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Does falling productivity mean recession for the Australian economy?
Gerard Jackson
In my last article on the Australian economy I said that the productivity situation strongly suggests that we have reached the peak of the boom. The Australian Bureau of Statistics had noted that private-sector productivity had fallen by 2.5 per cent over the year to March: the biggest drop in annual productivity since December 1986.
Nevertheless, Last May Rory Robertson, Macquarie Bank interest rate strategist, remarked that “the job market is a beacon of strength in what is otherwise a sluggish economy”. He went on to say: “We have a conundrum of unbelievably strong jobs growth at a time when GDP growth is unbelievably weak”. This is precisely the kind of commentary that we got from American economic analysts just as the US economy was on the brink of recession.
Adding to the confusion is that wages have been outstripping inflation. CommSec, the stockbroking arm of the Commonwealth Bank, reported that during the last three years wage growth exceeded the rise in prices by about $114 a week. This finding is confirmed by the Australian Bureau of Statistics findings that found average weekly ordinary-time earnings are continuing to rise
No wonder our economic commentariat is confused. Productivity is falling as employment and wages rise. What is more, production costs have also been rising, though producer prices seem to have leveled off. The best they can come up with to explain the situation is that it is a “conundrum”, as if there was something genuinely new and puzzling about this state of affairs.
But classical economists were very much aware of this phenomenon and knew that it always appeared at the peak of a boom. Karl Marx himself noted “…crises are precisely always preceded by a period in which wages rise generally and the working class actually get a larger share of the annual product intended for consumption” (italics added).
The same thing happened to the US economy. Shortly before its post-WW I boom collapsed productivity dropped dramatically. Four million military personnel were demobilised and absorbed into the economy with the peculiar result that in 1919 the production of physical goods actually fell compared with the 1918 level of output. This was accompanied by a rapid rise in the cost of labour and other inputs. The result was a profit squeeze.
From 1914 to June 1920 the Federal Reserve more than doubled the money supply (currency outside of the commercial banks, time deposits and demand deposits) with the inevitable consequences. In June 1920 it slapped on the monetary breaks and deflated the US economy. It was eighteen months before recovery fully kicked in.
The effect of the Fed’s monetary expansion was to generate massive malinvestments that were literally unsustainable. Moreover, this flood of credit (nearly all of the monetary growth consisted of credit) also stimulate the demand for marginal labour and activities. When the depression struck these were the first to go.
Going to the Australian economy of the 1920s we find a similar pattern. We find that industrial production correlates with money supply (currency and credit). Of particular interest is that after 1925 the economy deteriorated and was clearly heading for recession. Closer examination shows that industry found its profits squeezed between rising costs and stagnant productivity.
From March 1914 to March 1929 the money supply grew by 125 per cent. In March 1929 the monetary breaks were applied and deflation set in. By June 1931 the money supply had fallen in absolute terms by nearly 11 per cent, after which it began a steady increase.
Although Australia is not facing the dramatic and tragic situation of the 1920s, the pattern is still essentially the same. As I have said in other articles, though recessions can have different characteristics we must not allow this to divert our attention from the fact that the same economic forces are always at work.
Unfortunately our economic advisors media commentariat seem incapable of grasping what is at work here. The likely result is that Treasurer Peter Costello will not be the only one with egg on his face. As Yogi Berra said: “It’s deja vu all over again”.
Gerard Jackson is Brookes’ economics editor
BrookesNews.Com
Monday 20 June 2005