Introduction
Economics
aims to determine optimum efficiencies or outcomes from competing wants, which
exceed available resources, but overlaps social and political philosophy.
The key
determinants for optimum outcomes involve policy assumptions based on the so
called laws of supply and demand, the effect of interest rates, aggregates in
relation to the circulation of money, the role of exchange rates and how
agencies regulate markets.
But
policies and theoretical economic models are routinely hijacked by corruptive
power and the difficulty of obtaining and interpreting reliable data.
Notwithstanding,
the adoption of orthodox economics, supportive of market freedom, but subject to
prudential controls and embracing international trading, is suggested by most
economists to be an important factor in improved standards of living. But such
an advantage may be overstated in lieu of the significant contribution made from the
advancement of scientific and technological knowledge.
Early
beginnings
Economics
was not a word used in indigenous communities, but its application
within their non-technological existence was impressive.
Possibly
Australian aborigine’s trade between nations represented one of the
few really effective free markets. Like indigenous groups
elsewhere, they traded ceremonial artefacts, tools, skins, grain and even water
rights within respective nations, using interpreters and negotiators to secure
trade agreements.
A United
Nations approach was employed to ensure optimum outcome from the countries
limited resources, so that as crops prospered or game became scarce seasonally
in one area it was traded in exchange for goods available in another, just as
modern economics champions free trading.
But within the western world complexity was
increasing as new scientific discoveries
underpinned industrialization, in tandem with the Renaissance, the
Protestant Reformation, the age of enlightenment and colonization.
Philosophers reasoned this increased complexity in the
management of state affairs could best be served by applying scientific
knowledge, based on the assumption markets represented rational outcomes.
The
Industrial Revolution
As society
became transformed by the mechanised Newtonian world, evident in the
mass production of goods and services, philosophers concluded this
complexity must conform to laws, yet to be discovered, which, once unearthed
would enable optimum policy settings to be determined.
Scottish
philosopher David Hume, who was an influencer of Adam Smith, who wrote “Wealth
of Nations”, argued vehemently against the Mercantilists who believed the
best way for a nation to gain wealth was to restrict imports and exert total
control over exports to maximise gold accumulation in the home country.
Under this
system the American colonies were forced to supply all the raw materials for
Britain to manufacture into the finished goods which were re-exported to the
colonies, at an exchange rate highly favourable to Britain, a significant
factor in fuelling a world war.
Wealth of Nations
Adam Smith
expanded on Hume’s ideas and introduced the term “invisible hand”, to describe
how the market made decisions regarding supply and demand. This led him to a
rational theory governing outcomes in respect to aggregates for production,
consumption, distribution and their effects on markets.
He
concluded people generally acted out of an enlightened self-interest so that
the market is mostly able to achieve (by virtue of the “invisible hand”)
optimum outcomes. He also
championed thrift and saving as a virtue maintaining a national savings pool
provided the engine room to support investments which flowed on to improve
production and ultimately lead to enhanced living standards.
He concluded there need only be a limited role for government; in defence, education, public
works and the operation of the law. He sought to align a nation’s currency with
the holdings of precious metals, to ensure the government’s ability to
depreciate its currency was curtailed. This was the seeds of the so called
“gold standard” where a countries external liabilities were always to be
matched by a nations central banks holdings of gold.
Smith was
also a moral philosopher, who reasoned his economic theories represented
favourable outcomes for the nation and for world trade.
John
Stuart Mill
The
English philosopher and utilitarian, John Mill made a significant contribution,
who supported free markets but was
amenable to taxes to be imposed on services and was in favour of a flat tax system for everyone paid the same percentage of taxation.
His book Principles, which was first published in 1848,
and, like “Wealth of Nations” was widely acknowledged and accepted well unto the next century. He concluded that economic democracy arising in the form of worker
cooperatives was superior to capitalism.
The
Twentieth Century
A
significant contributor in the immediate post World War 2 period was Samuelson,
whose ideas became widely accepted in the aftermath of the frightful memories
of the Great Depression and war. Samuelson reinforced the earlier work of John
Maynard Keyes, whose motivating force was how to avoid a repeat of the horrors
of the Great Depression. Keyes had lost his fortune on the stock market and set
about determining what measures could be taken to reverse recurring slumps in the trade cycle and mitigate against the over buoyant
conditions that preceded the inevitable contraction.
What Keyes and Samuelson concluded was that both monetary
theory (supply of money and interest rates) and fiscal policy (taxation and
spending measures) could be used as tools to overcome the excesses of the trade
cycle; if inflationary pressures persist taxation and interest rates can be
increased , whilst stimulatory measures can be employed to reverse contraction. The
idea was also for governments to build surpluses in times of stability which
could be employed in the event of contraction or external shock.
Keyes recognized the pivotal role of investments, and the
effect of the investor multiple which represented a multiple of
many times consumption which it sought to satisfy. Keyes was a supporter of
government regulation, as a necessary lever in guarding against and offsetting excesses; for regulatory
agency bodies to have responsibility to ensure prudential standards were
maintained.
However as a result of rising inflationary pressures due
to the oil shock of 1973, as a consequence of supply restrictions imposed by
the OPEC nations, economies faced soaring unemployment as energy costs
escalated and businesses reduced their operations. This situation posed a
crisis for Keynesian economics, since his model called for stimulatory measures
in the face of a contraction and rising unemployment, but which if implemented
at that time would have only aggravated already rising inflation. Of course
nations could have simply opted to institute price control subsidies to reduce
fuel prices and inflation until the prices of oil stabilized and returned to
normal historical trends. Prior to this turning point Keynesian economics had
dominated policy in almost all capitalist governments.
Economic
schools of thought
Hence this
crisis in Keynesian economic “orthodoxy” fuelled interest in emerging different
schools of thought, as the monetarists in the USA gained ascendancy.
It is helpful to examine the effects on both microeconomics and
macroeconomics.
Microeconomics
is concerned with the choices of individuals who will pay less for a commodity
when they have more of it and more when they have abundance; applied to free
markets consumer’s choices determine prices, rather than firms. It is
only when firms hold monopolistic powers are they able to exert pricing power
over consumers. Of course, the values we hold collectively are unlikely to
always coincide with this simplistic economic principle, so that economists now
attempt to categorise consumer and business choices into sub groups in a
concerted effort to more accurately define aggregated
totals.
Macroeconomics
is concerned with the aggregates of production, supply, distribution, money
supply and so forth, where we encounter the divergent schools of thought. Along
with the diminished Keynesian economics, the Monetarists and others such as the
Austrian school placed more emphasis on uncertainty and is critical of many of
the modelling theories .
Monetarism, was the brain child of Milton Friedman whose
philosophical thrust was stability can be maintained by exercising control just
over the supply of money and central banking. Inflation in the seventies
dominated economic debate and monetarism simplistically attributed its root
cause to an excessive monetary supply by a central bank and for the reverse to
be the cause of recessionary cycles. The simplicity of such a new found
philosophy was popular with politicians, as it reduced the onus of regulation
and policy to just the supply on money, which became popular in the US.
Australia –embracing economic reform within
Keynesian economics.
In the
earlier post war period the government exercised control over leading economic
settings, so that exchange rates were set by the regulatory authorities, who
also imposed conditions over lending, setting interest rates, tariff rates and
banking.
It was not until the seventies that tariffs were reduced by 25% to
open up the nation to overseas competition but the pace of reform increased
markedly under the Hawke/ Treasurer Keating labour government of the eighties.
During
this period massive changes were instituted, with bipartisan political support,
to float the Australian dollar, reduce tariffs, reform the tax system, introduce an enterprise bargaining system for wages outcomes and
to privatize previous publically owned companies such as Qantas and the
Commonwealth Bank. Later national superannuation was introduced to play a
significant role in increasing our national savings pool.
More recently the Howard liberal Government established
the GST ,
and presided over a period of government surpluses arising from the mineral
boom, to establish a future Fund once federal government debt was eliminated.
During the global financial crisis the Rudd labour Government employed
classical Keynesian investment stimulatory expenditure to counteract any
adverse consequences, to ensure the economy remained strong.
Keynesian philosophy in favour elsewhere
There is a
growing realisation that placing all your faith in markets, reducing regulation
and having a very loose monetary policy with declining interest rates to
discourage savers and fuel reckless lending was a major determinate in the
outset of the Global Financial Crisis.
Furthermore
notable economists such as Joseph Stiglitz, James K. Galbraith, Robert Shiller
and Paul Krugman have all been critical on monetarism and have argued for
a return to Keynesian economics.
Modern day economics – the use of quantitative easing.
Quantitative easing is an unconventional branch of stimulatory monetary policy used when low
interest rates has proven to be ineffectual in reigniting sluggish economies,
QE has been employed in the US, the UK and the Eurozone, where real risk free
interest rates are virtually zero, and in Japan to reflate its economy and
reverse deflationary pressures.
QE does not initially involve the printing money,
since the volume of cash in circulation is unchanged, as no new financial
assets are added to the private sector. How it works is a central bank such as
the Federal Reserve in the US, buys a quantity of Treasury notes or bonds (
hence the word quantitative ) from the commercial Banks, who afterwards have a
corresponding lesser value of bonds held but more in reserves, to facilitate
more lending. Depending on the quantity of different maturing securities bought
relative yields can be influenced to make short term commercial interest rates
more favourable to longer term or vice versa. After the transactions the
central banks holding in government securities increases, according to the
quantity purchased, with a corresponding liability to the selling bank. This
process is often referred to as expanding its Balance sheet, since it is
increasing its assets (securities bought) whilst simultaneously increasing its
liability to the banks. No money changes hands as only a credit is registered
in the central bank as the amount owing to the commercial banks for the assets
purchased.
Banks themselves, have always had the ability to
create money through leverage as their lending is always a multiple of capital
and reserves, (typically a factor of about 10) so that through quantitative
easing they are able to create money once they engage in increased lending.
The ongoing criticism of quantitative easing is that
it has continued on for too long, from the early days when it could be argued
it was a valid policy response to counter the curtailment of credit before and
after the global financial crisis. Then credit was contracting sharply as corporates
and individuals deleveraged from the excesses of previous reckless lending that
preceded the global financial crisis.
What critics of quantitative easing claim is it is
creating distortions with asset inflation and we need to begin winding
back from QEs – the longer we wait the more painful the adjustment. The move to
scale back will most likely result in a reduction in the value of many inflated
asset classes as interest rates begin to increase to reflect long term mean
averages.
Growing inequality.
What is not always acknowledged is that economics
originally arose not only as a tool to ensure superior outcomes and improved
wellbeing for a nations citizens but more importantly to underpin moral values.
In this regard Smith rallied against the unethical stance of the mercantilists,
whilst later Keyes and others concluded your cannot legislate against human
greed and fear, but you can, with improved regulation, afford control over
inevitable excesses, to champion prudential management, under government agencies
supervision.
More recently economists, such as Joseph Stiglitz,
continue in this tradition to make the case growing inequality in
income distribution (evident mostly abroad), is not only an undesirable social
objective, but economically is irresponsible. In the US for instance, according to
Stiglitz, one in four people in the US will now be born into a family that will
be unable to afford even reasonable nutritional standards or heath care which
will substantially impede any future growth. In the US wages are not the
problem but a lack of demand emanating from contraction of the middle class and
an ineffective tax system. Even in China, which has, in the last 35 years of attempted to
emulate a market based economic system under centralist communist oversight,
produced inequality which increases the risk the sustainability of past impressive growth.
Inequality
increased under coalition’s first budget in Australia
The
incoming coalition’s first budget was designed to meet the structural decline
in the economy following declines in investments from the mining boom and as a
consequence the fiscal challenges from a reduced tax base. But the budget
represented a piecemeal approach, with no tax reform but a general notion it
was unfair, to overall represent about a negative
.3% drag on the economy.
Notwithstanding
the latest developments, inequalities have continued to grow, but albeit at a
vastly subdued rate compared to most other countries. According to economist
Judith Sloan, who recently appearing on Q & A on the ABC, the drift is
mitigated by the nations efficient tax and transfer system which redistributes
30% of income to those on lower incomes. The end result is real gains after
inflation for the past 23 years for the bottom percentile of 27 % compared to
33% gain for those in the top quartile. The latter increase, might well be
explained by enhanced income opportunities arising from higher
education.
But Sloan
is also critical of the recent first budget to impose a 6 month waiting period
for those under 30 to receive unemployment benefits. An alternative would be to
provide a relief to employers to employ say the unskilled at a rate below the
current minimum wage (about $33,000 pa) but above current unemployment benefits
for a period up until they became skilled and are entitled to minimum
compensation. In other words, similar to apprenticeships, imaginative solutions
need to employed to offer hope to young people and avoid Australia flowing on
the folly of accepting the very high rates of evident in much of the world
today.
Conclusion
Whilst the US has only just reached the level of
employment that existed just before the advent of the GFC, the new jobs are
mostly in in the lower paid category and hence they represent people who are
unable to save, many of whom are referred to as the working poor, unable to
afford basic heath or possibly nutrition, Elsewhere, as in the US, successive
governments ran up huge deficits, to exhaust all reserves, so that the last
resort was is in the use of quantitative easing.
Making up for decades long of unsustainable spending
and failure to ensure sound economics presents a formidable challenge ahead,
but accelerated tapering in relation to quantitative easing, with a goal to
completion in the next year will help remove the present distortions in asset inflation
and restore incentives for savers as rates return to normality.
A national savings flow is now also essential to
sustain future investment and to begin to build up a reservoir to employ
against any unexpected further external shocks. Although corporate balance
sheets are in much better shape now tax on earnings is hampered by the ease to
redirect earnings to low tax regimes, further exasperating respective countries
tax collections.
This requires a concerted effort by respective
government’s regulatory agencies to ensure multinationals pay a fair share of
tax.
Governments also need to revert to more imaginative
means pf employment, particularly for the youth and older displaced workers,
with the reintroduction of Keynesian style investment expenditures.
But placing more emphasis on savings and investment in expanded resources and
people will require a change in policy mix and the prospect of raising taxes of
one kind or another likely to be an anathema within current political debate.
The additional investment in both people and
facilities to counter downturns or sluggish economies is just as it was first
envisaged by Keyes so it remains even more relevant today.
