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Is the Australian economy sinking into recession?
Gerard Jackson
Economic indicators are looking bad for the Australian economy. Several times in the past I have said that the Treasurer Peter Costello is going to get egg on his face, mainly because he knows absolutely nothing about economics, the development of economic thought or even economic history. All of which makes him a typical politician.
I have lost count of the number of times I have pointed out that while the so-called boom-bust cycle consists of malinvestments it is generated by credit expansion. Professor Ludwig M. Lachman put it succinctly when he observed that while the boom is caused by monetary factors it constitutes real forces. This is something that the currency school never fully understood — and neither do neo-classical economists, including those in the Treasury and the RBA.
Loose monetary policies are the root cause of the business-cycle. These policies misdirect production, causing overinvestment in certain sectors. When the boom reaches its peak (I’m assuming that the central bank has not applied the monetary brakes) these malinvestments eventually emerge as idle capacity. At the same time productivity will be falling, despite the fact that investment has increased, wages will be bid up and profits squeezed.
The curious thing is that during this process unemployment will be rising in the manufacturing sector even as the general employment level remains comparatively stable. This is precisely what happened during the last US recession. In 2001 the Labor Department reported that labour costs leapt by a 5.2 percent rate in the first quarter while productivity fell by 0.1 percent. The last time labour costs exceeded 3.5 per cent was in 1990 when unit cost increased 6.1 per cent in the second quarter and then continued into the third and fourth quarters. For those who have forgotten, the US economy slid into recession in the third quarter of 1990.
Returning to the present we find that Australia lost nearly 100,000 full-time jobs in the past two months and that unemployment is still edging upwards. What has been overlooked, however, is that manufacturing had has about 50,000 jobs in the last 12 months and that profits are being slashed and productivity is dropping and has been for more than 12 months1.
October was a dismal month and revealed that manufacturing actually contracted with the Performance of Manufacturing Index falling to 47.8 points. Now some businesses are complaining that they over-invested in machinery and took on too many workers. No wonder the September quarter showed manufacturing suffering the worst fall in output since 1992.
In addition, a PricewaterhouseCoopers’ survey found that inventories had been rising for 6 straight months. A continuing inventory build-up is strongly suggestive of future job losses and reductions in output. This certainly appears to be the case. What has been puzzling some observers, however, is that the demand for labour rose even as manufacturing employment fell. But this is exactly what we should expect.
Unfortunately the job situation is still not generally understood. For instance, Paul Bassat, chief executive of Seek, said that “there are a lot more strong sectors than there are weak sectors, so it is a good situation generally for people looking for jobs”. The error here is to assume that a recession is a uniform process. It is not. Regrettably, the Jobs Network made the same error when it said the demand for labour had not slackened. This is why when a recession begins one should look at the pattern of employment instead of the aggregate employment figure.
As it stands right now there is every indication that the Australian economy is exhibiting all the symptoms of an impending recession. This view is tends to be confirmed by the performance of a very subdued Peter Costello who still, unfortunately, cannot get it right. He opined that the economy was slowing because investment was now a focus of growth instead of consumption. God help us.
Investment is growth –– not consumption, which is the true object of growth. And how can he in all seriousness make such a statement when he knows that many businesses are now complaining that they have ‘over-invested’? In the meantime manufacturing is taking a hit.
Earlier this year I attended the Liberal Speakers’ Group (a Liberal Party organisation2) where I was introduced to three federal politicians. I took the opportunity to try and explain to them that the Australian economy was facing an imminent slowdown in which manufacturing output would drop along with productivity and investment and that unemployment would begin to rise. Not one of them showed the slightest interest.
So can the Reserve avert a recession? If its reaction to the 2000 slowdown is anything to go by then the answer appears to be yes. A closer examination of the facts, however, suggests that a repeat performance by the Reserve might not be likely. During 1999 the Reserve expanded M1 by 9.5 per cent and for January 2000 to December 2000 increased it by 22 percent.
Fortunately for the country the terms of trade had started to quickly rise early in the same year. This had the effect of reducing pressure on firms’ input prices by significantly reducing the cost of imported capital goods. The Australian Bureau of Statistics made this clear when it pointed out that a dollar appreciation had forced the index of domestic materials used in manufacturing down. In the absence of this appreciation input costs would have rose by more than 30 per cent. In other words, a favourable change in the terms of trade had helped to temporarily remove the profits squeeze.
By March this year producer prices were rising at over 4 per cent a year. This increase should have alerted economic commentators to an emerging profits squeeze. Instead its significance completely passed them by.
The RBA finds itself in a bind. The current account deficit and a rising CPI have severely reduced the bank’s monetary options. If it does a repeat of 2000 it is bound to aggravate the deficit, assuming that it doesn’t drive the dollar down, while fuelling the CPI. Moreover, it has no guarantee that a looser monetary policy might rescue manufacturing. In fact, there is the possibility that we have reached the stage where a massive increase in M1 could actually impact unfavourably on manufacturing output and prices.
No matter what the RBA does recession can only be delayed and not avoided. And right now all the signs point to recession. Costello’s restrained parliamentary performance suggests that he has been quietly absorbing the bad news.
1Citigroup senior economist Paul Brennan has noted, along with others, that productivity has been declining since the end of the 1990s. However, where we have a situation in which labour is being priced back into work a decline in productivity should be expected unless the rate at which unemployment is falling is offset by an increase in the rate of capital accumulation.
2Unfortunately the original intention of the LSG to provide a platform for Party members has been perverted by Party blue bloods so that one now has to be an “important and influential figure” in order to address it. The result is that the Liberal Party, especially in Victoria, is being run by a group of economic illiterates with political tin ears. Needless to say, the Liberal Party has not won a state election anywhere in Australia since 1997.
Labour market reform comes under attack and the Liberal Government flounders
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 14 November 2005