It's The Economics, Stupid!

While everyone's attention has been diverted to more newsworthy events including the election of an erratic, slightly unhinged misogynist to the top job (no, not Mark Latham) or the appalling state of Australian cricket, the Federal Government has been quietly and consistently making a hash of managing the national economy.

This post has more graphs and denser economic theories than a Greg Jericho column.
Think that's impossible? Just watch!

Two recent revelations are illustrative of the Treasurer's inability to understand high school level economics. First, wages growth in Australia is the now at the lowest level recorded, a miserable 1.9%. Secondly and related to the first point, the Government is shortly expected to announce a worsening of its budget position in the order of some $24 billion in the mid-year budget update due early next month.

The relation between low wages growth and the worsening budget deficit becomes apparent simply by looking at the budget papers.

This table shows that the taxes on individuals are supposed to bring in $196 billion, $69 billion (nice) is to be collected from companies, and $104 billion from the GST and other indirect taxes. Combined with assorted smaller tax receipts and various sources of Commonwealth revenue, the government has budgeted for a total revenue collection of around $416 billion in the current year.

On the flip side, the budget papers include expenditure of around $450 billion, which you will probably notice is larger than the expected revenue figure this year. The difference between expenditure and revenue gives us the 2017 budget deficit figure of around $34 billion.

Now, the intent of this post is not to argue the pros or cons of any particular item of government expenditure. If I did intend to do that, I would be pointing out that the Commonwealth subsidies to private schools this year cost taxpayers $10.5 billion, which is more than the funding provided to universities ($9.5 billion). But nobody is pointing that out right now.

Nor is this post aimed at exposing the wretched hypocrisy of people complaining about young people being are welfare cheats and a drain on society by noting that "income support for seniors" is the largest single-purpose use of funds in the entire budget at $45.3 billion (only GST-funded grants to the states is bigger). But nobody is reminding you about the high number of aged pension recipients structuring their affairs to avoid means testing.

And this isn't a piece on how deficits are bad and how we need to return the budget to surplus yesterday. In theory, a budget surplus means that the government has collected more money from households and businesses than it has returned to the economy via spending. This actually reduces the size of the economy by removing money from circulation. In practice, the budget is likely to return to a surplus position when people have higher disposable incomes because their economic circumstances have improved.

This is what the Treasurer was hoping for. As set out above, just about half of the government's total revenue take is collected from individuals. Because we have a progressive tax system (people earning more pay comparatively more tax), as people's incomes go up, so does the proportion of tax on their income. This is called bracket creep, and it is a mechanism treasurers have relied on for decades to reliably increase their revenue.

Take for example the change to the second-highest bracket threshold in the last budget, from $80,000 to $87,000. If their wage grew by 4.5% per year as may was common during the boom years of the mid-2000s, they could expect to move up to the new $87,000 tax bracket within 2 years. With the current growth rate of 1.9%, the move from $80,000 to $87,000 would now take 5 years. Treasury did not budget for this, and it's hurting their coffers.

This explains the connection between our historically low rate of wage increases and the deteriorating budget position. In order to see the link between these problems and the government's economic policies, we need to understand some fundamental concepts in macroeconomics.

The Marginal Propensity to Consume and the Multiplier
Imagine I put $1000 in your bank account, right now, in addition to your current balance. No questions asked. What do you do with it? If you're reading this, you may use it for your normal living expenses because you have bills to pay. Or you might buy yourself something nice for yourself which you ordinarily wouldn't. You might do your grocery shopping that week at Harris Farm instead of Aldi. Would you save any of it?

CHEESE FOR THE BOURGEOISIE

Now imagine that I put an extra $1000 in Malcolm Turnbull's bank account. Malcolm Turnbull is one of our country's richest men. Does he spend any of it? How much of that $1000 does he save? My guess is that he will save more of that $1000 than you, perhaps keeping it in a Mossack Fonseca bank account for future investment in a speculative Russian mining venture.

The percentage spent and the percentage saved of the extra money gives you the fancily named "marginal propensity to consume" and "marginal propensity to save." All it means is that, for each extra dollar of disposable income someone receives, how much of it is spent and how much of it is saved. The trend is that people with lower disposable incomes have a higher marginal propensity to consume, and people with higher incomes have a higher marginal propensity to save, for the simple reason that those on lower incomes need to spend a higher proportion of their income on immediate needs such as food, housing or transport costs.

This sort of leads to the multiplier. If you go and spend some money in the economy (in accordance with your marginal propensity to consume), it doesn't just stop there, the recipient spends in amount in proportion with their marginal propensity to consume. The money that gets spent in the retail sector for example allows shop owners to afford to hire staff, who spend their wages in other shops, who in turn can afford to hire people, who spend their wages, and so on and so forth. At each step the business owner may receive a portion as profit, some of which is taxed, some of which may be spent on capital equipment, some of which may be spent in other shops. The number of times money circulates throughout this system is called the multiplier.

Aggregate demand and the four drivers of economic activity
One of the standard models of how national economies work is the four-sector model. It looks complicated

Okay it's a little complicated

but it can be broken down into showing that there are four drivers of economic activity which determine the size of an economy. These are:

• Consumption (like I just talked about)
• Investment
• Government spending
• The balance of eXports (money we receive for sending goods/service overseas) versus our iMports (money we send away for goods/services produced overseas)

The sum total of these is called our "aggregate demand" which is the economic measurement for everything which is produced in the economy. Economists have a fancy looking equation for this

AD = C + I + G + (X-M)

but all you really need to know for now is that the size of the economy is determined by the sum of the four things I just listed.

Of these four, the most important in the short run is consumption. The most important in the long run is consumption as well. Investment is important in the long run as well because it's how we increase the productive capacity of the economy but John Maynard Keynes said "in the long run we're all dead" so for now we're just dealing with consumption.

J.M.K. lives for the present!

For a practical example of how increasing consumption expenditure benefits the economy in the short term, remember how at the height of the financial crisis in 2009 how Kevin Rudd gave everyone $900?

It also gave us the title of the 2009 Wharf Revue, back when it was still funny

Remember how thousands of people went and spent that money at Harvey Norman, keeping them and their terrible ads in existence for years to come? Remember how we were encouraged to spend up, and most of us did? Do you also remember how Australia avoided a recession during the GFC and emerged in a much stronger fiscal position compared to the rest of the world? That was basically the applied version of these economic concepts: give a bunch of people with higher marginal propensities to consume (the poor outnumber the rich) some money to spend, it circulates throughout the economy a few times and the spending will promote economic growth.

It's not that we should repeat this tactic now. What the Pennies from Kevin illustrated is that an increase in government spending and consumption - the G and the C in our equation - is effective in increasing the size of the economy.

WON'T SOMEBODY PLEASE STOP THE ECONOMICS!!

If policies which increase government spending and consumption also increase the size of the economy, it follows that policies which decrease the government spending and consumption components of the economy have the effect of reducing economic growth.

This is exactly what the current government has done.

The current government has cut the level of support given to low income earners.

It has famously attacked the young by reducing their access to payments, lowering the threshold at which HELP repayments must be made and encouraging the proliferation of predatory poor quality private education providers.

The Government has cut the level of support given to the unemployed and placed more onerous restrictions on the access the unemployed have to this support.

All of these measures make life harder for low income families, young people and the unemployed, precisely the people with the lowest disposable income and the highest propensities to consume. Even if there is a proportion of "waste" in the system, these people spend nearly all of their income! In the economy! On food! And clothes, and study materials, and things to help them prepare for their next job interview. Everything we give to these people is put back into the economy, keeping businesses profitable and increasing the government's tax take. The easiest way to lift our economic growth is to put more dollars into the bank accounts of the poorest either directly or by making it easier for them to find employment.

The easiest way to stifle economic growth is to do precisely what the government has done. It is economic vandalism.

While I'm speaking about employment, it is important to acknowledge that in our current setup, everyone who isn't an *actual* socialist accepts that a certain level of unemployment is a design feature of the system. This may be variously called the "natural" or, if you're a jerk, the "non-accelerating inflation" rate of unemployment, and is considered to be somewhere in the vicinity of 4 - 4.5% at the moment.

The underlying theory as I understand it is something along these lines: imagine if everyone had a job. The only way to entice anyone to move jobs would be to offer them increased wages, But then competing businesses and that person's current employer would have to increase wages to match the new market level. Businesses couldn't afford not to match because there is no spare labour capacity in the economy. The overall increase in wages would be good for people at first, but with everyone having more money the price for everything would go up, leading to an inflationary spiral such that the real value of people's money decreases.

In our current setup then the Reserve Bank manages the supply of money in the economy to prevent high inflation, and we maintain some level of unemployment to effectively act as spare capacity for businesses to draw upon. This being the case, we can mitigate the harmful effects of this designed unemployment by (a) promoting policies to ensure that this is short-term rather than long-term unemployment and (b) having a decent safety net which ensures that the unemployed can still afford some level of consumption and as shown above, contribute to the economy. (We can also (c) make sure everyone has a decent standard of living because it's the right thing to do, the morally right thing and economically right thing here coincide.)

As an example of just how badly the Government is handling the economy, the Treasurer in an interview with the ABC on 21 November acknowledged that the historically low wage growth of 1.9% was the largest contributor to the increase in the deficit. Why then is the Government offering hundreds of thousands of its employees a barely larger pay increase of 2% which doesn't factor in the 0% wage growth in many public sector agencies since July 2013. Public sector enterprise bargaining has been so poorly conducted that the Senate is holding an inquiry on the matter. The very government which is complaining about low wages turns around and offers people low wages! It makes zero sense, and the multiplier effect means any increase in wages would be largely recouped from increased economic activity and tax collections.

I have already shown how the Government's centrepiece economic policy to generate "jobs and growth" was doomed to fail at the outset and will do nothing except lower the taxes paid by large foreign companies at the expense of individual taxpayers. I have also already shown that the Government's failure to reduce or remove the capital gains tax discount harms both housing affordability for young people and the budget bottom line.

There can be no question now that the Government has forfeited any claim it has to be effective economic managers. At every opportunity presented to them, both the previous and now the current Treasurer have managed to make precisely the wrong decision when it comes to increasing economic growth and living standards in this country. I said some disparaging things about Wayne Swan on this page in 2012 and I stand by that assessment, but he was surely a giant in comparison to the current mob.

Basic economics shows us what we need to do to fix this mess. Pray we get the opportunity soon.