Economy Archives - Page 76 of 132 - the patient investor

August 26, 2013

High-speed gravy trains

Infrastructure spending is fraught with pitfalls. One of the most dangerous is lobbying by special interest groups who stand to profit from the project.

Dr Richard Wellings from the Institute of Economic Affairs recently completed a report on the UK’s £43 billion High Speed 2 rail project — close to £80 billion if fully costed — and comments:

It’s time the government abandoned its plans to proceed with HS2. The evidence is now overwhelming that this will be unbelievably costly to the taxpayer while delivering incredibly poor value for money.

It’s shameful that at a time of such financial difficulty for many families the government is caving in to lobbying from businesses, local councils and self-interested politicians more concerned with winning votes than governing in the national interest.

The conclusions in his report The High-Speed Gravy Train: Special Interests, Transport Policy and Government Spending are even more damning:

The decision to build High Speed 2 is not justified by an analysis of the costs and benefits of the scheme. Even the government’s own figures suggest that HS2 represents poor value for money compared with alternative investments in transport infrastructure.
Ministers appear to have disregarded the economic evidence and have chosen to proceed with the project for political reasons. An analysis of the incentives facing transport policymakers provides plausible explanations for their tendency to favour a low-return, high-risk project over high-return, low-risk alternatives.
A group of powerful special interests appears to have had a disproportionate influence on the government’s decision to build HS2. The high-speed-rail lobby includes engineering firms likely to receive contracts to build the infrastructure and trains for HS2, as well as senior officials of the local authorities and transport bureaucracies that expect to benefit from the new line.
An effective lobbying campaign in favour of HS2 was initiated and funded by concentrated interests expecting to make economic gains from the project. This effort appears to have been effective at marshalling support for the scheme among policymakers.
‘Vote buying’ incentives were also important in building political support for a high-speed line. The policy was initially adopted partly as a response to local opposition to Heathrow expansion.
The main losers from HS2 – the taxpayers in every part of the UK who will be forced to fund it – are highly dispersed, and therefore have weak incentives to actively oppose it. By contrast, members of communities along the route, where losses are concentrated, have had very strong incentives to campaign. This pattern of activity has enabled the debate to be misleadingly framed in the media in terms of local objections versus national economic benefits.
Policymakers have strong incentives to ‘buy off’ opposition along the route at the expense of taxpayers, for example by increasing the amount of tunnelling or diverting the line. The large scale of HS2, its high political salience and its potential electoral importance, increase the risk that budgets will be expanded.
Local authorities, transport bureaucracies and business groups are already lobbying central government to fund new infrastructure along the route, with several schemes already identified. HS2 will trigger billions of pounds of additional expenditure on commercially loss-making, taxpayer-funded projects.
Along with design changes to ‘buy off’ opposition and subsidised regeneration projects, these proposals threaten to push total spending far beyond the basic budget. £80 billion plus is a plausible estimate of the overall cost, if these extras and the trains are included.
In addition to the direct costs, there will be even larger opportunity costs from the misallocation of transport investment. Institutional reform is needed to reduce the malign influence of rent-seeking special interests on transport policy. New infrastructure could then be provided on a more economically rational basis.

California is undertaking a similar scale high-speed rail project to connect Los Angeles and San Francisco. Elon Musk, founder of Tesla and SpaceX, has proposed an alternative Hyperloop solution that would transport travellers four times as fast at one-tenth of the cost. Debate still rages over whether the concept is viable, but the fact that alternatives were never adequately explored highlights the dangers inherent in allowing political control of infrastructure spending.

Unless adequate safeguards are in place to minimize political interference and adhere to market-related rates of return on investment, taxpayer funds are likely to be wasted on gigantic projects that are an ongoing burden on the fiscal budget.

August 23, 2013

The road not taken | Macrobusiness.com.au

By Houses & Holes at Macrobusiness.com.au
The Road Not Taken

So, with our Federal election mostly over, at least enough to get a good sense of where we’re going, I think it’s fair to conclude that we are not going to get out in front of the primary economic issues of our time. On the contrary, we’re going to make things worse for ourselves.

The only issue that this election should be about is the management of Australia’s post China boom adjustment yet it is barely mentioned. Where does this leave us then? First, let’s describe the issue once more.

Following the housing and mining booms in the post-millennium economy, in structural terms Australia finds itself with very high household debt but low public debt, very high asset values and historically low competitiveness in all industries including large swathes of mining and still high but falling terms of trade. In cyclical terms, we face big falls in the terms of trade, very big falls in mining investment, a probable stall and possible fall in national income, a still very high but falling currency and ongoing weak nominal growth as well as fiscal instability.

There have been two sensible policy matrices from our eminent economists aimed at managing the problems ahead. The first is by Warwick McKibbin, who has suggested that we both:

lower the currency asap through targeted money printing and
support economic growth, incomes and productivity through a large public infrastructure program.

These two make sense together because they simultaneously support weak private sector investment, boost competitiveness through the currency and productivity enhancements and prevent asset bubbles. However, it does risk a widening current account deficit and may leave you still uncompetitive at the end of it.

The second matrix of policy suggestions has come from Ross Garnaut and Peter Johnson who have focused more directly upon the issue of competitiveness. Garnaut argues that a nominal exchange rate adjustment (via the currency) is not enough. He sees our lack of competitiveness as so extreme – and it is hard to argue that it is not – that a real exchange rate adjustment is required. That means not only must the currency fall a lot, but as tradable costs rise, wages must not. He argues:

we should slash interest rates to lower the currency as soon as possible;
use macroprudential controls if low rates cause credit to rise too fast;
contain wages through a national program of burden-sharing and
deploy budget discipline as well as launch an unfettered productivity drive.

Johnson sees the same competitiveness issue but argues that monetary policy cannot serve two masters (addressing both currency and inflation) and prefers that we:

install capital controls to lower the dollar as soon as possible;
use interest rates to prevent asset bubbles;
deploy budget discipline as well as launch an unfettered productivity drive and
thinks recession is inevitable as a mechanism to lower costs.

My own view is that a combination of the McKibbin and Garnaut approaches is the way to go:

undertake a moderate, productivity directed infrastructure public spend to support growth, jobs and income;
slash interest rates to lower the dollar;
install macroprudential tools to ensure no credit blowoff;
undertake a national burden-sharing narrative to ensure wages don’t rise. We may not able to get a new wages accord but I would still bring everyone together and reframe the conversation, and
push for productivity anywhere and everywhere.

This approach ensures assets don’t deflate too quickly as we restore competitiveness in real terms. To my mind it is the basic minimum of policy innovation required, before we even get to tougher questions about Henry Review tax reform, cutting housing speculation incentives and making supply side reforms, increasing savings and taxing resources properly that will help us transition permanently towards a more balanced economy as well as tackle our long term demographic challenges.

Turning to the real world, what do we have from out elite currently?

the RBA is slashing interest rates too slowly to bring down the dollar fast enough;
it has explicitly repudiated macroprudential tools thus risking an even bigger asset bubble;
both political parties are ignoring the adjustment ahead in narrative terms
both parties are focused on long term spending but little on medium and short term productivity measures
both parties are ignoring probable ongoing fiscal instability and supporting interest groups over national interests

Where will this lead? It means we face a longer and ultimately more debilitating decline. The lack of redress for the dollar and inflated input costs ensures no big rebound in our tradabale sector investment, exposing us all the more to the mining cliff. Credit and asset prices will bubble up more than they should, inhibiting a tradables recovery and ensuring further hollowing out of the industrial base.

The lack of budget discipline ensures ongoing fiscal instability as promises are repeatedly broken, spending is cut and taxes jacked chronically. This will be an ongoing weight upon private sector confidence as policy fails to cope. It will also be a red rag to the rent-seeking bull as each round of cuts and hikes involves public campaigns by those effected, retarding competition and productivity. With no honest narrative of the issues, government will be reduced to stakeholder management.

In sum, it means a longer and far more destructive path at risk of repeated recessions, the entrenching of rentier capitalism, lower than otherwise asset prices, falling standards of living and broad disenchantment. Whocouldanode?

Reproduced with permission from Macrobusiness.com.au

August 19, 2013

U.S. Manufacturers Gain Ground | WSJ.com

James R. Hagerty reports:

….Boston Consulting Group — a leading proponent of the idea that U.S. manufacturing will come roaring back — predicts a surge in U.S. exports, partly helped by lower energy costs and stagnating wages. In a report for release Tuesday, BCG says rising exports and “reshoring” of production to the U.S. from China “could create 2.5 million to five million American factory and service jobs associated with increased manufacturing” by 2020. That, BCG says, could reduce the unemployment rate, currently 7.4%, by as much as two to three percentage points.

August 19, 2013

Targeting the Wealthy Kills Jobs | WSJ.com

T.J. Rodgers compares job creation through private investment to government investment.

Even European socialist democracies are starting to understand that tax-and-spend policies kill jobs. For example, both Italy and Spain have repealed their incentive programs for solar energy along with their “green jobs” because the countries have calculated that for every job created by government investment in green energy, somewhere between 4.8 jobs Italy and 2.2 jobs Spain are lost because of the reciprocal cuts in private investment.

August 19, 2013

Bloated business of banking | The Australian

Adam Creighton discusses the likelihood of taxpayers being asked to bail out too-big-to-fail banks.

In Australia that probability is now 100 per cent. Standard & Poor’s, a ratings agency, gives Australia’s biggest four banks a AA rating explicitly because taxpayers will provide “extraordinary support” to their creditors in any crisis, an implicit guarantee worth more than one-quarter of the four’s annual profits.

Since 1995, the big four Australian banks’ assets, reflecting a global trend, have ballooned from 94 per cent of Australia’s national income to $2.86 trillion, or 190 per cent.

August 13, 2013

EconoMonitor | Japan’s Three Arrows―Will They Fly?

Jerry Schiff writes:

We see encouraging signs that the desired changes to the economy are beginning to take place. Growth in the first quarter rose by an impressive 4¼ percent seasonally adjusted annual rate. Equity markets are up by some 40 percent for the year. Exports appear to be recovering. Credit growth has turned positive. Consumer and business confidence have picked up. And Inflation expectations are beginning to rise…… But the transformation is far from complete. In particular, higher investment and wages — two keys for ultimate success — are not yet observed.

August 12, 2013

Superannuation is inequitable and unsustainable | | MacroBusiness

I agree with Leith van Onselen that Australia’s aged pension/superannuation regime will be sorely tested over the next 30 years as the number of workers per retiree falls to below 2.5 to 1:

Workers per Retiree

But I don’t agree with his proposed solution:

…The flat 15% tax on superannuation contributions should also be axed in favour of a flat 15% concession. As illustrated above, under the current 15% flat tax arrangement, the amount of super concessions rises as one moves up the income tax scale, resulting in a system whereby higher income earners receive the most super tax benefit, despite being the very people that are the least likely to rely on the aged pension in retirement. A flat 15% concession, by comparison, would improve the equity and sustainability of the system by: 1) providing all taxpayers with the same taxation concession; 2) boosting lower income earners’ super savings and thus reducing reliance on the aged pension; and 3) reducing costs to the budget.

Argument that the flat tax on superannuation contributions is inequitable is based on the presumption that the present system of progressive tax rates is equitable. No doubt high income-earners benefit more from the flat tax than low income-earners, but the proposal ignores the fact that they pay more income tax in the first place. And even after the larger tax savings on their super contributions, the high income-earner will pay a significantly higher average tax rate.

August 12, 2013

China ‘hard landing’ could trigger Australia recession: Standard & Poor – The Economic Times

“Australia’s exposure to commodity demand from Asia, and China in particular, was a saving grace during the global recession of 2009. But by the same token it has become Australia’s Achilles’ heel,” the ratings giant [Standard & Poor’s] said.

“Particularly while mining investment remains such a large share of the Australian economy, and other sectors continue to lack growth momentum, Australia remains highly sensitive to a sharp correction in China’s economic growth.”

August 8, 2013

The Magical World Where McDonald’s Pays $15 an Hour? It’s Australia | The Atlantic

Jordan Weissmann compares wages paid to McDonalds workers in Australia and the US, raising four interesting points.

Firstly, McDonalds (or “Maccas” if we use its colloquial name in Australia) is profitable in both low-wage and high-wage countries:

The land down under is, of course, not the only high-wage country in the world where McDonald’s does lucrative business. The company actually earns more revenue out of Europe than it does from the United States. France, with its roughly $12.00 hourly minimum, has more than 1,200 locations. Australia has about 900.

They achieve this partly through higher prices, but also through adjusting their staff structure in Australia.

The country allows lower pay for teenagers, and the labor deal McDonald’s struck with its employees currently pays 16-year-olds roughly US$8-an-hour, not altogether different from what they’d make in the states. In an email, Greg Bamber, a professor at Australia’s Monash University who has studied labor relations in the country’s fast food industry, told me that as a result, McDonald’s relies heavily on young workers in Australia. It’s a specific quirk of the country’s wage system. But it goes to show that even in generally high-pay countries, restaurants try to save on labor where they can.

They also focus on increased productivity.

It stands to reason that in places like Europe and Australia, managers have found ways to get more mileage out of their staff as well. Or if not, they’ve at least managed to replace a few of them with computers. As Michael Schaefer, an analyst with Euromonitor International, told me, fast food franchises in Europe have been some of the earliest adopters of touchscreen kiosks that let customers order without a cashier. As always, the peril of making employees more expensive is that machines become cheaper in comparison.

That is one of the primary dangers of high minimum wages: automation is used to improve employee productivity and shrink the required workforce. Shrinking the national wage bill might seem like good business sense, but if we look at this on a macro scale, reduced incomes lead to reduced consumption and falling sales.

Finally, McDonald’s have attempted to add value to their product range, moving slightly more up-market in order to capture higher prices.

McDonald’s has also helped its bottom line abroad by experimenting with higher margin menu items while trying to court more affluent customers. Way back in 1993, for instance, Australia became home to the first McCafe coffee shops, which sell highly profitable espresso drinks. During the last decade, meanwhile, the company gave its European restaurants a designer make-over and began offering more localized menus meant to draw a higher spending crowd.

If we take McDonald’s as a microcosm of the entire economy, the trade-offs and benefits (or lack thereof) are evident. Funding wage hikes out of increased prices (for the same quality products) is futile. It adds no benefit: the increased wage is eroded by higher prices. Reduced wages for younger workers simply disadvantages older workers, excluding them from certain jobs. Increased productivity — higher sales per employee — on the other hand, can benefit the entire economy.

Improved training or increased automation may increase output, but run the risk of shrinking the jobs pool — unless new jobs created in training or manufacturing are sufficient to offset this. Product innovation, on the other hand, is an immediate win, raising sales while encouraging job growth in new support industries.

How do we encourage product innovation? Higher minimum wages is not the answer. Nor, on its own, is increased investment in research and education. What is needed is a focus on international competitiveness: reducing red tape, ensuring basic goods and services such as electricity, water, shipping and transport are competitively priced, lowering taxes and stabilizing exchange rates. That would encourage the establishment of new industry locally rather than exporting skills and know-how to foreign shores. We need a culture of innovation and entrepreneurship, rather than lip-service from politicians.

August 6, 2013

Henry Thornton | The recession we did not need to have

Henry Thornton expresses his opinion on the grim state of the Australian economy:

The Reserve Bank is widely expected to cut interest rates today. The economy is facing such a grim future that one can support such an outcome. But no-one, not even the Reserve Bank, is facing the main problem facing Australia, which is double-digit cost disequilibrium – a severe lack of international competitiveness.

Just like Treasury’s failure to be ahead of the curve in forecasting, the Reserve Bank’s apparent failure to understand our most important economic problem is bad news for all Australians….

Hat tip to Houses & Holes at Macrobusiness.com.au.