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Time for a new economic model

By Ken Wolff

Late in the 1970s Keynesian economics was largely abandoned when it failed to explain the stagflation that had occurred during that decade. Recently, in my piece ‘What economic plan?’, I quoted an Australian analyst with the CBA who suggested that recent national data released by the ABS was showing ‘bizarre’ results, an ‘anomaly’. That sounds suspiciously like the criticism of Keynesian economics in the ’70s. It suggests that it is time we reconsidered the current dominant economic models.

Under Keynesian economics inflation was normally associated with an expanding economy and increasing employment, leading to rising wages and prices. In the 1970s, however, inflation was rising but so was unemployment and production was falling – stagflation. Many put this down to the ‘oil-price shocks’ (which occurred twice during the decade) but Milton Friedman, with his monetary theory, put it down to faulty monetary policy on the part of governments and central banks. Although he had been developing his theory since the 1950s, the problems of the 1970s meant it was ready and waiting to be adopted and was initially taken up by the Reagan and Thatcher governments.

Friedman argued that inflation is always a monetary phenomenon: that prices could not increase without an increase in the money supply – he pointed out that the money supply should be matched to economic growth (GDP) to keep inflation under control and also to prevent governments simply printing as much money as they pleased. He also believed there was a ‘natural’ level of unemployment and inflation would also occur if unemployment fell below that level.

In his work Capitalism and Freedom he espoused the free market as the solution to many problems rather than leaving problems to government to resolve: government should keep an eye on the money supply and allow the market to take care of itself — the market was considered more efficient in dealing with inflation and unemployment.

His emphasis on monetarism and the free market led to two related approaches: supply-side economics and the rise of neoliberalism.

The free market which Friedman emphasised is based on the individual’s rights over private property, which the individual then uses to engage in the market. That was used by the neoliberals to place the individual at the forefront, not only economically but socially. The approach had been spelt out by the philosopher Robert Nozick during the 1970s.

Nozick considered that as each individual owns the products of her or his own endeavours and talents, it is possible for an individual to acquire property rights (as long as they are not gained by theft, force or fraud) over a disproportionate amount of the world. Once private property has been acquired in that way, it is ‘morally’ necessary (in a philosophic sense) for a free market to exist so as to allow further exchange of that property – it is only individual private property rights and market mechanisms that are logically important.

That captures much of the approach adopted by the neoliberals and helped give their approach a philosophic underpinning.

Nozick also posited that the state’s single proper duty is the protection of persons and property and that it requires taxation only for that purpose. That matches the current neoliberal argument for small government and minimal taxes and also fits with supply-side economics.

The basic argument of supply-side economics is that high taxes, particularly high marginal tax rates, are a disincentive to work, saving, investment and the efficiency of resource use. Some other taxes can also distort investment decisions by treating different types of capital investment unequally.

Supply-side proponents argue that:

  • lower taxes on wages will increase labour supply and increase employment by reducing the pre-tax real wage but increasing the post-tax real wage
  • lower taxes on interest and capital gains will lead to an increase in savings, leading to more savings flowing into capital markets and raising investment
  • for governments, lowering taxes will actually lead to higher tax revenue as people will work or invest more, thus increasing the size of the tax base.

What have these approaches actually achieved since the 1980s?

Following supply-side economics, many governments around the world have, since the 1980s, lowered marginal tax rates on income, including company tax rates, and the rates for earnings from investments and capital gains. Many other economists accepted that some of the outcomes suggested by the supply-side theories were possible but their impact was measurable only in decimal points of a percentage and the benefits were not as large as claimed by supply-side theories. The tax cuts made by the Reagan government were a classic example of supply-side theory but led not to an increase in government revenue but a huge increase in government debt, which other economists suggested over-rode any potential benefit.

Economists acknowledge that supply-side actions take a long time to show their benefits – although governments usually prefer to take short-term actions.

In 1996 one researcher wrote of the USA:

Economic growth, at its simplest, is the result of more people working and more output per hour (ie, increased productivity). Given two facts — annual productivity growth of about 1.1 per cent for more than two decades, and a slowdown in the growth of the working-age population — slower economic growth is the inevitable result. Since cutting (or raising) taxes has made no obvious, large difference in productivity, the idea that tax cuts will noticeably increase long-term economic growth is without merit.

More recently, to cover the long term nature of supply-side changes, some research has looked at the history of tax cuts in the USA going back to 1945, thus covering a period of about 65 years (at the time of the research). The research was conducted by the Congressional Research Service and first appeared in 2012. It found that there was no correlation between lower tax rates and saving, investment or productivity. What was found was that the changes had helped concentrate wealth in the hands of the top 1%, and particularly the top 0.1% of income earners, as their tax rates had fallen by more than 50%.

The market emphasis on the individual, supported by the neoliberal approach, basically endorses inequality because it results from individual ‘effort’. It ignores social responsibility and the common good. I won’t go into this as we have covered it before on TPS but it leads to the economists and neoliberals seeing no role for government in ameliorating the situation, or as the philosopher Nozick put it:

While it is true that some individuals might make sacrifices of some of their interests in order to gain benefits for some other of their interests, society can never be justified in sacrificing the interests of some individuals for the sake of others. [emphasis added]

Under this approach, governments should not intervene in the market, nor over-rule individual rights to reduce the increasing inequality, although it has been government decisions, under pressure from supply-side economists and neoliberals, that has exacerbated the situation.

Greg Jericho, writing recently in The Guardian, also pointed to the unusual outcomes occurring under the current economic approach:

The OECD has just released its latest compendium of productivity indicators and it shows that across the world productivity growth was slower in the decade from 2004‒2014 than it was from 1996‒2004.

But as the OECD notes, the slowdown in productivity growth has come during a time of “rapid technological change” and increasing participation of firms and countries in the global market – things which should see improved growth.

It is a “paradox” which the authors of the paper rather unsettlingly attribute to among other things, difficulties of measurement.

For its failures, supply-side economics has been disparaged and dismissed as voodoo economics’ (used by George H Bush as regards Reagan’s economic approach during the 1980 presidential primaries), although it still lingers among many governments, including the Liberal government in Australia. Despite the evidence, our government still believes that lowering taxes will help investment, economic growth and ultimately government revenue. In Fairfax papers on 9 June, Peter Martin wrote that the government’s company tax reduction would cost a nett $8 billion a year (after some increased income from personal taxation). For that cost, the benefit would be an improvement in gross national income of between 0.5% and 0.7% ‘after several decades’ or less than 0.1% per year (so low that at one decimal point it rounds to zero):

And the boost to jobs would be even smaller. Independent Economics says employment would eventually climb by 0.17% if the tax cut was funded by a tax on households, or by as little as 0.02% if it was funded by cutting government spending. That’s an eventual increase of between 2400 and 20,400 jobs. By way of comparison employment has climbed by an average of 24,000 per month over the past year. It means that after 20 to 30 years the $8 billion per year holds out the prospect of delivering an extra month’s worth of employment growth.

That certainly echoes the long-held criticism of supply-side economics that it produces only marginal improvements over very long time spans.

Another common problem is the acceptance of Friedman’s ‘natural’ level of unemployment: our government does nothing to reduce unemployment below 5%. That figure is the accepted norm within the Australian Treasury and its longer term projections, such as in the Intergenerational Reports, use that figure consistently over many years (linked to stable inflation). While it is all but impossible to achieve zero unemployment, prior to Friedman’s approach unemployment at about 2% was considered ‘full employment’. If we now accept that another 3% of the labour force (over 300,000 people in Australia) should always remain unemployed, doesn’t that also have an impact on demand and production?

To me, as an economic layman, controlling the money supply seems to have become more difficult because financial institutions have created artificial financial products that do not appear to bear any relationship to their actual value. In relation to the GFC, there was a small number of economists and market analysts, who pointed out that the total value of derivatives and futures traded was greater than the money supply in the US and of the total value of the goods being traded – so something had to give!

Following Friedman’s approach, perhaps that situation indicated the money supply was too low but, in fact, it was too high – deregulation of financial markets had seen to that!

Friedman and other monetarists envisioned strict controls on the reserves held by banks, but this has mostly gone by the wayside as deregulation of the financial markets took hold and company balance sheets became ever more complex. As the relationship between inflation and the money supply became looser, central banks stopped focusing on strict monetary targets and more on inflation targets.

For that reason, some argue that Friedman’s theory has not failed but that governments have moved away from it. Rather than controlling inflation through the money supply, control is now more focused on interest rates set by the central banks. On the other hand, Friedman argued for freedom in the markets and deregulation is just a way of achieving that – so is there an inconsistency in his arguments?

A number of governments around the world, have engaged in increasing the money supply (quantitative easing) following the GFC but it has not increased inflation (and growth) as Friedman’s theory suggests. Instead national economies are stagnating or growing painfully slowly and employment and production are not rising significantly. So if increasing the money supply is not working what will?

Whichever way you look at it there are more and more questions and anomalies in the current economic situation not explained by Friedman’s monetarism or supply-side theory.

A Keynesian would increase government spending and, if necessary, government debt to stimulate the economy. Friedman, however, warned that government debt is bad because it encourages governments to allow inflation to rise as a way to effectively reduce the debt – which was how many governments paid the debt they had accumulated during WW2. But as explained in ‘Bankers 3 Democracy 0’, such inflation is resisted by financial institutions because they are the ones that stand to lose.

Finally, some investment advisers in the US are warning that there is a danger that America could face the return of stagflation. While advising that it is only a small risk at this time, they are suggesting that investors may wish to hedge their position by placing more of their investments in gold and government bonds. If even Friedman’s approach is potentially leading to stagflation, shouldn’t it also be abandoned?

Do we return to Keynesian economics? Although supply-side economists say it shouldn’t work, it worked for Australia in the GFC: the Rudd government provided cheques to households to spend. That was pure Keynesian because it allowed a demand-driven boost to the economy without changing the underlying tax base (and thus future government revenue).

Which Australian political party will be brave enough to stand up to the economists, including those in Treasury, and say your current economic theories aren’t working? – reconsider what you are telling us and tell us something that will actually work! There are other economic approaches available, such as Modern Monetary Theory (MMT) and what is sometimes termed ‘middle out’ economics which uses a demand-driven model that emphasises the capacity for spending of the middle class to drive economic growth. Perhaps it is time that government, and the Treasury, gave these approaches more heed because Friedman’s monetary theory and supply-side economics certainly aren’t working.

What do you think?

Why should we stick by Friedman’s approach and supply-side economics when it is clear they are not explaining current ‘anomalies’ or ‘paradoxes’?

How can we support an economic approach whose greatest achievement seems to be increasing inequality?

This article was originally published on The Political Sword

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  1. Jack Russell

    All Friedman’s theory achieved, when put into application, was to create a global cabal of economic/corporate sociopathic criminals who set about deliberately constructing the legal and financial frameworks needed to support the gigantic siphoning off of the planet’s wealth to sequester it in tax-havens-of-choice for personal use – abetted by well-lubricated recruitment of corrupt politicians and the infiltration of government departments and public institutions world-wide with their disciples.

    Roughly 90% of the world’s people now live in this all-pervasive nightmare as victims and do the best we can despite the monstrous economic and social devastation.

    So, to answer your first question: Emphatically NO!

    As to how it can be remedied: A determined effort by the honest people who have the means – or bring on the guillotines!

  2. Freethinker

    No one of the 2 IMHO but if have to choose I will go for the Keynesian not borrowing foreign currency.

  3. kerri

    The logic behind trickle down or supply side is such practical nonsense!
    If small businesses were to gear up with new $6,000 toasters for example, they would soon go under if the majority of consumers are too poor to go out for toast and make it at home instead!
    Blind Freddy can see that!

  4. paul walter

    Just digesting it, so not too much comment, but I must admit I thought the other night that Bill Shorten was advocating for what is basically, a mild version of Rudd-ian fiscal stimulus rather than more the miserable austerity the Big End wants in its quest for Feudalism and looting by fiat.

    The Big End, Trump, Murdoch and co, are reactionary modernists who in the end are best represented by someone like Pauline Hanson, eg dislocated from reality and governed by impulse.

  5. michael lacey

    A good article and yes we are certainly late on a new economic model! My concern is the failure of capitalism and the way systematic failure, built into the system, eventually lays it exposed. We paint over it and cover it up for so long but eventually its contradictions catch up with it. We float along from boom to bust.

    You only have to look at history, in 1929 the world was not the same place as the world after 1929, just as the world was not the same place after 2008. With the entire Third World now exploited to the limits possible, the West has turned to looting its own. Ireland has been looted, and the looting of Greece and Portugal is so severe that it has forced large numbers of young women into prostitution. But this doesn’t bother the Western conscience.

    What has happened to Greece and Portugal is underway in Spain and Italy. The peoples are powerless because their governments do not represent them. The combination of propaganda, financial power, stupidity and bribes means that there is no hope for European peoples. The same is true in the United States, Canada, Australia, and the UK. We as citizens have quietly accepted the absence of any interest income on savings for years, the deterioration of sound supportive public infrastructure, endless wars, greater inequality, free trade agreements and a corporate directed public relations media. We are accepting the decline and accountable government in the West is history. Nothing but failure and collapse awaits Western civilization.

  6. John Kelly

    While it would be political suicide to advocate MMT prior to an election, a slow release after an election could work. A starting point could be to monetise 50% of the difference between revenue and spending in the first year. In the second year, 75%, in the third year, 100%. The effect would be a reduction of debt levels and no change to the money supply. At the same time introduce a trial job guarantee program to absorb specific areas of high unemployment, i.e., youth unemployment. Expand this in the second and third years to other demographics which would be reflected by a marked impact on welfare outlays.

  7. Ken Wolff

    Thank you everyone for your comments.

    There is no doubt that the current approach is being dominated by big business and financial institutions. The financial institutions won in Greece despite what a democratically elected government wanted to do. Governments talk about responding to ‘the market’ but ‘the market’ does not exist: it is wealthy individuals and big companies trying to manipulate trading for their own benefit, which can also be to the detriment of consumers when we exchange our labour for goods and services.

    Michael: I am working on another piece that looks at the history of economics and the rise of ‘the individual’ and ‘private property’ to the detriment of social responsibility and consideration of ‘the commons’ — that has allowed companies for the past 200 years to pour their waste into ‘the commons’ of the rivers, oceans and atmosphere and we are now paying for that. It would not have happened without the changes that took place in the Western approach to economics. It will probably be after the election now but that does not matter.

    John: I know from your articles and previous comments that you understand MMT much better than I do but I agree that a graduated approach monetising the so-called budget ‘deficit’ would be an effective approach. The problem., however, is that after years of being told that the government budget is like a household budget few would understand and there would likely be an outcry. One could only hope that the success of the approach would win over the populace before the next election. I do understand that the Job Guarantee is a central plank of the MMT approach and is certainly something that could help win over the doubters.

  8. Jack Russell

    If you haven’t already, then look up the A. L. E. C. group that operates inside (and outside) the USA. It is enlightening to see their modus operandi, who subscribes to it, and the reach of their tentacles.

    I get the impression that the ALP may be accepring of MMT, but that could be wishful thinking on my part.

  9. Miriam English

    Here is an interesting open letter from Jeff Blackwood, CEO of a large health company in USA about why he is moving his large corporation away from Kansas and its infatuation with right-wing economics to the somewhat more progressive state of Missouri.

    In it he notes that Kansas has become the truest example of “trickle-down” economics in USA and as a result has failed awfully, hurting everybody in the process. It is a warning that I’d like our politicians here in Australia take note of. Idoleogical devotion to a fantasy in the face of mountains of contradictory evidence has dire consequences in the real world.

  10. kizhmet

    Thank you for the link Miriam. If only more businesses had the same moral compass!

    Sadly the fundamentals of economics is lost on a significant portion of the population. I firmly believe politics should be a compulsory secondary school subject, covering budgets in that curriculum. Educating the general public is critical to effecting any kind of meaningful change. An informed general public – can you imagine it?

    “Supply side” economics is a failure of biblical proportions with 90% of the world paying the price of that failure.

  11. Miriam English

    The problem is that if they taught politics in school you could be pretty sure they’d teach it the way debating is taught — it’s all about point-scoring and emotional persuasion. Compare that with science, where knowledge and argument are an aid to getting at the truth. Sadly, our politicians think they’re debating team stars. They were taught to use argument to mislead and obfuscate, where it is legitimate to win at any cost.

    Perhaps if they taught politics with morality and philosophy things might change. Perhaps also with a side serve of mental health, so that they could understand the pathologies exhibited by many existing politicians. It might also have the advantage of bringing more women into politics.

    Certainly something needs to change. We need to neutralise the existing attack-dog culture in politics, where the cynically corrupt who are focused purely on short-term gain are best suited to survive. Instead, we want it to be a vocation that attracts smart, empathetic, people who genuinely want to help improve the world; where those people are lifted up instead of worn down.

  12. jim

    Hey,there’s never been a better time to be an Australian “chuckle,chuckle” smile smile smile ….. There’s a lot at stake this election. Turnbull’s economic agenda is about more than our politicians doing their big business buddies a favour – it will demolish our most valuable public institutions, creating a society that pits the “lifters” against the “leaners”.

    Together, we can deal it a serious blow and turn this election into a referendum: offering voters a clear choice between investment in our schools and hospitals or a handout to foreign investors – a statement that will have a lasting impact, well beyond this election.

    Thanks for all that you do,
    Nat, Daney and Ruby, for the GetUp team

    PS – The same independent crack team of corporate tax experts that authored the groundbreaking ‘Closing the Caribbean Connection’ report will delve into the details of the top 200 corporate taxpayers, and find out how much money Turnbull is shipping offshore. Their track record of getting serious public attention on major issues around corporate tax is second to none – so we’ve no doubt this research will make a big media splash. Click here to chip in.

    PPS – If Turnbull wins government, he’s tipped to move quickly to get his corporate tax handout through parliament. In the final week of the election, we can make clear to whoever takes control of the next senate that Turnbull’s big ‘economic plan’ is a farce and Australians won’t stand for his ‘trickle down’ tax cut. thanks to getup.org…link ok…. https://www.getup.org.au/

    I’m %&#Fcuk%#@* OUTRAGED.

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