Australia's Economy Sinks Further into Recession: Old Fallacies Abound

The Australian economy is on the skids and our economic commentariat don't even know it. The AIG (Australian Industry Group) report for November states that "manufacturing activity fell for a sixth month in a row". How can this be when unemployment has barely budged from 4.3 per cent? The important thing to note about the AIG performance manufacturing index is that anything below 50 indicates a contraction. We can see from the chart below that unemployment has been below 50 since February.

Economic Indicators

Source: The Australian Industry Group Performance Manufacturing Index for November 2008

In June both production and the PMI fell below 50 and stayed there. Starting in September all three indicators began to rapidly fall, with employment dropping from 46 to 33.2, the PMI from 47.2 to 32.7 and production from 48.7 to 30.4. Like a bunch of bunnies caught in the headlights of an oncoming car our commentariat were mesmerised by the low unemployment rate. So long as this remained low there could be no recession. Hence their current confusion.

In 1999 I warned the US economy was heading into recession. I stressed that emphasis on the falling unemployment rate would conceal the vitally important fact that manufacturing was contracting and shedding labour. What was being called a "dual economy" was in fact and economy that was experiencing the emergence of masses of malinvestments that signalled the beginning of a recession. The economy still appeared sound to economic commentators because unemployment was still falling.

But what they could not grasp — and still can't — is that monetary expansion had increased the demand for labour at the lower stages of production; those close to the point of consumption. Eventually the recession would work its way down the production structure, cutting output and raising the level of unemployment. This is exactly what happened, just as it happened to Clinton it happened to Bush. The same thing is also happening to the Australian economy.

Despite the fact that statistics clearly show the recession first striking at manufacturing (the higher stages of production) our brilliant economic commentariat insist on promoting the Keynesian snake-oil recipe of increased consumption spending to "counter the downturn". We had eight "prominent economists", apparently led by former Treasury secretary Tony Cole, proposing that Rudd temporarily cut superannuation contributions in order to increase consumption spending.

What they are proposing is based on the mercantilist myth — taken up by Keynes — that consumption drives the economy. Not one single member of the financial media know this. George Megalogenis, a senior writer for The Australian, is typical of the breed. According to this genius there need be no rise in unemployment because:

The case for business hanging on to staff is stronger than it was during recessions in 1990-91 and 1982-83 because the economy is in a radically different shape.

This is sheer economic illiteracy. Completely undeterred by economic laws, Megalogenis went on to argue that dismissing labour simply because the demand for a company's products is dropping is really "dumb" because it:

will only make any recession deeper than it need be because every dismissed worker drags down consumer spending with them. (Business's new mantra, The Australian, 6 December 2008).

This is the purchasing power of wages fallacy which holds that it is higher wages that raises living standards. This argument leads to the utterly absurd conclusion that poor countries can easily lift themselves out of power by legislating for wages to be raised to Western levels. To make is so simple that even Megalogenis can grasp it, wage rates are determined by the value of the worker's marginal product*. In plain English, his productivity. And the only thing that can bring about a sustained increase in productivity is capital accumulation.

Completely blind to what ought to be self-evident errors Megalogenis pursues the fallacy, arguing that the beneficial effects Rudd's $8.68 billion binge that is directed at "those with the most pressing living expenses" could be offset by higher income earners increasing their savings.

Let us understand something fundamental here: Savings fuel an economy and entrepreneurship drives it. Without savings there can be no capital accumulation, i.e. economic growth. Increased consumption is the result of this process, not the cause. The classical economists understood that what a country needs if it wants more consumption is more production.

What our media economists have yet to understand is that though consumption is something like 66 per cent to 70 per cent of GDP, the latter greatly underestimates economic activity because it does not take account of the expenditure of intermediate goods on the false grounds that it would be double-counting. My own rough estimate put consumption at about 33 per cent of total spending, meaning that nearly two-thirds of this spending would be by business. Given this approach it is easy to see that it is business spending that propels the economy and not consumption. John Stuart Mill presented the classical view on this matter when he wrote:

What a country wants to make it richer, is never consumption, but production. Where there is the latter, we may be "sure that" there is no want of the former. (John Stuart Mill, Essays on Economics and Society 1824—1845, Liberty Fund, 2006, p. 263).

Once again the economic commentariat find themselves without a clue. But surely Rudd's spending of the surplus could help stop the recession? No way. I do not know of a single case where consumption spending lifted an economy out of recession. Although it's possible for a government to trigger a consumption boom, such a boom would be marked by a largely stagnating manufacturing sector.

Moreover, from a purely economic perspective consumption alone could only be relied on to avert or overcome recession in a two-stage economy. This one in which there is a single production stage. The maintenance and supply of capital would then depend entirely on consumer demand. It goes without saying that this would be an impossible state of affairs. We live in a world of multiple stages of production. It can be no other way. However, the two-stage model brings into focus the fact that the argument for consumer spending to rescue the economy from recession is actually based on the fallacy of underconsumption.

In any event, recession has arrived and I consider an unemployment rate of 10 per cent to 12 per cent a distinct possibility, particularly when one considers Rudd's reactionary approach to wage rate determination.

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*The policy of keeping workers on the payroll even though the company is losing money is what helped prolong the Great Depression and drive down payrolls. When depression first struck Henry Ford along with a number of leading industrialists promised to maintain wage rate. By 1931 most of them were foreced to renege on that promise. Ford reluctantly followed suit in 1932.

Comments

[S M J:]

Beautifully written piece. I agree with your conclusion that economies are driven by businesses and production; not end-user sort of consumption. With the confidence of businesses and manufacturers drowning not only production will come to a halt but any consumption incentives such as Rudd's stimulus package, will only cause the money to be saved by the consumers because they would like to secure their future in case they are fired from work of which the possibility is increasingly high in these times. I tend to disagree with you that supply side economics hardly ever pulls an economy out of trouble because this is what Keynes made happen in 1930s. However, these are different times and I agree with you that little can be done about this recession where mood in both the manufacturing and working classes is at best pessimistic. If a higher minimum wage rate is fixed by the government as well as other conditions are put in place which will make hiring expensive and riskier for the manufacturers, then we have certainly had it. We are certainly talking about unemployment rate leaping at 12 percent or more within few months. Already the government's low unemployment figures are being disputed by various experts and institutions. Anyway, a very well written piece. Please keep it up. It will be good to know your thoughts as economic crisis deepens worldwide and affects Australia.

2008 Dec 18 04:19 AM

[WILFRED JOHN:]

It studied the impact the recession was likely to have on discretionary spend by consumers. Lack of funds to finance new services and consumer migration to ad-funded content was also likely to impact revenues.Operators will see that consumers are increasingly reluctant or unable to purchase content. They may in turn be less likely to roll out expensive, higher-risk services - a dedicated mobile broadcast TV network is a prime example.

DR.WILFRED JOHN
johnrwilfred2003@yahoo...



Holden added that some services, including adult and gambling, were less susceptible to the downturn due to a shift in consumers’ habits. Mobile data costs remain the biggest barrier to adoption of services, according to the report.



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