that worked under variable load. Attempts to smooth the load using a governor, adjusting braking in response to detected acceleration or deceleration was the obvious solution. But these governors created a feedback loop — highlighted by James Clark Maxwell in his famous 1868 paper On Governors to the Royal Society of London — that made these giant steam engines prone to self-destruct.
Constant interference with market forces in an effort to smooth economic growth has a similar effect on the economy. The lag between an actual event and its measurement, reporting and subsequent monetary policy response is susceptible to creating a feedback loop that amplifies the cycle instead of smoothing it, causing the system to self-destruct.
Economists on graduation should be required to make a pledge similar to the Hippocratic oath of the medical profession which starts: “First do no harm….”
It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
~ Mark Twain (Samuel Clemens)